Responsible Investment: Understanding the link between the investment system and human rights
Trillions of euros are invested in the companies that we buy from, that employ us, and that shape the world we live in. Companies can and do make very valuable contributions to our daily lives, but sadly our investment system can work to create a risk of human rights being violated by those businesses that pursue short-term profit above other considerations.
It is important that investors, and particularly large institutional investors, such as pension funds and insurance companies, take these risks into account in their investment decisions. The investment system has the potential of being a force for good, but only if asset owners and their managers make investment decisions in a responsible way. Responsible Investment is an approach which takes into account environmental, social and governance (ESG) issues which can often be material to investment returns, particularly over the long-term. This includes the risks related to some of the most horrific human rights violations in the world today.
Crucially, this is not only about doing the right thing from a moral standpoint. Responsible Investment is also in any investor’s own financial interest. Taking into account ESG considerations enables investors to identify new sets of financially material risks and opportunities. Investors who consider ESG criteria have a deeper understanding of a company’s operations, as their due diligence process takes into account a wider range of information. This allows investors to better manage the risks linked to human rights violations. Such risks can often result in significant financial impact, including potential impact on the reputation and brand of a company, with repercussions on sales, and legal sanctions on companies and their suppliers.
Simultaneously, the integration of ESG factors in the investment process does not only contribute to minimising risk, but also comes with many opportunities. It is increasingly documented as a source of long-term sustainable returns. A meta-study by Deutsche Asset and Wealth Management, which looked at more than 2,000 academic studies published since 1970, found that 62.6% of the studies examined show a positive correlation between ESG factors and financial performance.
The ways in which investors can practice Responsible Investment are diverse and keep developing. One of the most well-known approaches is divestment, where an investor uses an exclusions list based on which certain companies or sectors cannot be invested in.
But there are other ways. Rather than selling off shares in a company, investors can make use of the fact that, as shareholders, they have a stake in that company that cannot be ignored. On a basic level, this gives them the right to vote on the resolutions proposed at a company’s AGM based on ESG considerations. Going further, investors can also proactively seek to engage with their investee companies on issues related to human rights and other ESG factors.
While all of this might sound quite abstract, it can be more easily illustrated with a case study. Forced labour and human trafficking are good examples here: UK investors have been particularly alert to it thanks to recent policy developments. While forced labour and human trafficking are among the most heinous human rights abuses, they still persist widely today. According to the International Labour Organisation, almost 21 million people are victims of forced labour worldwide; with 19 million victims exploited by private individuals or enterprises and two million by states or rebel groups.
A new law introduced in the UK last year will give investors new tools to engage with companies and hold them to account. The Transparency in Supply Chains clauses in the Modern Slavery Act require companies and partnerships with a turnover greater than £35m that do any business in the UK to produce a statement each financial year, setting out the steps they have taken to ensure that slavery and human trafficking are not present in their business or supply chains.
Initially, this will enable investors, who are aware that modern slavery can impact on the companies they invest in, to signal to companies that this is an issue of interest and that disclosures under the Act will be looked at carefully. They can tell companies to be proactive in helping to eradicate these abhorrent crimes, and that failing to do so risks impacting not only their reputation, but also their operational effectiveness and, ultimately, their financial performance. The statements published by companies should also give investors a better understanding of the level of risk involved in terms of potential exposure to forced labour and human trafficking, from which further decisions on how to engage with the company can be made.
This example also shows that the availability of information about company performance in terms of ESG issues is vital for investors and needs to be encouraged; through legislation such as the Modern Slavery Act in the UK, but also through the work of NGOs, such as the Business & Human Rights Resource Centre and others currently working to produce the first-ever ranking of the world's largest publicly listed companies on their human rights performance [for more information, see the Corporate Human Rights Benchmark]. The information this will provide will be invaluable to investors trying to find out how a specific company deals with ESG issues.
Investors need to be at the forefront in ensuring companies act on this largely hidden issue and support the fight against modern slavery – as well as other human rights violations by companies. As shareholders of the largest companies on earth, investors have the power to change corporate behaviour to end these practices that have absolutely no place in today’s world.
 Friede G., Lewis M., Bassen A. and Busch T. (2015) ESG & Corporate Financial Performance: Mapping the global landscape, Deutsche Asset & Wealth Management and the University of Hamburg.