The impact of human rights abuses in portfolio companies and their supply chains is becoming more apparent to investors.
The emergence of slave markets in Libya following NATO’s military intervention, findings about forced labour in the construction of football World Cup venues in Qatar, allegations of forced labour in China and concerns about the fate of refugees from the Russia/Ukraine conflict have raised serious questions for investors about sources and treatment of human capital. Anti-modern slavery legislation is in its infancy and investors must rely on myriad sources of information to identify and mitigate the risk of slavery and forced labour in investee companies and their wider supply chains.
This explainer looks at the tools available for investors to mitigate the risks of exposure to modern slavery and related human rights violations.
What is modern slavery?
Human rights organisation Anti-Slavery International defines modern slavery as “the severe exploitation of other people for personal or commercial gain”. The organisation estimates 40 million people are trapped in modern slavery worldwide, with one in four of them children and 71% women and girls.
Martin Buttle, Head of Good Work at NGO ShareAction says, given the estimates, “there is a very real chance that victims are present in the global supply chains” of investee companies.
The most common forms of modern slavery are human trafficking (the use of violence, threats or coercion to exploit people for forced prostitution, labour, criminality, marriage or organ removal, etc); forced labour; debt bondage/bonded labour (the most widespread form of slavery); descent-based slavery (where slave status is passed down the maternal line); child slavery (including the use of child soldiers); and forced and early marriage.
Modern slavery can affect any business, in any sector and across supply chains, but is often hidden. Anti-Slavery International says the risk of slavery exists in both raw materials and in finished goods, as well as in distribution centres and other common areas (including, for example, commercial office cleaning suppliers).
What is being done at the policy level?
In 2011, the United Nations published guiding principles on business and human rights (UNGPs), in which it set out member states’ and corporations’ human rights responsibilities.
States must protect against human rights abuse within their territory and/or jurisdiction by third parties, including business enterprises, it states. This requires taking appropriate steps to prevent, investigate, punish and redress such abuse through effective policies, legislation, regulations and adjudication.
For businesses, the responsibility to respect human rights is a “global standard of expected conduct”, wherever they operate. This responsibility exists independently of states’ abilities and/or willingness to fulfil their own human rights obligations, and does not diminish those obligations. “And it exists over and above compliance with national laws and regulations protecting human rights,” says the UN.
Furthermore, businesses must take adequate measures to prevent, mitigate and where appropriate remediate adverse human rights impacts. Addressing adverse human rights impacts requires taking adequate measures for their prevention, mitigation and, where appropriate, remediation. Business enterprises may undertake other commitments or activities to support and promote human rights, which may contribute to the enjoyment of rights. But this does not offset a failure to respect human rights throughout their operations, says the UN.
How are individual governments acting against modern slavery?
Since the UNGPs were issued, various jurisdictions have begun to roll out legislation targeting modern slavery.
One of the first countries to enact laws was the UK, via the Modern Slavery Act 2015. Under the Act, commercial organisations with more than £36 million in annual revenue must prepare a slavery and human trafficking statement for each financial year. The statement should outline the steps the organisation has taken to ensure that slavery and human trafficking is not taking place in any of its supply chains or any part of its business. The statement may include information about the organisation’s structure, business and supply chains; its policies in relation to slavery and human trafficking; its due diligence processes; the parts of its business and supply chains where there is a risk of slavery and human trafficking taking place, and the steps it has taken to assess and manage that risk; and its effectiveness in ensuring that slavery and human trafficking is not taking place, measured against such performance indicators as it considers appropriate.
In Europe, myriad regulatory initiatives have been introduced that cover human rights disclosures and due diligence in business, including initiatives on corporate sustainability reporting, sustainable corporate governance, and sustainable finance, as well as trade rules and import/export restrictions. In September 2021, EC President Ursula von der Leyen announced the EU would propose a ban on importing products into the EU that have been made using forced labour. In February, the Commission issued a Communication on Decent Work Worldwide, which focuses on the elimination of child labour and forced labour in the EU and around the world.
In Germany, the Supply Chain Law, which will become effective from 2023, requires mandatory human rights due diligence on global supply chains. Large companies (initially those with more than 3,000 employees and from 2024 those with more than 1,000 employees) will face a fine of up to 2% of their global turnover for violation.
Australia introduced a Modern Slavery Act in 2018 that requires entities with an annual consolidated revenue of more than A$100 million to report annually on the risks of modern slavery in their operations and supply chains, and actions to address those risks. Other entities based, or operating, in Australia may report voluntarily. The Act sets out criteria that must be reported on in each annual statement, including the risks of modern slavery practices in the entity’s supply chains, and actions taken to assess and address those risks
In the US, the California Transparency in Supply Chains Act (TSCA) came into effect at the beginning of 2012 and applies to retail sellers and manufacturers that do business in the state of California and whose annual gross revenue exceeds US$100 million. Qualifying companies are required to disclose information regarding their efforts to eradicate human trafficking and slavery within their supply chains . At the Federal level, the Victims of Trafficking and Violence Protection Act of 2000 covers modern slavery. For US companies, the concept of corporate social responsibility, rather than statutory law, is the primary vehicle for extending human rights obligations throughout supply chains and communities.
