Sustainable Investment in China | Investor Opportunities in Addressing Conflict Minerals in Supply Chains
Conflict Minerals and Investment Risks
Growing government and civil society focus on company transparency regarding the use of conflict minerals is increasing supply chain and reputational risks for U.S.-listed companies and their global suppliers in the information and communications technology (ICT), automotive, jewelry, heavy manufacturing, and other sectors. Such demands for transparency and accountability on corporate ESG issues create opportunities for investors to develop a more thorough understanding of the risks and opportunities inherent in their investments.
Through BSR’s work with companies to understand and address conflict minerals in their supply chains, we have seen growing regulatory, stakeholder, and media pressure around the use of these materials—specifically, tin, tantalum, tungsten, and gold—whose extraction and trade may illegally fund armed groups in the eastern Democratic Republic of the Congo (DRC) and surrounding region that commit widespread human rights abuses. At the same time, there is pressure to identify and use conflict-free sources of these same materials from the region to support local livelihoods. These materials originate in many places around the world and are often blended during processing and component manufacturing—much of which occurs in China—which makes them difficult to trace as they enter global supply chains for computers, jewelry, automobiles, and aircrafts.
As the conflict minerals issue continues to evolve, it is likely to have an increasingly material impact on company value and performance, which is highly relevant for investors. As a group of global investors noted in their submission to the U.S. Securities and Exchange Commission on March 2, 2011, “Conflict minerals disclosures are material to investors and will inform and improve an investor’s ability to assess social (i.e. human rights) and reputational risks in an issuer’s supply chain.”
In China—where the issue is just beginning to be understood—companies are uniquely positioned to address concerns as a result of their central role in supply chains. Initial steps that investors in Chinese or other companies can take include understanding the issue and its consequences for investment targets, integrating the issue into investment due diligence, and actively engaging with relevant companies. These steps are described in more detail below.
Understand the Issue and Implications for Investment Targets
A recent NGO ranking of global electronics companies and draft U.S. regulations requiring U.S.-listed companies to report on the use of these materials in their products are emblematic of pressures that will increasingly affect companies beyond the United States and Europe, especially those in China. To understand the potential impact on companies and their value as investments, investors should:
» Be aware of brand risks. The U.S. law and likely future European laws are meant to increase supply chain transparency, so that customers, investors, and civil society organizations can encourage companies to take action on this issue. Advocacy groups such as the Enough Project have increased their focus on global brands in Asia, and Chinese companies like Lenovo and Huawei can expect to face public questions about their conflict minerals efforts in the future.
» Understand potential buyer pressure.The leading role that Chinese companies play in global ICT and other supply chains will subject these companies to growing pressure on this issue, regardless of whether they are required to report on their activities under U.S. or European laws. Those companies that are subject to reporting requirements are increasingly working together to develop conflict-free mineral certification schemes and supplier reporting mechanisms. Chinese or other companies that cannot guarantee “conflict-free” goods may have to restructure their supplier relationships or be placed at a competitive disadvantage as demand grows for such goods.
» Review supply constraints.The DRC provides up to 20 percent of the global supply of tantalum and is a smaller but still important source of tin and tungsten. Both the ongoing conflicts in the DRC and uncertainty about the U.S. reporting requirements have contributed to dramatic increases in global prices for these materials, and many mining operations in the DRC have shut down as companies no longer want to purchase material that may support armed groups. Some companies may be able to use alternative materials and so face reduced risks, but these supply constraints and increasing prices will continue to create challenges for companies that cannot ensure a stable, conflict-free source of critical raw materials.
Integrate the Issue Into Due Diligence
» Identify companies at risk. As noted above, this issue affects a range of companies in a variety of industries, and investors should understand where conflict minerals are most likely to be found. Particularly relevant areas for investors in China include:
- U.S. listed companies. Companies listed in the United States, including 185 Chinese companies listed on NASDAQ and 72 companies listed on the New York Stock Exchange, will be required to report on their use of conflict minerals and supply chain due diligence efforts if their products use tin, tantalum, tungsten, or gold.
- Electronics and ICT companies. Electronics manufacturers almost certainly use tin solder and tantalum capacitors, as well as tungsten and gold in select applications. Branded ICT companies with significant supply chains in China like Intel, HP, and Dell have been among the first to see pressure from civil society, and ICT industry organizations like the EICC and GeSI are at the forefront of efforts to introduce supply chain verification processes and questionnaires.
- Metal extraction and processing companies. Companies supplying tin, tantalum, tungsten, and gold to global markets, such as Zijin, are likely to face requests for verification of the conflict-free status of their materials.
- Jewelry companies. Eighty percent of the global supply of gold is used in jewelry, and the industry has been one of the targets of conflict minerals activist campaigns.
- Heavy manufacturing companies. Hardened metal automotive, energy, aircraft, and other component parts often include tungsten and possibly tantalum. Global manufacturers like GE are increasingly engaging with their suppliers to source conflict-free minerals without creating a de facto embargo on materials from the region.
» Identify leading companies. Companies that have strong supply chain due diligence processes in place to identify and address potential risks, and to proactively develop verified conflict-free sources from the DRC or elsewhere will be better positioned to manage the pressures discussed above. In particular, companies implementing the OECD Guidance on mineral sourcing, participating in the Electronic Industry Citizenship Coalition/Global e-Sustainability Initiative (whose members include China Telecom, Huawei, and Lenovo) or other industry supply chain efforts, and working with their suppliers to identify and use conflict-free source materials are likely to gain a marketplace advantage.
Engage With companies
» Request information about company activities to address conflict minerals. As this issue grows in importance, investors should expect companies that use tin, tantalum, tungsten, or gold to discuss their processes for identifying the origin of these materials and supporting conflict-free sourcing, as will be required by U.S. reporting rules. Such requests can be integrated into questionnaires sent to companies, as is already happening with SRI questionnaires in the United States and elsewhere.
» Encourage company action to reduce risks. Investors should be active owners and encourage companies that face conflict minerals-related risks to identify the source of their materials and take other steps to reduce their risks on this issue. The more investors engage with companies on this issue, the more attention companies will pay to it and develop an effective strategy to manage the risks it presents.
The impact of the conflict minerals issue on companies exemplifies the need to make supply chain transparency and accountability, together with other ESG issues, an integral part of investor due diligence—particularly for Chinese companies that play a crucial role in global supply chains and are becoming increasingly recognized international consumer brands. Chinese companies that are on top of this issue and establish effective mechanisms to address it are more likely to have identified other supply chain risks and mitigated, managed, and addressed them as well. Additionally, investors can use how well a company manages this issue as an indication of how well the company is managed overall.
More information about company supply chain processes and efforts to address civil society concerns will help investors better understand the risks and opportunities that companies face, support better investment decisions, and enable investors to engage with companies to proactively address other ESG issues in their supply chains.
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