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Investors press companies with Xinjiang ties to clean up supply chains

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The Volkswagen pavilion at the Auto Shanghai 2005 Exhibition. Volkswagen has said it will continue operating a factory in China's autonomous Xinjiang region despite allegations that Beijing is persecuting Uighurs and other Muslim minorities there.
Source: China Photos/Stringer/Getty Images News via Getty Images

Investors are raising the pressure on companies exposed to potential labor abuses in China's autonomous Xinjiang region to overhaul their supply chains as western governments move to impose stricter human-rights regulations on companies that do business there.

Large investors' focus on environmental, social and governance issues is increasing as the prospect of new trade restrictions and legal requirements is prompting closer scrutiny of companies' ties to Xinjiang, where Beijing is accused of persecuting Uighurs and other Muslim minorities and where the factories that supply dozens of global brands are alleged to employ forced labor.

Volkswagen AG's annual ESG conference in December 2020 offered a glimpse of the conversations about Xinjiang taking place between investors and corporate boards. As the meeting was wrapping up, an analyst asked executives with the German auto group how they intended to audit labor practices in a factory in western China. "Is there anything you can share with us to give us more confidence that this negative press coverage might be ending at some point?" the analyst asked.

Volkswagen's coordinator for business and human rights, Barbara Lamprecht, said executives "take this topic absolutely serious" and have dispatched employees from Germany to visit the facility. But because the plant is a joint venture with China's SAIC Motor Corporation Ltd., Volkswagen lacks "full management control."

In the months since that meeting, tensions between Beijing, which denies committing human rights abuses, and western governments over Xinjiang have escalated. After the sides exchanged sanctions in March, international companies were targeted on social media in China for taking positions that run counter to official Beijing policy.

Meanwhile, U.S. lawmakers continue to call for blanket trade restrictions on Xinjiang, and a majority in the European Parliament recently backed proposed legislation that would apply mandatory due-diligence requirements not only to manufacturers and other companies that depend on physical supply chains but also to their investors.

"The issue is clearly on people's radar. Investors know they need to do something with this," said Victor van Hoorn, executive director of the European Sustainable Investment Forum, whose members include institutional investors managing more than €8 trillion. "It's not something they can afford to ignore."

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Volkswagen CEO Herbert Diess (front left) and executives from BHP Billiton, Prologis, Goldman Sachs, Nokia and Swire Group wait onstage for Chinese President Xi Jinping during a 2018 summit in Beijing. Investors remain cautious about raising human rights issues in China.
Source: Pool/Getty Images News via Getty Images

Cautiously mobilized

Those risks are growing as U.S. President Joe Biden tries to craft policies designed to counter Beijing's influence around the world and bolster American supply chains, including those for raw materials that are critical to the transition away from fossil fuels.

But investors remain cautious about raising human rights issues in China, an economic powerhouse where some clothing brands have faced backlash on social media for past statements expressing concern about labor conditions in Xinjiang. So far, they have stopped short of threatening divestment or demanding that companies fully withdraw from China.

"Global investors are mobilized and already engaging their portfolio companies around the human rights risks posed by business ties to Xinjiang," Anita Dorett, program director at the Investor Alliance for Human Rights, said in early March. But "given the role of the Chinese government in this crisis and the very real potential for repercussions, the specifics of these engagements are not being made public as yet."

On March 30, the Investor Alliance for Human Rights launched a campaign to "focus attention on how business connections to [Xinjiang] may make brands complicit" in human rights abuses. The effort, which targets companies in the apparel, technology, food and energy sectors, was announced the same day the Biden administration for the first time officially accused China of committing "genocide and crimes against humanity" in Xinjiang.

The Investor Alliance for Human Rights, which represents institutional investors with more than $5 trillion in assets under management, is pushing companies to sever "any relationships that are directly in the region," Dorett said.

Calls to disengage from Xinjiang have grown louder as recent rounds of sanctions and other trade restrictions add to the reputational risks that companies and investors face in the region.

Manjit Jus, a managing director and global head of ESG research and data at S&P Global Inc., said the firm has downgraded the ESG scores of several companies in connection with allegations of forced labor in Xinjiang, including Apple Inc. An Apple spokesperson did not provide comment.

Sustainalytics BV, an ESG ratings and research division of Morningstar Inc., has warned clients that some of their portfolio companies are "involved in significant controversies pertaining to human rights" in the region and that they "need to start engaging with these companies" on the issue, said Roxana Dobre, the firm's associate director of ESG research.

S&P Global Market Intelligence reached out to a dozen asset managers that are top shareholders in companies that have been publicly linked to alleged labor abuses of Uighurs. None of the investors, including State Street Global Advisors Inc., FMR LLC and BlackRock Inc. — which has positioned itself as an ESG leader — would discuss their interactions with companies on the issue.

"Vanguard takes human rights issues very seriously, including allegations of forced labor," a spokesperson for Vanguard Group Inc., another large investor, said in an email. "If a company's business practices or products put people's health or safety at risk, they too can present long-term financial risks to investors."

