Human rights rules could give bankers a run for their money

Welcome back. Yesterday, a committee of lawmakers in Brussels held an important vote on a new EU law that could sharply increase the level of oversight that companies need to exercise over their supply chains. Some analysts are concerned about the outlook for the Corporate Sustainability Due Diligence Directive. It could still be watered down in the European parliament, or by EU member governments. And whatever happens, it won’t come into force until 2030.

Still, as Kenza explains below, this is an important law that could have a big impact. Also in today’s newsletter, I look at an unusual new study that hints at where companies are getting it wrong on diversity, equity and inclusion. (Simon Mundy)

PS Join the FT tomorrow at 17:00 BST for a free webinar on the challenges facing banks and investment firms in the US and Europe and how they should deal with them.

Human rights rules put banker bonuses under fire

It has been a decade since the Rana Plaza garment factory collapsed in Bangladesh, killing more than 1,000 people who had been making clothes for fashion brands such as Primark and Benetton.

To prevent this kind of disaster from happening again, regulators have been working on an overhaul of due diligence obligations.

Draft rules approved by the EU parliament’s legal committee yesterday would force large companies that do business in the bloc to identify and prevent environmental and human rights risks in their supply chain for the first time.

The most controversial change? The requirements would also be slapped on to the financial sector — and directors’ bonuses could be on the line. This comes despite strong opposition from some EU ministers and finance sector lobby groups.

Banks, insurers and asset managers could face fines of up to 5 per cent of global revenues for financing or underwriting companies accused of human rights and environmental violations.

They will also have to publish transition plans in line with the goal of reaching net zero emissions by 2050. And, for those with at least 1,000 employees, director pay will have to be linked in some way to the quality of these transition plans.

“This is on paper the most significant piece of law the financial sector has faced,” Richard Gardiner, head of EU policy at the Dutch non-profit World Benchmarking Alliance, told Moral Money. “It would mandate them to identify and mitigate real world risks for the first time.”

One drawback for proponents of tougher ESG standards is that investors will be told to “engage” with shareholders — but will not be hit with the same level of due diligence requirements as companies. Activists say this could mean an asset manager has to do full due diligence on its office coffee suppliers but not its cattle ranch investments.

The rules must still be debated in the EU parliament, and would not fully come into force until the 2030s.

If successful, this would be the first bloc-wide due diligence regulation focused on taking action rather than just disclosing data. It targets all global companies with at least €40mn in turnover within the EU, or local ones of a similar size and 250 or more employees.

Non-financial companies could be sued by victims for harms caused by their suppliers, a big step up from existing rules focused only on data disclosures.

The directive covers child labour, modern day slavery and other social harms, but also environmental problems such as deforestation, biodiversity loss, air or water pollution and waste.

“Beyond the financial sector this is important for every company . . . nothing else like this exists,” Adrián Vázquez Lázara, the liberal lawmaker who is head of the legal committee, told Moral Money. (Kenza Bryan)

To make a real dent in DEI, shake up your executive team

Nowadays nearly all major companies trumpet the priority they give to diversity, equity and inclusion — but how can you tell which ones are actually taking action?

The most obvious approach is to analyse the data disclosed on the gender and racial mix of companies’ boards or management team, or of their wider workforce. But while these can give a broad sense of diversity at a company, they tell you little about equity and inclusion as perceived by the people who work there.

A recent study, led by Alex Edmans at London Business School — who’s built a reputation for shaking up the consensus on ESG — has tried to do better.

It used a valuable but so far underexploited data set: responses to the surveys used to create Fortune’s annual list of the US’s best companies to work for.

That survey, carried out by the consultancy Great Place To Work, uses employee responses to dozens of questions to compile a list of 100 companies where staff wellbeing is highest. Edmans and his collaborators — Caroline Flammer at Columbia University and Simon Glossner of the Federal Reserve Board — were able to gain access to the full set of responses through a confidentiality agreement. Of the 58 questions, they identified 13 as being relevant to DEI, including “People here are treated fairly regardless of their race,” and “This is a psychologically and emotionally healthy place to work.” They used these to compile a DEI score for each company in the data set.

The results were striking. A higher level of gender or ethnic diversity in the overall workforce showed only a modest correlation with DEI scores. Having a higher ratio of women or ethnic minorities on the board had no positive correlation at all with DEI scores, and even showed some signs of negative correlation — possibly reflecting a superficial approach to this issue by some companies, according to Edmans. “You can always just expand the board to add a token person,” he told me.

So what did help? Having a higher proportion of women in executive roles was clearly associated with higher DEI scores in this study — perhaps because of the message this representation can send to employees, or because women are “more attuned” to related issues, the researchers suggested. (No such effect was seen with greater racial diversity in management — perhaps because even more enlightened companies had yet to reach “critical mass” on this front, with their management still tending to be overwhelmingly white, Edmans said.)

Smaller companies outperformed larger ones, probably helped by managers’ greater proximity to workers. And there were some clear sectoral trends: banking, energy and construction scored far above the confectionery and automotive industries, for example.

Beyond achieving better gender balance in management roles, companies might find the report light on actionable tips. But it does suggest that businesses that make serious progress on this front could reap financial rewards: DEI scores showed a positive relationship with both sales and profit growth. That tallies with work done by Dan Ariely at Duke University, which we featured in January, showing a strong correlation between employee motivation and stock returns.

And for all the flaws of the current approach to equity and inclusion, Edmans et al say it does seem to be bearing some fruit: the average DEI score from their calculations has risen from 4.1 out of 5 in 2006 to 4.35 in 2021. But if companies are serious about going further, the authors warn, they will need to do more than “add diversity and stir”. (Simon Mundy)

Smart reads

• Banque de France governor François Villeroy de Galhau’s recent speech on the macroeconomics of climate change is well worth a read. The bank is narrowing its time horizons to focus on “short-term supply shocks”, such as natural disasters or a sudden rise in carbon prices.

• In the Harvard Business Review, Ken Pucker of Tufts University takes a contrarian line on Vanguard’s exit from the Net Zero Asset Managers initiative. Vanguard is at least being open about its position, Pucker argues — unlike rivals who remain in the green coalition while failing to take climate issues seriously.