Modern slavery in investments and Australian regulations

The Commonwealth Modern Slavery Act 2018 (the “Act”) was passed by the Australian Parliament on 29 November 2018 and came into effect on 1 January 2019 with the aim of combatting modern slavery in global supply chains.  To help achieve this aim, the national Modern Slavery Reporting Requirement (“Reporting Requirement”) was established under the Act.

This article outlines:

• the key aspects of the Act from an investment perspective
• some observations in relation to superannuation funds following the first reporting period under the Reporting Requirement, and
• future trends that JANA expects to see as modern slavery reporting develops.

What is modern slavery?

The Australian Act was the first national legislation in the world to define the term modern slavery.  Modern slavery is defined as including the following types of serious exploitation:

• trafficking in persons
• slavery
• servitude
• forced marriage
• forced labour
• debt bondage
• deceptive recruiting for labour or services, and
• the worst forms of child labour, i.e. situations where children are subjected to slavery or engaged in hazardous work

Modern slavery can occur in every industry and sector; however, it is difficult to identify at the investee company level given the often deep and complex nature of global supply chains.  Evidence from the UK Modern Slavery Act, which came into effect in 2015, indicate that instances of modern slavery are typically identified at tiers three and four of the supply chain rather than at the investee company level.

What is the Reporting Requirement under the Act?

The Reporting Requirement aims to improve modern slavery transparency across large businesses and other large entities such as superannuation funds.  Under the Reporting Requirement, reporting entities are required to produce an annual Modern Slavery Statement addressing seven mandatory criteria:

1. identification of the reporting entity
2. description of the reporting entity’s structure, operations and supply chains
3. description of the risks of modern slavery practices in the operations and supply chains of the reporting entity
4. description of the actions taken by the reporting entity to assess and address these risks, including due diligence and the remediation processes
5. description of how the reporting entity assesses the effectiveness of these actions
6. description of the process of consultation with any entities the reporting entity owns or controls, and
7. provision of any other relevant information.

In accordance with the Act, the Modern Slavery Statements must be updated and published on an online, central register (modernslaveryregister.gov.au) each year by a specified deadline, typically six months after the reporting entities’ financial year end.

An entity is required to produce and publish an annual Modern Slavery Statement if the entity:

• has generated revenue of at least $100m over its annual reporting period

AND IS EITHER

• an Australian entity at any time in that reporting period

OR

• a foreign entity carrying out business in Australia at any time in that reporting period.

Given the size of their investment portfolios and associated investment related income (e.g. coupon payments, dividends, distributions etc.), large superannuation funds typically qualify as reporting entities under the Act; however, this isn’t always the case as we outline in the next section.

JANA observations – superannuation funds

As an industry with approximately $3trn invested globally, Australian superannuation funds can have a material influence on the fight against modern slavery.  As a result, they have an opportunity to use their collective size and influence to advocate against modern slavery and thereby strengthen the social systems on which capital markets and their investments rely.

We have reviewed the first round of Modern Slavery Statements produced by 20 large superannuation funds that are published on the central register.  We note that the majority of Modern Slavery Statements produced by superannuation funds focused explicitly on modern slavery from a “risk to people” perspective rather than the risk to the value of investments.  This is a pleasing outcome given the Modern Slavery Act focuses on the impact on individuals rather than impact on investments.  That said, there is a distinct link between the two.  For example, the prevalence of modern slavery risk in an investee company’s supply chain could lead to reputational risk which in turn could lead to a negative impact on the company’s share price.

We have assessed the sample of Modern Slavery Statements against a number of criteria set out in the table below.  The assessment was made from an investment perspective and was based on information provided in the Modern Slavery Statement only.

Modern Slavery Statement Assessment

JANA makes the following observations in relation to the Modern Slavery Statement assessment:

• In the majority of cases, the modern slavery risk assessment was not carried out beyond tier 1 of the assets.  Given this approach, it’s not surprising to see that no instances of modern slavery were identified in this first year of reporting given that modern slavery is more likely to be identified at tiers three and four.
• Internally and externally managed investment portfolios are both part of a superannuation fund’s supply chain.  All of the Modern Slavery Statements that JANA reviewed made reference to the risk of modern slavery from their investment portfolios, as well as their non-investment operations.
• There were a number of different approaches taken when carrying out a modern slavery risk assessment of the assets.  The approaches ranged from a high level regional and sector mapping of the listed equity assets only to a more thorough assessment across a wider range of asset classes, including infrastructure, property and corporate bonds.
• A small proportion of superannuation funds have a standalone investment specific Modern Slavery Policy.  We note that in some cases modern slavery risk is incorporated into wider ESG and Responsible Investment Policies.  In addition, a number of funds stated that they were in the process of developing a standalone policy.
• 45% of the funds reviewed have carried out some form of modern slavery specific training for staff.  The number of those that have carried out training at the Board level is even lower with the majority of training being targeted at those in procurement roles rather than investment roles.

A final observation is that less than 50% of the 20 superannuation funds analysed by JANA actually qualified as reporting entities under the Modern Slavery Act over the reporting period on the basis that they did not meet the $100m revenue threshold.  This was driven by the “net change in fair value of financial instruments” component of the revenue definition which was mostly negative for the reporting period given the COVID-19 related market sell off in Q1 2020.  It was pleasing to see that the majority of large superannuation funds elected to produce Modern Slavery Statements despite not meeting the revenue threshold in the first year of the Reporting Requirement.

Future trends

There was a wide range in the level of detail provided in the first round of Modern Slavery Statements across superannuation funds and other reporting entities in general.  Given that the Act encourages progress over a period of time rather than perfection right away, we expect to see a general improvement in the level of reporting year on year.

This will be driven by:

• improvements in modern slavery data
• deeper understanding of the issues and risk areas, and
• increased engagement and training on the topic of modern slavery across the industry.

From an asset owner perspective, we expect to see superannuation funds carry out deeper and wider analysis within and across asset classes over time.  Deeper analysis will involve looking further down the supply chain of investee companies and assets to try and identify any instances of modern slavery.  Wider analysis will involve understanding the risks of modern slavery across all asset classes rather than focusing on a select few.

In addition, as the assessment of modern slavery risk develops over time, we expect to see reporting entities actually identify and report on instances of modern slavery within their investment supply chain.  As the depth of analysis increases by looking further down the supply chain, so too should the rate of modern slavery identification across all reporting entities.

Finally, we expect to see the level of superannuation member engagement in relation to modern slavery increase over time in a similar manner as climate change over the past 5-10 years.

Future changes to the Act

The Senate Foreign Affairs, Defence and Trade Legislation Committee (the “Committee”) recently published a report making various recommendations to the Federal Government in relation to modern slavery.  The following two recommendations outlined in the report are directly related to the Act:

• Recommendation 11 – bring forward the review of the Act as soon as possible following the conclusion of the first reporting cycle on 30 June 2021 with a view to strengthening and broadening the Act.
• Recommendation 12 – establish an independent body to oversee and enforce implementation of the Act.

It could be some time before the Federal Government take action with respect to the Committee’s recommendations or commence a review of the Act.  That said, we note that there is an ongoing trend across jurisdictions of strengthening modern slavery related regulatory regimes.  For example, the UK Government is considering the introduction of financial penalties for non-compliance under the UK Modern Slavery Act.

Any changes to the Act from its current form would most likely increase the reporting and compliance requirements for all reporting entities.