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Corporate governance in the Norwegian Government Petroleum Fund

Norges Bank's letter of 8 December 2005 to the Ministry of Finance

8 December 2005

We refer to your letter of 30 August 2005 requesting Norges Bank to provide a more detailed account of how the Bank plans to organise its corporate governance activities in the Government Petroleum Fund. Norges Bank was also requested to discuss the interplay between the various instruments used to promote the Fund's ethical guidelines. The background for the questions was Norges Bank's letter notifying the Ministry of an increase in the use of resources for corporate governance activities from September 2005.

In this letter, Norges Bank stresses the importance of actively exercising ownership rights for a fund of the size and long-term character of the Petroleum Fund. Norges Bank wishes to exercise ownership rights in accordance with the guidelines laid down by the Ministry of Finance and in a manner that engenders the respect and confidence of the companies in which we invest, other investors and the Norwegian people. Corporate governance activities will be a key component in the Bank's work to ensure the long-term return on the Petroleum Fund and will also contribute to strengthening the ethical dimension of portfolio management.


In the first years after equities became an asset class in the Petroleum Fund (1998), the entire equity portfolio was managed by external management organisations. Norges Bank delegated the exercise of ownership rights to these organisations within the limits laid down in the regulation relating to the Petroleum Fund. In 1999, Norges Bank started gradually to build up its own equity management. Against this background, and as a result of the substantial increase in the assets under management and the many problems related to weak corporate governance internationally, Norges Bank started to build up its own apparatus for the exercise of ownership rights and the promotion of good corporate governance. Norges Bank informed the Ministry of Finance about these developments in a letter dated 12 February 2003. The letter also provided information about voting in the externally managed portfolios. A proposal was also made to amend the regulation relating to the management of the Petroleum Fund to provide for somewhat more active exercise of ownership rights.

Voting in the internally managed portfolios started in March 2003. More detailed information about voting in 2003 was provided in the Government Petroleum Fund's Annual Report for 2003. International developments with respect to protecting the rights of shareholders were described in an article included in the Norwegian version of the report (subsequently published in English on the Bank's website). Norges Bank's work with respect to the implementation and development of voting in the internally managed portfolios was also presented.

The exercise of ownership rights was defined as one of three instruments in the ethical guidelines for the management of the Petroleum Fund laid down by the Ministry of Finance on 19 November 2004. The regulation relating to the management of the Petroleum Fund was also amended as follows: "Norges Bank shall exercise ownership rights for the Government Petroleum Fund. The primary objective of the exercise of ownership rights is to safeguard the Fund's financial interests" (ยง11). The requirements relating to the exercise of ownership rights are defined more precisely in the ethical guidelines. Section 3.1 states that the primary objective of Norges Bank's exercise of ownership rights for the Government Petroleum Fund is to safeguard the Fund's financial interests. The exercise of ownership rights shall be based on a long-term horizon for the Fund's investments and broad investment diversification across the markets that are included in the investment universe. Section 3.2 states that Norges Bank shall report on its exercise of ownership rights in connection with its ordinary annual reporting.

In accordance with these guidelines, Norges Bank's Executive Board laid down new principles for corporate governance in December 2004. These guidelines are based on internationally recognised principles of good corporate governance as expressed in the OECD Principles of Corporate Governance, and on the assumption that the companies in which the Fund is invested act in accordance with the principles in the UN Global Compact and the OECD Guidelines for Multinational Enterprises. The new principles were presented to the Ministry of Finance in a letter dated 17 December 2004.

Strengthening ethical and financial competence

Corporate governance activities have primarily been carried out in the Equities Department of Norges Bank Investment Management. In June 2005, corporate governance activities were strengthened further by the establishment of a separate corporate governance group which reports to the Chief Investment Officer Equities. In this group, we have combined expertise in ethical issues and financial issues in order to strengthen the relationship between ethical management of the Fund and the long-term financial returns of the Fund.

The fundamental purpose of the exercise of ownership rights is to ensure that the interests of all shareholders are sufficiently protected by companies' governing bodies. In recent years, there have been cases where the rights and financial interests of shareholders have been poorly protected or not protected at all. These incidents seem to reflect that corporate management have based their decisions on short-term perspectives. Another common aspect has been the fundamental lack of ethics. Laws and rules have been violated and individuals have given priority to their own interests rather than to the interests of shareholders and the common good. Experience has made it clear that good corporate governance also includes an ethical dimension.

