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The consultation on the ethical guidelines for the management of the Government Pension Fund – Global

Norges Bank's letter to the Ministry of Finance of 12 September 2008

12 September 2008


The management of the Government Pension Fund – Global brings with it ethical challenges that must be addressed both judiciously and ambitiously. The Ministry of Finance and Norges Bank have established ownership activities where ethical dilemmas are tackled openly and unambiguously. At Norges Bank Investment Management (NBIM), the exercise of ownership rights is an integral part of the investment management strategy. The ethical guidelines for the fund reflect the importance of ownership activities. Good corporate governance is often characterised by high ethical standards and lays the foundations for sustainable value creation. Active ownership can prevent ethical transgressions and the destruction of assets. The guidelines also deal with the issue of companies behaving in ways that make investment in them ethically problematic. The criteria for the exclusion of companies are stable and based on an overlapping consensus on ethical principles among the general public. Ownership rights are exercised on the basis of broadly accepted international standards such as the UN Global Compact and the OECD’s Principles of Corporate Governance and Guidelines for Multinational Enterprises. Norges Bank believes that the ethical guidelines provide a sound basis for taking on these challenges.

The exercise of ownership rights – taking care of the fund’s equity ownership interests in companies – has been assigned to Norges Bank as part of the operational management of the fund. Ethically motivated restrictions in the investment universe are imposed by the Ministry, and the benchmark portfolio is adjusted accordingly. Thus the ethical aspects of ownership are handled in a way that is compatible with the institutional structure for the management of the fund. Norges Bank agrees with the Ministry that this clear division of responsibilities between political authorities and the operational manager is important for achieving the objectives for the management of the fund. It is also an important reason why the fund is looked on favourably abroad. We take for our basis that a key aim of the review of the ethical guidelines is to assess whether this separation of roles can be continued and work stepped up in the light of experience gained since the guidelines entered into force in 2004.

The Government Pension Fund – Global is a global portfolio invested in 55 countries. As manager of the fund, Norges Bank must deal with participants in a global securities market and with companies and standard-setters in every part of the world. The ethical guidelines must therefore be based on principles for which there is broad global understanding.

Ownership activities

Norges Bank agrees that the exercise of ownership rights is an important instrument in addressing the ethical aspects of equity management. Ownership activities are growing in importance due to the fund’s long time horizon, size, geographical diversification and expansion, the increased number of companies in the portfolio, and the growing number of companies in which the fund has a relatively large stake. Since the fund’s benchmark is a global market portfolio, the fund will in all probability be a long-term investor in the majority of large listed companies. It is therefore in the fund’s interests to strengthen these companies’ governance structure and capacity to create value. It is also in the fund’s interests for the markets to be well-functioning, open, well-regulated to reduce serious market failures, and subject to reasonable standards of conduct, such that they contribute to sustainable development. To be effective and legitimate, ownership activities must be grounded in the fund’s financial interests.

Norges Bank aims to play a leading role globally in corporate governance. We believe that it is right to be ambitious about what ownership activities can achieve, and would stress that:
- their effects will emerge in the long term and only rarely in the short term;
- although Norges Bank is increasingly among a company’s larger shareholders and often has access to decision-makers, its holdings will not be so large that its ownership activities will not need the understanding and respect of other participants in the financial market to be truly effective;
- our ownership activities have to be based on an understanding that an investor’s role is different to that of players such as public authorities and pressure groups (although they may in some cases pull in the same direction); and
- companies will normally present changes as their own initiatives rather than a reaction to investors’ wishes, and so the results of ownership practices are not always easy to document.

Challenges for ownership activities

The mandate for the exercise of ownership rights – to promote the fund’s financial interests, partly by contributing to sustainable development – represents an approach that NBIM finds demanding but realistic in its dealings with companies and other investors. The ethical guidelines set out a clear direction for this work:

“…This financial wealth must be managed so as to generate a sound return in the long term, which is contingent on sustainable development in the economic, environmental and social sense. The financial interests of the Fund shall be strengthened by using the Fund’s ownership interests to promote such sustainable development. … The overall objective for Norges Bank’s exercise of ownership rights for the Government Pension Fund – Global  is to safeguard the Fund’s financial interests. …”  (1)

There is a need to choose priority areas for the exercise of ownership rights on the basis of this mandate. The choice of priority areas is also based on our assessment of which types of issue are best suited to dialogue with companies and standard-setters. By prioritising our efforts in this way, we can increase their impact, partly by building expertise and alliances and by creating expectations at companies. This requires a long-term and predictable approach. The priority areas contribute to a division of labour between institutional investors, which often have similar principles for good corporate governance. Norges Bank’s Executive Board has selected the priority areas.

