Labor Standards in Development Finance: Recent Breakthroughs

The following summary was prepared by Kate Vyborny, Junior Fellow, Carnegie Endowment for International Peace

Purpose of the conference

A new trend has emerged in recent years among development finance institutions (DFIs) that provide finance for private firms in developing and transition countries. Increasingly, multilateral and bilateral DFIs are requiring borrowers to adhere to national labor laws and international labor standards in their operations. The new attention to labor standards arises from a recognition that effective enforcement of rights for workers contributes in an integral way to equitable development, sustainable economic growth and reinforcement of good governance.  Respect by firms for workers’ rights contributes to the welfare and dignity of workers and to advances in productivity.

Perhaps the most notable development in this sphere was the decision on February 21, 2006 by the International Finance Corporation of the World Bank Group (IFC) to adopt a new set of performance standards.  The new standards include the core labor standards agreed by member countries of the International Labour Organization to apply to workers everywhere and other labor protections. Another pivotal development is the decision by many of the “Equator” banks, private financial institutions that also lend to private enterprises in developing countries, to follow the new IFC standards for labor conditions in project finance. The IFC and Equator Banks join a number of national and regional development finance institutions that have already decided to require clients to respect worker rights as a basic condition of loans, loan guarantees or other assistance to the private sector. 

The institutions adopting labor requirements face considerable challenges in implementing such policies. These challenges include: making the standards clear and easily applied to private sector clients; implementing systems for initial evaluation and on-going monitoring and oversight of clients; and training of development finance staff to understand and apply the labor criteria.

“Labor Standards in Development Finance:  Recent Breakthroughs,” a two-day dialogue hosted by the Carnegie Endowment for International Peace and the International Labor Office (ILO), brought together practitioners from the IFC, national DFIs, private banks and other firms, trade unions and NGOs to discuss the process of implementing labor standards and to share best practices to achieve success on the ground. 

Opening Session
Sandra Polaski, Project Director and Senior Associate, Carnegie Endowment
Armand F. Pereira, Director, International Labor Organization Washington Office

The trend towards incorporation of labor standards in the lending practices of development finance institutions was made possible by the confluence of several factors.  These include the ILO’s 1998 Declaration of Fundamental Principles and Rights at Work, which embodies member state recognition of certain universal rights for workers; a growing understanding of the business case for labor rights, including the financial risks and reputational risks to lenders of noncompliance by clients; and the recognition of the importance of the quality as well as quantity of job creation for sustainable economic growth and poverty alleviation. 

The DFIs now face the challenge of implementing labor standards as part of their lending processes.   Successful implementation has the potential not only to improve labor practices on projects, but also to encourage other agencies to adopt similar standards for their procurement and lending processes, and more broadly to provide demonstration effects to other firms in affected industries and countries.  In order to attain this goal, the ILO can work with DFIs to provide technical cooperation and assistance, bringing the significant experience of its supervisory machinery to bear in addressing these challenges.

Keynote Panel: Labor Standards in Development Finance: The Contribution to Development
Dorothy Berry, Vice President, Human Resources and Administration, International Finance Corporation (IFC)
Rachel Kyte, Director of the Environment and Social Development, IFC
Suellen Lazarus, Senior Advisor, ABN AMRO

There is a very strong business case for improved labor standards, and an observed correlation between clients that are compliant with these standards and those that are economically successful.  However, building the case through a rights framework or through a business framework may have different implications for the way the policies are applied in practice, and the link between these two is important. 

The process of institutional change to adopt labor standards as official policies and as principles that affect the operations of the institutions is an important challenge.  The process of adoption itself requires significant consultation with stakeholders including communities, labor and client firms.  DFIs including the IFC have led the way in adopting comprehensive institutional policies, but now face the challenge of integrating them into their lending practices.  Part of this challenge consists of broadening the understanding and engagement of staff at every level of the institutions with the new standards.  This can present a challenge for organizations whose staff may see their corporate identity primarily as a lending institution, and may not want to deal with other priorities within the lending process. 

Cooperation between institutions is important to ensure the credibility of the standards.  Equator institutions report in some fashion on their application of social and environmental standards, but there is no comprehensive or fully comparable review process among them.  The benefit of being identified as an Equator institution could be diminished if some institutions apply the standards less effectively than others, creating a free rider problem.

Overview of Development Finance Institutions’ Labor Policies
Peter Thimme, Head of the Environmental and Social Department, DEG (Germany)
Robert Montgomery, Head of the Environmental and Social Unit, Inter-American Development Bank (IADB)
Amber Frugte, Social Specialist, FMO (Netherlands)
Alke Schmidt, Principal Environmental Adviser, European Bank for Reconstruction and Development (EBRD)

IMGXYZ475IMGZYX

DFIs face a range of challenges in designing systems to implement labor standards in their lending policies on the ground.  As a threshold issue, the question of how to interpret standards has been an issue for some institutions.  The core labor standards as defined in ILO conventions are a common base, but interpretation of these standards in operational terms may differ between institutions and between client sectors.  Ideally, DFIs should share a common interpretation as much as possible to strengthen the credibility of the standards as well as making them workable for clients.  In addition to these practical issues, some institutions expressed that the core labor standards are a minimum which should be supplemented by other conventions and standards, such as those governing occupational health and safety. 

