Chapter 4: Social Factors

Question 1

Social megatrends?

Answer 1

A. Globalisation.
B. Automation and artificial intelligence (AI).
C. Inequality and wealth creation.
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. Urbanisation.
I. Religion.

Question 2

Environmental megatrends that have a severe social impact

Answer 2

▶ Climate change and transition risks.
▶ Water scarcity.
▶ Mass migration.

Question 3

Globalisation

Answer 3

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 globalisation.

Globalisation 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. However, on the other hand, it is claimed to be detrimental to social well-being due to social structural inequality.

Examples of its implications include:

▶ Offshoring. Due to the lower wages of workers in the garment industry in developing countries, clothes are now mainly produced in countries such 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.

Question 4

Automation and artificial intelligence (AI)

Answer 4

Some of the biggest advantages of automation in industry are that it is:

a. associated with faster production and lower labour costs; and
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.

AI is expected to have a significant effect on sectors such as:

a. healthcare;
b. automotive;
c. financial services and auditing;
d. security (including military); and
e. creative (in particular, advertising and video games).

Question 5

Inequality and wealth creation

Answer 5

The Organisation for Economic Co-operation and Development (OECD) analyses trends in inequality and poverty for advanced and emerging economies. It examines the drivers of growing inequalities, such as globalisation, 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, labour 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. 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 optimisation 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.

Question 6

Digital disruption, social media and access to electronic devices

Answer 6

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.

As a consequence of digital technologies, the huge amount of data that can be collected, stored and processed (big data), and the ownership or use of the data (including data privacy, monetisation of data, etc.).

Big data has many opportunities including more personalised services, products and (health) treatments. However, controversies have arisen because some data is being used and sold in more extreme or socially unacceptable ways. Examples include social media companies, such as Facebook, Twitter and LinkedIn.

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.

Question 7

Changes to work, leisure time and education

Answer 7

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.

Whilst 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 labour market.

Question 8

Changes to individual rights and responsibilities and family

structures

Answer 8

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 labour 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 labour force and – when they do secure employment – often have to accept lower quality jobs. 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.

Question 9

Changing demographics, including health and longevity

Answer 9

Due to improvements made in healthcare and changes in lifestyle, life expectancy is increasing. 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 is forecast to rise to 45 by 2050.

An ageing 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.

Question 10

Urbanisation

Answer 10

Globally, the population has been, increasingly shifting from rural to urban areas.

This shift can have different kinds of implications for societies, including:

▶ Economic: dramatic increases and changes in costs, often pricing the local working class out of the market.

▶ Environmental: the existence of ‘urban heat islands’, where urban areas produce and retain heat, becomes a growing concern.

▶ Social: 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.”

These societal implications provide business opportunities because of the growing need for infrastructure development, but also require companies to address social and environmental issues related to urban living (for instance, pollution and waste management systems).

Question 11

Religion

Answer 11

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.

Norms-based exclusion has been one of the first environmental, social, and governance (ESG) investing
instruments and many of these first movers were faith-based investors.

Question 12

Environmental megatrends with social impact: Climate change and transition risk

Answer 12

Climate change and the neighbouring effect of transition risk has 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.

Question 13

Environmental megatrends with social impact: Water scarcity

Answer 13

Climate change has a negative impact on the availability of freshwater. 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:

▶ 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.

Question 14

Environmental megatrends with social impact: Mass migration

Answer 14

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.

Question 15

Environmental megatrends with social impact: Pollution and loss and/or degradation of natural resources and ecosystem services

Answer 15

Factors like pollution and land degradation can also result in stakeholder opposition, social unrest and/or migration.

Question 16

Where should investors start when implementing social factors in their investment decision?

Answer 16

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 categorised between those impacting external stakeholders (such as customers, local communities and governments) and groups of internal stakeholders (such as the company’s employees).

Question 17

SOCIAL FACTORS THAT IMPACT INTERNAL STAKEHOLDERS

Answer 17

Human capital development.
Working conditions, health and safety.
Human rights.
Employment standards and labour rights.

Question 18

SOCIAL FACTORS THAT IMPACT EXTERNAL STAKEHOLDERS

Answer 18

Stakeholder opposition and controversial sourcing.
Product liability and consumer protection.
Social opportunities.
Animal welfare and antimicrobial resistance.

Question 19

Internal social factors: Human capital development

Answer 19

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 behaviours 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, but also increases competitiveness and employability.

Question 20

For an investor the following business requirements could be assessed when analysing a company on human capital development. Questions should include:

Answer 20

Does the business…

▶ identify required skills or competencies to deliver on its strategy, and 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 (for instance, training hours, coaching, etc.) and its return on investment (key performance indicators (KPIs), such as employee engagement, turnover and ability to fill vacancies with internal candidates)?

Question 21

Internal social factors: Working conditions, health and safety

Answer 21

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 minimise 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.

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, and 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.

Besides minimising 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 sponsoring and training programmes 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.