Ownership activities aim to promote the fund’s interests by influencing portfolio companies and market standards. Sovereignty over investment decisions, formal shareholder rights, access to decision-makers and opportunities to generate publicity are key sources of influence. NBIM uses a variety of instruments in its active ownership work, as presented in its annual reports and elsewhere. Working processes are evolving based on experience gained. For example, we plan to establish robust procedures for abandoning engagement with companies where it does not have the desired result. NBIM usually has satisfactory access to companies’ boards and decision-makers.

To increase our influence, we attach importance to communicating as an investor and market participant. We primarily approach board directors and senior management and base our communication on the board needing to enjoy the confidence of shareholders, and on shareholders having assigned to the board the role of overseeing the company’s management. Unlike small niche investors and other societal stakeholders that aim to influence companies on individual issues, it is important for NBIM to maintain an investor profile that can ensure a lasting influence. To achieve this, we will avoid micro-managing companies. We need to be careful not to be marginalised as an investor that raises issues of little relevance to a company’s value creation.

This means that NBIM focuses on governance structure, procedures and issues which are of general significance to the company and with which we can expect the board and senior management to concern themselves. When assessing the information from a company, importance is attached to the norms established by accounting and reporting standards, and to the confidence on which the company depends. It will normally be more relevant to hold the board and management to account for the information they give investors than to demand documentation and verification beyond the requirements of generally accepted reporting and auditing practice.


Norges Bank believes that the principle of an overlapping consensus as the basis for the exclusion of companies should be retained. This principle is intended to ensure that the fund is subject only to restrictions that correspond to norms that are common to the majority of Norwegians and can be expected to be stable over time. Breaches of ethical norms must also be serious for companies to be excluded.

A model that is rather unusual in investment management has been chosen for the practical implementation of ethically motivated restrictions in the fund’s investment universe. The Ministry of Finance as principal itself issues a list of companies in which the fund must not invest. It is more common for the principal to lay down a number of criteria for exclusion and ask the manager to decide at company level. The model chosen for the Government Pension Fund – Global nevertheless has clear advantages. As investment restrictions can have a negative effect on the relationship between risk and return, it is reasonable for the principal to make these decisions. Norges Bank recommends that this practice be continued.

When it comes to the exclusion of companies, the guidelines differentiate between negative screening and ad hoc exclusion. Negative screening is linked to product categories and therefore a relatively easy-to-follow instrument. The principal has to weigh up two factors. On the one hand, the principal has a preference for avoiding association with certain products. On the other, restrictions in the investment universe bring the possibility of additional costs or risks. Of the 28 companies on the list of published exclusions from the fund’s investment universe, 20 have been excluded on the basis of negative screening for producing weapons of a type considered unacceptable on the basis of the ethical guidelines. Norges Bank attaches importance to screening continuing to be based on criteria for which there is broad support.

When it comes to ad hoc exclusion, the aim is to avoid an unacceptable risk of contributing to seriously unethical conduct as defined in the guidelines. Five companies (and three of their subsidiaries) are currently on the list of published exclusions on the basis of this criterion. We would refer to the report of the Graver Committee (2), which states that the possibility of having a positive impact through the exercise of ownership rights “may suggest that exclusion should be limited to the most serious cases where the company in which the Petroleum Fund has invested is directly responsible for unacceptable breaches of standards, and there are no expectations that these practices will be discontinued.”

Ad hoc exclusion on the basis of a risk of future unethical conduct is a demanding process. Experience has shown that the spotlight tends to fall on large companies with a wide range of activities, a broad geographical presence and relatively transparent reporting that have been singled out by active critics. Smaller companies with fewer areas of activity and a more local focus seem to be less prone to exclusion. There is a risk of exclusions hitting companies that are ambitious or leaders in their industries in terms of avoiding the very kinds of seriously unethical conduct in which the fund is to avoid complicity. It seems difficult to follow a consistent line on ad hoc exclusions. There is a risk of patterns of conduct that are not accepted at companies based in the industrialised world being tolerated in practice at companies in emerging markets with regulatory shortcomings. According to the guidelines, ad hoc exclusions are not to be a reaction to past actions but a defence mechanism to avoid complicity in unacceptable practices. It can be challenging to assess companies’ plans and assess the risk of such conduct in the future. All in all, there is a risk that the five groups of companies currently excluded for potential future unethical conduct are not actually the portfolio’s most problematic companies.

When a state is the beneficial owner of a fund, market participants, companies and other countries’ authorities will be alert to signs that the fund is operating with objectives beyond those of a pure investor. Both the framework for the fund structure and the implementation of its management could impact on how the fund is perceived. Ownership activities, the exclusion of individual companies and the principal’s presentation of these mechanisms can also play a role. A clear profile in this respect can be of importance for the ability to manage the fund successfully in the long term.

