Investors at the forefront of Human Rights Due Diligence

The PRI issued new recommendations to encourage investors to mainstream Human Rights due diligence. In this blog, Ksapa outlines a multi-year plan for investors to step up to the plate.

In a recent conversation with the Institute for Human Rights and Business, Ksapa alerted to the Human Rights implications of the Covid-19 global pandemic. Now, with a second wave (and perhaps a third) on the horizon, governments are seemingly willing to trade civic freedoms for public safety. Physically isolated by lockdown and social distancing measures, Human Rights defenders are all the more endangered.

What does that have to do with investors, you ask? 1.3 billion reasons. That is the record-breaking fine Westpac bank agreed to pay for breaching anti-laundering rules to enable the funding of child sex exploitation and possible terror activities. This is no way specific to Westpac. Though notoriously risk-adverse, investors have allowed crisis management rather than proactive action to demonstrate the reputational, financial and legal risks linked to Human Rights violations. Understanding their executives can and will be prosecuted, investors, institutional funders and development finance institutions are increasingly heeding global Human Rights frameworks. Human Rights are de facto material to business and clearly linked to the S in ESG policies. They can only become more so as Covid-19 fuels further social inequity.  

In a clear signal to the financial sector, the United Nations’ Principles for Responsible Investment launched a multi-year work program to enforce respect for Human Rights across its ecosystem. Institutional investors will now be expected to uphold a 3-part responsibility to respect Human Rights – namely, policy commitment, due diligence processes and access to remedy. Here, Ksapa calls on investors to develop a multi-year plan aligned with PRI recommendations. This is good for risk valuation. This is good for business. This is good to align with what stakeholders increasingly expect from investors.

The Regulatory Impetus Favors Investors Capable to Adapt to Their Business Environment

As the PRI moves well beyond financial materiality assessments, we at Ksapa salute this effort to encourage investors to build resilience through comprehensive ESG strategies. How? Investors, ensure your management of Human Rights impacts is embedded in your decision-making processes – notably across portfolio construction, security selection and asset allocation. In other words, managing Human Right issues well is more and more considered part of an asset owner’s fiduciary duties to beneficiaries.

In that respect, the PRI initiative converges around the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises. Existing regulatory efforts have been pushing for Human Rights due diligence for more than a decade, only to find investors shuffling their feet to revisit their strictly financial perspective and conventional risk-opportunity ratio. While nothing new, the PRI propose to focus not just on risk but on negative outcomes for actual people. Further regulatory efforts are expected to double down on the regulatory impetus for investors to demonstrate leadership. They include the prospective EU Directive on Mandatory Human Rights Due Diligence across the Supply Chain and the UN Zero Draft, a legally-binding instrument to regulate corporate activities in international Human Rights law.

Unlocking Investors’ Conventional Obstacles

With this convergence of regulatory efforts and sectorial mobilization, the stars are aligning for investors to spring into action. Here are 3 levers to unlock traditional obstacles to enforcing Human Rights due diligence and access to remedy across the investment value chain:

  • Data – In a blog on the European directive on non-financial reporting, Ksapa had already noted a key challenge lies in accessing homogenous methodologies as well as meaningful and comparable data. Human Rights are no different. Investors need enhanced data to address their Human Rights outcomes and develop solutions.
  • Maximum scope – In short, when it comes to Human Rights, everything is on the table. For instance, the European directive on mandatory due Diligence slated for 2021 would see to it that companies either based within the EU or foreign firms with a significant business presence there would fall in line. Much in the same spirit, the UN Working Group on Human Rights, transactional corporations and other business enterprises recommends the directive cover all European undertakings, regardless of company size, country of origin or sector, both in direct business relations and across extraterritorial operations.
  • Value chain approach – It stands to reason the same principles apply to investors, with regulations covering the entire value chain, not just supply chains. Investors will likely argue their complex network of intermediaries is not conducive to such an approach. The EU, UN and PRI among others would say otherwise. Human Rights policies and tools must apply to all intermediaries, including the use of fund-of-funds, benchmark administrators, engagement providers and stock exchanges.

While looking to first-tier suppliers is certainly a step in the good direction, the heart of the matter lies in documenting all business relationships wherever they occur, no matter the amount and regardless of their legal status. That calls for granular approaches and underpinning data.

Ksapa’s Multi-Year Human Rights Plan For Investors Adapting to Their Business Environment

Done right, Human Right due diligence allows investors to identify and prevent potentially adverse risks before they even occur and address or mitigate readily-identified impacts. Now, PRI signatories are expected to develop proactive tools, not just damage control when Human Rights risks occur. If for no better reason, proactively engaging on Human Rights makes business sense, as shareholder engagement improves profitability across target companies. How? Here’s Ksapa’s step-by-step approach.

1. Define Risk Profiles For Each Priority Investment Universe

The PRI will come to demand comprehensive due diligence processes of its signatories, starting with the identification of any investee’s actual and potential negative outcomes for people. Given the complexity of investors’ value chains, preventing and mitigating the outcomes thus identified depends on their capacity to structure and categorize investments based on broad Human Rights risk profiles. The teams at Ksapa have seen more and more financial players vow to screening their investments and flagging potentially high-risk placements. We suggest they focus on 3 key criteria:

  1. Local context – Similar investments made in an OECD versus a non-OECD country may generate a different calibration across several risks. For instance, corruption may impact the enforcement of safety and certification procedures, with clear implications for local communities’ Human Rights.  
  2. Key features – Certain features may call for more sophisticated due diligence than for other types of investment or financial activities. Among them, holding periods, the size of the investment stake, the nature of the markets in which they invest, and limited options for termination determine the necessary level of scrutiny.  
  3. Asset profile – Risk profiles of course hinge on asset profiles. Responsible investment in venture capital notably requires particular attention to ethics, labor conditions and data privacy across product features. 

