When one of the world’s most influential investors moves an issue up the investment committee’s agenda, private equity firms tend to take notice. So, as CalPERS has set about implementing its new labour principles over the past couple of years, GPs hoping to attract commitments from the influential $469 billion pension plan will likely be scrutinizing their current and future investments for violation risks.
Transcripts from an investment committee open session last June make clear that the pension plan’s intention is to bring about widespread change. Managers not taking responsibility for, and acting on, any violation in their portfolio companies will no longer receive a re-up from CalPERS.
CalPERS’ labor principles come against a backdrop of rising human rights risks in corporate settings, as a 2023 US Department of Labor investigation into Blackstone-owned Packers Sanitation Services illustrated. It found that the food safety firm had employed at least 102 children aged from 13-17 “in hazardous occupations” that “had them working overnight shifts at 13 meat-processing facilities in eight states.” The result was a $1.5 million fine and a comment from Blackstone that any such violation was “completely unacceptable.”
LPs taking action
CalPERS is far from the only LP zoning in on human rights in their portfolio. “It’s a developing area,” says Elin Ljung, head of communications and sustainability at Nordic Capital. “And while some LPs are still looking mainly at processes that need to be implemented, LPs in areas such as the Nordics, Canada, Australia and the Netherlands are quite advanced in their expectations. Overall, LP sentiment is building that there needs to be a greater understanding of human rights across the value chain, especially as we increasingly see reports of violations that are not just far away, but also close to home.”
Swedish pension fund AP6, for example, established human rights as a focus area in 2021, but its interest in this area predates that. “Human rights was a core pillar of our responsible investment approach when we formalized that 10 years ago,” explains Anna Follér, head of sustainability at AP6.
“Since then, we have always monitored our portfolio for adverse impacts on human rights, and a few years ago we decided to double down on the topic and develop our approach further in line with the UN Guiding Principles on Business and Human Rights (UNGP).”
This has included building a specific assessment framework for human rights and engaging fund managers on the topic, including through a workshop, to understand how they conduct human rights due diligence. “Our assessment last year found that maturity is generally higher in our private equity portfolio in the pre-investment phase,” says Per Norberg, sustainability specialist at AP6. “But some firms are less refined or advanced when it comes to continuous portfolio company monitoring.”
An evolving landscape
Patchy maturity levels are partly down to the broadening scope of what falls under human rights as new risks emerge. “We see firms focusing on what might be perceived as ‘typical’ human rights risks,” explains Follér.
“So, for example, we might see firms that invest in companies with complex supply chains doing work to identify the risk of forced or child labor. But this space is evolving, and we see increasing discussion and headlines about human rights relating to end users of a product or service too, such as software being used by regimes to restrict democratic rights or social media influencing elections in some countries. Also included in this are the potential adverse human rights impacts from the development and implementation of artificial intelligence.”
“Human rights will go up the agenda quite quickly once we start to see fines coming through”
Liam Naidoo
Hogan Lovells
This is familiar territory for Robert Sroka, partner at Warsaw-based Abris Capital Partners and head of industry body Invest Europe’s human rights working group. He categorizes private equity’s human rights challenges into four main buckets: employee conditions and equality, modern slavery, new technologies, and supply chains.
“There tends to be most focus on the supply chain, but I don’t think that’s the most critical,” says Sroka. “Obviously, investors need to know where their portfolio companies are procuring from, and that means there might need to be more scrutiny if that includes countries with poor human rights protections. But actually, modern slavery is far more critical because portfolio companies don’t have full control over where agencies source their workers. There are a lot of abuses here, especially in areas such as agriculture, hospitality and construction.
“And then AI’s impact on human rights could be significant if not adequately managed – and that won’t be sudden; it will have a quiet, slow, but lasting and profound impact. The technology is open to manipulation and there could be big mental health effects.” He points to the EU’s Artificial Intelligence Act and ethics guidelines as important workstreams that will set the tone for how some of these risks can be managed.
Focus on the risks
Despite the progress that has been made in some areas, many firms today are still not focusing specifically on human rights, believing that compliance with the relevant labour laws will be enough, according to Sroka.
“That’s not sufficient,” he says. “Investors need to see these as risks to portfolio companies and to their own reputation. ESG teams in many firms are familiar with the various frameworks and guidelines that cover human rights, but investment teams are far less so, even though they are responsible for identifying risk and protecting the portfolio.”
