Repercussions of Business & Human Rights on Trade and Investment Decisions

I was a member of parliament in the area of foreign policy and development policies. As a liberal, I have always been aware of the importance of development taking place via economic growth, which puts a focus on trade and investment, because that is what improves people's lives and incomes. In the last 30 years, with regards to the development of countries, we can see that globalization has been a positive force. Basically, we are working on the benefits of globalization, such as people and countries profiting from open borders and free trade. However, we should be sure to look at the downsides of globalization as well. For example, we often see situations where people are skeptical about globalism, and they make harmful anti-globalization decisions, one of which is the steel workers who voted for President Donald Trump because they falsely believed President Trump would improve their industry by making it difficult for Americans to buy foreign steel. The rise of anti-globalizing parties in Europe, generally, claim that globalization is to the detriment of some people. It is important to separate the argument into two parts; from a political perspective and from a perspective that people who are not taking their share from globalization where supply chains and value chains are making profits. For example, farmers and workers in some situations are not making profits. Finding these situations and addressing them is the basic idea behind the management consultancy and think tank that I founded four years ago.

There are three pillars supporting this; the legal pillar, the public pressure pillar, and the economic pillar. They may vary in their importance, but they are all evident.

With regards to the legal situation for companies in Germany, the United Nations (UN) guiding principles for business and human rights is included in soft laws. In 2011, the UN Human Rights Council unanimously adopted guidelines which introduce a different notion about the responsibilities of business. The guidelines clearly define that states have an obligation to protect human rights. Also, the guidelines state that companies have to respect human rights in their field of influence. Where companies operate and have influence, they have an obligation to respect human rights even if the state does not fulfill its human rights responsibilities. That notion is reflected in the Sustainable Development Goals (SDGs), and business has a responsibility to direct the world towards SDGs. A shift in the paradigm demanding that business takes responsibility towards developing the world in a better way is vital for progress. In Europe, soft laws are gradually developing into binding laws.

The European Union (EU) made three inroads into the system. The first one is the European Union Corporate Social Responsibility (CSR) Directive which requires member states to have big companies review their risks concerning environmental, human rights, and social standards issues. In addition, the companies must disclose what actions they take to discover risks and how they manage risks. It is a strong push for transparency. There are other examples of these laws, which include the Modern Slavery Act in the United Kingdom (UK). The commonality between these laws is that they demand that corporations be transparent in terms of identifying and managing risks. A new rule that will come into effect next year is the EU Regulation on Conflict Minerals, which demands the same as mentioned above for the mineral sector. Another one is the National Action Plan for business and human rights. The EU demanded that its members develop a national action plan which sets out guidelines for companies on what is expected, and also what governments are supposed to do to help companies develop their human rights due diligence. The National Action Plan in Germany has just started and the government is preparing to monitor German companies. The government wants to confirm if half of the companies have due diligence in place. If they find that less than half have due diligence, they will make due diligence compulsory by law. Moving from soft laws to hard laws or binding laws is playing more of a role in Germany.

The second pillar of expectations towards companies consists of public attention, public pressure, and public expectations. From social science and research, we are seeing that people's expectation of companies is shifting. Currently, social science finds that there is more of an expectation that companies reflect the effect they have on society around them, and they should make sure the effect is positive. This shift in expectations is moving towards more responsibility beyond the charity sector, for instance what effect the business has on society. People have started to realize that buying a cheap commodity comes at the expense of someone else, such as a garment worker in poor working conditions. That started to be reflected in German public debate, and there are a number of non-governmental organizations (NGOs) that have been conducting research on this subject.

The media is also eager to report on the public's efforts to pressure companies into appropriate behavior because they see that the general public is interested in it. German companies feel uneasy if they are in the spotlight in a negative way. If a company is portrayed in the media negatively, it has an effect on their staff who are identified with the company. For example, Volkswagen had an issue and is now in a situation where there is a shortage of qualified labor, and they have to take into account that their staff may be affected by negative reputation of the company. Any sort of public pressure puts pressure on the staff and might motivate them to leave, and new candidates will likely be less inclined to join the company. It is such a risk that most business executives do not like to talk to journalists because journalists could inadvertently put pressure on their company. There is research that shows that if the staff are identified positively with their company, they will speak more favorably about the company to others. In addition, they are more motivated to work for the company, and they act as ambassadors of their company which could have an impact on recruitment.

The third pillar is more business oriented. Retail companies make significant efforts to build a positive image around their brand. Once the brand is built up, the companies can make extra profit because consumers will pay more for the brand. However, if consumers find out that the products were made in poor working conditions, they will wonder why they paid so much for the product. For brands, any negative remark on the working conditions in the supply chain can badly damage their business. For example, Adidas was caught with using child labor to manufacture soccer balls. Their sales plummeted. Adidas has been working for 25 years to improve that tarnished image.

There are two other important business considerations: one is financial institutions and their expectations, and the other is business clients. More and more financial institutions are requiring transparency of Environmental, Social, and Governance (ESG) risks. They want to see that a company is aware of the risks they have in the supply chain and that they are managing those risks in a responsible way. They apply pressure to the companies to make sure human rights and due diligence are properly in place. The other business consideration is reporting requirements for business clients. Big companies are themselves responsible for making disclosures, and now they ask their suppliers to be transparent, too; they ask if suppliers have any risks and if procedures are in place to identify their risks, in their supply chain. The pressure to implement risk analysis and management is handed down from those who are required to report by law (big companies) to those who are not bound by law to report (suppliers/ small companies). That is very important in cooperation of the companies.

