Before paper

The following paper is fictitious. The paper is for an imaginary Australian financial services company, Anonymous Financial Services, which invests client’s money in managed funds and superannuation portfolios.

Appendices mentioned in the paper are not included.

Title: Review of potential worker exploitation in the Investment Portfolio

Summary

At the July Board meeting, the Board requested a review of possible worker exploitation in the manufacture of products sold by companies in the Investment Portfolio. This paper discusses the supply-chain risks with outsourcing and highlights companies in our portfolio most at risk.

Discussion

Worker exploitation, sometimes called modern-day slavery, is used throughout the production of many clothing products, furniture and appliances sold in Australia and globally. Worker exploitation may include child labour, forced labour, poor wages, long hours and unsafe working conditions.

Many household brand names, with reputations built up over decades, now outsource from a range of developing overseas markets. In Australia, China remains the dominant source of products, but sourcing is increasingly shifting to less-developed countries such as Bangladesh, Cambodia and Vietnam because the minimum wages are lower.

Outsourcing to less-developed countries has implications for working conditions because workers may have to work longer hours to cover their living expenses. Risks for companies include poorer quality products and higher turnover of workers.

The labour-supply chain includes planning, sourcing and producing goods. Often, the head office is in one country and production is outsourced to another country via agents, intermediaries or subcontractors, or by going direct to the factories.

Poor safety conditions have been highlighted in a number of cases, the most recent high-profile case being the Rana Plaza factory collapse in Bangladesh in 2013. Shops on the ground floor of this eight-storey building were closed when cracks appeared, but the garment workers were ordered to return to work the following day. The building collapsed during the morning rush-hour, killing 1,129 people and injuring approximately 2,500 others.

The building housed a number of separate garment factories and manufactured apparel for international brands including Benetton, Bonmarché, the Children’s Place, El Corte Inglés, Joe Fresh, Monsoon Accessorize, Mango, Matalan, Primark and Walmart. (See appendix 1 for more information.)

After the Rana Plaza Factory collapse, an international ‘Accord on Fire and Building Safety in Bangladesh’ was established to improve safety. It is a legally binding agreement including independent safety inspections at factories and public reporting of the results of these inspections. Where safety issues are identified, retailers are committed to ensuring that repairs are carried out and that workers at these factories continue to be paid a salary.

At the time of writing, the following Australian companies have signed the agreement:

  • Cotton On Group
  • Forever New
  • K-Mart Australia
  • Pacific Brands
  • Pretty Girl Fashion Group Pty
  • Speciality Fashions Australia
  • Target Australia
  • Woolworths Australia

Unsafe work conditions do not just exist in less-developed countries. A 2013 report by China Labor Watch of six Chinese factories producing toys for Mattel uncovered issues such as 84 to 110 hours of monthly overtime, up to 13-hour working days, hot and crowded dormitories, ineffective safety training, inadequate protection equipment and environmental pollution.

Child labour

The International Labour Organization (ILO) defines child labour as ‘work that deprives children of their childhood, their potential and their dignity, and that is harmful to physical and mental development’.

According to a 2013 ILO report, 168 million children worldwide are used for child labour, accounting for almost 11 per cent of the child population. More than half of the child labourers are involved in hazardous work that endangers their health and safety. Child labour is particularly prevalent in Asia-Pacific and Sub-Saharan Africa. The rate is 9.3 per cent for Asia and the Pacific. (See appendix 2 for more information.)

The 2012 Maplecroft Child Labour Index found that 76 countries pose an ‘extreme’ risk of child labour and that worsening global security and economic conditions had increased child labour violations in several countries. (See Appendix 3 for more information.)

The Index noted that supply chains of companies particularly exposed to the risk of child labour are in some of the largest growth economies, such as the Philippines, India, China, Vietnam, Indonesia and Brazil.

Most child labour is used in agriculture, but a growing number of children work in services and manufacturing. In India, for instance, Maplecroft says that evidence shows children are working in factories, gemstone cutting, quarrying, hybrid seed production, brick kilns, rice mills, garment assembly, silk thread production and textile embroidery.

