Aligning ESG Approaches with Human Rights: A Call to Action for Investors
By Aditi Rukhaiyar, Program Associate, Investor Alliance for Human Rights
Background: To foster alignment of Environmental, Social, and Governance (ESG) approaches in the financial sector with the UN Guiding Principles on Business and Human Rights (UNGPs), the UN Working Group on Business and Human Rights (UNWG) released a report on Investors, ESG, and Human Rights in June of this year. (An Executive Summary is available here). This report is the outcome of a series of regional consultations across multiple geographies as well as inputs from investors, civil society, and other stakeholders. To help ensure the report reflected a wide range of perspectives, the Investor Alliance for Human Rights co-organized two consultations in October and November 2023 with investors of different asset classes in North America. The goal of these consultations was to gather insights on ESG approaches in the context of financial products and services and how these incorporate human rights frameworks. The Investor Alliance also contributed with its own submission.
The Disconnect Between ESG and Human Rights
In the evolving landscape of ESG investing, the responsibility of institutional investors to respect human rights remains a pressing issue, and one that is increasingly legislated. Investors must be aware of these responsibilities and take decisive actions to integrate human rights considerations into their ESG strategies and portfolio management. This is crucial for an effective alignment with the UNGPs to ensure that investment activities respect people and the planet while still achieving positive returns and creating long-term company value.
The use of various ESG approaches is becoming more widespread but there remains a significant disconnect between human rights standards and ESG criteria. The UNWG notes that this gap often stems from the misunderstanding that environmental, social, and governance indicators alone sufficiently capture human rights issues. However, the report states that human rights considerations are frequently overshadowed by short-term financial priorities, mistakenly viewed as the sole focus of investors’ fiduciary duties. Rather, the focus should be on "double materiality", as codified in European regulation, which entails the consideration of “impact materiality” in addition to “financial materiality”. Investors must recognize that business impacts on people and the environment shape longer term societal-wide sustainability perspectives and in turn the value of companies.
Typically, investors rely on corporate disclosures, media and civil society reports, and commercial data providers to identify human rights impacts within their portfolios. During consultations with the UNWG, investors also highlighted that they use research and benchmarks published by non-profit organizations that assess companies’ human rights performance. This includes the Corporate Human Rights Benchmark and the Ranking Digital Rights scorecards, for engagements with investee companies such as those coordinated by the Investor Alliance. However, the consulted investors emphasized the need for increased capacity-building coupled with more comprehensive and decision-useful information to enable effective assessment of companies’ human rights impacts.
The UNWG reiterated that the lack of sufficient information leads investors to have an incomplete understanding of how their investments align with the UNGPs. The reliability of ESG scores is compromised by the issue of aggregation across the E, S, and G pillars, which allows a company to achieve an overall higher score by offsetting weaker performance in one pillar with stronger performance in another. The problem of lack of reliable data is also exacerbated by focusing on how ESG factors impact companies rather than how companies affect human rights, impacted communities, other stakeholders, and the environment. Therefore, there remains a significant need for more detailed and actionable data from investees on human rights and ESG alignment. Several investors collaborated in 2023 to launch the Investor Initiative on Human Rights Data to engage with ESG data providers and proxy advisors to support investors with stewardship and voting using better corporate human rights data. The UNWG recommends that investors advocate for improved ESG data quality and transparency from data providers, index compilers, and professional advisors.
“The problem of lack of reliable data is also exacerbated by focusing on how ESG factors impact companies rather than how companies affect human rights, impacted communities, other stakeholders, and the environment.”
Investor Leverage and Accountability: Human Rights Due Diligence
The UNWG lays emphasis on the responsibility of investors to respect human rights by avoiding causing or contributing to adverse human rights impacts, including those that are directly linked to their operations, products, or services. This responsibility is enshrined in the concept of human rights due diligence, which is distinct from traditional business due diligence by focusing on the impacts on people and the planet.
Human rights due diligence is not a one-time process but involves ongoing impact and risk assessments and mitigation, stakeholder engagement, monitoring, and communication. Amongst other resources, the report highlights the Investor Alliance’s Investor Toolkit on Human Rights that provides investors with ready-to-use guidance, practical tools, and illustrative case studies to address human rights impacts by implementing their responsibility to respect human rights throughout the investment lifecycle. The UNWG points out that vulnerable groups and gender-based impacts must be given special attention while conducting human rights due diligence.
The UNWG recommends that investors engage with their portfolio companies to ensure they have human rights policies and practices aligned with the UNGPs. Failing to do so risks shifting their involvement from being indirectly linked to human rights harms to directly contributing to them. Therefore, the UNWG specifically highlights that the investors’ responsibility to respect human rights extends to participating in the provision of effective remedies for adverse impacts. For that, investors must engage directly with affected stakeholders to understand and address these impacts effectively. Investors should also establish or participate in operational-level grievance mechanisms. Encouraging investees to publicly disclose their grievance mechanisms and efforts to provide access to remedies is considered best practice by the UNWG, particularly within ESG or sustainability approaches. Transparency is key here. Investors should publicly share outcomes of their leverage efforts and stewardship activities, even if these fall short of the desired results.
Specifically, in high-risk and conflict zones, investors must demand evidence from companies of their processes to identify impacts on both human rights and conflict dynamics in these regions. In response to the growing investor interest for tailored support and collaborative risk identification and management with civil society allies, the Investor Alliance launched with Heartland Initiative and PeaceNexus a pilot project, Investor Engagement on Conflict-Affected and High-Risk Areas, to support a group of investors in undertaking heightened human rights due diligence (hHRDD) of their investments in conflict-affected and high-risk areas (CAHRAs). By prioritizing actions based on the severity and likelihood of impacts, investors can ensure that their operations and those of their investees are aligned with human rights standards.
The Future of ESG and Human Rights Integration
Significant progress has been made in raising investor awareness about integrating human rights into ESG approaches. However, a more coherent and global response is urgently needed to ensure that investment practices effectively align with the UNGPs especially because the social impacts prioritized by ESG investors often occur globally. Despite some positive steps in the European Union, the regulatory attempts to bridge the disconnect between ESG and human rights have been somewhat fragmentary. The exclusion of the downstream activities of financial institutions in the Corporate Sustainability Due Diligence Directive reflects this disconnect. In the United States, the ongoing backlash against ESG investing presents additional challenges.
“...a more coherent and global response is urgently needed to ensure that investment practices effectively align with the UNGPs especially because the social impacts prioritized by ESG investors often occur globally.”
Looking forward, strong stakeholder demand for corporate engagement on ESG issues, along with expanding global legislation in support of sustainable investing, suggests that human rights considerations should become a critical component of both investors' and companies' long-term strategies. To support this, the UNWG recommends that the UN and other international bodies provide practical guidance for the financial sector to better align ESG approaches with human rights principles. Finally, the UNWG also endorses the critical role played by civil society, academia, and other stakeholders in educating investors on the importance of human rights integration, ensuring continued progress despite challenges.