CFA Certificate in ESG Investing Curriculum 2023 PDF

© CFA Institute. For candidate use only. Not for distribution. CHAPTER 4 Social Factors LEARNING OUTCOMES Mastery The candidate should be able to: 4.1.1 explain the systemic relationships and activities between business activities and social issues, including: globalization; automation and artif...

© CFA Institute. For candidate use only. Not for distribution. CHAPTER 4 Social Factors LEARNING OUTCOMES Mastery The candidate should be able to: 4.1.1 explain the systemic relationships and activities between business activities and social issues, including: globalization; automation and artificial intelligence (AI); inequality and wealth creation; digital disruption, social media, and access to electronic devices; changes to work, leisure time, and education; changes to individual rights and responsibilities and family structures; changing demographics; urbanization; and religion 4.1.2 assess key megatrends influencing social change in terms of potential impact on companies and their social practices: climate change; transition risk; water scarcity; pollution; mass migration; and loss and/or degradation of natural resources and ecosystem services 4.1.3 explain key social concepts, including: human capital: development, employment standards, and health and safety; product liability/consumer protection: safety, quality, health and demographic risks, and data privacy and security; stakeholder opposition/controversial sourcing; social opportunities: access to communications, finance, and health and nutrition; social and news media; animal welfare and microbial resistance 4.1.4 assess material impacts of social issues on potential investment opportunities and the dangers of overlooking them, including: changing demographics; digitization; individual rights and responsibilities; family structures and roles; education and work; faith-based ESG investing and exercise of religion; inequality; and globalization 4.1.5 identify approaches to social analysis at country, sector, and company levels 4.1.6 apply material social factors to: risk assessment; quality of management; ratio analysis; and financial modeling 228 Chapter 4 © CFA Institute. For candidate use only. Not for distribution. 1 INTRODUCTION TO SOCIAL FACTORS 2 SOCIAL AND ENVIRONMENTAL MEGATRENDS Social Factors Social factors are relevant from both a business and an investment perspective and are increasingly being factored into investment analysis and investment decisions. In many cases, investors expect companies to manage these issues by using a best-in-class approach, whereby a company is better than its peers on a number of material issues relevant to its sector (e.g., occupational health and safety or managing its impact on local communities). In other cases, a social issue can become the focus of an investable opportunity (e.g., gender equality funds). Companies are increasingly expected to engage with their stakeholders openly, transparently, and responsively. This chapter first gives an overview of various social factors and their material impact on potential investment opportunities. It then outlines the most relevant social megatrends, highlighting their relationship with business activities and investment opportunities. Descriptions are then provided of how to identify and apply material social factors, focusing on social analysis at country, sector, and company levels in both developed and emerging economies. Finally, all the above-mentioned topics are practically applied in case studies. 4.1.1 explain the systemic relationships and activities between business activities and social issues, including: globalization; automation and artificial intelligence (AI); inequality and wealth creation; digital disruption, social media, and access to electronic devices; changes to work, leisure time, and education; changes to individual rights and responsibilities and family structures; changing demographics; urbanization; and religion 4.1.2 assess key megatrends influencing social change in terms of potential impact on companies and their social practices: climate change; transition risk; water scarcity; pollution; mass migration; and loss and/or degradation of natural resources and ecosystem services Investors need to note the different social megatrends that could have an effect on the businesses of the investee companies. This section looks at the systemic relationships between these social megatrends and business activities of the investee companies, and it elaborates on the material impacts of these trends on potential investment opportunities. What Are Social Megatrends? Social megatrends are long-term social changes that affect governments, societies, and economies permanently over a long period of time. The following megatrends will be described in this section: A. Globalization B. Automation and artificial intelligence (AI) C. Inequality and wealth creation © CFA Institute. For candidate use only. Not for distribution. Social and Environmental Megatrends D. Digital disruption, social media, and access to electronic devices E. Changes to work, leisure time, and education F. Changes to individual rights and responsibilities and family structures G. Changing demographics, including health and longevity H. Urbanization I. Religion Some environmental megatrends have a severe social impact as well. These include the following: ► Climate change and transition risks ► Water scarcity ► Mass migration All of these could, in an extreme case, result in mass migration. These social megatrends will change the way we live, work, consume, and perceive the world and, as such, will pose new risks or opportunities for investors. Next, we will look at each of these megatrends in further detail. Globalization One of the biggest megatrends is the integration of local and national economies into a global (and less regulated) market economy. The growth in global interactions has increased international trade and the exchange of ideas and culture. This process is also called globalization. Globalization is caused by a rapid increase in cross-border movement of goods, services, technology, people, and capital. Depending on the viewpoint, it can be viewed as either a positive or a negative phenomenon. On the one hand, it is stated to have led to increased efficiency in the markets, resulting in wider availability of products at lower costs. On the other hand, it is claimed to be detrimental to social well-being due to social structural inequality. Examples of its implications include the following: ► ► Offshoring. Due to the lower wages of workers in the garment industry in developing countries, clothes are now mainly produced in such countries as Vietnam, Bangladesh, and China. This has led to the disappearance of the textile industry in Western countries. Offshoring also takes place in other sectors. Dependency. As US-based and Asian companies dominate the industry for mobile telephones, computers, and other IT products, European countries are more dependent on these suppliers. Automation and Artificial Intelligence (AI) Linked to the increased economic globalization is the trend of automation, which is the technology by which a process or procedure is performed with minimal human assistance. Some of the biggest advantages of automation in industry are that it is: a. associated with faster production and lower