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Tightened Conflict Mineral Regulations Could Pinch Unwitting Investors

The island of Jersey, long known as one of the go-to places for high-level finance for both international corporations and the ultra-high-net-worth, has recently made headlines over alleged failures to take action against the purveyors of “blood gold.”

Investors with no ties to Jersey and no direct investment in gold still might want to follow the dispute, because so-called conflict minerals could take a toll on their portfolios as compliance scrutiny intensifies on the regulations governing such investments.

Gold is just one of a group of natural assets whose role in financing violent conflicts has made them hazardous investments in more ways than one. Other conflict minerals—including casserite, which yields tin; wolframite, which yields tungsten; and coltan, which yields tantalum—are mined in areas of political unrest and used by warlords to finance war and violent intimidation.

Tin, tungsten, tantalum and gold—known collectively as 3TG—are used in the manufacturing of a wide variety of products. The SEC’s Conflict Minerals rule requires public companies that manufacture or contract for manufacture of products to report annually on whether those products contain any 3TG and what the sources for those materials are. The end goal, of course, is to keep financing from reaching the perpetrators of atrocities in the Democratic Republic of Congo (DRC), and the central African countries that adjoin it: Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia. Companies were required to file their initial reports by June 2.

The 2006 film Blood Diamond, which starred Leonardo DiCaprio, illustrated the role diamonds—often another conflict investment—played in financing the Sierra Leone civil war. The Kimberley Process Certification Scheme (KPCS), adopted in 2003, is supposed to prevent blood diamonds from coming onto the market and contributing their considerable value to ongoing conflicts, but there is ongoing debate about how effective the strategy is.

But back to Jersey, which made headlines a couple of years ago. Threatened crackdowns on loopholes that allow protection of both corporate and private assets against taxation caused it to threaten to break its ties with the U.K. Jersey is what is known as a “peculiar possession” of the British Crown, accountable directly to the Queen, and has its own parliament, legal system and treasury. While it’s treated as part of the European Union and is included in many U.K. international agreements, it’s had its own constitutional rights since 1204. And while it is quick to point out that it has signed on to a number of international agreements regarding the sharing of financial information, its business is still the care and preservation of vast fortunes.

Allegations that Jersey regulators, and the island’s police as well, have failed to take action against a company selling gold tied to a rebel militia group in the DRC have renewed public scrutiny on how the island makes its money. The controversy has also pushed conflict investments back into the spotlight.

Hussar Ltd., a Swiss company that is nominally owned by Jersey company Osiris Trustees Limited, is being investigated by Swiss authorities on charges that it sourced gold it provided to Switzerland-based gold refiner Argor-Heraeus SA during 2004–2005 from middlemen in the DRC connected to rebel militia.

Argor-Heraeus has denied the charges and Jersey’s Financial Services Commission has said that Hussar was not a regulated financial company. However, the Conflict Awareness Project (CAP) has said that it provided evidence to the Jersey authorities that was sufficient for the Swiss to launch an investigation, but no action was taken in Jersey.

The question of conflict minerals is not, of course, only a problem in Jersey or only a problem with gold or diamonds. Those initial reports filed by public companies with the SEC indicate that many companies have not dug deeply enough to uncover potential sourcing problems in their supply chain, far less taken concrete steps to improve the situation. Others didn’t bother to file at all. Of those that did file, IBM and HP were among dozens of firms that found gold sourced from North Korea, which is under sanctions, in their supply chains.

It’s true that with conflict minerals necessary for the manufacture of so many products—from smartphones and other electronics to jewelry and even clothing and accessories (such as metal zippers)—identifying where minerals originate can be challenging. However, the risk of doing nothing about it is growing.

While the SEC may be lenient as companies embark on the process of learning whether conflict minerals are in their supply chain and considering what to do about it, other risks lie ahead for those companies. Few companies have conducted the required independent private sector audit (IPSA) to uncover conflict minerals, and by 2016 the grace period to do so will expire. That puts companies that failed to file way behind the curve. In addition, some states have passed or are considering the passage of legislation that would bar companies failing to file from obtaining state contracts.

However, companies engaging in conflict mineral trade not only court legal risk but also reputational risk. Bobby Kipp, PwC’s conflict minerals leader, said that it’s important for investors to be aware of the conflict minerals issue because “Some investors care about responsible sourcing and this is a responsible sourcing issue. How a company deals with conflict minerals might also be reflective of how they deal with other responsible sourcing matters.”

PwC’s most recent conflict minerals study reveals that “almost half (45%) of respondents have plans to become conflict free, with 7% planning to do so within the next two years, Kipp said. However, most others had not yet made any decision on this, so of the respondents who had, the number planning to become conflict free is a much higher 92%.”

Kipp added, “The drive toward conflict free correlates closely with the number of respondents expecting revenue-impacting consequences if they are not ultimately found to be conflict free. These include 36% concerned about loss of customers, 31% concerned about the risk to their brand and 8% concerned about product boycotts. This is not really a regulatory risk that companies are worried about although they do have a regulatory requirement to file. The key risk here is reputational and customer risk—including any potential impacts from the state procurement guidelines that may change based on some of the state legislation that has passed.”

Companies that can’t avoid conflict minerals—if the minerals, Kipp said, “need to be there for the product to function”—have to make a decision, as do investors, about how much they care about sourcing. “And for companies that sell products to other companies (vs. consumers), whether their customers ‘care’ about the source of those minerals, if companies aren’t paying attention to what their customers want, they could have a business problem.”

And NGOs will likely make sure that noncompliant companies will have that business problem by publicizing the results—something that’s already occurring. The good part is that companies that take the necessary steps to comply will also come in for publicity that can boost their brand. As companies have repeatedly learned the hard way, social media campaigns can do extensive damage to a brand over a company’s failure to live up to expectations. Investors should keep up to speed on the potential for that risk within their portfolios by watching companies’ progress with regard to conflict minerals.

 

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