What is the Uyghur Forced Labor Prevention Act and what does it mean for investors?
- The Uyghur Forced Labor Prevention Act (UFLPA) is seeking to prohibit imports made by forced labour in the Xinjiang Uyghur Autonomous Region (XUAR) of China to the US.
- The scope of the UFLPA is potentially broad and very disruptive, with cotton, tomatoes and polysilicon having been specifically identified as high-priority goods, but it may also affect many other products.
- The UFLPA is likely to raise awareness of the use of forced labour in XUAR, and companies that have goods seized or impounded may find themselves facing reputational damage and revenue losses, and there may also be upstream supply chain disruption.
- This Act is an example of where an ESG issue (in this case, a primarily social issue) has become financially material as a result of regulatory action.
On 21 June 2022, US Customs and Border Protection (CBP) began enforcing the Uyghur Forced Labor Prevention Act (UFLPA), which was signed into law by President Biden on 23 December 2021. The Act is seeking to prohibit imports made by forced labour in the Xinjiang Uyghur Autonomous Region (XUAR) of China to the US, by essentially blocking all goods from the region, unless the firm seeking to import those goods can rebut the presumption that forced labour was involved. It is expected that CBP’s scrutiny will grow over time, and that it may expand its scope to detain, exclude or seize and forfeit any goods that it determines use inputs originating from Xinjiang that end up in products manufactured, assembled or shipped from other jurisdictions.
Scope of UFLPA
XUAR exports $10-15 billion in goods globally every year, and of that, goods with a value of roughly $650 million are exported to the US.1 The scope of the UFLPA is potentially broad and very disruptive. The ‘high priority’ goods affected are cotton, tomatoes and polysilicon (used in the manufacture of solar panels); however, other imports affected may include other food products, additives, supplements, apparel/shoes, electronics, aluminium alloys, personal protective equipment (PPE), lead acid batteries, train parts, pharmaceuticals, furniture and home appliances.
We understand from experts in the industry that this issue is likely to be broader in scope than has been reported. First, forced labour often occurs at the input level, particularly for electrical goods, where the final product may be assembled or finished outside XUAR, but relies on inputs from the region. Secondly, some experts believe that forced labour is being moved beyond Xinjiang, so the issue is not isolated to companies with suppliers in this region. Moreover, we think that the legislation is likely to expand over time and move beyond high-priority commodities.
We believe the market may be underestimating the risks that UFLPA presents to businesses, as well as its potential impact on supply chains. According to our research, there are many companies that do indeed have direct or indirect exposure to UFLPA but have not disclosed this risk in regulatory filings.
A significant ESG risk
The UFLPA is likely to raise awareness of the use of forced labour in XUAR, and companies that have goods seized or impounded will no doubt find themselves facing reputational damage, being viewed as exploiting forced labour. Any publicly traded logistics company that sells goods from Xinjiang and China has exposure risks here. The ‘importer of record’ is the company with the burden of demonstrating that goods are not made with forced labour, meaning that operational costs and complexities are rising across the supply chain.
We believe that the companies most at risk are those with supply chains in China, but which import significant quantities of products to the US. This is where regulation may be disruptive and may give rise to a higher likelihood of reputational issues. The risk is even greater where a company may struggle to relocate supply chains either owing to the prevalence of a particular commodity in China or because it will suffer in the Chinese market if it ceases to maintain operations there.
This law is likely to have a disproportionate impact on small and medium businesses that import to the US but do not have the resources to perform due diligence on their supply chains for goods sourced from China and Asia, or that do not have appropriate experience in relocating supply. Over time, this will become an additional scale benefit to larger retailers and more sophisticated manufacturers that do have the additional resources.
There may, however, be companies that are not affected by the UFLPA, but that provide solutions which can assist with supply-chain due diligence. Examples of this are businesses that can help to provide DNA analysis and other microchemical tests to determine geographic origins, as well as blockchain vendors.
Difficult to rebut
Importers face significant challenges to rebut the presumption that forced labour has been used. Some of the requirements will be demonstrable with strong supply-chain management, such as engagement with suppliers and mapping of the supply chain from raw materials. However, depending on the stringency of interpretation and enforcement, some could be difficult to meet, including the development of a code of conduct that addresses the risk of Chinese government labour schemes, as well as the remediation of forced labour conditions or termination of the supplier relationship.
