
Human rights in private equity: Information and summary
This paper provides an overview of human rights due diligence (HRDD) in relation to private equity (PE) investors. Topics covered include the responsibility of PE, the value of HRDD for PE, the characteristics of PE, integration of HRDD into PE processes and implementation challenges.
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OVERVIEW
This paper is the product of a workshop convened by the British Institute of International and Comparative Law (BIICL) and the Principles for Responsible Investment (PRI) in June 2017, with the aim to explore implications of expectations for human rights due diligence (HRDD) by investors, private equity (PE) firms and/or their portfolio companies.
The concept of HRDD was introduced by the UN Guiding Principles on Business and Human Rights (UNGPs) in 2011. The UNGPs expect all business enterprises to carry out HRDD to identify, prevent, mitigate and account for how they address adverse human rights impacts associated with their business practices. Although the UNGPs are not legally binding, the concept of HRDD is being incorporated into laws, legal claims, contracts, industry standards, guidelines and tools, and civil society expectations.
HRDD has three distinct features: it should be an ongoing process, it should include all relevant human rights, and it should focus on risks faced by rights-holders rather than risks faced by the business.
A risks-to-rights-holders approach confronts the traditional business perspective on risk, which typically limits ESG risk assessment to stakeholders and fails to ensure all rights-holders are accounted for. HRDD focuses on prioritising the severity of harm rather than the level of control or the feasibility of addressing the impact. Consequently, UNGPs need to clarify how the severity and salience of human rights violations within the PE context correspond to concepts of materiality and fiduciary duty.
The responsibility of PE investors for human rights impacts:
HRDD best practice involves identifying current and potential human rights issues across a business’s operations and value chain, considering factors of causation, contribution and association. HRDD should also consider risks emanating from specific operating contexts, such as activities in developing countries where there is a higher risk of wage violations, modern slavery, discrimination and workplace accidents.
Analysis of the business’s degree of involvement across operations and the value chain will inform the course of action, which includes applying leverage, direct action or a combination of both. The course of action selected is also impacted by varying responsibilities of limited partners and general partners of a private equity fund. For instance, the limited partner has limited influence over the fund, so the best course of action is applying leverage through engagement with the fund manager. The general partner can exert more power over a company and therefore has more responsibility for addressing actions that cause harm, beyond only exercising its leverage with the third party.
The responsibility of general partners should be taken seriously with the increase in corporate accountability for human rights in case law. For example, there is an emerging test where courts consider factors such as the level of control, knowledge, proximity or foreseeability the defendant company had over the alleged violations, even if violations were undertaken by a separate legal entity.
Failure to identify, prevent and address adverse human rights impacts may lead to reputational, operational, financial and legal risk for PE investors, and effective HRDD can mitigate these risks.
KEY INSIGHTS
- A portfolio company with an effective HRDD process in place protects itself, investors and the relevant rights-holders, thanks to its capacity to identify, prevent and address human rights impacts even before they arise.
- PE is uniquely positioned to deal with human rights issues, as PE firms can “price in risk”, influence improvements and share HRDD best practice approaches across fund portfolios.
- A PE firm capable of, and with a reputation for, embedding strong HRDD processes into formerly high-risk portfolio companies can benefit financially by protecting value through risk reduction, cost reduction (such as reducing workforce turnover), or creating value by enhancing the company brand.
- Reputation is an important consideration for PE investors, and workshop participants agreed that reputational risks are currently a stronger driver for PE firms to adopt HRDD than compliance risk.
- BIICL’s research on HRDD has shown that a commitment to monitor compliance should be included when human rights are incorporated into contracts, and that steps towards enforcement should be taken where necessary.
- Lack of clarity around concepts such as supply chain labour conditions and modern slavery risk is a limitation to incorporate human rights provisions into policies, contractual arrangements, codes of conduct and risk assessments. More research is required on how to establish clearer company commitments and stronger monitoring mechanisms of human rights.
- General challenges of HRDD include limited resources, especially for small companies to comply with and implement HRDD measures, managing complex company supply chains, internal communication and lack of education around international human rights standards, and monitoring and grievance mechanisms.
- PE investments are typically held for up to seven years, and there are time constraints around what companies can do and achieve within this time frame, particularly if HRDD is not yet established. At the same time, the nature of PE means that divestment is difficult and inadvisable in cases of breaches or unwillingness to improve from the company.
- HRDD should be integrated into PE processes as part of the ESG framework through deepening and adding a human rights lens to existing measures. Human rights impact assessments should be undertaken to identify the issues most at risk within the operations and supply chain of each acquisition target.
- Prioritising the severity of human rights impacts can be done by considering their scale, scope and irremediable character. Prioritising certain impacts and communicating this to the investment team can help drive HRDD internally.