Modern slavery is more than an ‘ethical issue’ to investors
Modern Slavery isn’t just a legal issue, it is of increasing importance to investors. The Sustainable Development Goals include an aim to eradicate slavery by 2030. This means regulatory attention focused on modern slavery will likely be increased. The UK Modern Slavery Act, introduced in 2015, followed by the Australian Modern Slavery Act in 2018, are likely just the beginning. Other countries are also considering legislation. Investors were part of the consultation period in the lead up to the Australian Modern Slavery Act’s passing.
Above and beyond the increased legal risk for companies that do not manage this issue, the relevance to investors is twofold:
Consumers of modern slavery statements
First, investors that integrate Environmental, Social and Governance (ESG) aspects will be consumers of modern slavery statements by investee companies. However, the Modern Slavery Act is not about compliance and reporting per se; investors will be interested in understanding how companies manage the risks in their operations and supply chains. One of the key reasons for integrating ESG safeguards is to help investors make better-informed investment decisions. Transparency acts, such as the Modern Slavery Act, can help. In addition to managing earnings risks, the way a company manages its ESG risks, including modern slavery, can be seen as a proxy for management quality, often a key factor in investment decisions.
Investors will also need to report themselves
Second, many investors will also need to report themselves. At the time of writing, this will likely relate to modern slavery risks in the investment portfolios. This means that investors will, like any other business, report on how they identify the risk of modern slavery, what they are doing about it and how effective those actions have been. Companies’ statements will be read and judged by the public and so will investors’ statements by their clients. As a result, investors doing their due diligence will need to understand the portfolio’s risk exposure and how investee companies are managing the issues. This will depend on the quality of their reporting.
Reporting will not be perfect from the start, but should improve over time, and it will be a journey. However, modern slavery statements will likely act as conversation starters in investors’ engagement activities with investee companies. In addition to companies’ own reporting, investors will likely consult a number of other tools, such as company rankings, benchmarks and other forms of independent research. From an investor perspective, high-risk sectors include those with oligopolistic features, particularly where there is major focus on price pressure and/ or demands for shorter lead times, which often results in subcontracting. Other common risk flags are when an industry is highly dependent on migrant workers, or others vulnerable to exploitation, as well as industries with little union influence.
Modern slavery is more than an ‘ethical issue’ to investors. Investment risks related to slavery include reputational and brand damage, but also regulatory changes and general business risk. Brands can be costly and time-consuming to restore and brand damage can originate from issues deep down in a company’s supply chain. Brand damage can have both external and internal impacts, including loss of sales and negative impacts on the ability to attract, motivate and retain staff.
Companies that take a leading role on responsible sourcing might be more resilient over time. Ultimately, the issue comes down to earnings sustainability. Investors prefer stable earnings but a business model that relies on operations, or supply chains, with underpaid workers, forced labour, weak regulation and/ or weak enforcement of regulation will unlikely be able to produce sustainable earnings growth over time.
Modern slavery is a complex and often systemic issue that requires a multi-stakeholder effort to address it. No government will be able to eradicate slavery on their own. Transparency and collaboration are key. The financial industry, including investors, can play a major role, particularly through constructive engagement with investee companies. In addition to improved transparency, some of those engagements may involve encouraging companies to adopt industry best practice or practical points, such as increased ability to influence by incentivising suppliers and other business partners to manage the risks in their supply chains, reduced reliance on audits with more focus on building long-term strategic relationships, additional training of staff, better alignment of key performance indicators between ethical sourcing staff and procurement staff. While such measures may present some challenges, measuring their effectiveness might prove to be the most challenging part.