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A woman outside a Nike store in Beijing. Chinese state media and consumers on social media have called for boycotts of major Western brands, including Nike.
Source: Kevin Frayer/Getty Images News via Getty Images

Risk becomes absolute

Given China's vast markets, geopolitical clout and deep integration in global supply chains, there appears to be little chance of western companies and investors exiting the People's Republic entirely.

For now, investors troubled by allegations of human rights abuses there appear to be pressing companies to better understand their own supply chains and to make public the steps they are taking to mitigate risks, rather than to disengage from Chinese suppliers.

ESG specialist fund Trillium Asset Management LLC, for example, has taken that approach with Nike Inc., a company accustomed to dealing with questions around the conditions in its Asian factories and suppliers.

Trillium has asked the apparel giant to map out its supply chains inside and outside of China to identify all business connections to Xinjiang and to disclose its efforts to disengage from companies in the region. Nike has said it does not source products from Xinjiang and that it has confirmed with its contract suppliers that they are not using textiles or spun yarn from the region.

Trillium believes that Nike is "actively working to address the sourcing issue regarding cotton from Xinjiang," said Cheryl Smith, an economist and portfolio manager at Trillium, in a statement to S&P Global Market Intelligence. But the firm continues to press Nike to "explore deeper supply chain connections" to the region. Nike did not respond to a message seeking comment.

Without dependable access to Xinjiang, conducting oversight in the region is beyond the capabilities of most western companies. According to the Congressional-Executive Commission on China, a panel of U.S. lawmakers and administration officials that monitors human rights in the country, third-party audits in Xinjiang are unreliable because it is impossible to obtain accurate information from the region.

"As soon as there is no more transparency, then the risk becomes absolute, and our customers will typically choose to vote with their feet and look elsewhere for sourcing,” Leonardo Bonanni, CEO of Sourcemap Inc., a supply chain mapping company, told U.S. lawmakers at a March 18 hearing.

Some apparel companies and many firms in the U.S. solar industry appear to have reached the same conclusion, saying they are avoiding doing business with companies in the region.

But quitting Xinjiang is not without costs.

Cotton prices are rising as a result of "the humanitarian crisis in the Xinjiang province," Harvey Kanter, president and CEO of U.S. clothing retailer Destination XL Group Inc., told investors in March. And some clothing brands appear to have removed statements about Xinjiang and forced labor from their websites under pressure from Chinese consumers, who have called on social media sites for boycotts of certain labels.

"Most companies who are looking at their supply chains are either already good actors or are doing it on a wholly voluntary basis that they can then back off of as convenient," Luis C.deBaca, an anti-human trafficking ambassador during the Obama administration, told U.S. lawmakers on March 25 in calling for a national supply chain transparency law.

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Chinese Premier Wen Jiabao is encouraged to climb into a Volkswagen electric car by former CEO Martin Winterkorn (right) at the company's factory in Wolfsburg, Germany, in 2012.
Source: Sean Gallup/Getty Images News via Getty Images

Unswayed

With American legislators targeting imports from Xinjiang, the U.S. SEC is also staking out a more aggressive position on ESG issues, increasing pressure on companies with operations in high-risk regions such as Xinjiang, said Ken Rivlin, a partner at Allen & Overy, an international law firm headquartered in New York City, and the firm's global co-head of international trade and regulatory law.

U.S.-listed companies are balancing "maintaining business relationships in China ... with adhering to accepted human rights principles and rules," Rivlin said. "This is an issue. It's not just brand, and it's not just principle, but it's also, certainly for listed companies, a potential SEC liability."

Canada and the U.K. have also announced measures targeting allegations of forced labor in Xinjiang, including the introduction of financial penalties for businesses that do not comply with the U.K.'s Modern Slavery Act.

Europe is considering legislation that could have even further-reaching implications. A recent proposal supported by an overwhelming majority of lawmakers in the European Parliament would require companies to identify and remedy parts of their supply chain that infringe on human rights, including forced labor. Notably, it would extend due-diligence requirements to financial investors and banks, according to Erik Hormes, a senior policy adviser on the proposal.

The European Parliament has also called for import bans on products linked to forced labor and asked the European Commission, the bloc's executive, to investigate whether any Xinjiang-based companies that export to the EU are involved in human rights violations.

But many companies still look ill-prepared to ensure that their suppliers are free of human rights abuses.

An analysis by the World Benchmarking Alliance last year found that few companies had improved their voluntary vigilance around human rights, despite pressure from international investors with more than $4.5 trillion in assets under management. Of the companies the group assessed for the first time in 2020, 70% failed to score any points on human-rights criteria.

Volkswagen, for its part, is staying put in Xinjiang, an industrial hub in the world's biggest auto market.

A Volkswagen spokesperson said the company has no evidence of forced labor in the supply chain of Volkswagen Group China or its subsidiaries, and that no outside organization "has any role or influence in hiring decisions." Late last year, however, the CEO of Volkswagen Group China, Stephan Wöllenstein, told German broadcaster Deutsche Welle that the company could not guarantee workers were not coming to the Xinjiang factory from detention camps.

"We feel committed to continue those operations," Frank Witter, Volkswagen's head of finance and a member of the company's board of management, said of the Xinjiang plant during an investor call in July 2020. "And we knew from the start, it's not going to be easy, but we're moving forward."