labor costs; and it b. replaces hard, physical, or monotonous work. The largest (social) disadvantage, however, is that it displaces workers due to job replacement, as technology renders their skills or experience unnecessary. It is expected that this trend will increase due to the rise of AI. 229 230 Chapter 4 © CFA Institute. For candidate use only. Not for distribution. Social Factors AI is expected to have a significant effect on such sectors as: a. healthcare; b. automotive; c. financial services and auditing; d. security (including military); and e. creative (in particular, advertising and video games). EXAMPLE 1 Implications for Investors The transportation industry is currently on the brink of becoming more automated, and it is expected that some jobs for drivers (of taxis, buses, and trucks, for example) will disappear due to self-driving vehicles. This will be beneficial for companies that develop the best self-driving cars, but less so for traditional heavy goods vehicle (HGV) companies that do not innovate. One of the largest expected implications of this is that by automating the transport industry, major job losses will occur. One possible solution is to invest in upskilling staff to enable their transition to a more AI-enabled world. Investors should take this into account when assessing the risks of an investee company. Inequality and Wealth Creation The Organisation for Economic Co-operation and Development (OECD) analyzes trends in inequality and poverty for advanced and emerging economies. It examines the drivers of growing inequalities, such as globalization, skill-biased technological change, and changes in countries’ policy approaches. It also assesses the effectiveness and efficiency of a wide range of policies, including education, labor market, and social policies, in tackling poverty and promoting more inclusive growth. According to the OECD Centre for Opportunity and Equality (COPE) 2015 report, the average income of the richest 10% of the population is about nine times that of the poorest 10% across the OECD.1 This is also called economic or income inequality. There is increasing evidence that growing inequality affects economies and societies. Educational opportunities and social mobility may be reduced, resulting in a less skilled and less healthy society with lower purchasing power among the lower and middle classes. This limits total economic growth. An issue related to the topic of inequality is corporate tax strategies and whether companies are too aggressive in their tax optimization strategies. As regulators put more focus on this issue, some companies (for instance, in the technology sector) have had to pay huge fines. Others will need to adopt more conservative tax strategies in the future that will impact their bottom line. 1 The Organisation for Economic Co-operation and Development (OECD). 2015. OECD Insights: Income Inequality – The Gap between Rich and Poor. Available at: www​.oecd​.org/​publications/​income​ -inequality​-9789264246010​-en​.htm © CFA Institute. For candidate use only. Not for distribution. Social and Environmental Megatrends Digital Disruption, Social Media, and Access to Electronic Devices Another important social trend is the rise of digital disruption, which is the change that occurs when new digital technologies and business models affect the value proposition of existing goods and services. This trend is closely related to the increased automation and rise of AI discussed in sub-section B above. Some exemplary cases of disrupting companies include Amazon, Uber, and Airbnb. They have managed to enter an existing market but with different and more digital business approaches than their competitors, effectively challenging existing business models. There are opportunities for investors who are about to invest, preferably at an early stage, in such companies, although such investments can carry a high-risk profile. A related consequence of digital technologies is the huge amount of data that can be collected, stored, and processed (big data) as well as the ownership or use of the data (including data privacy, monetization of data, etc.). Big data has many opportunities, including more personalized services, products, and (health) treatments. However, controversies have arisen because some data are being used and sold in more extreme or socially unacceptable ways. Examples include social media companies—such as Facebook, Twitter, and LinkedIn—selling data for political or marketing campaigns (e.g., the case of Cambridge Analytica allegedly using Facebook data to try to manipulate elections). Due to these types of scandals, there is a debate around the growing need for regulating the industry. This can affect the profitability of these companies and should be considered by investors. Finally, electronic devices are now found everywhere. Almost everyone, both in developed and emerging economies, owns a mobile phone (in many cases a smartphone) and a tablet. The Internet of Things (IoT) is the next frontier, where semi-intelligent appliances (called ‘embedded systems’) communicate directly with each other and with the internet and make autonomous decisions. For investors, disruption represents both risks and opportunities. Analysts need to take a forward-looking approach to determine which sectors and companies will thrive and which will struggle in a digital society. Changes to Work, Leisure Time, and Education The way we spend our lives has changed dramatically over the last few decades. Various measures have emerged that aim to provide a broad sense of the state of our societies and of how people’s lives are evolving. The OECD examines issues of well-being in its Better Life Index, which rates a wide range of developed and emerging economies in a number of areas, including life satisfaction. Most countries in the developed world have seen average hours worked decrease significantly. In the UK, the average annual hours actually worked per person in employment decreased from 1,775 hours in 1970 to 1,538 in 2019.2 This is partially caused by increases in automation and part-time employment. New technologies increasingly enable workers to be connected to their work from remote locations. This creates an opportunity for employers and employees to adopt more flexible working patterns. However, the constant connection also makes the notion of work–life balance more elusive and can cause stress-related illnesses. 