Norway’s position is that there is no need for separate regulation of so-called sovereign wealth funds. The emphasis on transparency, separation of roles and professional investment management reinforces this position. This suggests that the Ministry should retain the practice of steering the management of the fund by means of a mandate and clear limits.

The report of the Graver Committee states: “Thus, a decision to exclude a company from the portfolio for ethical reasons does not necessarily imply an accusation that a company has engaged in unethical activities or that it is unethical to invest in the company, but that, pursuant to the guidelines drawn up for the Petroleum Fund, the ethical risk associated with inclusion in the portfolio is unacceptable.”

We agree with this. It should not be taken as an accusation when a company is excluded from the portfolio. The way in which decisions on exclusions are published may play a role in how they are perceived. This could be actively exploited. When decisions on individual cases are communicated as administrative decisions triggered by the guidelines, there will be a reduced risk of the exclusion of individual companies being taken as an expression of special initiatives.

Exclusions must be based on the broadest possible body of evidence. The quality of the judgements made can impact on market participants’ understanding of the exclusion mechanism. The choice of companies excluded may also be significant. The recommendations published by the Ministry have been based on evidence from a number of open sources, expert reports and independent observations, and only to a limited extent on communication with the companies themselves. Especially when it comes to the risk of unacceptable future conduct, Norges Bank believes that it will be difficult to understand and assess a company’s ongoing improvement work and plans without obtaining information through direct contact with the company.

Norges Bank believes that direct contact with companies through meetings with relevant personnel is necessary in many cases to shed light on the complex question of whether there is an unacceptable risk of future unethical conduct. It should be possible for the processing of cases to involve the companies themselves at an earlier stage than today, and before a draft recommendation for exclusion has been prepared. This will improve both access to and the quality of the information used for the assessment.

Today’s procedure for communication with companies being considered for exclusion on the grounds of unacceptable conduct affords them limited opportunities to enter into a dialogue. This reduces the likelihood of companies understanding the concerns that the exclusion mechanism in the ethical guidelines aims to address. Direct dialogue is also relevant because companies can then be given real opportunities to identify which behavioural changes the guidelines will require for exclusion to be avoided. Companies can then find out how long they have to take action and how this action is to be documented. More two-way communication may strengthen the “expectations channel” by giving the Council on Ethics better opportunities to answer companies’ questions on what is needed for them not to be recommended for exclusion.

If increased communication during the processing of these cases paves the way for companies to take corrective action, the long-term outcome could be fewer exclusions. This would satisfy the guidelines’ requirement that there be a high threshold for exclusions. There is reason to believe that, on balance, this would improve the function of these mechanisms. Norges Bank does not anticipate that increased communication with companies in the processing of exclusion cases would conflict with NBIM’s ownership activities.

Coordination between ownership activities and exclusion

Norges Bank believes, as mentioned above, that the mandate for ownership activities is robust. We believe it right that the issue of avoiding complicity is addressed where necessary by the Ministry itself through restrictions in the investment universe on the basis of the criteria set out in the guidelines. It is important to continue to keep these considerations separate. If the exercise of ownership rights is to tackle issues other than the fund’s long-term economic interests, there is a risk of the legitimacy of ownership activities being undermined, opportunities to establish common ground with companies and fellow investors being limited, and ownership activities therefore becoming less effective. Norges Bank should not, therefore, be involved in the processing of exclusion cases. Clear separation of roles is also necessary to achieve appropriate control and delegation and to enable the allocation of responsibility retrospectively.

The Government Pension Fund – Global has shares in more than 7,000 companies. In line with the mandate, Norges Bank’s exercise of ownership activities in a particular case will be determined by how critical the problem observed is believed to be for the fund’s long-term economic interests, how suitable the problem is for ownership activities, and, as a result, how highly the problem is prioritised in the overall ownership strategy. We have described above and in NBIM’s annual reports how we analyse these issues. We have also described the need to concentrate our efforts on particular priority areas in order to lend our initiatives sufficient weight. There may, therefore, be individual cases that appear important in themselves but are nevertheless not allocated ownership resources. Thus it can be difficult to guarantee that active ownership will be exercised in all individual cases where there are problems but exclusion is not relevant. It would not be desirable to have coordinated case processing at individual company level. When the Ministry writes that it is making the final assessment of whether to exclude a company or try active ownership, this will be in cases where NBIM has plans to exercise ownership activities. Norges Bank assumes that the number of cases where both exclusion and ownership activities are designated as relevant options will remain so small that there is no need to make institutional changes.