Reputational risks

The exploitation of workers is an emotive issue and negative publicity can haunt a brand for decades. Brands that have been tarnished by poor labour chain practices include Nike (1990s), Apple (2006), and Sherrin (2012) where it emerged that children were being used to hand-stitch footballs.

Operational risks

Serious incidents, such as the Rana Plaza factory collapse, cause loss of life, but other less publicised incidents can lead to:

  • Disruptions to supply
  • Late deliveries
  • Poor quality products

ASX importers

Traditionally, most Australian Stock Exchange (ASX) importers used wholesalers or intermediaries with established relationships with international factories. These wholesalers or intermediaries understood the culture and were skilled at the logistics, such as carriers, routes and required documentation.

Two trends in recent time are:

  • Direct sourcing – the retailer goes straight to factories to source products
  • Private labelling – products are manufactured by factories under the store’s brand

With both these options, companies have direct contact with the factories. Both strategies cut costs and increase profits without the need for raising prices. However, without the knowledge of the wholesalers and intermediaries, there may also be hidden costs, such as faulty products and late deliveries.

More importantly, there is a risk that companies will not have a transparent view of the factories’ work standards and practices. According to a 2006 article in BlombergBusinessWeek, many factories in China have become adept at duplicity. Fake, but authentic-looking records are created, and employees with grievances are hustled out when audits are conducted. Consultancies have sprung up specialising in giving advice to factories on how to pass audits.

Serious incidents can result in worker unrest or shutdowns and so disrupt the security of supply. Poor working conditions or worker disengagement can affect product quality. Disruptions to supply can prove particularly costly to businesses in terms of management time dealing with such crises and potential loss of customers, who may find a substitute product or retailer.

In 2013, the Australian Council of Superannuation Investors (ACSI) released a report entitled Labour and Human Rights Risks in Supply-Chain Sourcing. It states that the sectors most exposed are consumer staples and consumer discretionary companies.

The research assessed 34 companies from the ASX200 and found that the consumer staples and consumer discretionary sectors are lagging on implementing controls to manage supply-chain labour and human rights (LHR) risks. LHR issues within the supply-chain are likely to manifest as reputational risks, operational risks and legal risks, all of which have the potential to impose costs or constraints on companies. The report noted that board oversight of LHR risks was significantly lacking.

The report states: ‘The lack of depth in company disclosure regarding LHR risks potentially indicates poorly developed strategies and programs for addressing these risks within their supply-chains. This presents difficulties for companies facing higher consumer expectations about their supply-chain oversight and practices.’

A February 2013 study released by Oxfam suggested that 75 per cent of Australians do not feel there is enough information about sourcing of food and drink products and how they are made and 52 per cent considered a company’s ethical credentials when choosing food and beverage brands. Social media has also become an outlet for discussion and information-sharing on global supply-chains and labour standards.

Some labour rights and human rights are becoming protected under law. For instance, effective January 1, 2012, the California Transparency in Supply Chains Act of 2010 (S.B. 657) aims to give consumers access to detailed information about the human rights practices behind the production of goods they buy and assist their buying decisions.

Increased NGO activism seeks to hold companies to their ethical claims. In May 2014, Baptist World Aid Australia published Electronics Industry Trends. This report grades companies across four categories: policies; traceability and transparency; monitoring and training; and worker rights. The highest grade awarded was B+ and the median C-.

The highest grade (B+) was awarded to Nokia, LG, Microsoft and Apple. Apple reported finding eight facilities using child labour in 2014, but the B category does not reflect that supply chains are free of abuse, but that companies are proactively addressing these issues (See appendix 4 for a full list of companies assessed and their scores.)

Categories in the C grade include Woolworths Australia, Tom Tom, Sony and IBM, and companies in the D grade include Amazon Kindle, Asus, Canon, Dick Smith Electronics and Oracle.

In August 2013, Baptist World released The Ethical Fashion Guide assessing the labour supply chain of leading Australian companies.

