Without proper human rights due diligence, investors’ portfolios are at risk.

Investors are exposed to the financial, reputational and legal risks associated with poor human rights practices at investee companies.

To date, measures on human rights due diligence have been largely voluntary.

But the European Commission’s recent proposal on corporate due diligence signals the imminent arrival of far-reaching mandatory measures.

Investors need to proactively ensure these measures are sufficient.

Human rights issues are far-reaching – tackling them is essential

Companies face a broad range of human rights risks.

This includes areas such as discrimination, health and safety, pollution, land use, and product testing.

This risk is often magnified by the global nature of company operations and the complexity of their supply chains.

Human rights due diligence is an essential process. It drives companies to identify and understand the risks of their business to human rights and the environment; to mitigate and prevent these risks; and to address the adverse impacts of any human rights violations.

For those already choosing to implement human rights due diligence - usually on a voluntary basis - international guidelines such as the United Nations Guiding Principles on Business and Human Rights (UNGPs) and the OECD Guidelines for Multinational Enterprises have helped shape the process.

Due diligence processes reduce risks for companies, but there is real room for improvement.

Human rights due diligence helps companies act more responsibly. Investors benefit from this.

ShareAction’s Workforce Disclosure Initiative, which works with institutional investors to increase corporate workforce transparency, finds that companies that conduct human rights due diligence are better able to assess the risk of human rights issues.

Our 2021 survey found that 88 per cent of companies that conduct due diligence were able to identify at least one salient human rights issue, compared to 67 per cent of companies who don’t.

But the survey also highlights the enormous room for improvement in human rights due diligence practices - and the ongoing exposure to risks for investors.

Thirty-one per cent of companies surveyed don’t monitor the effectiveness of actions taken to address the negative impacts on the human rights of workers.

The fact that such a large proportion of companies are not holding themselves accountable for how they act in the face of human rights violations - a central element in the human rights due diligence process - indicates that the current voluntary approach is ineffective.

The imposition of mandatory measures will compel companies to establish more comprehensive and robust processes of human rights due diligence.

New legislation offers an unprecedented opportunity for investors to influence human rights due diligence practices

In February 2022, the European Commission adopted its Proposal For A Directive Of The European Parliament And Of The Council On Corporate Sustainability Due Diligence.

The directive aims to ‘foster sustainable and responsible corporate behaviour throughout global value chains’ by requiring companies to identify and prevent, end or mitigate the adverse impacts of their activities on human rights and the environment.

The directive’s broad reach means it will have a profound impact on investor portfolios and standards for responsible investment globally.

It is expected to lead to mandatory requirements on human rights due diligence practices for all companies operating in the single market.

The legislation will also influence the development of policies and practices on due diligence more widely by indirectly affecting the practices of the suppliers of EU companies and acting as a reference point for mandatory due diligence in other jurisdictions.

But startling gaps remain. And these should be a concern for investors.

The directive was initially referred to as 'Sustainable Corporate Governance', but only includes a few elements which would foster the integration of sustainability and long-term thinking in corporate governance rules.

There also needs to be more clarity on obligations of company directors on due diligence. Only then would it move from a tick-box approach to a more strategic and transformative one that truly addresses business impacts on people and the planet.

The directive also currently has a narrower scope of human rights due diligence than international guidelines, disturbing the level playing field for companies that voluntarily disclose.

Companies’ responsibility under the directive would be restricted to ‘well-established relationships’, unlike the UNGPs, which call for companies to look at negative impacts across all business operations and supply chains.

Unlike these guidelines, the directive covers only very large companies (more than 500 employees and a net turnover of over €150 million), except for agriculture, textiles and mineral extraction, where large companies (more than 250 employees and a turnover over €40 million) are also considered. The directive restricts due diligence responsibilities of financial sector companies to the pre-contractual phase of client relationships and to the operations of their large corporate clients.

These gaps in coverage could lead to a persistently high level of unidentified and unaddressed human rights violations in companies that don’t have to establish due diligence processes.

Companies that are not sufficiently transparent, or fail to take necessary actions, face significant reputational and financial risks, particularly where violations are exposed by other sources, such as the media or activist groups.

A company’s license to operate is predicated on maintaining transparency and accountability. Both of these are supported by good due diligence practices.

Ultimately, businesses could face legal proceedings for human rights violations. This could lead to the imposition of legal penalties and the payment of financial compensation.

The directive also takes a narrow view of the assessment of companies’ adherence to due diligence process. It relies upon compliance-based mechanisms such as contractual obligations and auditing. It overlooks the capability of companies to leverage their relationships with suppliers to influence their business practices.

Allowing for a wider scope of assessment would encourage more creative and holistic approaches to due diligence across company supply chains and reduce investor exposure to risk as a result.

Investors need to make their voice heard

The European Commission is taking feedback on its Corporate Sustainability Due Diligence directive until 23 May 2022.

The time is now for investors to make their voices heard so that legislation in the European Union, and in other jurisdictions, leads to meaningful change in human rights due diligence practices.

In doing so they will be reducing risk exposure for investors and facilitating the identification of sustainable investment options, creating a level playing field for companies, and reducing adverse human rights, climate and environmental outcomes for all.