2 OECD. 2020. Average Annual Hours Actually Worked per Worker. Available at: https://​stats​.oecd​.org/​ index​.aspx​?Datasetcode​=​ANHRS​# 231 232 Chapter 4 © CFA Institute. For candidate use only. Not for distribution. Social Factors While the number of average working hours has decreased, the average level of education has increased. The percentage of employees with a higher education degree has grown over the last few decades. Yet, some sectors suffer from a lack of qualified employees and are facing an intense ‘war on talent’ to attract the most skilled workers. Investors who are assessing companies that rely heavily on employees as a key asset need to pay attention to those companies’ human capital management strategies. They should evaluate how the companies are coping with these structural changes in the labor market. Changes to Individual Rights and Responsibilities and Family Structures In recent decades, not only has the way we divide work and leisure time changed but also the role and importance of family (especially in developed countries). Individuals are also less reliant on the structure of the family for (economic and physical) security. The workforce has become more diverse: More women are now entering the labor market, which has provided women with more financial independence. However, in comparison to men, women are still more likely to become and remain unemployed, have fewer chances to participate in the labor force, and often have to accept lower quality jobs when they do secure employment. Women also face wage gaps in comparison to men. To improve gender equality, a number of different initiatives have been created, and there is growing evidence that a more diverse workforce leads to better (financial) results for the company. Some best-in-class funds and impact investors take diversity (gender and other types of diversity) into account in their risk analysis and stock selection. Changing Demographics, Including Health and Longevity Due to improvements made in healthcare and changes in lifestyle, life expectancy is increasing. For example, female and male life expectancy (from birth) in the United Kingdom increased by two years between 2002 and 2010 (to 78.4 years for men and 82.5 for women).3 As of 2019, this stood at 79.4 for men and 83 for women. This increased life expectancy, combined with a falling birth rate, have caused many developed countries’ populations to age. The overall median age rose from 28 in 1950 to 41 in 2015, and it is forecast to rise to 45 by 2050.4 An aging population has substantial effects on society: 1. The ratio between the active and the inactive part of the workforce drops, impacting national tax revenues and challenging pension systems, including an impact on pension pots that need to last longer. 2. Older people have higher accumulated savings per person than younger people but spend less on consumer goods, which is a business risk for some industries. In some categories, such as healthcare, expenditure rises sharply when populations age. 3 Office for National Statistics. 2018. National Life Tables: UK. Available at: www​.ons​.gov​.uk/​peoplepop​ ulationand​community/​birth​sdeathsand​marriages/​lifeexpectancies/​datasets/​nation​allifetabl​esunitedki​ ngdomrefer​encetables 4 United Nations. 2015. World Population Ageing 2015. Available at: www​.un​.org/​development/​desa/​ pd/​sites/​www​.un​.org​.development​.desa​.pd/​files/​files/​documents/​2020/​May/​un​_2015​_w​orldpopula​ tionageing​_report​.pdf © CFA Institute. For candidate use only. Not for distribution. Social and Environmental Megatrends CASE STUDIES The Impact of the Global COVID-19 Pandemic The COVID-19 pandemic is one of the largest global health, economic, and social crises in recent history. Although it affects every population segment, it is particularly detrimental to those in the most vulnerable situations, including people living in poverty, older people, people with disabilities, adolescents, and the indigenous peoples. Health and economic impacts are being felt disproportionately by poor people, particularly among the homeless as they are unable to safely shelter and are therefore highly exposed to the dangers of the virus. People without access to running water, refugees, migrants, or displaced people also stand to suffer disproportionately both from the pandemic and its aftermath. This could include limited movement, fewer employment opportunities, and increased xenophobia.5 Other impacts include the following: ► Educational: Potential learning loss may occur due to the widespread closures of schools and universities. ► Increased inequality: It has been found that low-income individuals are more likely to contract COVID-19 and die from it. This is likely because poorer families are more likely to live in crowded housing and work in low-skilled jobs, such as supermarkets and elderly care, which are deemed essential during the crisis. In the United States, millions of low-income people may lack access to healthcare due to being un- or underinsured. ► Psychological: There is a concern for a potential spike in suicides, exacerbated by social isolation due to quarantining and social distancing guidelines, fear, unemployment, and financial factors. ► Reshoring: Companies and countries may decide to reduce supply chain risk by relocating production of strategic importance back to high-wage countries.6 ► Work environment: There has been a changing demand for office buildings with increased working from home.7 Investor Initiatives: Equitable Circulation of COVID-19 Vaccines To ensure a more equitable global circulation of the COVID-19 vaccine, different investor initiatives have been launched. The pharma group Moderna faced a shareholder proposal demanding to open up its COVID-19 vaccine technology to poorer countries and requesting an explanation regarding the high prices given the amount of government assistance it had received. Another initiative concerns vaccine manufacturers being asked to increase the availability and deployment of vaccinations around the world. A group of 65 institutional investors have demanded that the global 5 United Nations. 2020. Everyone Included: Social Impact of COVID-19. Available at: www​.un​.org/​ development/​desa/​dspd/​everyone​-included​-covid​-19​.html 6 UNCTAD. 2020. How COVID-19 Is Changing Global Value Chains. Available at: https://​unctad​.org/​ news/​how​-covid​-19​-changing​-global​-value​-chains 7 Pew Research Center. 2020. How the Coronavirus Outbreak Has – and Hasn’t – Changed the Way Americans Work. Available at: www​.pewresearch​.org/​social​-trends/​2020/​12/​09/​how​-the​-coronavirus​ -outbreak​-has​-and​-hasnt​-changed​-the​-way​-americans​-work/​ 233 234 Chapter 4 © CFA Institute. For candidate use only. Not for distribution. Social Factors availability of vaccines would become part of the remuneration policy of managers and directors. In this way, investors have aimed to hold them accountable for their contribution to solving this problem. Urbanization The places where people live also change. Globally, the population has been increasingly shifting from rural to urban areas. In the 1950s, approximately 30% of the world population lived in an urban environment. This is expected to increase to 68% by 2050. This shift can have different kinds of implications for societies, including the following: ► ► ► Economic: Dramatic increases and changes in costs can often price the local working class out of the market Environmental: ‘Urban heat islands,’ where urban areas produce and retain heat, have become a growing concern. Social: There has been increased mortality from non-communicable diseases associated with lifestyle, including cancer and heart disease. Residents in poor urban areas (such as slums) also suffer “disproportionately from disease, injury, premature death, and the combination of ill-health and poverty entrenches disadvantage over time.”8 These societal implications provide business opportunities because of the growing need for infrastructure development, but they also require companies to address social and environmental issues related to urban living (for instance, pollution and waste management systems). Religion As a social factor, the changing religious landscape around the world has consequences for consumer preferences. Religion-based