PRI guidance on human rights

A regular briefing for the alternative asset management industry.

The responsibility of investors for the environmental and social harms caused by their investee companies is a hot topic. Increased reporting obligations, driven by regulators and end-investors, often reveal issues that demand a response. Meanwhile, debates rage at EU-level about how to include the financial sector in the CS3D, a law that will require many companies to identify and mitigate harms in their own operations and in their value chains.

But the evolving European laws – and, indeed, the international standards that underpin them – are not always clear about what is required from investors, especially those with controlling stakes or significant influence.

Private equity investors are clearly in a different position to investors in public markets, who typically have relatively little leverage over their investees (at least if they are acting alone). On the other hand, although they may have more influence, private markets funds often invest in smaller and early-stage companies, many of which have not yet properly engaged with the sustainability agenda. That makes due diligence significantly more difficult and more expensive.

For that reason alone, publication earlier this month of PRI guidance on Human Rights Due Diligence for Private Markets Investors will be welcomed. Many private equity firms are signatories to the UN-sponsored Principles for Responsible Investment (PRI), but even those who are not are likely to find this guidance helpful. It neatly summarises the requirements of the UN Guiding Principles on Business and Human Rights, and their specific application to investors with significant influence or control.

PRI guidance

(Source: PRI, Human Rights Due Diligence for Private Markets, June 2023)

If a firm aspires to conform to the UN Guiding Principles, its starting point should be "due diligence". In this context, that means robust processes to identify and assess – on an ongoing basis – any actual or potential adverse human rights impacts in which their portfolio companies are implicated. The firm should then put in place processes that seek to prevent or mitigate any identified adverse impacts, and track and communicate those efforts, including through use of appropriate metrics. The PRI guidance provides useful assistance to a firm that is creating or reviewing such internal processes.

...there are important legal considerations for a firm that is seeking to follow the PRI's helpful guidance. Alternative asset managers must be careful not to overreach by making commitments … that they cannot or do not keep.

The guidance also emphasises the need for a public commitment to respect human rights, and makes some best practice recommendations for the way in which that commitment should be articulated.

Helpfully, the guide makes a very clear distinction between the obligations of an investor in a company, including a private equity investor with a control position, and the obligations of the company itself. The UN framework has three categories of involvement in human rights abuses: "cause", "contribute", and "directly linked". The level of involvement determines the extent to which the investor is responsible for providing a remedy for the harms caused. Generally, an investor will be "linked to" the impacts of its portfolio companies, rather than having a greater level of involvement (although that is an important factual question which should be answered based on the specific circumstances). Investors who are "linked to" adverse impacts should contribute to the "remedy ecosystem", but may not have to provide the remedy themselves.

But there are important legal considerations for a firm that is seeking to follow the PRI's helpful guidance. Alternative asset managers must be careful not to overreach by making commitments, public or otherwise, that they cannot or do not keep. With the current regulatory focus on greenwashing, it would be sensible for legal and compliance teams (and/or outside counsel) to be consulted on communications regarding the extent of a firm's involvement in portfolio company ESG performance.

There are also responsibilities to LPs that must be carefully considered. In most cases, it is the fund's investors who will bear the burden of any additional liability that the sponsor accepts, and it is therefore important that any such liability is accepted knowingly and willingly. Here there are dangers with emerging legal doctrines that might put more onus on a firm than it is willing to accept.

For example, any public policy commitment on human rights, such as that recommended by the PRI guidance, must be carefully drafted. On the whole, firms will not want to accept legal responsibility for harmful acts that are committed by portfolio companies without the investor's knowledge and consent. While the "soft law" obligations imposed by the UN Guiding Principles are important and demanding, they are not themselves intended to create legally binding responsibilities. However, some domestic courts, most notably in the UK, have looked at public statements, as well as group wide policies and internal processes, in deciding whether it might be appropriate to impose a direct duty of care on parent companies towards people or environments harmed by the actions of their subsidiaries. Private equity fund sponsors, especially those taking controlling stakes in companies in developing countries, need to keep a close eye on this emerging jurisprudence when deciding how best to conform to international standards.

Alternative asset managers active in Europe face ever-increasing pressure – from lawmakers, regulators, investors and other stakeholders – to use their leverage to influence corporate behaviour. Many are doing just that, now commonly managing funds that put sustainability at the heart of their strategy. But firms must also beware of overreaching: warm words and public declarations are important, of course, but they must be carefully calibrated to ensure that they are realistic and operationalised. False or misleading claims are dangerous, and there are clear legal and reputational risks to accepting responsibility for things that are, in fact, outside of the investor's control.

On a slightly different topic, we recently sat down with Sebastien Akbik from UNPRI to discuss how tax fits in to ESG and sustainability, and what good tax governance actually means. Listen to our podcast.