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After Russia’s invasion of Ukraine exposed complacency among many firms and investors, 2023 could see a more systematic approach to human rights due diligence.

Timur Izmailov, a 33-year-old IT specialist, was killed by mortar fire in Ukraine on 13 October 2022, three weeks after being conscripted into the Russian army. Under a mobilization law effective from 21 September, all companies operating in Russia are required to facilitate conscription of employees, albeit with exemptions for critical sectors. Working on payment systems at the Moscow office of Raiffeisen Bank International qualified Izmailov for exemption, so his Austrian employer applied to the Russian central bank. But a lack of coordination between authorities over the new processes prevented Izmailov from being released from his military duties.

His death is one of countless personal tragedies resulting from Russian President Vladimir Putin’s invasion of Ukraine last February. It also highlights the dilemmas facing firms which have chosen to maintain Russian operations: either break local law, or become complicit in human rights abuses and risk failing to protect employees, the well-being of the latter being a consideration for many firms that resisted calls to quit. Raiffeisen, for example, has more than 9,000 employees in Russia, across a banking franchise built up over three decades, ranked Russia’s 10th largest by assets.

The mobilization law has even wider implications for Russia’s foreign-owned firms and their investors. It also requires them to put their assets at the disposal of the Russian state, should they be needed to support its military objectives, with compliance meaning even closer proximity to human rights abuses. This effectively makes it impossible for firms to simultaneously meet obligations under local and international law, exposing them to sanctions as well as multiple legal and reputational risks.

According to the Heartland Initiative, a US-based non-profit focused on the rights of people in conflict-affected and high-risk areas, investors have been seeking information from investee firms about their response to the new law and their continued commercial rationale for operating in Russia. But the responses so far have been “inadequate”.

Executive Director Rich Stazinski says the invasion of Ukraine exposed the shortcomings of human rights due diligence (HRDD) processes of asset owners, asset managers and companies, when it comes to conflict. Rather than being surprising or unprecedented, Stazinski argues the invasion was “wholly predictable”, and its consequences will pose complex and wide-ranging challenges in 2023 and beyond.

“Great awakening”

“This was a moment of great awakening. The question is: how will investors and companies rethink their policies and practices? And will they apply precedents elsewhere? This is deeply challenging as many investors were not as deeply invested in Russia as they are in China, for example.”

Sam Jones, President of the Heartland Initiative, says investors have largely been piecemeal and inefficient in monitoring and managing their exposure to human rights abuses in high-risk areas, characterising their approach as conflict “whack-a-mole”.

“While there is excellent guidance on heightened human rights due diligence for individual companies operating in a conflict-affected or high-risk area, as called for by the UNGPs, there’s almost nothing available for investors that may have thousands of companies in their portfolios,” he says.

Officially adopted by the UN in 2011, the Guiding Principles on Business and Human Rights (UNGPs) are recognised as the standard for the private sector to follow, and is increasingly incorporated into domestic legislation, especially in Europe. But as Jones suggests, many investors need more specific guidance, especially with regard to the heightened due diligence required in conflict zones, while some still lack the basic foundation of a formal human rights policy.

Heartland helps investors and firms take a systematic approach to HRDD which prioritises high-risk areas and conflict zones as these are where salient human rights risks most often translate into financially material risks, through strategic litigation, regulatory enforcement, operational disruption or brand damage.

Being more systematic helps develop a comprehensive view of companies’ risks, enables cooperation between investors, and embeds policies which beneficially impact rights holders, they contend. Heartland also recommends a three-part test to identify the corporates with the closest proximity to human rights harms with regard to geographic, relational and operational context.

This can help investors set priorities, but they face considerable challenges in accessing data, assessing risk and engaging with investee corporates in a way that minimises risk for them and rights holders.

The rising number of global conflicts, and populations impacted by them, gives investors little choice but to devote greater attention to HRDD, As they do so, investors face a mix of positive and negative trends.

Shedding light

It’s still very hard for investors to look through long and complex supply chains, admits Phil Bloomer, Executive Director at Business and Human Rights Resource Centre, especially when they extend into authoritarian states, conflict zones and other high-risk environments.

“Investors have to be far more active in their engagement, insisting that companies can demonstrate the heightened due diligence demanded by the UNGPs,” he says.

This means asking companies to interact with and provide independent and verifiable evidence of impacts on rights holders. For sectors with extended supply chains such as the apparel industry this is all but impossible in locations including China or Myanmar, where access to information on workers’ conditions is compromised by false documentation and intimidation.

Increasingly however, alternative data sources are shedding light from afar, for example using geospatial technology to reduce supply chain opacity. Further, initiatives such as the Open Apparel Registry are making supply chains more traceable for participant and non-participant brands alike.

