Human rights issues: how will they impact the financial sector in the future?

September 2017 | PROFESSIONAL INSIGHT | BANKING & FINANCE

Financier Worldwide Magazine

September 2017 Issue

Historically, human rights were designed to protect the individual against the exercise of power by states. Over the last few decades, however, it became increasingly clear that not only governments but also the private sector can be a threat to human rights. For instance, the internationalisation of supply chains can put the rights of individuals at risk. Many business enterprises, which have become global players, now play a crucial role in the protection of human rights.

Recently, multiple sets of legal rules have started to develop which seek to regulate compliance with human rights in the private sector. At the international level, the most relevant of these sets of rules include: (i) the OECD Guidelines for Multinational Enterprises; (ii) the UN Global Compact; and (iii) the UN Guiding Principles on Business and Human Rights.

In 2011, a section regarding human rights was added to the OECD Guidelines for Multinational Enterprises. Accordingly, multinational enterprises which are domiciled in an OECD member state are asked to respect human rights and prevent human rights violations related to their own activities. The OECD Guidelines suggest, among other things, certain forms of risk management and cooperation with labour unions. There are national contact points in OECD member states, where complaints about companies violating the guidelines can be raised. For instance, in 2014, ECA Watch Austria, an NGO focusing on the monitoring of export credit agencies, raised a complaint against a leading industrial company because it had supposedly violated the OECD Guidelines while contributing to a dam-building project in Asia. The company promised to clarify the accusations.

The UN Global Compact is a global pact between private companies and the UN with the goal of working toward a more socially responsible and sustainable economic future. Members have to agree to 10 principles, some of which relate to human rights. For instance, principle five calls for the abolition of child labour, and principle six for the elimination of discrimination in employment and occupation.

The UN Guiding Principles on Business and Human Rights rest upon three guiding principles, the so called ‘Ruggie Principles’, named after former UN Special Representative for Human Rights, John Ruggie. First, the state has a duty to protect human rights, also against activities of private corporations. Second, there is a corporate responsibility to respect human rights. Third, the victims of human right violations by private corporations must be guaranteed access to effective remedy.

The UN Guiding Principles take a wide approach toward the international responsibility of corporate activities. All duties set forth in the UN Guiding Principles apply not only to the parent company but also to affiliated companies and suppliers. Throughout its supply chain, a company has to ensure compliance with human rights standards.

The UN Guiding Principles recommend national implementation, to make the principles binding. This leads to a general issue with the above-mentioned international legal instruments – following them is largely voluntary. Corporations that ignore them do not have to fear any direct consequences in the sense of governmental repercussions.

Generally, international agreements regarding human rights are not binding for the companies that sign them. However, there may be other incentives for private companies to respect human rights standards. Deliberately ignoring human rights can lead to negative campaigns by NGOs and the media and consequently to a loss of reputation among consumers.

Besides, there are also national legal sources regulating the private sector with regard to human rights. For instance, the California Transparency in Supply Chains Act requires mid-size and large retailers and manufacturing companies with a worldwide annual revenue of $100m or more to report on their specific actions to fight slavery and human trafficking in their supply chains.

In the UK, the Modern Slavery Act 2015, which was modelled on the California Transparency in Supply Chains Act, was passed. Its goal is to fight trafficking and slavery in the UK and requires large companies to publish a slavery and trafficking statement for each financial year on their website. In this statement, the company has to list the steps taken by the organisation to ensure that slavery and trafficking are not taking place in any of its supply chains and in any part of the business.

Another example for national legal sources are the national implementations of EU directive 2014/95/EU. According to the directive, companies have to issue a managing report which must also contain information about how the company respects human rights. In Austria, for instance, a national law (the Act to improve sustainability and diversity) now obligates companies with more than 500 employees to add details about the company’s compliance with human rights, anti-bribery and anti-corruption laws into their management report.

Repercussions for the financial sector

It is obvious that these new standards can materially affect the financial sector in a number of ways, both directly and indirectly, by affecting clients of banks and other financial institutions.

For several decades, an early precedent for this has existed in the form of lender liability under the US-American Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). Based on CERCLA, US jurisdiction has determined that a creditor of a company causing environmental damage may be held liable for such damage. This line of law has resulted in substantial new risks for lenders. Suddenly, the worst case scenario was not only to be stuck with the debts of a bankrupt debtor but to be confronted with an immense demand for damages, potentially beyond the lender’s reasonable control. CERCLA includes a secured creditor exemption, which was designed to protect creditors that do not “participate in the management” of a borrower’s facility. However, this exemption was largely eroded by the courts under two theories. First, when a financial institution forecloses on a parcel of land, it may then be found liable as an owner. Second, when a lender attempts to exert financial control over a debtor’s business operations in an attempt to prevent failure, that lender has effectively “participated in the management” of the debtor’s business and therefore loses the secured creditor exemption. In one case (United States v. Fleet Factors Corp), the 11th Circuit Court of Appeals determined that irrespective of a statutory exemption for secured creditors, a lender could be liable just for having the potential to influence a debtor’s hazardous waste disposal decisions. Under CERCLA’s strict liability scheme, defendants, such as commercial lenders, are liable unless they can invoke one of CERCLA’s affirmative defences. Consequently, lenders find it virtually impossible to claim protection under CERCLA’s secured creditor exemption.

With CERCLA as an early precedent of lender liability for failures by borrowers to comply with the law, human rights and related issues have entered the fray of the financial world much more broadly. Leading financial institutions have begun to proactively address human rights issues in their communication, often citing the UN Guiding Principles on Business and Human Rights, the Principles of the UN Global Compact and the OECD Guidelines for Multinational Enterprises. Some publicly emphasise the avoidance of human rights violations through business relationships with clients and vendors. For many financial institutions, human rights considerations already play a role in the selection of clients. Just like traditional financial risks, lenders seek to understand the social risks associated with their clients or transactions.

For instance, in a widely reported development, a number of financial institutions funding the Dakota Access Pipeline in the US have recently come under pressure by activists and some have, reportedly, started to divest their interest in the pipeline funding.

Another human-rights related risk that is specific to the financial sector is lending practices that are found to be discriminating toward minorities. Further, in the context of project finance, issues such as forced relocations, displacements and unjustified expropriations can occur. Investing in foods or other agricultural products can lead to an increase of prices and subsequently to serious consequences for vulnerable communities. Financing businesses which produce products or services is always connected with a risk of contributing to child labour, slavery or human trafficking somewhere in the supply chain.

Even though many of the relevant legal sources are not yet binding on lenders, it is still advisable for finance companies to seek to abide by them. The public has become sensitive toward the topic of human rights and negative media coverage and the activities of NGOs can lead to a loss of reputation among costumers. Big financial institutions affirm their determination to prevent human rights violations. Their actions have a strong effect on the rest of the private sector as well, as their investment decisions can be a big incentive for other companies to pay more attention to human rights issues.

Friedrich Jergitsch is a partner and Sebastian Allerberger is an intern at Freshfields Bruckhaus Deringer LLP. Mr Jergitsch can be contacted on +43 1 515 15 218 or by email: friedrich.jergitsch@freshfields.com.

Friedrich Jergitsch and Sebastian Allerberger

Freshfields Bruckhaus Deringer LLP