Monday, February 22, 2010

Business and Human Rights Part XXI--Issues: Finance

This Blog Essay site devotes every February to a series of integrated but short essays on a single theme.  The Ruminations Series in 2009 produced a month long series of aphoristic (ἀφορισμός) essays, meant to provoke thought rather than explain it. The hope was that, built up on each other, the series would provide a matrix of thoughts that together might lead the reader in new directions. 
For 2010, this site introduces a new series--Business and Human Rights.  The series takes as its starting point the issues and questions raised by John Ruggie, the United Nations Special Representative of the Secretary-General (SRSG) on business and human rights, in a global online forum 
The U.N. "Protect, Respect, Remedy" framework is made up of three pillars: the State duty to protect against human rights abuses by third parties, including business; the corporate responsibility to respect human rights, which means to avoid infringing on the rights of others; and greater access by victims to effective remedy, judicial and non-judicial.  The forum is currently focused on the corporate responsibility to respect human rights, the second pillar of the framework. The forum is divided into sections, each of which contains multiple topics with space for discussion and comment.
New Online Forum for U.N. Business and Human Rights Mandate, United Nations Press Release, New York and Geneva, Dec. 1, 2009. Each of the Essays will consider one of the topics raised in the online consultation.  My hope is to help generate discussion and to encourage further discussion of the issues within the framework fo the consultation  framework. 

Part XXI: Human Rights Due Diligence--Issues: Finance.

There is something of a disjunction between the SRSG's discussion of supply chain obligations of corporations, and the discussion of the obligations financial institutions involved in the financing of corporate activity.  With resoect to the former, the SRSG has proposed a broad sweep of obligations   United Nations Special Representative of the Secretary-General on Business & Human Rights, Issues: Supply Chains., discussed in Larry Catá Backer, Business and Human Rights Part XVIII--Issues: Supply Chain, Law at the End of the Day, Feb. 19, 2010.     
With respect tot he later, the SRSG notes:

While financial institutions have a responsibility to respect human rights like every other company, they are generally at least one step removed from the human rights impacts of the business activities that they enable with their funds.
A bank’s human rights due diligence for a project loan will differ from that of the company operating the project -- banks are unlikely to have the capacity to visit every site to which they provide capital.  Nevertheless, banks must conduct human rights due diligence to meet their responsibility to respect human rights -- and the human rights risks of a client may also become risks to the funder's liability, returns and reputation.
Beyond banks lies an even more complex array of other lenders, investors, and asset managers, all of which have different means of engagement and leverage with companies.
United Nations Special Representative of the Secretary-General on Business & Human Rights, Issues:  Finance.

The difference, and a critical one, lies in the relationship between corporations and supply chain partners, on the one hand, and corporations and their financiers, on the other.  It appears that corporations ought to have a strong responsibility to respect huamn rights in downstream relationships (suppliers and supply chain partners), but that there is a qualitative difference between downstream relationships involving operating companies and their suppliers, and that between financial institutions and their borrowers.  I am not as sure that this qualitative difference ought to affect the scope of the responsibility to respect human rights.  Banks are in the business of risk assessment.  They are better at that than most operating companies.  Banks are also in the business of surveillance and monitoring their borrowers.  Loan agreements are cluttered with negative and positive covenants that can reach virtually all aspects of the operations of borrowers.  banks have routinely inserted clauses limiting corporate discretion with respect to all sorts of activity.  And banks can reserve to themselves a roght to approve certain fundamental corporate activity--from mergers to reorganizations and similar activities.  It seems odd to suggest that an industry with such a  sophisticated approach to the monitoring and control of borrowers would be incapable of adding another layer of monitoring and review--that centered on human rights--to an already well established list of risk assessment protocols.Indeed, it would seem that banks are in a better position to monitor compliance form their borrowers than companies might be able to monitor the conduct of their down chain supply chain partners.

An objection might be made that such an imposition--down from lenders to corporate borrowers--would increase the cost of capital.  In the worst cases it might make capital impossible to obtain.  Yet the same argument might be made with respect to the burdens of monitoring a supply chain.  Conceptually, the problem is less that financial institutions are different and more that the framework of the Second Pillar is centered on operating companies and their downstream obligations.  The Second Pillar does not recognize upstream relationships within its framework.  That makes the relationship between corporations and their lenders problematic within the Second Pillar.  If lenders create a downstream relationship with their borrowers, then the focus of the responsibility to respect might have to be refocused on the financial sector.  But that does not make sense given the realities of economic activity. On te other hand, the financial sector ought not to be excluded form the Second Pillar.  What that may suggest is the need to specify a special set of rules describing the nature of the relationship between the financial sector and the responsibility to respect huamn rights in lending activities.

And what about special financial entities--for example sovereign wealth funds.  I haveargued that these entities, though priate in form, exercise public policy in ways that are different in quality from those exercised by private funds.  See Larry Catá Backer, Sovereign Wealth Funds as Regulatory Chameleons: The Norwegian Sovereign Wealth Funds and Public Global Governance Through Private Global Investment (May 4, 2009). Georgetown Journal of International Law, Vol. 41, No. 2, 2009.   I have also suggested that sovereign wealth funds, together with integrated outbound activities of state owned enterprises, can serve as instruments of state policy effectuated through private ,mrkets--reaping both economic profit and state political objectives. See, Larry Catá Backer, Sovereign Investing in Times of Crisis: Global Regulation of Sovereign Wealth Funds, State Owned Enterprises and the Chinese Experience. Transnational Law & Contemporary Problems, Vol. 19, No. 1, 2009.  This framework suggests that government owned entities of this sort might better be understood as subject to the First Pillar state duty to protect.  Yet that is too simple a conclusion.  Global institutions have been moving to treat state enterprises, like SWFs and SOEs that meet certain conduct norms like private entities.  That movement ought to be respected within the Three Pillar Framework.  What that suggests is not that SWFs and SOEs be treated strictly under the Second Pillar, but that such enterprises ought to have multiple sources of obligations--a duty to protect huamn rights co-extensive with the chartering state's own legal duties, and an autonomous and additional responsibility to respect human rights  under the Second Pillar.  The advantages of state ownership ought to  come bundled with the obligations imposed on states, and with the freely undertaken decision to operate like a private enterprise ought to come the obligations arising from operating in that form.   

Yet even that is too simple.  Where sovereign wealth funds invest primarily in share of  other entities, then, to that extent they ought to be subject to the same scope of responsibility as other funds of the same type.  In that case the obligation would be that of a shareholder investor, and to a large extent, remote form the operaitons of the corporations whose ahares are acquited in the market.  Yet Norway has already shown that even in that context, a SWF can exercise fairly substantial human rights responsibilities, and to do that without substantially burdening the financial success of the SWF itself.  See, Simon Chesterman, The Turn to Ethics: Disinvestment from Multinational Corporations for Human Rights Violations - The Case of Norway's Sovereign Wealth Fund.  On the other hand, SWFs that own contyrolling interests in an enterprise ought to face substantially broader responsibilities.  And SWFs that own financial operations--banks and the like--ought to be responsibility for their downstream operations like any other enterprise.    For these entities though, the real issue relates to the linkage between their status and the application of First Pilar obligations, obligations that ought to be precise and mandatory in character. 

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