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What do the UN Global Compact Principles mean for investors?

Please see the below article that we received from fund managers Quilter Investors yesterday afternoon:

With climate-related risks and environmental challenges seemingly at the forefront of investors’ minds, it’s important that all those involved in the investment industry adopt a broad approach when assessing the major risks facing corporate sustainability today. This should include human rights abuses and forced labour and corruption, as risks to corporate sustainability affect not only shareholders and bondholders but also other stakeholder groups including customers, suppliers and employees.

The UN Global Compact is one of the many tools that can help investors assess threats to sustainable business across the companies in which they invest.

The UN Global Compact – what is it?

Launched in 2000, the UN Global Compact is the world’s largest corporate sustainability initiative aimed at promoting corporate sustainability and encouraging innovative solutions and partnerships through 10 guiding principles.

The UN Global Compact supports companies in responsibly aligning their strategies and operations, in addition to helping them to advance broader societal change, through initiatives such as the UN Sustainable Development Goals.

It also sits alongside the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises, which is another voluntary initiative to support sustainable business.

The UN Global Compact’s principle-based framework is broadly split into four key areas – human rights, labour, environment and anti-corruption – to help guide businesses in their activities in these areas. The framework is derived from numerous international declarations for companies and countries, such as the Universal Declaration of Human Rights and the Rio Declaration on Environment and Development.

The 10 Principles

Human Rights

  • Principle 1: Businesses should support and respect the protection of internationally proclaimed human rights.
  • Principle 2: Businesses should make sure that they are not complicit in human rights abuses.

Labour Standards

  • Principle 3: Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining.
  • Principle 4: Businesses should uphold the elimination of all forms of forced and compulsory labour.
  • Principle 5: Businesses should support the effective abolition of child labour.
  • Principle 6: Businesses should uphold the elimination of discrimination in respect of employment and occupation.

Environment

  • Principle 7: Businesses should support a precautionary approach to environmental challenges.
  • Principle 8: Businesses should undertake initiatives to promote greater environmental responsibility.
  • Principle 9: Businesses should encourage the development and diffusion of environmentally-friendly technologies.

Anti-corruption

  • Principle 10: Businesses should work against corruption in all its forms, including extortion and bribery.

Protection of human rights

Principles one and two relate to the importance of businesses to both support the protection of human rights and ensure that they are not complicit in human rights abuses.

A company that may be deemed to be in violation of the human rights principles could have revenue exposure to jurisdictions or authoritarian governments where human rights abuses are prevalent.

These companies are frequently flagged across emerging markets. For instance, an Indian port infrastructure company was flagged for being in violation of the principles given its financial ties to the Myanmar military.

However, a violation of the principles can be more explicit than this. For example, an Asian engineering and construction company was recently deemed to be non-compliant following a collapsed dam in Laos resulting in fatalities and the displacement of local communities.

Human rights is one of the main areas where investors can see which companies violate the UN Global Compact. It poses a higher risk across sectors such as aerospace and defence where businesses may be involved in the manufacture of controversial weapons.

The UN Global Compact is one of the many tools that can help investors assess threats to sustainable business across the companies in which they invest.

Labour best practice

Principles three, four, five and six are concerned with how sustainable businesses should uphold the effective recognition of the right to collective bargaining, eradicate all forms of forced (including child) labour and eliminate occupational discrimination.

Companies tend to fall foul of these principles less commonly. Following an investigation by Norway’s Council on Ethics, the forced labour risk has been particularly high in the Middle East over recent years. Migrant workers coming from India, Pakistan and Nepal face little hope of paying off the debt they owe to ‘recruitment agencies’ who have charged workers a fee for access to jobs in countries such as Qatar and the UAE.

As a result, there has recently been significant reputational damage to companies allegedly practicing forced labour in the Middle East.

Environmental responsibility

Principles seven, eight and nine provide guidance on how businesses should consider the negative impact of environmental damage, as well as the cost to a company’s reputation should a negative environmental event occur.

The principles also encourage investment in research and development around the long-term benefits of environmentally-friendly technologies.

Companies that are commonly deemed to be in violation of the environmental principles operate across the materials and utilities sectors.

For instance, an Indonesian aluminium business was found to be non-compliant given its interests in a mine that uses riverine tailings disposal (using rivers for mine waste disposal), a practice banned in many countries due to its severe environmental impacts.