politics and conflicts can also have a profound impact on specific local economies. All investors (faith-based or not) should therefore judge if investee companies take these changes into account from a financial perspective. A distinction should be made between exercise of religion as a social factor and faith-based investing. Faith-based investors aim to invest their money in line with a specific named faith. The two most common types are: ► ► Christian investors, who aim to align their investment principles to the Bible. This means that they may refrain from investing in certain companies whose activities or processes are considered to not be aligned with Christian values. Islamic investors, who look to invest in line with Shariah principles. They would not invest in companies that profit from alcohol, pornography, or gambling or companies involved in pork. They will not own investments that pay interest or invest in firms that earn a substantial part of their revenue from interest. Norms-based exclusion has been one of the first environmental, social, and governance (ESG) investing instruments; many of these first movers were faith-based investors. The Church of England, the Church Investors Group, the Interfaith Center 8 International Institute for Environment and Development/United Nations Population Fund. 2012. Urbanization and Emerging Population Issues – Working Paper 7. Available at: https://​www​.unfpa​.org/​ sites/​default/​files/​resource​-pdf/​UEPI​%207​%20Tacoli​%20Mar​%202012​.pdf © CFA Institute. For candidate use only. Not for distribution. Social and Environmental Megatrends on Corporate Responsibility, and other faith-based investors continue to play an important role in ESG advocacy and company engagement and in submitting shareholder resolutions. Environmental Megatrends with Social Impact Climate change and transition risk Climate change and the neighboring effect of transition risk have social implications. A widespread call is that the transition should be a ‘just’ transition. In the process of adjusting to an economy that does not adversely affect the climate, sectors that employ millions of workers (such as energy, coal, manufacturing, agriculture, and forestry) must restructure. It is feared that the period of economic structural change will result in ordinary workers bearing the costs of the transition, leading to unemployment, poverty, and exclusion for the working class. Water scarcity Climate change has a negative impact on the availability of fresh water. Some corporations with high water usage pose a significant threat to clean and affordable water for communities. The construction of wastewater treatment plants and reduction of groundwater over-drafting appear to be obvious solutions to the worldwide problem. However, this is not as simple as it seems for the following reasons: ► Wastewater treatment is highly capital intensive, so there is restricted access to this technology in some regions. ► The rapid increase in the population of many countries makes this a race that is difficult to win. ► There are enormous costs and skillsets involved in maintaining wastewater treatment plants, even if they are successfully developed. Mass migration The scarcity of fresh water and desertification due to climate change in several emerging countries is believed to be one of the reasons for mass migration streams from developing countries to developed countries where these issues are less present. Climate change might result in an increase of ‘environmental migrants,’ with the most common projection being that the world will have 150 to 200 million climate change migrants by 2050. Pollution and loss and/or degradation of natural resources and ecosystem services Factors like pollution and land degradation can also result in stakeholder opposition, social unrest, and/or migration. Conclusion As discussed in this section, different social megatrends provide both opportunities and risks for investors and analysts. It is therefore important to be aware of these trends and take them into account when making investment decisions. More specific information on how to apply these trends to investing can be found in Section 7. The next section, Section 3, considers key social issues and business activities. 235 236 Chapter 4 3 © CFA Institute. For candidate use only. Not for distribution. Social Factors KEY SOCIAL ISSUES AND BUSINESS ACTIVITIES 4.1.3 explain key social concepts, including: human capital: development, employment standards, and health and safety; product liability/consumer protection: safety, quality, health and demographic risks, and data privacy and security; stakeholder opposition/controversial sourcing; social opportunities: access to communications, finance, and health and nutrition; social and news media; animal welfare and microbial resistance Where should investors start when implementing social factors in their investment decision? 1. A good starting point is to determine which social factors are most controversial or financially material in each industry. 2. As a next step, investors can assess how exposed certain companies are to these sector-specific social factors and if and how the company manages these risks. This might depend on their business models or on the nature and geographical location of their business operations. 3. Finally, where relevant, investors should assess critical social factors in the supply chain. It should be noted that the social elements that are considered to have the largest financial materiality depend on specific aspects mostly related to their field of industry. The Sustainability Accounting Standards Board (SASB) framework gives guidance on the financially material topics within industries. Social factors can also be categorized between those impacting external stakeholders (such as customers, local communities, and governments) and groups of internal stakeholders (such as the company’s employees). See Exhibit 1 for examples of social factors that may affect these stakeholders. Exhibit 1: Examples of Social Factors That Impact Internal and External Stakeholders Social factors that impact internal stakeholders: Human capital development. Working conditions, health, and safety. Human rights. Social factors that impact external stakeholders: Stakeholder opposition and controversial sourcing. Product liability and consumer protection. Social opportunities. Internal Social Factors © CFA Institute. For candidate use only. Not for distribution. Social factors that impact internal stakeholders: Employment standards and labor rights. 