Human rights – no longer a remote problem for companies and investors

November 2023 the United Nations special rapporteur on extreme poverty and human rights, Olivier De Schutter, turned his sights on the CEOs of three prominent US corporations (Walmart, Amazon and DoorDash), calling on them to respond to allegations of exploitatively low wages that trap employees in poverty and compel them to rely on government assistance. It was a clear sign that human rights issues are no longer a remote problem, but an increasingly urgent issue for companies across the globe.

De Schutter was responding to a Government Accountability Office report indicating that Walmart and Amazon were among the leading US businesses in terms of the number of employees enrolled in Medicaid, the federal health insurance programme for people on lower incomes; Walmart was ranked first and Amazon sixth. The unwelcome publicity demonstrates the pressure on companies to pay attention to social impact issues arising from their business operations as well as financial and environmental risks.

Until recently, social impact considerations such as human rights tended to be the poor relation to climate and environmental issues amid the focus on how companies are addressing ESG issues (which also encompass corporate governance). While climate change is now well established as a legislative priority, and subject to greater scrutiny by investors, pressure to ensure accountability on social issues – especially human rights – is growing rapidly.

EU legislation drive

This focus on human rights is also beginning to be reflected in legislation, especially in Europe. In February 2022, the Platform on Sustainable Finance, an advisory body to the European Commission, published its final report proposing a structure for a social taxonomy in parallel with the EU’s taxonomy for environmentally sustainable activities, a common classification system for environmental activities and objectives underpinning the European Green Deal and legislation such as the Sustainable Finance Disclosure Regulation.

However, little progress has been made since on the social taxonomy, prompting frustration among institutional investors keen to step up investment in projects with a social impact.

Another plank of the EU’s legislative drive, the Corporate Sustainability Due Diligence Directive (CSDDD), is intended to complement the Corporate Sustainability Reporting Directive, expanding reporting and due diligence standards to require larger companies to identify, stop or prevent, mitigate and account for negative human rights and environmental impacts, not only in their company’s own operations, but also in those of their subsidiaries and supply chains.

In April 2024 the European Parliament approved a compromise text of the legislation endorsed by member states after pushback against the original proposal threatened to block adoption of the CSDDD altogether. The threshold for companies to be included has been raised from a minimum of 500 employees to 1,000, and net turnover from €150m to €450m, while proposed lower thresholds for high-risk sectors have been delayed for at least two years. Together the changes will reduce the number of companies covered by the directive by around two-thirds.

Legal exposure

The compromise deal also removes the possibility for civil society organisations to take legal action against businesses over harmful social or environmental impact from supply chains. Most financial institutions have also been exempted from the CSDDD provisions, although this may be subject to a review at a later date.

Some of these issues are already covered by existing national legislation. For example, France created its own due diligence law in 2017. It was prompted by the catastrophic collapse of the Rana Plaza clothing factory building in Bangladesh, which killed over 1,130 and injured 2,500 employees of companies that made clothes for major Western brands. At the beginning of 2023 Germany’s Supply Chain Due Diligence Act came into force, requiring companies to monitor for any potential human rights risks in their supply chains.

Human rights violations and abusive employment conditions can become a major reputational, legal and financial risk for companies.

Human rights violations and abusive employment conditions can become a major reputational, legal and financial risk for companies, such as those that rely on cheap labour in their manufacturing processes. In 2021, eight children launched legal action in a US court against the world’s largest chocolate producers, claiming they had been used as slave labour on cocoa plantations in Côte d’Ivoire.

A second case, brought by International Rights Advocates in 2023, sought to compel the US government to enforce 1930s-era federal legislation requiring it to ban products created by child labour from entering the country. While the sums involved may be relatively limited for large companies, the reputational damage can be significant.

Financial cost

In some cases, however, there can also be a substantial financial impact from neglecting human rights. UK clothing group Boohoo had made a virtue of its UK-based manufacturing capability, but during the Covid-19 pandemic, the media uncovered evidence of exploitation at the group’s factories in Leicester. Boohoo’s share price dropped by 90% from a peak of £413 in June 2020 and has since yet to recover its past value.

A 2021 report by academic economists from Monash University in Melbourne and the University of Oxford put forward evidence confirming that being linked to human rights abuses in any way can have a significant negative influence on a company’s stock market valuation. In particularly egregious cases, it may force a company out of business altogether.

In less damaging instances, such allegations are still liable to create a significant increase in costs and consequent losses, especially if companies are obliged to find new suppliers, which may well interrupt product availability. They may lose business because of customer boycotts, find it harder to recruit employees, and suffer permanent damage to their brand, all of which are likely to impact investors’ returns.

Assessing human rights risks

How can investors make sure that companies in which they own shares are paying attention to potential threats to their profitability in their supply chain? Assessing the risks may not be straightforward. Companies have to consider not only their own employees, but what is happening across their entire supply chain. The excuse put forward in the past that manufacturing was being carried out in a distant country, by a company subject to domestic rules, may no longer absolve them from blame.

Companies need to monitor and understand activities that are part of their supply chain wherever they are in the world and be able to respond swiftly to any criticism or allegations of wrongdoing. The response of some companies has been to bring supply chains closer to home (although post-Covid disruption has also been a factor), or shift to trusted, although potentially more expensive, providers.

Fund management groups and wealth managers increasingly have teams of staff engaging with the companies in which they invest on human rights, employment terms and other social issues. They scrutinise portfolio companies’ supplier relationships and how they treat their employees, launch dialogue with the management team if problems arise, and make efforts to get them resolved as quickly as possible.

In many cases investors will join forces to put greater pressure on investee companies to make changes. This can be an important step in protecting the value of their investments and encouraging broader changes throughout business sectors or national economies. As a last resort, however, if companies are intransigent, investment managers may sell their shares – which may in turn prompt other shareholders to divest.

Such activist investment initiatives are likely to become more important as regulators step up their scrutiny, new legislation pushes social factors further into the spotlight, and the impact of human rights and related issues on a company’s financial performance becomes increasingly well understood by the investment community as a whole.

Companies accused of human rights violations may lose business because of customer boycotts, find it harder to recruit employees, and suffer permanent damage to their brand, in turn impacting investors’ returns.