Investors and financial institutions are facing increasing demands to influence supply chain environmental, social, and governance (ESG) due diligence practices. Given major changes to the regulatory landscape and increasing headlines about human rights violations in supply chains, financial actors are expected to be more hands-on with investee companies than ever before.
A group of investors with assets in a household name activewear brand recently called on the sportswear giant to increase transparency about its suppliers and improve its human rights protection for workers after the company was reportedly tied to wage and benefit issues in its supply chain. While the company maintains its current ‘robust practices,’ the push from investors should serve as a catalyst for further due diligence strategies from financial actors across the board.
The United Nations Human Rights Council recently called for more engagement from investors, saying, “Most financial actors fail to connect human rights standards and processes with environmental, social and governance - or ESG - criteria and investment practices,” attributing this to a “prevailing lack of understanding in that sector.” The UN said investors “must place risks for people and the planet at the center of their decision-making,” through implementing human rights into their policies and focusing on human rights due diligence and risk remediation.
Investor due diligence is not a recommendation, but a mandate
New laws also require this connection between investment and ESG strategies, as regulations like the European Union’s Corporate Sustainability Due Diligence Directive (CSDDD) calls for financial institutions to carry out due diligence on their own operations and those of their subsidiaries. The EU’s Corporate Sustainability Reporting Directive (CSRD) also calls out investors, requiring them to disclose information about their due diligence process, including the identification of material impacts, sustainability risks and opportunities.
New due diligence regulations indicating investor engagement
- Sustainable Finance Disclosure Regulation (SFDR)
- Corporate Sustainability Reporting Disclosure (CSRD)
- Corporate Sustainability Due Diligence Directive (CSDDD)
- Alternative Investment Fund Managers Directive (AIFMD)
To reduce the rising business risks that ESG issues in companies’ supply chains pose, investors need to apply more sophisticated due diligence approaches, including going upstream and on site. The financial performance of an investor’s portfolio is inextricably linked to the management practices of the companies within it, and ESG practices are no exception.
Meeting investor due diligence needs
Best practice for investors looking to incorporate effective human rights and ESG practices into their investment strategies, which are also outlined in regulatory requirements, can include the following high-level steps:
Implementing due diligence policies
- Adopt a policy in line with international standards
Embedding due diligence processes
- Identify actual and potential adverse impacts from investee companies
- Prevent and mitigate actual and potential negative outcomes identified
- Track ongoing risk management
- Communicate to clients, beneficiaries, stakeholders and other external parties about due diligence outcomes and actions taken
Providing remedy access
- Enable or provide access to risk remediation
- Invest in capacity building and human rights education and training
Focusing on human rights and due diligence is integral to risk management and mitigation, as well as long-term value creation. In the era of Assurance 4.0, a new era of risk defined by further due diligence and supply chain risk management, investors can increase market value by increasing business sustainability and ESG resilience. Investors now must recognise that companies embracing responsible practices are better positioned for success in a rapidly changing environment.
Contact us to find out how we can support you with your sustainable investment and due diligence strategies.