237 Social factors that impact external stakeholders: Animal welfare and antimicrobial resistance. INTERNAL SOCIAL FACTORS 4.1.3 explain key social concepts, including: human capital: development, employment standards, and health and safety; product liability/consumer protection: safety, quality, health and demographic risks, and data privacy and security; stakeholder opposition/controversial sourcing; social opportunities: access to communications, finance, and health and nutrition; social and news media; animal welfare and microbial resistance This section will provide an overview of the key internal social factors that can be of interest for investors. Human Capital Development A company’s long-term strategy should take into account the development of its workforce. This ensures that the workforce: 1. is well equipped for performing its tasks and responsibilities; 2. operates under the latest standards and regulations; and 3. remains motivated. Good human capital management generates a culture and behaviors where the workforce is positively disposed and productive, rather than taking excessive risks or harming customer relationships. It enhances social inclusion, active citizenship, and personal development while increasing competitiveness and employability. For an investor, the following business requirements could be assessed when analyzing a company on human capital development. Questions should include: Does the business… ► identify required skills or competencies to deliver on its strategy as well as identify gaps within the company and areas of skill shortage in the industry (‘war on talent’)? ► develop an attractive value proposition to attract talent as well as ways to develop competencies of internal employees to retain talent? ► develop measures to monitor its investment in human capital development (e.g., training hours, coaching) and its return on investment (key performance indicators, or KPIs, such as employee engagement, turnover, and ability to fill vacancies with internal candidates)? 4 238 Chapter 4 © CFA Institute. For candidate use only. Not for distribution. Social Factors Working Conditions, Health, and Safety One of the most widely felt social factors that has been incorporated by institutional investors is health and safety. Its focus is on protecting the workforce from accidents and fatalities. A specific subtopic is occupational health, which is about limiting workforce exposures to minimize the risk of occupational diseases (such as silicosis) or injury (for example, vibration white finger). An example of a health and safety factor can be seen in the Rana Plaza disaster, examined in the following case study. CASE STUDIES Rana Plaza Disaster On 24 April 2013, a structural failure resulted in the collapse of the Rana Plaza, an eight-story commercial building in Dhaka, Bangladesh. This resulted in a death toll of 1,134 people. Approximately 2,500 injured people were rescued from the building alive. It is considered the deadliest structural failure accident in modern human history. The building's owners ignored warnings to avoid using the building after cracks had appeared the day before. Garment workers were ordered to return the following day, and the building collapsed during the morning rush hour. The high death toll of this disaster is at least partially caused by the managers’ decision to send workers back into the factories despite knowing the risks. Managers claimed they ignored the warnings due to the pressure to complete orders for buyers on time. Some have argued that the demand for fast fashion and low-cost clothing motivated minimal oversight by clothing brands and that collectively organized trade unions could have responded to the pressure of management. This massive tragedy drew attention to pervasive human rights abuses in the garment sector, as well as the failure of the Bangladesh government and corporations sourcing there to create workplaces that respect and protect the lives of workers and mitigate the risk to companies and their investors. As a result of the Rana Plaza disaster, over 175 brands, such as Adidas, Marks and Spencer, and H&M, have signed the Bangladesh Accord,9 where they pledge to commit to higher fire and health and safety standards in Bangladesh. Led by the Interfaith Center on Corporate Responsibility, the Bangladesh Investor initiative, an investor coalition comprising 250 institutional investors and representing over US$4.5 trillion (£3.2 trillion) in assets under management, was formed in May 2013 to urge a strong corporate response to Rana Plaza, including participation in the Accord.10 Health and safety performance indicators should be assessed for both permanent employees and contractors. For example, several oil and gas companies report only fatalities of their permanent employees but not of their contractors. Given the volume of contracted workers in this sector, it is critical for investors to understand if the company is providing a safe place to work. This is particularly pertinent in emerging market extractive companies. 9 Bangladesh Accord. 2019. The Accord on Fire and Building Safety in Bangladesh. Available at: http://​ bangladeshaccord​.org/​ 10 Interfaith Center on Corporate Responsibility. 2019. Protecting Worker Rights: Garment Workers. Available at: www​.iccr​.org/​our​-issues/​human​-rights/​protecting​-worker​-rights​-garment​-workers Internal Social Factors © CFA Institute. For candidate use only. Not for distribution. Besides minimizing accidents and fatalities, health and safety has evolved a broader concept of working conditions that promotes employee well-being, as seen for instance through ergonomic workplaces and flexible working hours. The focus is also increasingly on mental health (such as burn out risks in the finance industry) and other employee benefits to promote their well-being outside of the workplace (including medical checks, gym membership sponsorship, and training programs on nutrition-related risks). Another example is “financial wellness,” which is a fairly well-established term among US employers and HR departments. Assistance with personal financial issues like personal budgeting and retirement planning/saving leads to less distracted and less stressed workers. Human Rights Another important social factor for investment professionals is human rights. These are rights inherent to all human beings, regardless of: 1. race; 2. sex; 3. nationality; 4. ethnicity; 5. language; 6. religion; or 7. any other status (e.g., age, ability, socioeconomic level, or gender identity). Human rights include the following: 1. the right to life and liberty; 2. freedom from slavery and torture; 3. freedom of opinion and expression; and 4. the right to work and education. Everyone is entitled to these rights, without discrimination. The most important foundation for international human rights is the Universal Declaration of Human Rights (UDHR). This declaration was proclaimed by the United Nations General Assembly on 10 December 1948 by General Assembly resolution 217A and is a common standard of achievement for all peoples and all nations.11 Human rights violations usually occur deep within supply chains. Companies to which major investors most often have direct exposure, and even their first and second tier suppliers, are less likely to be directly implicated in such practices. For example, in the garment industry, it is more likely that human rights violations will take place in emerging countries where clothing is produced, rather than at the stores where the clothing is being sold. However, both clients and governments expect companies to take responsibility for activities within their supply chain. UN Guiding Principles and OECD Guidelines for Multinational Enterprises There are many different guidelines with respect to human rights. However, two have a direct effect on companies and investors: ► ► The United Nations Guiding Principles on Business and Human Rights (UNGPs) The OECD Guidelines for Multinational Enterprises (MNEs) 11 United Nations. 