Question 22

Internal social factors: Human rights

Answer 22

Another important social factor for investment professionals is human rights. They 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.

Human rights include, for example:

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.

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.

Question 23

United Nations Guiding Principles on Business and Human Rights

Answer 23

The UNGPs are a set of guidelines implementing the United Nations’ Protect, Respect and Remedy framework on the issue of human rights and transnational corporations and other business enterprises.

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; and
3. access to remedy for victims of business-related abuses.

Question 24

OECD Guidelines for Multinational Enterprises

Answer 24

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 maximise 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 areas such 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.

Question 25

Corporate Human Rights Benchmark

Answer 25

The Corporate Human Rights Benchmark (CHRB) is a collaboration led by investors and civil society organisations 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 systematise 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. They are:

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.

Question 26

Internal social factors: Labour rights

Answer 26

Assessing how companies uphold labour rights is important for investors to gain insights into the corporate culture and the level of employee satisfaction. The most important labour rights have been summarised in International Labour Standards. These are aimed at promoting opportunities for women and men to obtain decent and productive work, in terms of freedom, equity, security and dignity, and are included in the fundamental conventions of the International Labour Organization (ILO). These include:

1. freedom of association and protection of the right to organise;
2. right to organise and collective bargaining;
3. forced labour and abolition of forced labour;
4. minimum age;
5. worst forms of child labour;
6. equal remuneration; and
7. discrimination (employment and occupation).

Question 27

Labour rights: Freedom of association and employee relations

Answer 27

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, which 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 labour rights violations, such as forced labour, child labour and discrimination, are better safeguarded.

The lack of freedom of association can occur directly at the level of the investee companies, but 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.

Question 28

Labour rights: Modern slavery and forced labour

Answer 28

Two topics that are less frequently mentioned in responsible investment policies are modern slavery and forced labour.

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 practices such as forced labour, debt bondage, forced marriage and human trafficking.

Forced labour 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”.

Modern slavery and forced labour can take place in every kind of work or service, either in the private, public, informal or formal marketplace, but 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 labour.

It is often hidden away in supply chains in the second tier and beyond. Most companies that address modern slavery and forced labour, however, both start and end their due diligence by focusing on their first-tier contractors and suppliers. Besides modern slavery, forced labour can take subtle forms, which makes detecting it very difficult.

The use or threat of physical violence is not essential to characterise a labour relationship as forced labour. 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.

In 2015, the Parliament of the United Kingdom adopted the Modern Slavery Act, which was designed to combat modern slavery.

Question 29

Labour rights: Living wage

Answer 29

In sectors that employ and rely on masses of manual labour (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.

Question 29

Free Prior Informed Consent

Answer 29

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 authorised, 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.

This 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.

Question 30

Consumer protection

Answer 30

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.

Question 31

Product liability

Answer 31

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

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.

Question 32

Access to Medicine Index

Answer 32

The tool analyses 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, evaluating them in areas where they have the biggest potential and responsibility to make change, such as research and development (R&D) and pricing.

Question 33

Farm Animal Investment Risk and Return (FAIRR)

Answer 33

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.

Question 34

EU taxonomy for sustainable activities

Answer 34

The EU taxonomy sets performance thresholds for economic activities that make a substantive contribution to one of six environmental objectives:

1. climate change mitigation;
2. climate change adaptation;
3. sustainable and protection of water and marine resources;
4. transition to a circular economy;
5. pollution prevention and control; and
6. protection and restoration of biodiversity and ecosystems.

The activity should substantially contribute to one of the objectives to become taxonomy-aligned, whilst doing no significant harm to the other five, where relevant, and comply with minimum safeguards (e.g. OECD Guidelines on MNEs and the UN Guiding Principles on Business and Human Rights).

The European Parliament and the Council established that for an economic activity to be taxonomy-aligned, the activity should be carried out “in alignment with the OECD Guidelines for Multinational Enterprises and UN Guiding Principles on Business and Human Rights, including
the International Labour Organization’s (‘ILO’) declaration on Fundamental Rights and Principles at Work, the eight ILO core conventions and the International Bill of Human Rights”. Where applicable, more stringent requirements in EU law still apply.

Question 35

UK Modern Slavery Act

Answer 35

The Modern Slavery Act requires both medium- and large-sized companies to provide a slavery and human trafficking statement each year, which sets out the steps taken to ensure modern slavery is not taking place in their business or supply chains. Many of these statements provide not only general information but also specific numerical data, such as the number of audits initiated for
suppliers at high risk or the number of suppliers that have established corrective action plans, which can help investors assess materiality.

The regulatory pressure on companies to provide useful social data is likely to increase further. For example, in the USA, the Human Capital Management Coalition, which includes influential investors such as leading US pension funds, has petitioned the Securities and Exchange Commission to require issuers to disclose information about their human capital management policies,
practices and performance. International collaboration is also key. The International Organization of Securities Commissions (IOSCO) connects regulators over the world and provides global frameworks to support worldwide standardisation, which regulators in each country can use as a basis for their own regulations.