In the field of business and human rights, companies face a number of challenges in understanding how to undertake human rights due diligence. The UN Guiding Principles on Business and Human Rights establishes, in particular for companies, the responsibility to conduct due diligence in the context of business operations. Operationalizing this responsibility has resulted in businesses, academics and civil society developing approaches for conducting human rights due diligence largely in the context of “footprint” projects, that is, capital-intensive business operations that have a physical impact on people in surrounding communities. However, the task of assessing human rights impacts becomes amorphous in business sectors that have a more indirect impact on human rights, most notably in the banking sector.
In an interview conducted last year but recently released to the public, Roel Nieuwenkamp, Chair of the OECD Working Party on Responsible Business Conduct explains how the due diligence process can be undertaken in the banking sector. In the interview, held at the annual meeting of the Association of Supervisors of Banks of the Americas in Montevideo, Mr. Nieuwenkamp explains the due diligence process in assessing risk for project financing. Interestingly, the methodology he presents has broader application to other financial products and services offered by banks and other financial institutions. Mr. Nieuwenkamp’s interview can be viewed in its entirety here.
In summary, Mr. Nieuwenkamp argues that due diligence for banks in their supply chains and value chains necessitates that these institutions take responsibility to not cause or contribute to human rights harm. To do this, Mr. Nieuwenkamp proposes a two-step process consisting of identifying, mitigating, and accounting for how risk is addressed and embedding the due diligence process into all business management activities. While this may seem obvious to some observers, he lays out a straightforward process for undertaking the due diligence process in the banking sector, framed as a problem of risk for the banking institutions.
With regard to assessing human rights and environmental risk, he argues that impacts on human rights and the environment cannot be totally avoided, but in managing these risks they must be prioritized in terms of the severity of the impact. In other words, it is not a zero tolerance standard, but an iterative process where these banks learn from their mistakes and improve their due diligence processes for avoiding similar risks in the future.
From this process, these financial institutions must develop and operationalize their human rights policies and, perhaps most importantly, develop mitigation and remediation strategies for future risks.
Mr. Nieuwenkamp also explains that the process for assessing risk should focus on the severity of the various risks in its business operations and prioritize human rights due diligence processes based upon this assessment.
Finally, Mr. Nieuwenkamp makes an important point about leverage, that is, the ability of a financial institution to influence business activity where it is playing a small part in project financing. He argues that where a lender has minimal influence, it should work with other financial institutions to urge the borrower to take appropriate action vis-à-vis impacted people and communities, thereby leveraging their collective influence to affect change. If this fails, only then should the institution divest its investment in the company or project in question. While the likelihood that a bank would engage or divest its financial interests in a business operation is minimal, the approach suggested is an interesting first step in developing due diligence processes in the financial sector. This approach has broader implications for investors generally when assessing the risks associated with their investments. Engagement rather than avoidance as the first step in addressing human rights risk is the logical approach to be undertaken.
The framework laid out by Mr. Nieuwenkamp can be extended to other banking products and services as well. The challenge facing banks is in assessing human rights risks, in terms of their severity and the possibility of occurrence. The global mortgage crisis of 2008, from which people, communities and banks are still recovering, speaks to the need to develop a deeper understanding of the probability and impact of specific financial services as well as the political will to take action in the face of lost revenues from financial products and services not provided. The challenge, then, is in the will of banking institutions to take this internal political risk that places human rights in the path of core banking operations.
Applying the identification/assessment process and the subsequent embedding of the due diligence into banking operations presents both practical and political challenges that may prove daunting.
Current human rights impact assessment methodologies are ill suited to the task of assessing impacts from banking activities with attenuated links to those impacts. A case in point is where commodity derivatives sold by a number of major banks resulted in a massive flood of investor capital that resulted in a dramatic spike in global food prices. In this example, institutional investors were seeking ways of exiting the mortgage-backed securities market because of the collapsing housing markets in the U.S. and Europe. As an alternative, banks offered investors commodity index swaps, a complex derivative pegged to the commodity markets. The appeal of these derivatives was the notion that commodity prices did not track equities or other traditional asset classes. Investors moved literally trillions of dollars into swaps that drove demand to record levels with the price of those commodities increasing as a result of the demand. By some estimates, the cost of commodity foodstuffs rose more than 100%, driving tens of millions of people into poverty.
The revenues from these swaps were significant to say the least. Had this human rights risk been identified at the outset, would the banks that realized substantial returns have acted any differently? Perhaps but the problem is that there were no apparent due diligence processes in place that would have allowed for the consideration of these risks that became a reality. Putting aside the clarity of hindsight, the human rights due diligence process that could have occurred required the identification of the potential risks, assessing their impact and putting in place mitigation strategies to prevent undue harm. In the case of commodity index swaps, forecasting demand in light of the collapse of the mortgage backed securities market and the mass exodus from those investments should have been a warning of the commensurate demand for this new investment product.
More importantly, the institutional willingness to embed human rights analysis into the operational process of the derivatives trading units within these banks pose the greater challenge. History suggests that these banks could not resist the lure of significant profits from derivatives trading and by inference, suggests that commodities regulators around the world failed with respect to their duty to protect their citizens from the deleterious effects of these swaps.
Mr. Nieuwenkamp’s modest proposal, if undertaken by financial institutions, would at the very least focus attention on the human rights implications of this particular financial product, thereby ameliorating the impact on millions of hungry people. Whether banks undertake this analysis remains unclear.