Due Diligence Roars Back into Fashion

Lack of awareness of human rights violations in apparel supply chains is no longer an excuse as incoming legislation forces accountability.

On 23 April, 2013, large structural cracks were discovered on the Rana Plaza, an eight-story commercial building in Bangladesh. Warnings to avoid the building were ignored by garment factory owners on the upper floors, due to pressure to fulfil product orders. The next day, managers again forced workers to enter the building and it collapsed, killing 1,134 people.

A number of global brands – such as Mango, Primark and Benetton – had placed orders with the five garment factories in the building. Attempts to hold the firms to account, although largely unsuccessful, drew attention to the wider responsibilities of apparel corporates – and their investors – to their supply chains.

The right to a safe working environment – alongside other human rights – has only risen up the investor agenda since. This week, independent anti-slavery commissioner Dame Sara Thornton called on G7 countries to ban state-controlled forced labour, in particular with reference to China.

“Labour and human rights violations in supply chains are a systemic issue for the apparel industry,” says Filip Gregor, Head of the Responsible Companies Section at law firm Frank Bold.

Modern slavery, child labour and pay below minimum wage are just a few of the human rights violations investors in the apparel industry are exposing themselves to if they invest in corporates with poor visibility of workforce conditions across their supply chains, he says.

Non-profit organisation Business and Human Rights Resource Centre recently published its 2021 KnowTheChain Apparel and Footwear Benchmark, which ranked 37 of the world’s biggest apparel and footwear companies on their efforts to tackle human rights issues across their supply chains. The majority of companies didn’t even score 50% in their efforts to tackle human exploitation, despite the fact 97% of these companies have supplier codes of conduct that expressly promise to monitor supplier processes and prohibit forced labour.

Furthermore, 27% of workers in apparel global supply chains are paid below minimum wage, the KnowTheChain benchmark report noted.

What you don’t know can still hurt you

Investors don’t want to be associated with human rights violations and have little tolerance for it if made aware of particular incidents in corporate supply chains, says Adam Gillett, Head of Sustainable Investment at global advisory firm Willis Towers Watson.

“Investors recognise that human rights violations pose a financial and reputational risk, as well as being morally and ethically wrong,” he says. “But there’s still a shock factor when I highlight to an asset owner how their investments are potentially exposed to modern slavery or child labour.”

This shock stems from the fact investors rarely have visibility of the supply chains of the apparel corporates they invest in, making it more difficult to determine their exposure to risk.

But with policymakers gearing up to take action and mandate supply chain due diligence, investors need to go much further to ensure that the apparel industry is not exposing them to human rights risks in supply chains.

“Investors have leverage over the companies they invest in, which they should use to drive better, more responsible business decisions and activities,” says Camille Le Pors, Lead for the World Benchmarking Alliance’s (WBA) Corporate Human Rights Benchmark.

“Investors [want] to fulfil their own responsibilities and ensure that they do not have companies in their portfolios that fail to respect human rights and labour rights. Investors should engage with companies and use the various tools at their disposal to encourage better practices. They should require companies to work with their suppliers to achieve this, rather than just imposing requirements without the right level of support,” Le Pors tells ESG Investor.

Due diligence moves up legislative agenda 

The United Nations first published its ‘Guiding Principles on Business and Human Rights’ in 2011, calling on countries, investors and corporates to “respect, protect and fulfil the human rights of individuals” under their responsibility. With policymakers increasingly building on this foundation, investors need to be more proactive in engaging with companies to uncover human rights violations or risk legal repercussions, experts warn.

On 10 March, 2021, the European Parliament adopted a resolution setting out a draft Directive on Corporate Due Diligence and Corporate Accountability. It is expected that the European Commission will publish a legislative proposal this month, which will be subject to debate by both the EU Parliament and Council.

Germany has already introduced its draft Supply Chain Act, which will come into force from 1 January, 2023.

The EU directive aims to ensure corporates and investors are exercising due diligence over human rights and environmental issues, not only in relation to the corporate’s own operations, but along the whole value chain. This includes entities with which the corporate has a direct or indirect business relationship upstream or downstream that may supply products or services that contribute to the undertakings of the corporate’s products or services.