It is also important to note that long-term investors, such as the Government Petroleum Fund, often have other interests than investors with a short-term horizon. It is in the interest of long-term investors, with investments spread over large parts of the world, that rights are increasingly respected, that the environment is protected, that armed conflicts are terminated and that the political framework is optimal. For these reasons, there is often synergy between ethics and financial interests for an investor with a long-term investment horizon. In addition, an active and serious interaction between companies and their surroundings is important for the companies' reputation and market confidence.

It must also be emphasised that the long-term financial soundness of the Fund is a genuinely ethical concern where consideration for future generations is particularly important. Therefore, it is not simply a question of whether ethics and financial interests are complementary, but also to what degree different aspects of ethics are complementary.

Of course, financial interests and ethics - or in other terms: the ethical protection of the Fund's financial interests on the one hand and ethical interests related to e.g. human rights or the environment on the other - will not always be complementary. It is therefore important to emphasise, as the Graver Committee also did, that in cases where the connection between ethics and long-term return is either unclear or negative, the exercise of ownership rights will not be an appropriate instrument for promoting ethical interests. Nevertheless, Norges Bank works on the premise that good ethics will normally be compatible with protecting the long-term interests of the Fund and that expertise in ethics - and carefully prepared communication of ethical matters - is therefore important for Norges Bank's exercise of ownership rights.

In addition, we must assume that it is important in those cases where the Fund's long-term financial interests and other ethical principles may seem to conflict that we are aware of such conflicts and discuss thoroughly how they may be solved in each individual case. Often, an investor can best contribute to solving such conflicts by focusing on fundamental, recognised principles of good corporate governance, such as the independence and competence of the board of directors, transparent and understandable reporting, sensitivity to investors' views, compliance with the rule of law, the absence of corruption and appropriate remuneration systems for managers. All of these are principles of good corporate governance which in most cases will lead to greater transparency and respect for ethical, human rights, social and environmental issues. An investor's most important task may therefore consist of being active with regard to these types of corporate governance issues through the exercise of ownership rights, thereby contributing to well-run and responsible companies that report openly about their activities. The investor should not least hold companies' boards of directors accountable. It is the companies' boards that supervise the companies' day-to-day management and operations and ensure the existence of adequate internal control systems.

These are some of the considerations underlying Norges Bank's decision to bring in ethical competence as part of our work to strengthen the corporate governance activities in the Petroleum Fund. The Bank has strongly emphasised that this competence shall be integrated into and have an influence on the operational management of the Fund, which is why the corporate governance group is subsumed under equities management.

Instruments for engaging actively in corporate governance

The foremost instruments of active corporate governance may be summarised in the following four points:

  • Communicating the investor's corporate governance principles. Norges Bank's principles of corporate governance make clear demands on companies' governing bodies. These principles are available both in printed form and on Norges Bank's website. They have been distributed to a large group of other similar investors. Experience so far indicates that the principles are generally in agreement with the corporate governance principles of other large investors, except that they are more explicit with respect to requirements governing the relationship between companies and their surroundings and employees. Norges Bank is working on plans to communicate these principles to the most relevant companies. The Bank is also working on further development and more precise formulation of the principles.
  • Exercising voting rights. This includes gathering external analyses and combining these with our own knowledge of companies, as well as using externally available logistics for exercising voting rights. Norges Bank has already made considerable progress in this area: In 2005, Norges Bank voted on more than 18,000 items spread over 2,000 companies. All voting in the externally managed portfolios was moved into the Bank at the beginning of 2005. This ensures consistency and further control over the voting. The Bank is currently discussing which items and issues should be given priority and how to more efficiently deal with the follow-up work in connection with voting.
  • Contact and cooperation with other institutional investors. For an institutional investor like the Petroleum Fund, with an average ownership stake of 0.3% in each company at present, cooperation with other investors is absolutely essential to ensure influence in important matters. It may also be appropriate to participate in formal and informal international networks of investors to ensure coordination and thus greater influence. In some cases, it will also be necessary to have contact with regulatory and legislative authorities, e.g. by participating in consultative processes. Contact and coordination with other investors may also be of importance in the aforementioned case. Since June, Norges Bank, on the invitation of the United Nation's Secretary-General, has worked with a number of other investors to formulate common principles for integrating factors relating to ethics, the environment and corporate governance into investment operations. Norges Bank has decided to endorse these principles which are highly consistent with our own principles of corporate governance and ethics.
  • Direct contact with individual companies in addition to voting at annual meetings - alone and together with others, and primarily with the companies' board of directors - in order to exercise influence in matters which are important for the Fund's long-term return in accordance with the corporate governance principles.