1948. Universal Declaration of Human Rights. Available at: www​.un​.org/​en/​universal​ -declaration​-human​-rights/​index​.html 239 240 Chapter 4 © CFA Institute. For candidate use only. Not for distribution. Social Factors United Nations Guiding Principles on Business and Human Rights The UNGPs12 are a set of guidelines implementing the United Nations’ “Protect, Respect and Remedy” framework for the responsibilities of transnational corporations and other business enterprises with regard to human rights. Developed by the Special Representative of the Secretary-General (SRSG) John Ruggie, these guiding principles provided the first global standard for preventing and addressing the risk of adverse impacts on human rights linked to business activity. They also continue to provide the internationally accepted framework for enhancing standards and practice regarding business and human rights. The UNGPs encompass three pillars outlining how states and businesses should implement the framework: 1. The state duty to protect human rights 2. The corporate responsibility to respect human rights 3. Access to remedy for victims of business-related abuses OECD Guidelines for Multinational Enterprises The OECD Guidelines for MNEs are a comprehensive set of government-backed recommendations on responsible business conduct. The governments adhering to the Guidelines aim to encourage and maximize the positive impact MNEs can make to sustainable development and enduring social progress. The Guidelines are important recommendations addressed by governments to multinational enterprises operating in or from adhering countries. They provide voluntary principles and standards for responsible business conduct in such areas as: 1. employment and industrial relations; 2. human rights; 3. environment; 4. information disclosure; 5. combating bribery; 6. consumer interests; 7. science and technology; 8. competition; and 9. taxation. The study, Responsible Business Conduct for Institutional Investors,13 helps institutional investors implement the due diligence recommendations of the OECD Guidelines for MNEs in order to prevent or address adverse impacts related to human and labor rights, the environment, and corruption in their investment portfolios. It is important to note that these guidelines do not focus on the impact social factors can have on investments (financial materiality) but rather on the responsibility investors have for the adverse impacts their investments/ companies can cause to society. Nowadays, many investors are convinced that they should take ESG factors into account, but these guidelines require governments and investors to adopt a so-called double (or dual) materiality approach and take the (positive and negative) “social return on investments” into account. 12 Business & Human Rights Resource Centre. 2019. UN Guiding Principles. Available at: www​.business​ -humanrights​.org/​en/​un​-guiding​-principles 13 OECD. 2017. Responsible Business Conduct for Institutional Investors: Key Considerations for Due Diligence under the OECD Guidelines for Multinational Enterprises. Available at: https://​mneguidelines​ .oecd​.org/​RBC​-for​-Institutional​-Investors​.pdf Internal Social Factors © CFA Institute. For candidate use only. Not for distribution. The OECD guidelines and UNGPs are further backed by the European Union (EU) corporate social responsibility (CSR) strategy, its regulation on sustainability-related disclosures in the financial services sector, and its taxonomy for minimum social safeguards for sustainable activities. In the Netherlands, the government, non-governmental organizations (NGOs), and institutional investors have signed a Responsible Investment Agreement in which investors agree to adopt this double materiality approach, follow the OECD guidelines, and take responsibility to try to mitigate the negative impact of their investments.14 Corporate Human Rights Benchmark The Corporate Human Rights Benchmark (CHRB)15 is a collaboration led by investors and civil society organizations dedicated to creating the first open and public benchmark of corporate human rights performance. The CHRB provides a comparative snapshot year-on-year of the largest companies on the planet, looking at the policies, processes, and practices they have in place to systematize their human rights approach and how they respond to serious allegations. Initially, only companies from three industries — agricultural products, apparel, and extractives — were chosen on the basis of their size and revenues. The measurement themes and indicators within the CHRB provide a truly rigorous and credible proxy measure of corporate human rights performance, which can be used by analysts and investors. The themes consist of multiple questions that are listed in the report. These questions address: 1. governance and policy commitments; 2. embedding respect and human rights due diligence; 3. remedies and grievance mechanisms; 4. performance — company human rights practices; 5. performance — responses to serious allegations; and 6. transparency. Human Rights 100+ Following in the footsteps of Climate Action 100+, Principles for Responsible Investment (PRI) has recently launched a new collaborative initiative for investors to address human rights and social issues through their stewardship activities: Human Rights 100+. The initiative acts as a platform that can encompass a broad range of social issues, allowing investors to prioritize the most severe human rights risks and outcomes within their stewardship activities. It includes investor collaborative engagement with companies, along with potential further escalation where needed, and also supports investor engagement with policymakers and other stakeholders to make progress on the overall goal. Labor Rights Assessing how companies uphold labor rights is important for investors to gain insights into the corporate culture and the level of employee satisfaction. The most important labor rights have been summarized in International Labour Standards. These are 14 International RBC/SER. 2021. Agreements on International Responsible Business Conduct. Available at: www​.imvoconvenanten​.nl/​en 15 Corporate Human Rights Benchmark (CHRB). 2020. Corporate Human Rights Benchmark. Available at: www​.corporatebenchmark​.org 241 242 Chapter 4 © CFA Institute. For candidate use only. Not for distribution. Social Factors aimed at promoting opportunities for women and men to obtain decent and productive work with freedom, equity, security, and dignity. These standards are included in the eight fundamental conventions of the International Labour Organization (ILO): 1. Freedom of Association and Protection of the Right to Organise 2. Right to Organise and Collective Bargaining 3. Forced Labour 4. Abolition of Forced Labour 5. Minimum Age 6. Worst Forms of Child Labour 7. Equal Remuneration 8. Discrimination (Employment and Occupation) We will now explore some of these conventions in further detail. Freedom of Association and Employee Relations A company operates most effectively and efficiently when the workforce is positive and productive. This ensures that the costs of turnover, absenteeism, or strike actions are reduced. In order to ensure that the rights of the employees are well served, employees should have the freedom to form or join an association or a trade union that advocates for the interests of the employees. In some countries or industries this right is limited. For example, several companies within the retail industry are renowned for their