How have corporates responded to policy initiatives?
A review of corporate governance reporting by the UK Financial Reporting Council (FRC) found that “the low quality of reporting on modern slavery by companies is concerning”. Only 19% of companies referred to KPIs or other non-financial performance indicators relating to modern slavery in their annual reports. Overall, reporting on modern slavery in annual reports was “largely descriptive and superficial”. Reporting on engagement with suppliers in modern slavery statements was generally limited. Only 27% of companies disclosed how they work with suppliers to improve their labour rights practices, with only a quarter of those providing a comprehensive disclosure. The FRC encouraged companies to build trust with investors and wider stakeholders by explaining how they are combatting modern slavery in their supply chains.
“Whilst the (UK) Modern Slavery Act has raised awareness, it is largely seen to have failed to get meaningful disclosure on the extent of modern slavery risks that exist in corporate supply chains,” says Buttle. “There have been a variety of efforts to strengthen the legislation and develop guidance on expectations and create a registry of reports.”
Buttle would welcome a UK requirement on mandatory human rights due diligence similar to the proposed EU directive on corporate sustainability due diligence, “but one that includes financial sector actors and requires them to identify and, where necessary, prevent, end or mitigate adverse impacts of their activities on human rights, including modern slavery”.
A similar disappointing reaction to legislation is seen in Australia, where corporate response to the Modern Slavery Act 2018 is lagging, according to a study by ISS ESG’s Modern Slavery Scorecard and Monash University Centre for Financial Studies (MCFS). It found that operational-level modern slavery risks tend to be overlooked, especially in the professional services sectors. There is also “a significant discrepancy” between S&P/ASX 300 companies’ own assessment of their operational modern slavery risks as disclosed in their statements reviewed by MCFS, and the external assessment of companies’ risk by ISS ESG.
A study by the European Commission on due diligence to identify, prevent, mitigate and account for abuses of human rights in supply chains found that just over one-third of business respondents indicated that their companies undertake due diligence which takes into account all human rights and environmental impacts. A further one-third undertake due diligence limited to certain areas.
However, the majority of business respondents which are undertaking due diligence include first-tier suppliers only, with due diligence practices beyond the first tier and for the downstream value chain “significantly lower”. The most frequently used due diligence actions include contractual clauses, codes of conduct and audits. Divestment was the least selected due diligence action by both business and general respondents. When asked about the primary incentives for undertaking due diligence, business respondents and industry organisations selected the same top three incentives as being: reputational risks; investors requiring a high standard; and consumers requiring a high standard.
“Presumably because of the existing lack of regulatory or legal requirements to undertake due diligence, business and industry organisation respondents indicated that regulation or legal requirements are currently, or have been in the past, the least selected incentives for companies to undertaking due diligence,” said the study.
Are tougher policy steps required?
A decade after the introduction of the UN Guiding Principles on Business and Human Rights, most of the world’s largest companies have yet to implement even baseline human rights due diligence, says a joint report by corporate benchmark service KnowTheChain and NGO Business & Human Rights Resource Centre (BHRC). “Modern slavery acts and their forced labour reporting requirements have not brought the change they promised and have proven largely ineffective in addressing egregious labour abuses in global supply chains. In contrast, due diligence requirements linked to penalties, such as the US Customs and Border Protection’s seizure of goods connected to forced labour, have brought rapid transformation in high-risk sectors and geographies.”
The report calls for voluntary action to be strengthened with robust regulatory requirements for companies to identify human rights risks and prevent abuse. It also underlines the key elements of effective regulation to ensure due diligence does not become just another administrative “box-ticking” exercise by companies.
What can investors do to mitigate the risks of human rights violations in their portfolios?
Modern day slavery due diligence should be an explicit part of investors’ stewardship and public policy engagement, says Lauren Compere, Managing Director/Head of Stewardship & Engagement at Boston Common Asset Management, a sustainable investment manager with US$6 billion AUM which has been a long-term advocate of mandatory disclosure on modern slavery and human rights due diligence.
While the firm supports the need for mandatory modern slavery and human rights due diligence disclosure to harmonise and standardise reporting, “it is essential that companies demonstrate alignment with the UNGPs, focus on governance of human rights, and assess and mitigate human rights risks”, adds Compere. “Global reporting on these issues varies greatly and it remains up to investors to review current disclosures and assess how companies are managing these risks to inform investment and engagement priorities. Regulators should also be focusing on how companies are managing human rights risks and whether they are making remedies accessible for those impacted.”