Remediation is a part of human rights guidance that companies tend to struggle with, suggesting that termination of supply contracts may be more likely. For certain commodities, such as cotton, shoes and polysilicon, this may create significant disruption, given that, for example, China provides more than 70% of shoes by quantity to the US market each year,2 and Xinjiang produces 45% of the world’s solar-panel-grade polysilicon.3 In any case, CBP has indicated that exceptions to the presumption of forced labour will be rare.
Further decoupling of China and the West
Similar trade restrictions are likely to be introduced in other Western economies, given that the US State Department has been specifically tasked by law with getting partner nations to follow its lead. If, for example, the European Union adopts a similar stance, this may move the needle in the solar and aluminium markets in particular, but in several others too.
The Uyghur Forced Labor Prevention Act sets a clear precedent for the European Union and its Member States, who should follow suit and introduce, without further delay, an ambitious proposal for mandatory supply chain due diligence legislation supplemented by a mechanism that bans the imports of products made by forced labourDolkun Isa, President of the World Uyghur Congress4
In addition, this may further accelerate the theme of deglobalisation and the decoupling of China and the US/West that we have been seeing for several years, as the UFLPA introduces an entirely new level of friction and cost to sourcing at a time when many Western companies are already concerned about de-risking their supply chains. The law may cause some companies which have exposure to China within their supply chains to consider decisions to have goods manufactured outside China and possibly closer to home. Cotton and cottonseed are top cash crops for the US agricultural sector, producing roughly US$8.8 billion in sales in 2021.5 It is therefore not unreasonable to view early US trade restrictions on XUAR-produced cotton as a protectionist move in addition to a strategy to protect human rights.
Given the strain that the UFLPA will place on supply chains, it is likely that this will add to inflationary pressures for the US, but also more widely, which may mean that there is a delicate balance that needs to be struck by those responsible for the enforcement of the Act given the political headwinds presented by rising inflation in the US.
Benefits of a multi-dimensional approach
The Uyghur Forced Labor Prevention Act is an example of where an ESG issue (in this case, a primarily social issue) has become financially material as a result of regulatory action. From our perspective, this is a nuanced topic, and clearly not all businesses in Xinjiang will necessarily have exposure to forced labour. However, the UFLPA, by its very nature, is unambiguous in its methodology. We therefore need to assess its impacts accordingly, irrespective of the broad-brush approach taken by the UFLPA.
In order to better understand the implications from an investment perspective, we seek to help our wider investment team gain practical insights into a company’s management of the UFLPA. This consists, where we deem it appropriate, of engaging with management to understand a company’s approach to identifying risks, supply-chain management, policies and procedures, and grievance reporting and remediation. For example, we have spoken to companies across a range of sectors, including apparel, autos, IT, health care, and alternative energy, to better understand their approaches to such risks. We believe this also highlights the benefits of multi-dimensional research, which involves our investigative team, responsible investment team, research analysts and portfolio managers working together to form a broader perspective.
- Reuters. Factbox: U.S. legislative clamp-down on products from China’s Xinjiang. 10 December 2021
- CNBC.com. 70% of shoes sold in the US come from China. With new tariffs, the industry braces for a hit. 2 August 2019
- Reuters. Factbox: U.S. legislative clamp-down on products from China’s Xinjiang. 10 December 2021
- Worker Rights Consortium. Coalition Calls Passage of Uyghur Forced Labor Prevention Act a Defeat for Corporations Complicit in Forced Labor and a Huge Victory for Uyghur Human Rights. 16 December 2021
- United States Department of Agriculture. National Agricultural Statistics Service, Crop Values 2021 Summary. February 2022
These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This is not investment research or a research recommendation for regulatory purposes. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors. Newton manages a variety of investment strategies. Whether and how ESG considerations are assessed or integrated into Newton’s strategies depends on the asset classes and/or the particular strategy involved, as well as the research and investment approach of each Newton firm. ESG may not be considered for each individual investment and, where ESG is considered, other attributes of an investment may outweigh ESG considerations when making investment decisions.