anti-union stance. Walmart has been targeted by several international institutional investors to adopt a more pro-union stance. When freedom of association is established, often other labor rights violations — such as forced labor, child labor, and discrimination — are better safeguarded. The lack of freedom of association can occur directly at the level of the investee companies, but it is more likely to be an issue in companies’ supply chains. By engaging with their investee companies on this topic, investors can press for better industrial relations within a specific sector or country. Modern Slavery and Forced Labor Two topics that are less frequently mentioned in responsible investment policies are modern slavery and forced labor. Modern slavery refers to situations of exploitation that a person cannot refuse or leave because of threats, violence, coercion, deception, and/or abuse of power. This is considered to be an umbrella term encompassing such practices as forced labor, debt bondage, forced marriage, and human trafficking.16 Forced labor is defined by the ILO as: “All work or service which is exacted from any person under the menace of any penalty and for which the said person has not offered himself voluntarily.”17 Modern slavery and forced labor can take place in every kind of work or service, either in the private, public, informal, or formal marketplace, but it typically occurs in industries that are poorly regulated and where the production process requires many workers. In total, no fewer than 25 million people are estimated to be in forced labor. 16 United Nations. 2021. Slavery Is Not Merely a Historical Relic. Available at: www​.un​.org/​en/​ observances/​slavery​-abolition​-day 17 International Labour Organization. 2019. Forced Labour, Modern Slavery and Human Trafficking. Available at: www​.ilo​.org/​global/​topics/​forced​-labour/​lang​-​-en/​index​.htm Internal Social Factors © CFA Institute. For candidate use only. Not for distribution. It is often hidden away in supply chains in the second tier and beyond. Most companies that address modern slavery and forced labor, however, both start and end their due diligence by focusing on their first-tier contractors and suppliers. Beside modern slavery, forced labor can take subtle forms, which makes detecting it very difficult. The use or threat of physical violence is not essential to characterize a labor relationship as forced labor. Debt bondage, threatening to denounce a worker to immigration authorities, or the retention of identity papers can ‘force’ workers as well. The increasing complexity and international character of supply chains makes more transparency essential.18 In 2015, the Parliament of the United Kingdom adopted the Modern Slavery Act, which was designed to combat modern slavery. Further information on the UK Modern Slavery Act is provided in Section 6 of this chapter. Living Wage In sectors that employ and rely on masses of manual labor (such as the garment and footwear, food and beverage, consumer electronics, or retail sectors), wages are often insufficient to cover workers’ basic living expenses (food, clothing, housing, healthcare, and education). The benefits of paying a living wage are clear. Workers who earn a living wage can meet their own basic needs and those of their families and put savings aside, thus being more likely to find their way out of poverty. They work regular working hours instead of excessive overtime to make ‘ends meet’ and are more likely to send their children to school instead of work. In short, the focus on a living wage also advances the respect for a number of other fundamental human rights in global supply chains. EXAMPLE 2 Platform Living Wage Financials The Platform Living Wage Financials (PLWF)19 was established at the end of 2018. This is a coalition of (mainly Dutch) financial institutions that encourage and monitor investee companies to address the non-payment of a living wage in their global supply chains. The investor coalition has over €2.6 trillion (£1.9 trillion) of assets under management and uses its influence and leverage to engage with its investee companies. They: 1. measure their performance on living wage; 2. discuss the assessment results; and 3. support innovative pilots. Finally, they make sustainable investment decisions based on (the lack of ) progress subject to individual choices and policy preferences of each member of the platform. 18 Holtland, H., and A. Höften. 2018. Dutch Pension Funds and Forced Labour – Speak up. Available at: www​.vbdo​.nl/​wp​-content/​uploads/​2018/​12/​SPEAK​-UP7​.pdf 19 Platform Living Wage Financials (PLWF). 2020. Platform Living Wage Financials. Available at: www​ .livingwage​.nl/​platform​-living​-wage​-financials/​ 243 244 Chapter 4 5 © CFA Institute. For candidate use only. Not for distribution. Social Factors EXTERNAL SOCIAL FACTORS 4.1.3 explain key social concepts, including: human capital: development, employment standards, and health and safety; product liability/consumer protection: safety, quality, health and demographic risks, and data privacy and security; stakeholder opposition/controversial sourcing; social opportunities: access to communications, finance, and health and nutrition; social and news media; animal welfare and microbial resistance This section will provide an overview of the key external social factors that can be of interest for investors. Stakeholder Opposition and Controversial Sourcing When a company operates in a certain area, it should strive for good relationships with stakeholders, including its local communities. This ensures that the company can continue operating without political interference or informal protest and disruption. Companies should focus on local communities (located near companies’ operations) and recognize how they can be involved in stakeholder engagement processes to understand their needs and concerns and how these can be addressed. A way to establish bottom-up participation is to use Free Prior Informed Consent (FPIC). EXAMPLE 3 Free Prior Informed Consent A company that plans to develop on ancestral land or use resources of a territory owned by indigenous people should establish FPIC: ► ► ► Free simply means that there is no manipulation or coercion of the indigenous people and that the process is self-directed by those affected by the project. Prior implies that consent is sought sufficiently in advance of any activities being either commenced or authorized, and time for the consultation process to occur must be guaranteed by the relative agents. Informed suggests that the relevant indigenous people receive satisfactory information on the key points of the project, such as: ● its nature; ● its size; ● its pace; ● its reversibility; ● the scope of the project; ● the reason for it; and ● its duration. External Social Factors © CFA Institute. For candidate use only. Not for distribution. “Informed” is the more difficult term of the four, as different groups may find certain information more relevant. The indigenous people should also have access to the primary reports on the economic, environmental, and cultural impact that the project will have. The language used must be able to be understood by the indigenous people. ► Finally, consent means a process in which participation and consultation are the central pillars.20 Controversial sourcing is also an issue for