Under the CSR Directive, companies with more than 5,000 employees must fulfill criteria related to public interest. The law requires reporting on five different criteria: environment, employees, community, human rights, and corruption. Human rights issues that need to be reported on may include slavery, child labor, excessive overtime, prison labor, and other human rights violations. It is up to the company to make a risk assessment and determine which of these risks are possible or already occurring. Companies must answer four questions related to the above reporting issues: description of due diligence including results; observation of their own business activities, describing important risks they identified and solutions to manage those risks; observation of their products, services, and business relations in which they need to look at their supply chain; and finally, report on the non-financial indicators, how they measure them, and what kind of monitoring system is being implemented to follow their progress. As a secondary effect, these reporting requirements are extended to suppliers and other business partners.

Other legal requirements, apart from the previously mentioned Modern Slavery Act, include the Dodd-Frank-Act in the United States (U.S.) and Loi de Vigilance in France. If a company has good due diligence in place, then they can mostly comply with these laws. German companies have to comply with the legal requirements of countries in which they engage in business.

Germany's National Action Plan involves five non-binding requirements. These laws will come into effect at some point because companies want all other companies, especially their competitors, to equally comply with the laws. The laws basically state that company leadership should make clear statements that they are respecting human rights in their business activities. Then, they should establish risk analysis systems, and a process to manage and mitigate risks. A grievance mechanism as an instrument to have a second look at their supply chain has also proven to be useful. The last requirement is that companies become and remain transparent.

There are three organizations in Germany that companies work with depending on what the company does or intends to do. There is one that is most suitable for beginners and SMEs (Deutscher Nachhaltigkeits Kodex), another which is used by all major companies (Global Reporting Initiative (GRI)), and another for international business (United Nations Global Compact).

A good German company would always comply with what the government demands, and 90% have published reports so far. Companies take different approaches, and there is no uniform approach. GRI is the preferred standard used by approximately 75% of the companies. The advice that I give to companies is they need to build up more knowledge in reviewing their social standard and supply chain risks, and improve reporting in the coming years.

Looking at the textile sector as an example, companies take different approaches. However, they all look at their supply chain. Memberships and partnerships are available which provide ways of taking action together. The framework of companies' due diligence addresses what they want to focus on. In Tchibo, for instance, they focus on working conditions and fair wages; in C&A, seeking sustainability at fare prices; in H&M, developing lasting relationship with new suppliers for different kinds of partnerships; and in Adidas, avoiding slavery risks in tier 2 and tier 3 suppliers.

Looking at the coffee sector, we see a completely different approach compared to the textile sector. The major German coffee companies have three similar approaches which include purchasing coffee from certified providers of sustainable coffee, creating their own projects with coffee farmers, and organizing green projects such as setting up ecological farms.

The National Action Plan by the Japanese government is in progress. The Ministry of Foreign Affairs is holding discussions with stakeholders, and the Ministry of Economy, Trade and Industry (METI) is cooperating with them to publish the Action Plan. The plan is to serve as guidance for collaborative value creation, and is intended to become a common language for investors and companies. It should help companies more easily incorporate ESG issues into their value creating strategy. ESG stands for environment, social and governance, and human rights belong in the social category. The environment and social factors are risks for investors, and risks should be identified with understanding that business environment and social expectations change over the time. Now Japanese investors are very conscious about ESG issues. Engagement of stakeholders including suppliers is vital, but at the same time, investors will also have to look at ESG carefully. I hope Mr. Loening's lecture today serves to inform us that the social expectations are changing in the many places arround the world.

Q1: What was the idea behind giving industries a few years before considering further action such as introducing due diligence?

Markus LOENING
All of the legislation was discussed with civil society and business associations involved in the National Action Plan. NGOs were involved with public hearings. The government and the general public stated they want companies to be aware of and fulfill their responsibilities. However, it must be recognized that this was new for companies, and we had no readymade tools or instruments. Tools and instruments needed to be developed to identify and to manage risks, so there was a lot of work in progress. We needed experience, and then we needed processes and tools to be tested. After that, we could make laws that included minimum requirements and standards, but I believe it was too early to do it immediately because we lacked experience and information.

Q2: Where would the line be drawn between companies' legitimate concern and appetite for cheap labor, and slavery conditions? Also, do you have any concern about the condition between fair human rights and disguised protectionism?

Markus LOENING
Countries do not want child or slave labor, but for some, cheap labor is a competitive advantage for their country, and they want to make use of that advantage. In drawing this line, you have to consider the economic situation, living costs, and employment situation. Even though workers in garment factories in Southeast Asia make very little money, it is their only option and their only way to move forward. There is a mix of considerations that must be taken into account when setting wages. People will claim protectionism if the standards are too high. On the other side, labor unions claim that cheap labor like there is in Southeast Asia cannot be allowed to continue; it is a political debate.

Q3: In the EU, do the countries have the same levels of regulations, directives, or obligations towards companies eliminating such competition?

Markus LOENING
The EU has the same regulatory framework. There is no framework on wages, but there is a framework on the allowed number of hours to be worked and social security. There is competition because some countries have lower costs of living and lower wages, so they are able to deliver lower prices than competitors which drives competition. There is movement of labor across the EU. So, if there is a bad labor market in some countries, they will move to other labor markets. Competition between companies that implement this kind of due diligence depends on the industry.

Investing in making a company sustainable attracts talent. Being as sustainable as possible prevents reputational issues for companies with strong brands. There is research which shows that the more sustainable a company is, the more valuable it is in the stock market in the long run.