Even the most robust ESG due diligence process may not cover all Human Rights risks. That said, complying with the UNGP in terms of Human Rights due diligence can clearly enhance existing ESG processes.

2. Embed Human Rights Across Investment Lifecycle

The PRI insist Human Rights risk management should be reflected across the investment lifecycle – before and after the investment decision. To that end, Ksapa outlines key considerations to structure this approach:

  1. Pre-acquisition due diligence – This step ensures portfolio companies embed Human Rights due diligence in their respective operating systems. Otherwise, exiting investments because of unexpected Human Rights risks would be impractical – and incur major financial impact.
  2. Real-world minority reports – Portfolio companies must systematically implement Human Rights due diligence processes to protect themselves, investors and relevant rightsholders. The goal is to identify, prevent and address their Human Rights impacts before they happen.  
  3. End-to-end approaches: Human Rights outcomes may also be of major importance at the exit stage. Poor reputation attached to assets clearly impact overall quality and valuation, making investors’ exit strategy even more complex.  

Engaging with issuing companies should reflect their specific Human Rights priorities, in a way that is fully embedded in their procedures and throughout the investment lifecycle. This may imply strengthening their ESG screening tools as well as contractual and procedural documents. It could also mean systematically including Human Rights on the agenda for any and all critical meetings between investors and companies.

3. Structure Data Collection Processes Accordingly

Having embedded Human Rights outcomes across their investment lifecycles, organizations can more easily structure the relevant data collection processes. This step corresponds to the PRI’s indication signatories should track their progress on Human Rights risk management. To that end, streamlined methodologies determine investors’ ability to access meaningful and comparable data on Human Rights outcomes. Here are some of the key hurdles to overcome:

  1. Sensitivity – Engaging issuers, investors, partners and other stakeholders on Human Rights is sensitive. This demands preparation, to focus on exactly how Human Rights could impact operational aspects of the investment at stake… and what to do about it.
  2. Interconnectedness – With more than 100 issues listed in global frameworks, the issue of Human Rights is both vast and complex. Human Rights are also inherently interconnected. Sound due diligence allows investors to connect the dots, to correlate their ESG considerations across field operations and into their financial models.  
  3. Automation – The ultimate goal of data collection is to refine investment decision-making. Key players are therefore turning to artificial intelligence to help them automate collection across complex data universes, first to identify material risks and, in the near-future, infer additional insights to predict the occurrence of Human Rights risks.

Given the sensitive nature of Human Rights, investors must cross-reference their data, local stakeholder input and their own – experience-driven and qualitative – assessments. Echoing international frameworks, the PRI clearly indicate data and engagement are crucial for investors to identify Human Rights risks locally, to develop and implement relevant risk management plans.

4. Develop the Internal Know-How to Address Human Rights

Next, the PRI encourage signatories to communicate on Human Rights with clients, beneficiaries and affected stakeholders, both in terms of outcomes and action plans. Engagement teams, however, often find these considerations too political or disconnected from their typical business agenda. Here are a few tips for investors to encourage capacity-building across their teams:

  1. Develop cohesive systems: CEO Statements. Group policies. Taxonomies. Engagement activities must feed a single, cohesive impression among stakeholders: that investors have embedded respect for Human Rights in their decision-making and across their operations.
  2. Identify champions: One way to distill a cohesive Human Rights strategy internally is to identify ambassadors. Done right, this creates an network of champions able to onboard peers much more dynamically than through top-down corporate due diligence assignments.
  3. Keep it simple: Real-world examples and case studies help teams identify situations they have encountered and may manage again. Capacity-building programs typically include some level of role play, to encourage staff to step into the shoes of specific rightsholders.

5. Secure Asset Valuation From Adverse Human Rights Outcomes

The Westpac example goes to show how proactive due diligence is relatively cheap. Compared to managing the Opex/Capex impacts of a Human Rights case, it is also fairly easy to integrate. At Ksapa, we therefore encourage investors to assess the Human Rights risk exposure of their activities and portfolio companies.

A good reality check for an investor’s alignment with the PRI 3-part responsibility plan is to value the risks both identified and mitigated trough its issuers’ due diligences. For instance, an investment that depends on land acquisition must seek documentation. This may involve public consultations, actual property titles, municipal land allocations consistent with actual land usage and resettlement plans aligned with relevant international standards. Any loophole calls in the question the entire due diligence process. It also signals likely Human Rights.

In times of Covid-19, investors have even more of an imperative to demand issuers fully integrate Human Rights risks in their operational plans. A number of our clients are well aware lockdown measures disproportionately affect migrant workers. For now, vulnerable rightsholders are first to suffer from the crisis but they could come to haunt investors. In in the long run, institutional and local stakeholder buy-in stands in the balance and with it, their very license to operate.

Conclusion | Now What? Influence Your Entire Ecosystem of Stakeholders

Like the UN Guiding Principles on Business and Human Rights, the PRI clearly state Human Rights are not the sole responsibility of a single investor but that of multiple duty-bearers. That said, investors are in a prime position to leverage their influence across their value chain. That way, they encourage other duty-bearers to mitigate their own risks.

As governments develop Covid-19 recovery packages, they will likely need to balance their immediate need to attract foreign investors and demanding long-term resilience plans from investors or businesses. In highly uncertain times, Human Rights plans in fact help develop more predictable business environments through nurturing trust between duty-bearers. At Ksapa, our team is of course ready to help you do just that, with approaches dovetailed to your business priorities, portfolio and corporate culture.

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