Bloomer says these developments increase the pressure on investors to engage more forcefully with firms where there is evidence of “salient and severe” human rights risks, such as forced labour, which he expects to spread in 2023.

“The purchasing practices we saw in the pandemic that drive abuse at the bottom of supply chains are being repeated with the economic downturn,” he adds.

At the same time, says Nikolaj Halkjaer Pedersen, Senior Lead on Human Rights and Social Issues at the Principles for Responsible Investment (PRI), disclosure standards and reporting requirements are also bringing both more data and responsibility to investors.

The Global Reporting Initiative’s recently updated approach to human rights disclosures has informed the requirements of Europe’s recently approved Corporate Sustainability Reporting Directive. It is currently unclear when internationally agreed standards will be included in regulatory regimes more widely as the International Sustainability Standards Board is taking a climate-first approach to its standards development work, albeit with human rights included among its 2023 priorities.

“As well as regulation on companies, both Sustainable Finance Disclosure Regulation and the Green Taxonomy’s minimum social safeguards bring human rights standards into the obligations of investors,” says Pedersen.

Qualitative and quantitative

In terms of assessing risk, he says investors are increasingly realising that they need to be able to make qualitative judgements, using sectoral and geographic factors to inform their priorities, before drilling down to the company level.

The PRI recently announced its new Advance initiative, which aims to work with members collaboratively to drive engagement on workers and human rights, initially focused on the metals and mining and renewables sectors, following an assessment of the significance of these industries’ impacts on workers, communities and end users.

As part of its preparations for Advance, the PRI worked with Canadian responsible investment NGO SHIFT to identify the areas where investors were having most difficulty accessing information from firms on human rights risks. Areas where information is lacking include how boards and leadership teams embed commitments into company culture and practice, the quality of their due diligence processes, and quantitative information about their contribution to positive human rights outcomes.

In many of the more qualitative areas, there is broad consensus on good practice, says Pedersen, but these areas do not necessarily fall under reporting requirements, thus putting a heavy due diligence burden on investors.

Jones says the overall regulatory and legal environment is improving, both in terms of mandatory HRDD and a gradually emerging body of international jurisprudence concerning rights-violating companies. But this is not yet making a tangible difference to companies’ impact on rights holders on the ground.

“Until regulation includes criminal and civil liability for corporate violations, enforcement against violators becomes more consequential and consistent, and companies broadly perceive the material risks associated with violations, I don’t think we’ll see systemic corporate change beyond policy development and reporting,” he says, noting that Heartland is actively encouraging firms to include human rights criteria in enhanced know-your-customer due diligence.

Stazinski adds that a decade of increasing familiarity with the UNGPs has had highly mixed results, in terms of firms’ responses to investor concerns around managing human rights risks.

“Increasingly, firms are directing investors to human rights policies which have been developed to protect their profits rather than the rights of impacted stakeholders, or they are simply choosing not to engage, even with large investor coalitions,” he says.

High risks; high stakes

A key driver of change but also a potential risk to investors in high-risk firms is the rise of strategic litigation on human rights issues. In October, French cement manufacturer Lafarge became the first company to plead guilty in the US to aiding terrorists, admitting that it paid a US$5.92 million bribe to Islamic State and al Nusra Front to protect staff at its plant in Syria during the country’s civil war.

US Attorney-General Lisa Monaco said the Department of Justice would continue to take a close look at transactions and due diligence undertaken by firms operating in high-risk environments.

“This case sends the clear message to all companies, but especially those operating in high-risk environments, to invest in robust compliance programmes, pay vigilant attention to national security compliance risks, and conduct careful due diligence in mergers and acquisitions,” she said.

Lafarge, now owned by Swiss-based Holcim, also faces a separate case in France, where it is charged with complicity in crimes against humanity.

Investor reappraisal of HRDD requires a more systematic analysis at a company, sector and country level, involving more critical and clear-eyed assessments of both firms and sovereigns. But investors are also highly aware of the urgent need to support climate- and nature-related projects in locations not necessarily associated with strong transparency or governance.

“This is a real dilemma. Both for the UN Sustainable Development Goals and climate mitigation and adaptation, capital is needed in the Global South,” says PRI’s Pedersen. “But in some of these countries there are concerns around issues such as governance, corruption and human rights. Moving capital away from human rights risk is counterproductive, leading to poorer consequences for those affected. The question is: how can investors play a positive role when the identify these issues.”

For most investors, engaging as bondholders with governments is an unfamiliar but evolving practice. Asset owners and managers are increasingly sharing their views and concerns of environmental issues, notably on deforestation, but are aware of the need to tread carefully.

“Investors in sovereign bonds have a voice, but they also need to be delicate as governments are ultimately accountable to their citizens. Investors should not interfere with democratic processes, but we can at least expect governments to meet commitments made under international agreements,” says Pedersen.

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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