Why banks should sit up and pay attention

Modern Slavery

While the issue of slavery might seem remote to Western business, the tens of millions of workers trapped in webs of debt, threats, illegality and physical coercion are integrally tied to the global economy. Slavery and human trafficking lurk in commodity production and low-value manufacturing, in the subcontracted workforce at emerging market industrial developments, and even in some economic sub-sectors in Europe and North America.

Think about why this matters to the world’s leading companies, and supply chain exposure probably comes to mind. After all, last year’s UK Modern Slavery Act (MSA) included a special clause requiring the annual reporting of supply-chain risk. Other laws, such as the 2010 California Transparency in Supply Chains Act or a French bill which is currently under review, take the same line.

At first glance, these laws don’t seem immediately relevant to banks, but focus on sectors like retail which depend on commodity production and unskilled manufacturing where slavery is most often found. True, bank supply chains do have minimal exposure to forced labour via outsourced activities like cleaning, catering and construction, especially in emerging markets; but, the issue has not exactly kept banking risk professionals awake at night. Indeed, for bank CSR departments, compliance with modern slavery laws may only seem important as a way of burnishing sustainability credentials.

However, it may be time for a rethink. Here’s why.

Banking business is everybody’s business

By providing accounts, making markets and lending money, banks play a central role in most global business. This matters because global norms on who is responsible for human rights violations are shifting. The notion that a company shares responsibility for the transgressions of its suppliers has been accepted for some decades. But as expressed in the overarching 2011 Guiding Principles on Business and Human Rights, momentum is now building behind the idea that all forms of business relationship generate human rights responsibility.

As per the conclusions of the Thun Group, seven leading European banks, which met to discuss the Principles, the banking industry has begun to slowly adjust to this reality. The no-questions-asked Swiss banker of Bond movies is now more fiction than fact. Addressing human rights responsibility is still more voluntary than mandatory, but not for much longer: where norms lead, law and regulation eventually follow. Banks should prepare for a future of obligatory human rights due diligence.

Know your client, know their slavery risk

When it comes to the know-your-client procedures banks use to work with people and small businesses, that future is already here. Slavery and human trafficking are creeping onto the list of predicate crimes that underpin money laundering –arguably banks’ greatest compliance bugbear. In the UK, the passing of the MSA prompted their inclusion late last year in the first ‘national risk assessment’ and ‘action plan’ for anti-money laundering and combating the financing of terrorism (AML/CFT). Industry-specific regulations will be the next step.

As in the UK, so in the US. The 2006 classification of human trafficking as a predicate offence under the country’s AML law has raised the stakes in relation to slavery as well; many if not most of those who work as slaves have at some point been trafficked. Activist lawmakers and a handful of proactive banks have established transaction-specific ‘red flags’– for example employers withholding or immediately clawing back a majority of payroll funds - that in practice apply to both trafficking and forced labour.

Caveat creditor

Change is also looming for investment banking. Here, indeed, banks are seen as having more ethical responsibility. By providing finance to projects and firms – and sometimes taking equity stakes in them – they effectively become long-term stakeholders. Leading banks have long agreed that lending creates human rights responsibility. The voluntary Equator Principles, first launched in 2004, now have 84 signatories covering over 70% of project finance debt in emerging markets and include a prohibition on forced labour in clients’ operations and supply chains.

That is the theory, however. In practice, voluntary due diligence by lenders is uneven. Even the development finance institutions that aspire to set the standards for their corporate counterparts regularly fall short, according to NGO critics. But here too, banks will likely see moves towards mandatory requirements as governments begin to implement the Guiding Principles. On one side, a clutch of emerging-market host countries – such as BrazilMongoliaNigeriaPeru and Vietnam - have already adopted mandatory (or quasi-mandatory in Mongolia) sustainable banking rules. On the other, a sharper civil society focus on forced labour will not only increase reputational risks, but may even prompt new human rights legislation in banks’ HQ countries relevant to overseas lending.

Banks: Still guilty until proven innocent

Despite reforms and increased CSR efforts since the 2008-2009 global financial crisis, banker-bashing is still in vogue. Recent cases – for example a report on alleged abuses by Indonesia’s leading palm oil producer – illustrate how NGOs will zero in on banks’ ethical responsibilities regardless of how much these are reflected in law. Against this backdrop, civil society activism is likely both to accelerate law-making on modern slavery and increase the reputational costs for banks of failing to act. In this context, getting ahead of the law by acting early on slavery and trafficking just makes sense.

James Lockhart-Smith

Head of Financial Sector Risk