The current reporting standards in existing modern slavery laws leave “questions on the table”, says Compere. These include:
- Is there a centralised disclosure library?
- Which companies are not in scope?
- Is there an independent organisation analysing responses?
- Does the company provide external assurance?
- What are the penalties for non-compliance?
How are industry-level initiatives supporting greater investor scrutiny?
Shareholders awareness of the impact modern slavery and other human rights abuses on their portfolios is being reflected in the priorities of investor networks. In December, the UK-convened Principles for Responsible Investment launched a new stewardship initiative focused on human rights and related social issues. An investor toolkit issued by the Responsible Investment Association Australasia (RIAA) highlights the impact human rights violations in supply chains can have on the share prices of portfolio companies.
For example, the share price of UK-listed clothes manufacturer Boohoo halved between 30 June and 8 July 2020 and a number of retailers suspended sales of the brand following reports by the NGO Labour Behind the Label and newspaper the Sunday Times of labour rights abuses in the company’s supply chains. In Malaysia, the share price of medical glove manufacturer Top Glove suffered in March 2021 as the US Customs and Border Protection ordered seizure of their goods stating it had sufficient information to believe that Top Glove used forced labour in production.
RIAA recommends a number of areas of engagement for investors to help companies progress towards industry-leading practice. These include understanding the supply chain, adopting a “robust” ethical sourcing and responsible procurement policy or demonstrating senior management buy-in, building closer relationships with suppliers, adopting a unified and “thoughtful” auditing approach and increasing presence on the ground in key locations.
The KnowTheChain/BHRC report advises investors to:
- Assess whether potential investee companies have in place appropriate human rights policy commitments, due diligence processes which include addressing forced labour risks, and grievance mechanisms;
- Review portfolio companies’ human rights due diligence processes to inform their view on the effectiveness of managing forced labour risks;
- Engage with companies on how they are ensuring workers are effectively consulted throughout their human rights due diligence processes, such as in the assessment and monitoring of forced labour risks, and the involvement of workers in the design or performance of grievance mechanisms;
- Engage with workers and their representatives and directly engage portfolio companies regarding allegations of forced labour and other labour rights abuses; and
- Support human rights due diligence resolutions and/or vote (at annual general meetings) against management of companies that consistently fail to demonstrate respect for human rights in supply chains
How have investor initiatives on modern slavery performed to date?
Asset manager Rathbones considers modern slavery to be “the widest ranging and significant social risk to our portfolios”. It set up Votes Against Slavery (VAS) – an investor collaboration with £7.8 trillion in assets under management – in 2019 to coordinate the response of the investment community on the issue and to provide the accountability for compliance with the UK Modern Slavery Act.
The VAS report of March 2022 notes that while there was much broader collaboration in terms of the number of supporting investors and the number of target companies engaged with, the ongoing effects of the Covid-19 pandemic contributed to “the significant increase in non-compliance” with the Act. This was partly because several target companies furloughed the employees responsible for reporting. “We also noticed an uplift in the number of outdated statements, signalling that some companies saw reporting as a ‘one-off’ box tick event.” By year end, 59 out of the 61 target companies were compliant and that the remaining two companies became compliant in January 2022.
Rathbones says the VAS project demonstrates the benefits of a collaborative approach between business, government and the investment community. “We believe that it is only through such an approach that we can deliver the systemic change necessary to eradicate modern slavery.”
Independent Anti-Slavery Commissioner (a role created under the UK’s Modern Slavery Act) Dame Sara Thornton says VAS demonstrates the potential that investors have to drive up standards across the business community. “Investors and lenders need to maintain ongoing vigilance of their financial portfolios. The principles behind Votes Against Slavery should integrated into mainstream operations as soon as possible.”
Buttle agrees that investors should be engaging with companies in their portfolios on modern slavery as part of their ESG engagement to understand the extent of the risk and the steps the companies are taking to mitigate the risk. “If investors think the due diligence processes are insufficient for the level of risk, they should be engaging to strengthen those processes.”
Because modern slavery is largely hidden, Buttle says it is difficult for stakeholders to measure. Recognising this fact, the Modern Slavery & Human Rights Policy and Evidence Centre have developed a list and categorisation of data sources available to investors seeking to better understand modern slavery risks in the companies in which they invest.
On engagement, there are examples of good practice, for example the Find it Fix it initiative and Finance Against Modern Slavery (FAST). “However, considering the extent of the risk and the complexity of tackling issues, investors could and should be doing more to ensure that due diligence is occurring in the companies they invest in. Increasingly, governments and supranational bodies are setting an expectation that companies conduct rigorous and meaningful human rights due diligence,” says Buttle.