Focus on human rights a challenge in China

Human rights could be poised to challenge climate change's lock on the hearts and minds of ESG investors even as that topic has left some global retailers under pressure this year in the world's fastest-growing consumer market.

Over the past month, name-brand global retailers such as Hennes & Mauritz AB, Stockholm (H&M), and Nike Inc., Beaverton, Ore., have faced a backlash in China's huge consumer market after eschewing cotton grown in that country's Xinjiang province over concerns about forced labor involving members of China's Uyghur minority.

Against that backdrop, Principles for Responsible Investment, the London-based organization that's helped make environmental, social and governance concerns a focus for institutional investors over the past five years, announced April 12 that human rights will become a priority area for the organization in coming years — joining climate change as a focus for the high-profile responsible investment forum.

Fiona Reynolds, PRI's London-based CEO, said in an interview that over the coming five years, human rights-related questions will be added — on a voluntary basis at first but later mandatory — to the reporting framework agreed to by PRI's signatories, which number nearly 4,000 and oversee more than half of institutionally managed assets globally.

A growing number of policymakers and investors have come to understand that all ESG issues are interrelated; "you can't just do one and not the other," Ms. Reynolds said. For example, the need to shift to renewable energy from fossil fuels is urgent but understanding the social cost for workers losing relatively high-paying fossil-fuel jobs and transitioning them to similarly good-paying jobs will be key to facilitating that shift, she said.

Human rights will be the next big issue for investors, said Hortense Bioy, Morningstar Inc.'s London-based director of sustainability research. With the relentless advance of information technology, it will become ever harder for companies to ignore seamier elements of their supply chains they've managed to keep opaque until now, she said.

ESG's S pillar — including human rights, racial justice, and diversity, equity and inclusion — is where Ropes & Gray LLP, a New York-based law firm that advises companies, money managers and asset owners around the world on ESG-related issues, has seen the greatest pickup in interest among clients over the past year or two, said Michael R. Littenberg, a New York-based partner with the firm.

The decision to put a spotlight on human rights could usher in a more contentious era for an ESG movement that's gone to a mainstream focus of asset owners and managers alike from a cottage industry in recent years focusing on climate change-related issues.

The environment has led the way in bringing investors into the ESG fold, with "climate change in particular … stealing the limelight because you get consensus on climate," Ms. Bioy said.

With climate change posing an existential risk, it's been relatively easy to make the case for cooperation, agreed Joey Alcock, principal consultant and chairman of the responsible investment group with Melbourne-based investment consulting firm Frontier Advisors. Meanwhile, the environment, and climate change in particular, have proven to be fertile ground for "constructive engagement," offering win-win opportunities for companies on one side and money managers and their asset owner clients on the other to work toward better outcomes, analysts say.

Willis Towers Watson PLC's April 15 announcement that it will target net-zero greenhouse gas emissions for its $166 billion delegated investment business by 2050 and a 50% reduction by 2030 offers a taste of the dynamics that have made climate-related action mainstream, with Craig Baker, the firm's global chief investment officer, noting that being ahead of the curve on a low-carbon transition will "significantly improve risk-adjusted returns for our clients ... (and) be one of the biggest sources of alpha across all asset classes" in coming years.

By contrast, the S or social pillar that includes human rights is "wrapped up in differences of cultures, values and ethics" — both more granular and more localized, Mr. Alcock said.

PRI's announcement that human rights will become a priority, meanwhile, comes as the brickbats being thrown at global retailers on the Chinese mainland raise the prospect that foreign companies assiduously adhering to ESG standards and reporting on their activities, as organizations such as PRI call for, could be putting their access to the world's fastest-growing market at risk — a threat, analysts say, that could dent ESG momentum even if it's unlikely to derail it.

Some observers — noting that instances of global companies ruffling the feathers of overseas consumers and seeing their business suffer temporarily as a result are nothing new — predict the current brouhaha on the mainland could follow that pattern. "It's not the first time" Chinese nationals have launched boycotts, and Korean brands, Japanese brands and Australian suppliers have all been targets in the past, noted Robin You, a Hong Kong-based senior investment analyst with investment consulting firm RisCura Holdings (Pty) Ltd. "It comes and goes in a few months," he said.

Others say growing geopolitical tensions between China and the U.S., technological advances such as the spread of social media and the importance of online sales could make the current backlash by Chinese consumers trickier to defuse, with little or no scope for the kind of constructive engagement that's animated climate-related issues and even other social issues widely viewed as problematic, such as child labor.

The aggressive pushback now on the mainland against these foreign companies' sustainability statements or credentials "is pretty unchartered territory," with the potential to impose more damage on their businesses in China than previous boycotts have, said a Hong Kong-based ESG executive with one global money manager, who declined to be named.

It's a sort of "rock and hard place" situation with "one cohort of your customers — and your growth option — telling you that you're crazy and ... being really rude and misrepresenting what's going on ... and another set of your customers and NGOs in markets that you're listed in telling you that it's potentially genocide and that you're participating in slave labor and having goods blocked from coming into the U.S. as a result of these sorts of things," the executive said.

In this instance, threading the needle "is going to be very, very tough," agreed Frontier's Mr. Alcock. "The (Chinese) consumers who are boycotting the Western brands, for whatever reason, are stating that the reasons why those companies are not buying the cotton are erroneous," lies and conspiracies, he said.

Market participants predict the fireworks of the past month or so should eventually recede but they add that how the foreign companies being targeted now can get there from here remains considerably murky.

The collision of ESG with geopolitics in China last month won't necessarily be a game changer but it could prove to be a key case study — part of the "bumps and turns and learnings" that will accompany the continued embrace of ESG, Mr. Alcock said.

While some elements of the latest news about foreign companies grappling with human rights issues in China point to a "new dynamic" in terms of the level of engagement by state and local actors, navigating labor challenges around the globe is not new and tensions vis-a-vis China are unlikely to derail the takeup of ESG by companies, money managers and asset owners, Ropes & Gray's Mr. Littenberg said.

Still, as clients get further up the curve on ESG, they've come to realize it's "more complex than they originally thought it was, especially around social issues," Mr. Littenberg said. "Our advice is these are issues that are nuanced, complex, likely to be managed over the course of many years," he added.

PRI's Ms. Reynolds acknowledged the potential conflicts a greater focus on human rights could create but called the decision to move forward unavoidable.

"We're not pretending it's going to be easy," she said, or that "every investor will be, by the end of next week, expert in human rights." That's why PRI is rolling out a five-year program designed to help investors understand their role in the area of human rights, including how to report about their decisions in that sphere, she said.

Despite the challenges that could come from focusing more on issues such as modern-day slavery, estimated to affect a record 40 million people around the globe at present, Ms. Reynolds predicted the broader momentum ESG has experienced in recent years should continue.

Market participants likewise expect investors to continue embracing ESG factors, even if the near-term outlook for the Chinese market could be a distraction.

There'll be controversial issues that prove challenging but the only way forward is "to start the momentum and deal with the issues as you're going along," Ms. Reynolds said. After all, even five years ago a lot of people were still insisting that investors had no important role to play in combating climate change and now "it's considered completely mainstream," she said.