How human rights due diligence affects the ‘E’ in ESG

February 2024 | SPOTLIGHT | RISK MANAGEMENT

Financier Worldwide Magazine

February 2024 Issue

Increasingly, investors are evaluating and rating investments based on environmental, social and governance (ESG) performance, and companies are using ESG reporting frameworks to publicly report on ESG issues.

ESG has put additional focus on companies’ commitment to respecting human rights, and particularly, how that commitment impacts social indicators in ESG. In addition to ESG trends, these initiatives are largely driven by emerging legal frameworks requiring companies to report on human rights and environmental issues, such as the European Union’s Corporate Sustainability Reporting Directive (CSRD), emerging mandatory human rights due diligence legislation, and increased legal enforcement and litigation risks.

In response, companies are increasingly developing human rights policies, conducting human rights due diligence, and facilitating proper access to remedy to impacted rightsholders, consistent with the UN Guiding Principles on Business and Human Rights (UNGPs) and other internationally recognised frameworks.

These measures, particularly human rights due diligence, are not synonymous with a company’s social performance in ESG, because the ‘S’ in ESG covers topics that touch upon human rights risks, but go beyond them (e.g., employee relations) and because a robust human rights due diligence programme will necessarily affect a company’s environmental ESG performance.

The framework for human rights due diligence

Consistent with the UNGPs, companies assess and address potential and actual adverse human rights impacts by conducting robust human rights due diligence. UNGP 17 calls on companies to undertake human rights due diligence to identify, prevent, address and mitigate adverse human rights risks and impacts.

According to the UNGPs, typically this diligence includes: (i) identifying and assessing human rights risks and impacts; (ii) integrating findings across relevant company processes to mitigate risk and remediate impacts; (iii) monitoring the effectiveness of these measures; and (iv) reporting out to relevant stakeholders on how risks and impacts are being addressed.

At each of these steps, stakeholder engagement plays an important role. The UNGPs call on businesses to understand adverse human rights risks and impacts from the perspective of potentially affected stakeholders. Specifically, UNGP 18 states that human rights due diligence should involve meaningful consultation with potentially affected stakeholders.

These measures are typically associated with the ‘S’ of ESG (and to some extent, the ‘G’). Social factors in ESG are typically thought to include issues like data privacy, employee relations, supply chain sustainability, diversity, equity and inclusion, and human rights. To be sure, human rights goes beyond ESG, and companies seeking to develop a human rights due diligence process simply to respond to ESG factors may run the risk of creating a piecemeal, ineffective human rights due diligence programme that does not focus on rightsholders.

Human rights due diligence and environmental factors

There is a growing trend of companies recognising that environmental issues are human rights issues, and that these issues can be addressed in part through human rights due diligence. Environmental issues often impact rightsholders’ human rights, including the rights to life, health, enjoyment of cultural heritage, water and food. In practice, companies have long assessed these issues from the perspective of rightsholders in their human rights risk assessments. For example, a company might consider how their operations’ water usage are potentially affecting the ability of local stakeholders to access clean water.

In addition to these issues, in 2022, UN member states, in UN General Assembly Resolution 76/300, recognised the right to a clean, healthy and sustainable environment. Recognition that human rights issues and environmental issues are closely linked continues to increase. At the most recent United Nations Forum on Business and Human Rights in November 2023, panellists across various industries discussed at length the intersection between human rights issues and environmental issues. The CSRD requires certain companies to report on their human rights and environmental impacts. Emerging human rights frameworks across multiple jurisdictions similarly addresses both human rights and environmental risks. As such, human rights due diligence necessarily involves an assessment of environmental impacts.

In this developing framework, a duty to respect human rights, as referenced in the UNGPs, means that a company is addressing issues related to the right to a clean, healthy and sustainable environment, and the rights to life, health, cultural heritage, water and food, among others – issues that impact the ‘E’ of ESG.

Robust human rights due diligence will therefore not only address the human rights focused social indicators, but will also support environmental indicators. For example, Morgan Stanley Capital International’s (MSCI’s) ESG indices risk ratings on the environment include an issue score for water stress and lists as one of the risks associated with water stress a “loss of access to markets through community opposition”.

These issues align with community members’ human rights related to water access, and a human rights due diligence process would lead to engagement with community members to assess whether the company’s water usage is causing or contributing to adverse impacts on the community members’ human rights, or whether the company’s activities may have any potential adverse impacts on community members.

Human rights due diligence goes even broader because it calls upon companies to identify risks and engage with stakeholders before those risks materialise into impacts. This provides the company with the opportunity to avoid a situation in which it would lose access to markets due to community opposition in the first place. By contrast, an assessment of water usage and community opposition focused solely on environmental ESG indicators may overlook potential adverse human rights impacts on communities related to those rights, such as the right to health or enjoyment of cultural heritage.

Similarly, companies using ESG reporting standards can leverage their human rights due diligence to report on environmental indicators. The Sustainability Accounting Standards Board (SASB), which has developed guidance for 77 different industries on disclosing ESG factors that would be financially material to investors, provides guidance for companies in the metals and mining industry to disclose issues related to waste and hazardous materials management. This includes the amount of hazardous waste the company is generating and recycling, and the “the total number of significant incidents associated with the handling, storage, transportation, or disposal of hazardous materials” including incidents that impact “employees or surrounding communities”.

Related to human rights due diligence efforts, companies are integrating human rights assessments into broader social and environmental impact assessments, to minimise disruption to operations and create efficiencies. These assessments allow companies to address issues related to waste management and other environmental issues as they impact employees and surrounding communities, as well as addressing the SASB’s reporting metrics, focused on social indicators, regarding worker health and safety incidents, efficiently.

Leveraging human rights due diligence to address the E in ESG allows companies to avoid blind spots that may be left behind by an ESG-centric approach. By viewing issues solely from the perspective of investors, rather than rightsholders, they can proactively identify risks before they materialise into impacts leading to harm to the company, its investors and other stakeholders. They can also find efficiencies in simultaneously addressing human rights and environmental issues, while making the best use of company resources and minimising disruption to company operations.

Proper human rights due diligence addresses a company’s regulatory and legal risks, social ESG factors, and environmental and governance ESG factors. It may increase the possibility for more buy-in across the company in devoting time and resources to human rights due diligence. Some internal stakeholders may be more likely to agree to devoting resources to human rights due diligence if they recognise that the impacts of doing so are broad, affecting all ESG factors, in addition to mitigating legal risk.

Mary Mikhaeel is a senior associate at Miller & Chevalier. She can be contacted on +1 (202) 626 5909 or by email: mmikhaeel@milchev.com.

Mary Mikhaeel

Miller & Chevalier