Anonymous Financial Services LHR exposure risks

Anonymous Financial Services has potential exposure to LHR risks in:

  • X companies in international shares
  • X ASX200 companies
  • X companies in the ABC multi-sector growth fund

Next steps

Given that Anonymous Financial Services only has small holdings in each company, management will assess whether to retain these shares.

The review criteria will include:

  • Companies’ codes and policies and whether LHR policies are reviewed at board level
  • Transparency of the supply chain – how many suppliers and subcontractors are in the supply chain and if this information is made public
  • Monitoring practices – how companies monitor their LHR practices and if the results of their audits are made public

We acknowledge that we have limited ability to effect change. However, we will continue to learn more by:

  • Engaging with the companies directly
  • Talking to our fund managers
  • Engaging with NGOs such as the Baptist World Aid Australia and Oxfam
  • Keeping up with industry research

Rewritten paper

Title: Review of potential worker exploitation in the Investment Portfolio

Summary

At its July meeting, the Board requested a paper on the Investment Portfolio’s exposure to companies with potentially poor labour and human rights (LHR) practices in their supply chains.

Based on our preliminary research, Anonymous Financial Services has potential exposure to companies with LHR risks in:

  • X companies in international shares (plus names and size of investment)
  • X ASX200 companies (plus names and size of investment)
  • X companies in the ABC multi-sector growth fund (plus names and size of investment)

These investments account for X per cent of our overall investment products.

If management chooses to retain investments with companies with potentially poor LHR practices, we will consider how we can influence those companies’ policies and practices.

Discussion

Our preliminary research indicates that the following companies in our portfolio are at risk of potential LHR issues.

Fund Name of company LHR risk Size of investment Possible action
X X X X Sell
X X X X More research
X X X X Engage with management

 

This research was based on:

  • Interviewing our fund managers to find out their views on the most exposed companies to LHR risks
  • Attending investment seminars organised by leaders in this field
  • Meetings with Baptist World Aid Australia, which has published two ethical buying guides (electronics and fashion)
  • Reading industry reports

The following two reports have been placed in the board paper Reading Room:

  • 2013 Responsible Benchmarking Report, Responsible Investments Association Australasia, 2013.
  • Labour and Human Rights Risks in Supply-Chain Sourcing. This study was commissioned by the Australian Council of Superannuation Investors and prepared by Regnan – Governance Research and Engagement, 2013.

Outsourcing concerns

Outsourcing has been a common practice since the 1990s, providing cheap products for customers, but with mixed LHR results. There have been ongoing concerns around child labour, forced labour, poor wages, long hours and unsafe working conditions.

Brands that have been tarnished by poor LHR practices include Nike (1990s), Apple (2006), and Sherrin (2012) where it emerged that children were being used to hand-stitch footballs.

Our clients are becoming increasingly concerned about ethical investing, sometimes known as socially responsible investing, and expect more transparency in their investment portfolios.

Three recent outsourcing practices are causing our clients concern:

  • More outsourcing to less-developed countries: More companies are outsourcing to less-developed countries such as Bangladesh, Cambodia and Vietnam, which have lower wage rates and less developed LHR practices. The Rana Plaza factory collapse in Bangladesh in 2013 that killed 1,129 people highlighted safety concerns.
  • Direct sourcing: Traditionally, most Australian Stock Exchange (ASX) importers have used wholesalers or intermediaries with established relationships with factories. In recent times, more retailers are going straight to factories or contractors to source products, and problems can arise when outsourced production is outsourced again to other factories and home workers.
  • Private labelling: Retailers themselves do not have production experience, so are dependent on the suppliers in their global sourcing networks.

Next steps

The Investments Portfolio team plans to review our investment portfolio with LHR risks in mind. The review criteria will include:

  • Companies’ codes and policies and whether LHR policies are reviewed at board level
  • Transparency of the supply chain – how many suppliers and subcontractors are in the supply chain and if this information is made public
  • Monitoring practices – how companies monitor their LHR practices and if the results of their audits are made public

Based on this review, the Investments Portfolio team will decide whether to retain or sell equities, or retain and keep a watching brief on LHR progress.

Our Investment Portfolio team will also engage directly with our ASX200 retailers to encourage more open LHR reporting.