Norges Bank will apply all of these instruments. Priorities and the use of resources will be adapted over time on the basis of experience. The Bank will place considerable emphasis on behaving in a manner that earns the respect of other investors and companies so as to achieve a positive influence. In this context, it is important to remember that some countries will have corporate governance and political traditions that are not consistent with Norges Bank's guidelines. This requires thoroughness in preparations and integrity in form. The common denominator that can draw many investors together will be long-term returns. Requirements that cannot be justified also on the basis of such financial considerations will hardly win considerable support and will also raise doubts about the basis of Norges Bank's corporate governance activities. An important aspect of communication with other investors will be to show how and why following a code of ethics and taking into account the impact of activities on the environment and society in general may be important for the long-term financial performance of both companies and portfolios.

Norges Bank will provide information about its use of these instruments in its annual report to the Ministry of Finance. The report will describe which activities have been carried out and which matters have received priority. Over time, we will also try to shed light on the impact of corporate governance activities on the most important issues. Norges Bank considers it important to be transparent concerning these issues. The primary objective, however, is to achieve a positive influence. This implies that when there has been direct contact with a company, the Bank will be cautious about publicising its conduct with respect to the company on individual issues.

It must be stressed that the exercise of ownership rights in individual cases very often takes time and requires patience. In addition, ownership rights must be exercised in a manner that protects the Fund's international reputation. This is decisive to our ability to influence future issues. Although the exercise of ownership rights may generate substantial results, also in connection with issues of great ethical significance, we can therefore normally not expect swift changes or immediate results in individual cases.

The relationship between the means for observing the ethical guidelines

The ethical guidelines for the management of the Petroleum Fund are in accordance with the recommendations of the Graver Committee. The exercise of ownership rights delegated to Norges Bank is one of three instruments. The other instruments are negative screening and exclusion. Decisions concerning the latter two are made by the Ministry of Finance in accordance with recommendations from the Petroleum Fund's Advisory Council on Ethics.

The instruments have two different purposes. Negative screening and exclusion shall primarily prevent the Fund from complicity in grossly unethical actions and the production of ethically unacceptable products. The purpose of exercising ownership rights is to have an influence on companies. The Graver Committee assumed that the exercise of ownership rights would in many cases be a more effective means of influencing companies' behaviour than exclusion. This implied a narrow framework for defining which companies should be considered for exclusion. The exclusion mechanism is not meant to be retrospective and punitive.

The implementation of the ethical guidelines is based on a clear and logical division of responsibility: the Ministry of Finance shall, on the advice of the Petroleum Fund's Advisory Council on Ethics, make decisions concerning exclusion and negative screening from the investment universe. Norges Bank shall exercise ownership rights in the companies in which the Fund is invested. Therefore, Norges Bank's active ownership does not conflict with the work of the Ministry of Finance and the Advisory Council on Ethics. Norges Bank shall not and should not have any co-determination in matters concerning exclusion or negative screening, and the Advisory Council on Ethics/Ministry of Finance on the one hand and Norges Bank on the other must generally set their agendas and manage their operations independently of one another.

Nevertheless, it is possible that Norges Bank's increased emphasis on active exercise of ownership rights may in some cases have an impact on decisions concerning exclusion or negative screening. If the Fund's manager can follow up issues which for various reasons may provide grounds for considering winding down or exclusion, and through the exercise of ownership rights can have a real influence on these issues, it should be relevant for the Advisory Council on Ethics to take this into account when they provide advice to the Ministry of Finance. This is also inherent in the Fund's ethical guidelines, which state in section 4.5 "The Council may request that Norges Bank provides information as to how specific companies are dealt with in the exercise of ownership rights." Norges Bank considers it natural to interpret this sentence to mean that the Advisory Council on Ethics may request information about how ownership rights are actually exercised now and how they may be exercised in the future, i.e. that the Council can request information other than retrospective information on how ownership rights have been exercised earlier.