Only four mines in the world engage in riverine tailings disposal, and in the case of this business, the mine in question has impacted one of the world’s most bio-diverse regions, Lorentz National Park, a UNESCO World Heritage Site.

Anti-corruption guidance

Principle 10 targets corruption in all forms, including extortion and bribery. The financial services sector is a particularly high-risk area of the market for exposure to corruption, specifically in relation to failings in anti-money laundering procedures.

Money laundering scandals have thrown the spotlight on the major Nordic banks in recent years, particularly those with exposure to the Baltic region, which has been beset by allegations of financial crime.

Our Comments

We have written about these UN Global Compact Principles in the past.

This is one of the key ESG processes that investment managers use to form their ESG screening process in relation to sustainable investments.

These principles are the foundation for investment firms who wish to bring ESG on board within their investments.

The main 2 methods of screening that investment managers use to assess whether or not the companies they choose to invest in are considered compatible with the 10 principles are positive and negative screening. Some firms go above and beyond this and look deeper, some use a combination of both.

Positive Screening is Investment in sectors, companies or projects selected for positive ESG performance in comparison to industry peers. This involves selecting firms that show examples of environmentally friendly and socially responsible business practices. This also includes avoiding companies that do not meet certain ESG performance thresholds.

Negative Screening is the exclusion from a fund or certain sectors or companies involved in activities deemed unacceptable or controversial (e.g. tobacco, arms, gambling etc). This involves avoiding companies that create negative impacts considered incompatible with the UN Global Compact Principles.

Just using these screening methods isn’t enough to ‘change the world’ so to say. It’s important that fund managers engage with the firms they are investing in, to challenge their practices to move them further along the ESG journey and ensure they are adhering to the UN principles.

ESG investing is still a new world, however, since we first started talking about it over a year ago, the ESG landscape has already moved forward, and fast.

We have more of our clients now engaging and starting the discussions around ESG and sustainable investing.

Interestingly, we listened to a compliance update earlier this week from our compliance partners, Paradigm. In this update there was a comment made that the view from MSCI is that they believe that clients will have to opt out of ESG investing in the future, rather than opt in, as they do now.

This supports the view we have had for a while now, that ESG investing will become the new normal.

Andrew Lloyd DipPFS

24th September 2021

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Sustainable fashion: Why it matters, and how to identify the winners

Please see the below article from JP Morgan received yesterday, 26/04/2021:

The concept of sustainability is rapidly rising up the agenda within the fashion industry. Yet while consumers are increasingly interested in sustainable fashion, they are not willing to pay a premium for it. Still, sustainability can be a competitive advantage. We have seen companies delivering a sustainable message, but identifying the true leaders from the potential greenwashing takes research.

Consumers care about sustainabilty, but not at any price

As the global population grows, the negative environmental impacts of our demand for fashion are becoming more apparent. The industry is responsible for 10% of global carbon emissions and 20% of global wastewater, as well as producing significant amounts of waste. The equivalent of one garbage truck of textiles is dumped in landfill or burned every second.

75% of consumers view sustainability as ‘extremely’ or ‘very important’ in their fashion purchasing decision. And over 50% of consumers would switch for a brand that acts in a more environmentally and socially friendly way. But in practice, are consumers really willing to pay? Not yet, it seems. Only 7% of consumers say sustainability is the most important factor in their decision making.

Exhibit 1: Consumers care about sustainabilty, but not at any price – most important factors in decision making

Consumers continue to rate ‘high quality’ and ‘good value for money’ as the most important factors in their decisions. This is backed up by our engagements with fashion companies, who claim that consumers are not willing to pay a premium for sustainability, although at the same price point they would choose the more sustainable offering.

To us, this signals that consumers have a preference for sustainability and it can be a competitive advantage for retailers. But companies need to see it as a way to maintain or grow their market share rather than a way to increase prices. Sustainable leaders should be investing in innovation and scale for sustainable solutions to bring prices down and maintain their brand position.

Case study 1

Re:NewCell: Driving down costs for sustainability in fashion

Re:NewCell is a Swedish company driving down the costs of sustainable materials through innovation. The company has developed and patented Circulose, a high quality material made from recycled clothes. We expect Circulose – which has already been adopted by the likes of H&M and Levi’s – to see increasing uptake within the fashion industry, helping to lower the cost of sustainable materials and improve the industry’s environmental footprint.

