18
DEC
2014

Human Rights and the Institutional Investor

As businesses and governments operationalize the UN Guiding Principles on Business and Human Rights, their application to a wider range of business activities is becoming more apparent. This is true when applying the Guiding Principles to institutional investors faced with an array of investments. In this article, we propose several ways to consider how institutional investors can go about integrating the UN Guiding Principles on Business and Human Rights into their investment processes.

For those unfamiliar with institutional investors, this broad group includes public and private pension funds, public institutions including Universities and other educational institutions, local state and national governments, sovereign wealth funds, insurance companies, mutual funds and other large investors. In a 2005 study, the Bank of International Settlements estimated the worth of institutional investors in the U.S. at almost $22 trillion and the combined value of institutional investors in 18 countries including the U.S., total in excess of $46 trillion. Nine years later, this number has no doubt risen significantly.

While an increasing number of institutional investors are beginning to consider non-financial factors in their investment processes, including human rights implications of investment decisions, the vast majority of institutional investors simply do not consider human rights as part of this process. However, out of necessity, institutional investors will eventually face the realities of a changing world and steps must be taken to address this issue.

For those unfamiliar with the UN Guiding Principles on Business and Human Rights (UNGPs), the underlying rubric for applying human rights principles to business activities falls within the “Protect, Respect, Remedy” framework. In particular, the responsibility to respect the human rights of people falls on companies whose operations impact affected individuals and communities. In addition, a number of voluntary principles have been developed that establish responsibilities for financial institutions in a variety of situations. The Equator Principles is one such example, in that they establish “a risk management framework [that is] adopted by financial institutions, for determining, assessing and managing environmental and social risk in projects and is primarily intended to provide a minimum standard for due diligence to support responsible risk decision-making.” In addition, the Thun Group of Banks, an assemblage of U.S. and European banks met in Thun, Switzerland in 2013 and released their paper, UN Guiding Principles on Business and Human Rights: Discussion Paper for Banks on Implications of Principles 16–21, which laid out an interesting starting point for discussion about financial institutions and their responsibilities with regard to respecting human rights.[1] The process of adopting human rights policies and procedures in the context of the financial sector is in its infancy but is progressing as these institutions develop a better understanding about how they should go about establishing these policies and procedures to the unique circumstances of the financial sector.

Given that the financial sector is in the early stages of adopting the UN Guiding Principles, we would argue that institutional investors must look at human rights in their investment decisions in two ways. First, they must consider the human rights implications for various asset classes. Second, their investment management providers, whether in-house or as is most often the case, outside professional advisors retained to provide these services.

Human Rights and Investments

With regard to applying the Guiding Principles to asset classes, it is important to understand what those asset classes are: Equities (stocks), debt (bonds), real estate, alternative investments (hedge funds, derivatives) as well as an array of other investment vehicles. Within each of these broad classes is any number of sub-classes of investments. For example, real estate includes direct ownership of domestic and/or foreign land, agricultural and commercial property financing, infrastructure investments and the like. In addition, indirect ownership through pooled investments and by other means must be added to the mix. Each of the other asset classes also has many specific types of investments within those categories. This makes the task of applying the U.N. Guiding Principles much more difficult and time consuming since different approaches to human rights due diligence is required for each of these different kinds of investments.

An Assessment Methodology

To simplify this process, we propose a methodology for addressing human rights due diligence for institutional investors. First, investors must look at how their service providers address human rights as part of their investment decision-making. Second, specific due diligence approaches to the broad classes of investments must be developed, if for no other reason than to begin a discussion about the application of a human rights rubric to a range of investment products. This approach is implicit in the analysis laid out by the Thun Group paper and is expanded upon below.

With regard to applying a human rights due diligence framework to the selection of investment management professionals, institutional investors face a seemingly intractable problem. This problem is manifested in part by investors’ fiduciary duty to the beneficiaries of the investments made on behalf of the institutional investor (pension beneficiaries, mutual fund share owners, etc.). The concept of fiduciary duty has been the subject of many years of debate with the predominant view being a vary narrow reading that can be summarized in the phrase, “maximizing investor return.” What this means in practice is that advisors to institutional investors argue that the safest way to ensure that representatives of institutional investors act within legal norms is to invest in those assets that maximize a risk-adjusted rate of return for that asset class. For example, a conservatively managed pension fund containing an aging beneficiary base may not want to invest in a real estate venture in Zimbabwe with an annual rate of return of 30%, opting instead for a similar investment in real estate in New Zealand, where the estimated rate of return is much lower.

Fiduciary Duty vs. the Responsibility to Protect

The practical reality is that institutional investors, saddled with the responsibility to act prudently with respect to their investment decisions at the risk of personal liability will more often opt for the safer investment route. In addition, their investment managers, investment consultants, legal counsel and other professional advisors all approach the investment decision in s similar narrowly defined fashion. That is not to say that specific investment advisors do not consider other factors. Examples abound with regard to socially responsible investors who consider non-financial factors in their investment decisions but do so up front and with the understanding that investor rates of return will reflect for these additional considerations. However, the predominant approach with regard to fiduciary duty is the more narrow view.

With regard to investment managers, they are also constrained by pressures from a variety of constituents, some of who are not concerned about human rights as part of their investment decisions. In addition, many investment managers are part of larger financial institutions that provide a range of services to an array of clients, including the very companies that they invest in through various means: equities, debt instruments, capital lending and so on. This mix of client interests and pressures places investment management professionals in a quandary. As one senior manager at a prominent Wall Street firm once told me, “I don’t want to read about my investment decisions on the front page of the New York Times.”

From an investor perspective, applying the UN Guiding Principles to their investments is a complex exercise and cannot be effectively done within the operational and financial constraints of the institution. However, this problem is circumvented in other contexts through the development of guidelines that their investment professionals are obliged to address as part of their investment responsibilities. For example, with the growing concern by investors that they must address a range of corporate governance issues by way of voting their proxies received through their equity holdings, Proxy Voting Guidelines[2] have been developed that set forth a range of policies for voting proxies in a variety of circumstances, e.g. executive compensation, social responsibility, director elections, and so on. An analogous approach could be taken by requiring that investment management firms establish human rights policies with an accompanying demonstration of operationalizing those principles within the company.

Asset Class Guidelines

A more significant challenge faces institutional investors when they try to apply the UNGPs to specific asset classes. Here, institutional investors, along with investment management professionals and human rights and business experts must come together and begin to develop asset-specific approaches to the application of the UN Guiding Principles.

Applying the Guiding Principles to specific asset classes won’t be easy but there are a few starting points for moving this effort forward. For example, investors should require their equity managers to evaluate the policies established by their portfolio companies with respect to human rights due diligence. While investment managers may be constrained in their buy/sell decisions to include human rights policies as part of the decision-making, the managers should report back to their investor clients whether those policies are in place for the equities held in the client portfolios. Extending this precatory approach to other asset types, institutional investors can begin to send a message to their clients, industry and to the capital markets that human rights considerations are on the rise as part of their overall investment processes.

[1] See also, Domiano De Felice, Banks and Human Rights: The Thun Group and the UN Guiding Principles on Business and Human Rights, 2014, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2477126, which is a critique of the Thun Group paper.

[2] As an example, see Glass Lewis & Company, Guidelines: 2015 Proxy Season, 2014, http://www.glasslewis.com/assets/uploads/2013/12/2015_GUIDELINES_United_States.pdf.