Such a need for information concerning the exercise of ownership rights will naturally not apply in cases where the Advisory Council on Ethics is of the opinion that a decision concerning exclusion is in accordance with the Fund's ethical guidelines because there has been a major, very gross and systematic breaches of the Fund's ethical guidelines, and where it also seems apparent that there is little or no chance of a change in these conditions within a reasonable time frame. In cases where there is somewhat more doubt as to whether the conditions clearly involve gross breaches of the ethical guidelines, e.g. because the conditions in question exist in a subsidiary and/or involve a very small part of the company's operations, the exercise of ownership rights will normally be a much better means of bringing about change in the companies concerned than negative screening and exclusion. When the Fund withdraws from a company, it loses every opportunity to exercise influence in the capacity of shareholder. In precisely such cases, where there is this type of uncertainty, it will probably be of importance for the Advisory Council on Ethics to be given an account of how Norges Bank exercises its ownership rights.

The ethical guidelines state which types of breaches may be defined as so serious that they provide the basis for negative screening or exclusion. The criteria are in accordance with the recommendations of the Graver Committee. The Committee has also discussed which types of relationships between the company concerned and the Petroleum Fund constitute complicity in the company's operations. On the one hand, it is clear that we are complicit when there is a breach of the ethical guidelines in one of the companies where we have a direct ownership share. On the other hand, the relationship is relatively unclear when the breach occurs at a subcontractor to one of the companies in which we have shareholdings. The Graver Committee did not recommend a specific definition of complicity, but assumed that a separate assessment would have to be made in each individual case. However, it was pointed out that if complicity is drawn too far out into indirect associations, this will lead to a pulverisation and dilution of responsibility as "nearly everyone" is considered to be complicit and the ethical argument against complicity will lose its force. In cases where the degree of complicity is unclear, and it therefore seems irrelevant to withdraw the Fund from investments in the company in question, the exercise of ownership rights in the form of voting and pressure on the company may nevertheless be appropriate and contribute to changing unethical or otherwise undesirable behaviour.

We also assume that in some cases, after the Advisory Council on Ethics has recommended exclusion, it may be relevant for the Ministry of Finance to ask Norges Bank whether the exercise of ownership rights may warrant postponement of a decision concerning exclusion.

With respect to the relationship between various instruments for observing the ethical guidelines, Norges Bank applies the following guidelines:

  • In line with the current guidelines, the Advisory Council on Ethics may in connection with its clarification work ask Norges Bank whether they consider it expedient and realistic to actively exercise ownership rights in cases where such activity may have an effect on the behaviour that is found to warrant action. Norges Bank shall not be involved in the Council's decision-making process, but only provide information concerning the exercise of ownership rights that may be of importance for the Council's recommendations.
  • Formally, the Advisory Council on Ethics has neither an obligation nor a mandate to weigh negative screening/exclusion against the Fund's long-term financial interests. Therefore, the Ministry of Finance must be responsible for this. In special types of cases, the Ministry should therefore consider whether the exercise of ownership rights can be seen as an alternative instrument, even though the Council has recommended exclusion. Norges Bank will then provide the Ministry with the information requested.
  • While such contact should exist when necessary, it is important to maintain a clear distinction between the responsibilities of the Ministry of Finance and those of Norges Bank in order to maintain a sound and logical division of functions - ethical, political and legal - between the negative screening and exclusion mechanism on the one hand and the exercise of ownership rights on the other.

Norges Bank has a long-term agenda for the exercise of ownership rights within its management framework, with the objective of making an optimal contribution to the long-term return on the Petroleum Fund. Norges Bank shall exercise ownership rights in a large number of companies and be responsible for ensuring that the overriding principles for corporate governance are maintained, developed, communicated and observed. It will not always be possible for Norges Bank to allocate substantial resources to work on individual cases that have not arisen through processes or priorities initiated by the Bank. For Norges Bank, it is therefore natural to see the interplay with the Advisory Council on Ethics and the Ministry of Finance primarily as an exchange of information where Norges Bank provides information about its exercise of ownership rights in general and - when natural - in individual cases.

Norges Bank is of the opinion that changes in the ethical guidelines are not required at this time. However, when we have more experience with both company exclusions and corporate governance activities, it will be natural to consider whether the guidelines provide a reasonably sound balance between the important considerations underlying them.

Yours sincerely,

Svein Gjedrem

Henrik P. Syse