Case study 2

Adidas: Leading the charge on sustainability

Adidas, the well-known sportswear brand, is at the forefront of sustainability within the fashion industry. The company particularly stands out on circularity, which is embedded in its strategic priorities: by 2024, Adidas has committed to replace virgin polyester with recycled polyester. The company already partners with the environmental organisation Parley for the Oceans to use recycled polyester made out of plastic collected from the coastline. All of Adidas’s cotton is sustainably sourced via the Better Cotton Initiative, earning Adidas the top spot in a 2020 independent ranking on sustainable cotton sourcing. Adidas has committed to reducing greenhouse emissions across its entire value chain by 30% between 2017 and 2030, and then achieving climate neutrality by 2050. As a further validation of Adidas’s sustainability efforts, these goals were submitted for external verification by the Science Based Target initiative in February 2020.

Sources: Adidas and the Sustainable Cotton Ranking 2020 (77 companies).

The companies above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell.

Distinguishing the real from the fake

The fashion industry is highly fragmented, and sustainability standards are still in their infancy. More and more companies are reporting on both their environmental and social impacts. But with different companies focusing on different disclosures, metrics and measurement methodologies, how can we identify the best? For us, fundamental research and company engagement are key, allowing us to assess whether fashion brands are paying lip service to sustainability or whether they are truly committed to it.

What do we look for in a sustainable fashion leader? 

  • Has the company signed up to measurable targets to reduce its negative environmental footprint?
  • Is the company abiding by external certifications to demonstrate the sustainability of its products?
  • Is the company accurately measuring and reporting its entire carbon footprint?

The last of these requires particular research focus as only about 5% of a fashion retailer’s carbon footprint comes directly from its own operations (scope 1 emissions) or indirectly from generating the energy used by the company (scope 2). The vast majority of carbon emissions occur in the company’s value chain (scope 3). This includes production, processing and transportation of fibres and fabrics, transportation of the end product to its final destination, and emissions related to use, care and disposal. Unsurprisingly, this complexity means that emissions are currently underreported, with many companies only reporting on transportation of the end product. Fundamental research is therefore key to understand the supply chain picture and determine what companies are really doing to reduce their total emissions.

Conclusion

While price sensitivity remains key for consumers in the fashion industry, evidence points to sustainability becoming more important in purchasing decisions and ultimately to long-term brand value. This implies a material opportunity for sustainable leaders to stand out while unsustainable fashion brands lose out. Yet the potential for greenwashing is rife in the industry, making it difficult to distinguish between leaders and laggards in the transition to sustainable fashion. Company research and engagement is key.

Our Comments

This is another example of sustainability and ESG themes filtering down to everyday life.

The fashion industry, particularly the problematic ‘fast fashion’ companies seem to hit the headlines on a regular basis for all sorts of issues, from waste to poor working conditions so the sustainability of the fashion industry is starting to be questioned more often.

With fund managers now also becoming increasingly more concerned with ESG and sustainability issues, the fashion industry will have to also adapt to these changes in the way consumers and investors are thinking and what it is they are looking for when investing or purchasing their products.

Shopping for items such as clothes became pretty much an online only occurrence for a large proportion of the past 13 months, I have myself noticed that sustainability is being used a selling point, whether it be statements on the companies website or even noted in the products description. Some companies plant a tree for every item of clothing purchased.

As this article highlights, a lot of people would consider switching to more environmentally and socially friendly brands, but they may not be willing to pay an extra premium for it. Personally, I don’t think it will be long until paying extra won’t be an issue, as the world changes and now has ESG principles under a microscope, these companies will have to adapt to remain competitive in the marketplace.

From a personal experience perspective, I recently purchased an item of clothing having no idea it was part of a ‘sustainable’ line until I was checking the label for the washing instructions only to find out that the item was made out of 100% recycled plastic bottles and textile waste that had been processed and melted down into new fibres in an effort to save water, energy and reduce greenhouses gases.

The item was no more expensive than a ‘non sustainable’ item and the quality was probably better than products that use ‘virgin’ or non-recycled materials.

As consumers, if you don’t have to compromise on cost or quality, then why wouldn’t you choose more sustainable options?

Andrew Lloyd

27/04/2021