companies, with suppliers operating in emerging economies. Companies enjoy the cheap products of their suppliers, but when the cost-driven practices of many of them in these chains come to light, there is often considerable debate over the ethics of these practices. A rather well-known example is the case of conflict minerals and blood diamonds, which are natural resources extracted in a conflict zone and sold to perpetuate the fighting. The most prominent contemporary example has been in the eastern provinces of the Democratic Republic of Congo (DRC), where various armies, rebel groups, and outside organizations have profited from mining while contributing to violence and exploitation during wars in the region. Investors should be aware of issues around controversial sourcing and stakeholder opposition because they can become a business and reputational risk for the investee company. Product Liability and Consumer Protection Consumer protection refers to laws and other forms of government regulation designed to protect the rights of consumers. It is based on consumer rights, or the idea that consumers have an inherent right to basic health and safety. These are safeguarded by: a. enforcing product safety; b. distributing consumer-related information; and c. preventing deceptive marketing. Product liability is the legal responsibility imposed on a business for the manufacturing or selling of defective goods. The laws are built on the principle that manufacturers and vendors have more knowledge about the products than the consumers do. Therefore, these businesses bear the responsibility when things go wrong (even when consumers are somewhat at fault). Product liability cases can result in civil lawsuits and lucrative monetary judgments for the plaintiffs. They can have consequences for the share price of a company if it has regular product recalls or lawsuits. Investors should take this into account in their investment analysis. There are three main types of product liability: 1. businesses being found liable to consumers when a court finds design flaws; 2. manufacturing defects; or 3. a failure to warn consumers of a possible danger.21 20 Food and Agriculture Organization of the United Nations. 2016. Free Prior and Informed Consent – Manual for Project Practitioners. Available at: www​.fao​.org/​3/​a​-i6190e​.pdf 21 Dugger, A. 2019. “What Is Consumer Protection? – Product Liability, Laws & Rights.” CLEP Introductory Business Law. Available at: https://​study​.com/​academy/​lesson/​what​-is​-consumer​-protection​ -product​-liability​-laws​-rights​.html 245 246 Chapter 4 © CFA Institute. For candidate use only. Not for distribution. Social Factors Product liability is likely to lead to reputational risks since consumers can easily express their opinions via social media or boycott the product or service when it is found to be liable. Especially around consumer products, analysts should be aware of such risks. Social Opportunities Lack of social opportunities, especially in developing countries, is an important social issue. Many of the Sustainable Development Goals (SDGs) focus around this area. The most closely linked are access to basic needs and services in different areas related to health (including water), education, energy, housing, and financial inclusion. Originally, only such specific investors as development finance institutions, NGOs, and foundations focused on these topics. For example, they invested in microfinance institutions and other impact funds to ensure that people have access to products and services related to communications, finance, and health and nutrition. However, enabling broad and affordable access to basic products and services has proved to be a good business model as well and is increasingly seen as an opportunity for both businesses and investors. This is especially true when aligning the investments with the SDG framework or trying to achieve both a financial and social return on investments. A similar tool that can be used by investors is the Access to Medicine Index. The tool analyzes how 20 of the world’s largest pharmaceutical companies are addressing access to medicine in 106 low- to middle-income countries for 82 diseases, conditions, and pathogens. It evaluates these companies in areas where they have the biggest potential and responsibility to make change, such as research and development (R&D) and pricing.22 Animal Welfare and Antimicrobial Resistance Concerns around animal welfare have become more prevalent among consumers and investors as they increasingly recognize that it is not only ethical to minimize harm caused to animals, but it is also important to understand the negative impacts on human health resulting from intensive farming practices. As a result of antimicrobial resistance (i.e., bacteria, viruses, and some parasites becoming more resistant to antibiotics, antivirals, and antimalarials), standard treatments become increasingly ineffective and infections persist, which can result in deaths and increased spread to others. A growing investor initiative that is focused and engaged on the risks and opportunities linked to intensive livestock production is Farm Animal Investment Risk and Return (FAIRR). FAIRR focuses particularly on the increased prevalence of antimicrobial resistance due to intensive farming practices and poor antibiotic stewardship. Companies operating in these ways are more likely to face lawsuits and pressures to change their practices. 22 Access to Medicine Foundation. 2021. 2021 Access to Medicine Index. Available at: https://​access​ tomedicine​foundation​.org/​publications/​2021​-access​-to​-medicine​-index © CFA Institute. For candidate use only. Not for distribution. Identifying Material Social Factors for Investors IDENTIFYING MATERIAL SOCIAL FACTORS FOR INVESTORS 4.1.4 assess material impacts of social issues on potential investment opportunities and the dangers of overlooking them, including: changing demographics; digitization; individual rights and responsibilities; family structures and roles; education and work; faith-based ESG investing and exercise of religion; inequality; and globalization 4.1.5 identify approaches to social analysis at country, sector, and company levels Given the wide range of social trends and factors that could have an effect on the risks and opportunities in a portfolio, these should be considered by investors. Until now, these factors and trends have been discussed in a general sense, as if these factors would have an impact on each country, sector, or company equally; however, this is not the case. Analyzing which social topics are material from an investment point of view should start with an understanding of materiality at both the geographical and industry level. Once this is established, the company-level exposure can be determined by looking at the sector it operates in and which countries/regions it mostly operates in as well as by considering locations of key suppliers, plants, customers, and main tax jurisdictions. Country The importance or relevance of a specific social issue depends on the regional or country context, including the level of economic development, regulatory framework (e.g., when local labor laws do not fully comply with ILO principles), and cultural or historical factors. For example, population aging is an important problem in the developed world, but it is l