The huge range of issues now included under the human rights umbrella also means that firms need to consider risks more holistically, both at the due diligence phase and beyond, especially as portfolio companies expand. “Human rights is a complex area of responsible investing, and the scope has broadened considerably,” says Nordic Capital’s Ljung. “People often talk about the reputational risk – and this is important – but the financial, operational and legal risks are just as important.”
What to do?
“There is a lot that GPs can do to help portfolio companies manage these risks and take concrete actions,” says Ljung. “We break the human rights topic down into action points. So, for example, we can train board members and investment teams on what human rights means for a particular type of business in a particular sector, how to prevent violations, and how to manage, address and change aspects to reduce risks.”
In June 2023, the UN PRI set out guidance specifically for private markets firms, based on the UNGPs, on how they should approach human rights due diligence. It outlines how firms can meet a three-part responsibility to respect human rights by establishing a policy commitment, conducting due diligence, and enabling or providing access to remedy. And in a 2024 report based on the 2023 reporting cycle, the PRI found that 82 percent of private equity signatories now track KPIs on social issues.
“AI’s impact on human rights could be significant if not adequately managed”
Robert Sroka
Abris Capital Partners
This KPI tracking is unlikely to be sufficient, however, as increased regulation starts to bite (see box). “Human rights will go up the agenda quite quickly once we start to see fines coming through from agencies enforcing legislation such as the German supply chain act,” says Liam Naidoo, investigations and white-collar crime partner at Hogan Lovells. “But it’s much better to be prepared and build human rights protections into compliance processes now.
“Every single responsible company and responsible investor should be assessing the adverse human rights impacts of their operations, including at pre-transaction due diligence, but also in the way portfolio companies are managed and monitored.”
With tighter regulation coming into play and more scrutiny from LPs, then, private equity firms are clearly going to need to do more to formalize their human rights due diligence and monitoring processes. But this will be neither quick nor easy, AP6’s Follér notes. “These issues are often complex and not measurable in concrete numbers. The UNGPs provide practical guidance on how companies can consider human rights impacts, but it won’t happen overnight.
“We are on a journey towards working out what good looks like and how to get there – so is the private equity industry and, indeed, companies worldwide. As investors, we need to understand that things can go wrong; the important points are how you respond to that and how you improve over time.”
Wading through the ‘regulatory soup’
It’s not just LPs driving an increased focus on human rights. Regulatory pressure is also building
According to Daniel D’Ambrosio, ESG and impact partner at Kirkland & Ellis, assessing potential human rights issues is becoming more and more important throughout the deal lifecycle, particularly as a wave of fresh regulation on the subject comes into force. “There’s a regulatory push in Europe, including under the Sustainable Finance Disclosure Regulation, the EU taxonomy and the incoming Corporate Sustainability Due Diligence Directive (CSDDD),” he explains.
When implemented in EU member states, the CSDDD will require companies employing more than 1,000 people and with more than €450 million in global revenues to identify and address potential and actual human rights issues in their own business and their supply chains.
Moves are also underway at a national level. In the US last year, for instance, the government updated its National Action Plan to strengthen laws prohibiting human trafficking and forced child labour. Meanwhile, the UK’s Modern Slavery Act of 2015 is set for reform and tightening, and in Germany, violations of the 2023 Supply Chain Due Diligence Act could result in fines of up to 2 percent of global turnover.
While none of these regulations in isolation is likely to result in significant changes to the way private equity firms assess target companies, “there is now a soup of regulation that touches on human rights,” says Hogan Lovell’s Liam Naidoo. “And when you have that level of regulation, there is a high risk of follow-on litigation if you get it wrong.”
Naidoo points to a trend of class actions in this area, including against companies for actions carried out by overseas subsidiaries. “Private equity owners need to be mindful of an assumed duty of care to third-party employees and customers within their supply chain,” he says. “We’ve seen efforts by companies to apply human rights rules across their group or on suppliers get used against them in litigation.”
Overall, it’s less a case of overhauling due diligence processes, and more about staying on top of risks as they emerge, according to John Livesey, private equity partner at Hogan Lovells. “Firms need processes for ongoing monitoring. It’s not just about setting up a framework; it’s about making sure the firm can monitor compliance and take action where necessary.”
