Human rights due diligence as part of 'social' in ESG

Environmental, social & governance (ESG) due diligence has become an important part of investment decisions, corporate finance and business strategies in a very short time. The influence of ESG in the business processes of many companies is becoming increasingly clear. Developments in national and international legislation will only increase this. This article describes developments in the field of human rights due diligence as part of the 'social' domain in ESG. Attention will be paid to the growing relevance of this subject for the supply chain of companies. The reason why financial institutions should also pay attention to human rights due diligence is discussed as well.

The social Factor in ESG

The 'S' in ESG covers a multitude of factors: including human rights, modern slavery, corporate security, diversity, employee relations, supply chain sustainability, consumer relations and personal data protection.

Translated to due diligence and compliance within companies, social in particular refers to policies regarding industrial accidents, anti-discrimination, privacy, third party risk, whistleblowing, corporate social responsibility, consumer relations and product safety. It is important to recognise that, from a European law perspective, 'social' is explicitly part of the concept of 'sustainability'. To associate this concept only with the 'E' of Environmental or Ecological, is too limited. According to the European Commission, ecological and social considerations are often intertwined, because especially climate change can increase existing inequalities. According to the preamble of the Regulation on sustainability disclosure in the financial services sector ('SFDR', Regulation (EU) No 2019/2088, OJEU L317), which is expected to come into force in March 2021, respect for human rights is explicitly part of the concept of `sustainability factors', alongside social and employment issues, among others.

Human rights as part of 'social' in ESG due diligence

The scope of human rights covered by the 'S' of ESG is quite broad. For example, it includes the 30 human rights listed in the 1948 Universal Declaration of Human Rights (such as the right to life, freedom and security, the right to equality before the law, the prohibition of torture and slavery, the prohibition of forced labour, the prohibition of discrimination, etc.). In addition, human rights include what is laid down in the Convention on Civil and Political Rights (1966) and in the International Covenant on Economic, Social and Cultural Rights (1966). Finally, nine UN treaties are also relevant, which, for example, deal with the rights of the child, the prohibition of discrimination against women or the rights of migrant workers.

With regard to respecting human rights in the conduct of business, the UN Guiding ¬Principles on Business and Human Rights (UNGPs; 2011) are the most important source. These contain ten principles that oblige states to protect human rights and fourteen principles that deal with the responsibility of companies to respect human rights. In addition, there are various sector-specific guidelines, guidelines from the International Labour Organization (ILO) and from the OECD. The OECD Guidelines for Multinational Enterprises (MNE) regard due diligence as an ongoing process of systematically and proactively identifying risks and potentially negative consequences for corporate social responsibility. It also includes the monitoring of business relationships of the company, so that this notion of due diligence goes beyond a single initial investigation into the prevention of reputational, financial or legal damage to the company itself.

From ‘soft law’ to ‘hard law’

The guidelines just mentioned can only be applied by companies on a voluntary basis. That is why they are called 'soft law'. Internationally, however, there is a trend towards making human rights due diligence mandatory and enforceable. This is called 'hard law'.

Recent examples include the UK's Global Human Rights Sanctions Regulations 2020 (July 2020) and the Dutch Child Labour (Duty of Care) Act (November 2019). In Switzerland, Germany and Norway, legislation on transparency and due diligence in the supply chain is in preparation.

A look ahead: Mandatory Human Rights Due Diligence regulations from Brussels

On 1 January 2021, the Regulation on responsible trade in minerals from high-risk or conflict-affected areas will come into force. This regulation obliges importers in the EU of tin, tantalum and tungsten, the corresponding ores and gold from certain conflict zones to apply due diligence to their supply chain.

Secondly, at the end of April 2020, European Justice Commissioner Didier Reynders announced that legislation for mandatory human rights due diligence would be proposed in 2021. A January 2020 academic study on due diligence requirements through the supply chain had shown that voluntariness had not led to the necessary changes in companies' behaviour. This led the Commissioner to propose mandatory legislation.

Human rights due diligence and the financial sector

Today, most banks have included respect for human rights in their ESG policies and due diligence processes.

If a sportswear manufacturer wants to take out a loan from a bank, he currently stands no chance of getting that loan if child labour occurs in his supply chain. A smartphone manufacturer will experience the same if the essential raw material tantalum is found to have been mined with forced labour in an area of Africa controlled by armed militias. These are factors that banks want to examine as part of their human rights due diligence, which thus has a broader scope than a bank's usual due diligence, focused on preventing risks to the bank itself.

For banks, this will mean that what they already apply as 'soft law' will soon become 'hard law'. However, mandatory transparency with respect to their clients' respect for human rights, independent of the sector, will make it easier for banks to determine their risk profile. Legislative developments will therefore have consequences for (future) risk management in the financial sector.

The factors 'customers and supply channels' and 'third parties', which are relevant to the legally required risk analysis by financial institutions, have common ground with human rights due diligence and supply chain management. Violations of supply chain integrity in relation to human rights can be added to the list of infringing behaviours in that analysis.

Also for asset managers, the relevance of human rights due diligence and the social factor will increase from (expected) March 2021, because according to the SFDR, respect for human rights and anti-corruption are circumstances that can have an impact on the value of an investment as sustainability risks and therefore need to be reported.

Compliance challenges

We do not yet know exactly what the European legislation on Mandatory Human Rights Due Diligence will look like. When organising due diligence and compliance in this area, already existing anti-corruption compliance programmes can be used as examples. As corruption and lack of respect for human rights often go hand in hand, combating them can find synergy in the standard elements of an effective anti-corruption compliance system. This can lead to a culture of ethical and sustainable business within companies. This ESG approach can be a plus for investors and increase the value of a company.

In my view, the European legislator will also have to take into account the complexity of supply chain management, if indeed a due diligence regulation is introduced that should apply to all sectors and companies, regardless of size. The OECD MNE guidelines, for example, allow for flexibility, depending on the specific circumstances a company faces. Proportionality should also be taken into account as different requirements may be imposed on SMEs than on multinationals.

Recommendations for practice

• Companies and the financial sector should be aware of developments in international human rights due diligence legislation.
• A comprehensive legislative operation in this field is being prepared in Brussels.
• Existing anti-corruption compliance can serve as a stepping stone to effective human rights compliance.
• For financial institutions and asset managers, human rights due diligence as part of the ‘S’ factor of ESG is becoming a regular element of their risk management, integrity risk analyses and own due diligence processes.