In order to apply social policies consistently throughout the lending practices of the institution, investment officers who make lending decisions need the standards to be translated into operational terms for highly diverse sectors and situations.  Investment officers also need significant training, at a minimum to become the first observers who can alert specialists within the institution to higher-risk projects which may require more attention and intensive work to design appropriate plans to address social issues as part of the loan.  Some institutions classify projects by level of risk through various “risk mapping” systems. 

Applying the standards also requires changes in the incentive systems faced by investment officers, who may not receive rewards for consistent application of social policies in their lending practices. Some DFIs have established bonus systems for officers who apply the social policies well in their practices, and are exploring ways to make these incentives more systematic. 

Overview of Labor Standards and Role of the International Labor Organization
Lee Swepston, Senior Adviser on Human Rights, ILO

The adoption of performance standards by the IFC reflects the result of an inclusive consultation process.  It is important to understand that the adoption of performance standards does not mean that clients will apply international standards directly, but rather the national standards which reflect ILO conventions.  The process of standard setting, which precludes reservations, and the wide ratification of ILO conventions make them a strong base.  The ILO supervisory machinery requires that parties to the conventions report every five years, and the reports can be verified or challenged by input from employers and unions.  However, this yields a series of comments on a country’s progress, rather than the snapshots of a country’s application of the standards that the DFIs also need.  ILO is adding tools for the promotion of standards, over and above the existing supervisory role; these tools, such as guidelines for firms on how to apply labor standards, can be of use to the DFIs in their implementation process, and additional tools could be developed in collaborative work between the institutions. 

Applying Labor Standards in the Private Sector Workplace
Amber Frugte, Social Specialist, FMO (Netherlands)
Ros Harvey, Chief Technical Advisor, Better Factories Cambodia Project
Emily Sims, Senior Specialist, Multinational Enterprises Programme, ILO
Steve Gibbons, Director of Labour Rights, Ergon Associates

IMGXYZ476IMGZYX

The staff at DFIs who are responsible for ensuring compliance with social policy must understand the legal terms of the financial instruments to know and enforce what the client is obligated to do and ensure consequences for compliance and noncompliance.  DFIs should engage and train clients to improve their performance systemically and change the culture of their organizations, rather than make superficial changes which may conceal larger issues.   

In the monitoring process, DFIs must determine how far down the supply chain to apply binding standards, particularly in industries with complex supply chains.  Conversely, the role of customers and evolving pressures for accountability in the supply chain must be recognized and addressed with respect to labor conditions.  The application of the standards within different cultural contexts, such as the non-discrimination standard, may require very careful treatment.  The application and monitoring of the rights of informal workers, who may in fact make up the majority of the workforce in some client operations, is a particular challenge.  One of the largest and most challenging issues is how to engage and improve the situation when problems are endemic to a country because of weaknesses in national law or enforcement. 

Coordination between DFIs is important to improve the credibility of the standards and to reduce the costs of monitoring, evaluation and engagement both to DFIs and to their clients.  The ILO has expanded its role in providing more tools adaptable for specific sectors, given the different nature of their supply chains.  Some innovative information management systems such as that implemented by the ILO’s Better Factories Cambodia project have the potential to enable information sharing across institutions. 

Risk Mapping, Due Diligence, Assessment
Sofie Michaelson, Social Specialist, FMO
Dan Viederman, Executive Director, Verite
Jorge Perez- Lopez, Director of Monitoring, Fair Labor Association
Bruce Moats, Chief Strategist, Moats Associates

Once standards are established, the institution must determine whether to apply the standard to entire countries in which it may not lend because the national level of compliance is so poor, or to individual clients.  In the case of application to entire countries, an important question is raised regarding what level of noncompliance should be seen as grounds for withdrawal, and at what level continued engagement could improve the situation.  In some countries, international engagement may be the only force for labor standards improvement in industries which have little protection for labor rights.  In the case of application to individual firms in countries which systematically deny rights such as freedom of association, calling for clients to ensure a standard which is hampered by the national environment is a serious challenge.  Holding clients accountable to an individual DFI’s requirements may also be difficult in situations in which the institution is providing only a relatively small amount of financing relative to the size of a large multinational client, for example. 
 
