- Signatory type: Investment manager
- Asset class: Private equity
- Operating region: Northern Europe
FSN Capital is committed to transforming businesses into more robust and sustainable companies. We have maintained a strong focus on ESG since inception, and our ethos – decent people making a decent return in a decent way – guides our processes and our teams.
Why we address human rights in the value chain during pre-acquisition due diligence
To identify new portfolio companies that share our vision, we have strict exclusion criteria and complete an ESG due diligence in every transaction. Our responsible investment policy clearly states that we exclude investments in any company that have contributed to systematic denial of human rights and that show a pattern of engaging in child labour or forced labour. After a company passes our initial screening process, we always involve external experts to conduct a pre-acquisition ESG due diligence, of which human rights are an integral part.
The objective of our ESG due diligence is threefold. First, we want to identify potential “showstoppers” – i.e., if we uncover anything that we do not believe can be fixed during our ownership period, we will stop the investment process. Second, we want to ensure that ESG risks and opportunities are included in the pricing considerations and transaction documents. This stems from our requirement to safeguard and enhance the return of our portfolio investments. Finally, we want to establish what the current practices are so we can plan how best to onboard and make continuous improvements during our ownership phase.
Our philosophy is that to reach the UN’s Sustainable Development Goals we need every company to move in the right direction. We may be willing to invest in a company with workers’ rights that are not up to our standards as long as we are confident we can change these practices and improve the lives of workers early on during our ownership period.
How we address human rights in the value chain during pre-acquisition due diligence
Our pre-acquisition ESG due diligence process and method of engaging with our portfolio companies follows UN’s Guiding Principles for due diligence. In the pre-acquisition phase, we identify and assess potential and actual human rights risk in a company’s operations and supply chain (UNGP 17). To ensure that key risks are accurately accounted for, we always involve industry leading ESG experts to conduct due diligence and ask that they use our standard ESG due diligence framework (see Figure 1 below).
Figure 1: FSN Capital’s ESG DD Risk Framework
The first thing we screen for to identify human rights risk is the inherent risks associated with the target company’s jurisdiction(s) and the industry in which it operates. We look at the company’s entire value chain: its in-house operations, partners, suppliers, and customers. Indicators for high human rights risk include operating in countries with historically poor/limited employee protection and low labour standards, labour-intensive work, and high volume and/or low-cost products. We use a range of sources, including Transparency International, Human Rights Watch, Amnesty International, industry reports and company websites.
The assessment of the inherent risk profile dictates the ESG DD scope and thereby which areas we focus our DD efforts on. To understand how the target company currently addresses the identified risks, we do a combination of management sessions, interviews with discreet sources, questionnaires and on-site due diligence. Mitigation of these risks can be achieved through, for example, third party audits of suppliers and other signs of strong supply chain management, whistleblowing channels and ethical guidelines.
After assessing how the target addresses the current risks, we rate the residual ESG risks from high to low. Finally, we ask the ESG experts to provide their recommendations for how to address the residual risks. This last step is critical when building an action plan for how to integrate, act and follow up on risks in our ownership period (UNGP19 and UNGP20).
We place high importance on ensuring the deal team owns the ESG work. As such, although the ESG team provides support throughout the process, it is the deal team that runs the ESG due diligence process and works directly with the external experts to conduct the analysis and to create the corrective action plans. The results of this process are always a standard part of the investment decision material presented to the entire firm and to the investment committee.
Example: Human rights in the value chain of a textile company
In 2020 we looked at acquiring a textile company with a production and supplier base in Europe and MENA. We identified that the inherent human rights risks for this company were high, not only because of its industry, but also because of the jurisdictions where the production and tier-1 suppliers were based. Human rights risks included workers’ rights, working hours, remuneration, and health and safety. To address these risks, the company in question had mandated its manufacturers to be compliant with third-party social auditing schemes. However, given the high risk in these jurisdictions, we saw it as imperative to thoroughly investigate the sites during our due diligence phase.
Given that the COVID-19 pandemic had the world in lockdown, neither we nor our trusted advisers could conduct site visits. As such, we had to get creative: a full vendor ESG due diligence was initiated as well as the customary audits, and we accessed videos and pictures of the production site to get an overview of the situation. Critically, we interviewed current and former employees at the production and supplier sites using discreet sources to get a feel for the conditions there. We also conducted interviews with local authorities.
Our thorough investigation found no human rights violations, but we did see a need to improve site conditions to meet our standards. Following our investment philosophy, we looked at this case as an opportunity to have a positive impact on people’s lives, rather than to disregard the company or to move production to lower risk jurisdictions.
As per our standard process, the deal team created a detailed action plan. In addition to running the company through the FSNC ESG Governance Framework to implement our standard policies that address human rights (e.g., Code of Conduct, Supplier Code of Conduct, whistleblower policy and HR policy) and conducting mandatory supplier screens and audits through verified third parties, the deal team committed to sending one representative to visit the sites in person once COVID-19 restrictions would allow. If insufficient social standards were identified in the supply chain, a corrective action plan would be demanded, and if this plan was not implemented the supplier would be replaced as a last resort. Further, human rights certifications like the Fair Wear Foundation would be obtained. The deal team also committed to be directly involved in the process, as well as appointing a dedicated person with relevant experience for the daily management of ESG and human rights at the company level. Although we ended up not doing the deal, our ESG due diligence framework positioned us to make an educated decision and be prepared to be responsible owners from day one.