“This is not only based on the UN’s Guiding Principles, but it’s going further by setting a precedent for investor vigilance,” Gregor says, noting also that the directive imposes legal requirements for the supply chains of EU companies well beyond Europe’s borders.

“The Corporate Sustainability Reporting Directive (CSRD), updated in April, also requires qualifying European corporates to disclose their exposure to social risks, such as human rights violations,” Gregor points out, meaning investors should be ensuring corporates are adequately disclosing their exposure to social-related impacts in accordance to the directive.

Existing rules-based international systems that commit signatories to supply chain accountability include: the Dutch Agreement on Sustainable Garments and Textiles (AGT), The Fair Wear Foundation (FWF) and the UK Ethical Trading Initiative (ETI).

While investors are not directly responsible for the human rights violations that may occur throughout an apparel supply chain, legislation such as the EU’s due diligence draft directive are placing accountability on those who are “complicit”, Gregor notes.

“The question has become: How have your actions contributed to [this human rights violation]?”

At the time of the Rana Plaza accident, it was hard enough to claim complicity of corporates higher up the supply chain, although investors were still caught in the crossfire, standing to lose financially.

As policies continue to develop, investors should be actively advocating for due diligence legislation for supply chains, Gillett said.

“As this is a systemic issue, investors need to engage on a systemic level on human rights issues with policymakers and regulators in order to help bring about change,” he says.

Asking the right questions 

The economic value of apparel companies is very closely related to the reputation of their brands, giving investors a keen financial interest in supply chain visibility and human rights due diligence, according to Eckhard Plinke, ESG Senior Analyst at Vontobel Asset Management (US$150.19 billion in assets under management).

Because investors in the apparel sector are often far removed geographically from the companies and their supply chains, it can be harder to exercise vigilance. Nonetheless, in order to manage their own exposure to social-related issues in the apparel industry, investors need to be asking corporates the right questions to secure decision-useful information.

“Investors need to rely on the assessment of a company’s risk exposure based upon its business model (e.g. manufacturing outsourcing degree and locations), its programmes and activities, as well as various media reports about controversies to assess the quality of a company from an ESG point-of-view,” Plinke says.

Investors can also use apparel-focused benchmarks, such as the Corporate Human Rights and KnowThe Chain, to assess whether corporates have core indicators in place, in order to provide transparency of their relationships with and treatment of suppliers. These can also track firms’ public commitments to fair pay and health and safety.

“As part of a robust human rights due diligence system, companies have to map out their supply chains and [outline] where risks to stakeholders are highest,” Le Pors says. “Companies then have a responsibility to undertake necessary measures to manage these risks and ensure they do not turn into impacts.”

Sports apparel brands, such as Adidas, Puma and Nike, were among the first to be criticised for child labour and poor working conditions in their supply chains. But they are also good examples of corporates that have since done their due diligence and are now far more attractive options for ESG investors, Plinke points out.

“These companies established supplier codes of conduct, including general social and environmental requirements; established auditing programs to control compliance, and organised cross-company auditing programmes with uniform standards,” he tells ESG Investor.

“In recent years, they shifted their activities towards co-operative measures, such as supporting suppliers in setting up proper health and safety systems and labour representations,” Plinke adds.

Purposeful engagement

To address human rights shortcomings in investee companies, investors have been joining initiatives to manage human rights risks in the apparel industry, such as the Shareholder Association for Research and Education (SHARE) Canada, the Transparency Pledge and the Interfaith Center for Corporate Responsibility (ICCR).

Investors representing US$6.2 trillion AUM also signed the KnowTheChain investor statement, pledging to support the United Nations’ Sustainable Develop Goal 8.7, which refers to the eradication of forced labour.

Through these kinds of initiatives, investors are focusing their engagement with companies on their supply chain transparency.
Nonetheless, investors have the power to enforce change independently, WTW’s Gillett emphasises, adding that corporates are unlikely to implement radical changes to their operational processes unless investors give them “that extra push”.

Engagement needs to be sustained, long-term and purposeful, with investors setting specific targets for corporates to fulfil within a set timeframe, he says.

“Stewardship can’t be meandering here,” Gillett says. “There needs to be a stronger intent from investors, in which they ask for supply chain commitments and improvements and, if that doesn’t happen immediately or quickly enough, investors need to be willing to escalate the issue through voting or further engagement.”

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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