DFIs and monitors for private sector buyers have various processes for assessing risk.  They may use government reports on human rights, ILO reports, and research conducted by unions, as well as the reports of their staff in the field.  Their assessments may take the form of mathematical formulas or a set of standards that are mandatory, and may permit some latitude.  This assessment plays a part in determining not only whether to form a relationship with the client, but also what kind and how intensive engagement is needed.  It is promoted by some DFIs as a service to the client, which can help it improve supply chain management and achieve compliance certification by independent organizations. 

The assessment of less concrete standards, particularly freedom of association, is still a challenge, which emphasizes the need for coordination and information sharing among DFIs and the use of local expertise, including stakeholders such as local NGOs, trade unions, and independent experts and consultants. 

Role of Stakeholders and External Partners
Motoko Aizawa, Corporate Policy Advisor, Environment & Social Development Department, IFC
Peter Bakvis, Director of the Washington Office, Global Unions
Adam Greene, Vice President, Labor and Corporate Responsibility, United States Council for International Business

Significant time and outreach for consultation with stakeholders including labor unions, NGOs, clients and communities is crucial in the adoption of standards into a DFI’s policy and on an ongoing basis, including in the process of approval of individual projects.  Given the importance of confidentiality of some business information of DFI clients, enabling stakeholder input on individual projects presents an important challenge, which may be addressed in part through standing advisory committees on labor issues established by the DFIs.  Extensive consultation may be needed to ensure input before projects begin rather than afterwards.  Involvement of stakeholders such as labor organizations can make the business foundation for involvement more robust, for example by informing the DFI about the labor situation in a country or firm, or by enabling the process of engagement to improve a poor situation.  The transparency of the stakeholder involvement process is important to the value and credibility of the process. 

It is important that the scope of potential roles the DFI can play be clear to all the stakeholders: they must understand what the institution can do and cannot do, such as replacing the government in labor inspections.  The consultation process has the potential to draw the local authorities into the issue, and to provide a foundation for reform of national labor laws and institutions within the context of dialogue involving employers (clients) and workers. 

On-Going Supervision and Monitoring of Projects after Approval
William Bulmer, Associate Director, Environment & Social Development Department, IFC
Lejo Sibbel, Consultant, Sibbel Consulting
Jorge Perez- Lopez, Director of Monitoring, Fair Labor Association

Once a financial relationship is underway, intervention may be more difficult than before it has begun.  It is necessary to extend the intervention mechanisms beyond requirements of improvement before initial disbursements are made in order to ensure sustained improvements.  Engaging management at the highest level of client firms, as well as the managers who work directly with employees, is important in making it clear that adherence to the standards is important to the DFI.  As with the incentives within the institutions for investment officers, more positive incentives are needed for clients that improve or those with an already high level of compliance with the standards. 

Monitoring serves the purposes of assessing the situation, informing the decision on the financial relationship and revealing underlying causes of problems in the situation.  There is some degree of tension between the goal of transparency, of reporting results to the public and stakeholders, and that of engagement, because once problems are publicized it may be harder to work with firms to improve their standards.  However, engagement of workers as well as clients from the beginning of the monitoring process, such as in the selection of monitors, can help to ensure that all parties trust the process, because they have been involved and agreed from the start. 

Specific quantitative indicators such as the percentage of workers represented by a collective bargaining agreement, or the number of days lost to dispute, can be used for ongoing monitoring as with the original risk assessment; however, these indicators usually fail to capture some of the most serious problems with freedom of association. 
 
Most institutions require that clients be in compliance with all standards, and excellent performance in most does not outweigh performance in another that is unsatisfactory.

Gender, ethnic identity, nationality and language of monitors, as well as the time, location and frequency of their visits and the associated logistical challenges must be considered; all these factors can impact the ability of monitors to understand the reality of the situation on the ground.  The accessibility of the process and the monitors to the workers is a key factor in determining the reality.  The costs of monitoring can be significant but can be reduced by a great deal through cooperation between DFIs, and with the ILO and other stakeholders. 

Dealing with Problems, Grievance Mechanisms, Remediation
Mark Constantine, Principal Strategy Officer in the Global Manufacturing Department, IFC
Judy Gearhart, Program Director, Social Accountability International
Patrick Neyts, Senior Advisor, VECTRA International
 
Monitoring alone is insufficient to address the challenges of adherence to labor standards.  Designing effective engagement with clients which affects their fundamental management systems, rather than just the superficial symptoms of an individual violation, is needed, along with incentives for change.  Otherwise clients may simply conceal labor standards problems from inspection rather than solve them.  This requires clear communication of expectations and working with all the stakeholders: asking workers what they want, examining the incentives that workers, management and buyers may face that run counter to the improvement of conditions, and exploring ways to minimize that resistance.  Engaging buyers involved with the client can also be helpful in ensuring broad-based improvement over the long term.

Capacity building, including employer and employee trainings, can provide an option for progress on issues endemic to a country.  The inclusion of workers and unions in the governance of the grievance process, and transparency to workers of grievance response, is vital in making the dispute resolution process effective.