Norges Bank shares the Ministry’s view that exclusion should be avoided if a good dialogue on expectations and situation report can prevent and correct. This goal can best be achieved through effective long-term ownership activities and sound procedures for communication with companies when processing exclusion cases. We believe it a reasonable conclusion that these two approaches have the potential to work together well over time. If the Ministry wishes to coordinate these mechanisms more directly, this should take the form of the Ministry as principal ensuring that the priority areas for exclusion and the exercise of ownership rights do not overlap.

The consultation paper discusses the possibility of using the threat of exclusion to reinforce ownership activities. This was covered in our letter of 6 June 2008 concerning the consultant report on the implementation of the ethical guidelines:

“The Report seems to assume that influence in engagement is based to a high degree on a threat of divestment.

“Although this may sometimes be the case, it is Norges Bank’s view – a view which seems to be shared by many market participants – that the basis for influence is more complex, and that possible divestment is not necessarily important and could on some occasions reduce influence. Commercial asset management firms, such as several of NBIM’s external active equity managers, are generally perceived as potentially exercising great influence on companies, while they typically do not use divestment as a tool.

“Norges Bank’ s assumption is that large investors’  views and concerns are perceived as important for companies because they want to market their securities long-term. Companies want to be well understood and trusted in the stock market, and thus achieve the best possible valuation. …

“In addition to the investment decisions, the Fund has a number of other measures in its ownership toolbox such as exercising voting rights, proposing board candidates, corporate actions such as securities transactions and issuance, top-level meetings, investor collaboration, publicity measures, etc.”

Against this background, Norges Bank does not see a need to use the Ministry’s exclusion mechanism as a threat in its exercise of ownership rights. As mentioned earlier, NBIM has other options when stepping up the pressure on a company. We also have the option of selling down our holding in a company if the contact we have had with the company so warrants.

Norges Bank will inform the Ministry about its ownership activities in the standard manner. The Ministry can then inform the Government Pension Fund – Global’s Council on Ethics, and it can inform Norges Bank about the Council’s plans. Where desirable for the exchange of information, this could take the form of the Ministry asking the Council to take part in meetings between the Ministry and Norges Bank. Mutual awareness of each institution’s priorities in both the short and the longer term will reduce the chances of unintentional overlap as the volume of cases grows. However, such an exchange of information should not limit the Council and Norges Bank’s scope to perform their respective roles.

Positive selection and earmarking of funds

Since the fund was started, the development of its investment strategy has moved slowly but surely towards expansion of the fund’s investment universe and benchmark portfolio. It now has equity investments in more than 7,000 companies and most countries with well-functioning capital markets. The universe of companies in which the fund may invest is substantially larger than this. The development of the investment strategy is to ensure the best possible relationship between expected risk and return.

A shift towards positive selection of companies based on criteria other than expected return would represent a break with the fund’s investment strategy, reduce the spread of the fund’s risk, and increase company-specific risk. Depending on the criteria applied, positive selection could also increase exposure to systematic risk factors. There is no evidence that a positive selection criterion can be linked to higher expected returns. Norges Bank advises against developing the fund’s strategy in the direction of positive selection of investments based on normative assessments, as this would conflict with the fund’s long-term financial objective.

Norges Bank would refer here to the analyses performed by professors Gjølberg and Johnsen. They illustrate how inopportune this type of selection model turned out to be for many SRI funds and indices in the period 2003-07.

The earmarking of investment capital for companies in specific sectors or geographical areas would mean applying a different required rate of return to these investments than to other investments by the fund. In the same way as positive selection, a portfolio based on extensive earmarking of investment capital will increase the risk in the portfolio but probably reduce the expected return, as the required rate of return is lower.

The aim of earmarking investment capital for special purposes would be to achieve additional goals besides long-term financial returns. Norges Bank believes that such earmarking of investments should take the form of allocations in the annual government budget. The management of earmarked investments should not be part of the management of the Government Pension Fund, but handled by separate managers. Norges Bank would refer here to the state already having established management organisations with such separate objectives.

Common to investment strategies based on positive selection and earmarking of investments is the goal of also achieving results other than the purely financial. Although models for positive selection and earmarking can be designed in different ways, they will all involve a considerable degree of discretion. For example, some environmental funds and indices might aim to avoid nuclear power due to problems with waste management, while others may overweight the nuclear power industry due to the climate change issue. Engineering companies might be excluded due to their links to polluting industries, or included as producers of public transport solutions, wind turbines and other renewable energy technologies. Another example might be metals and chemicals related to the battery technology for electric cars. The interrelationships within the economy and financial markets are so complex that it will be difficult in retrospect to identify any connection between an investment strategy and the outcome in the area in question, assuming that any such connection exists.

The fund’s investment strategy means that the fund’s capital is invested in most geographical areas and the full spectrum of industrial sectors. If the Ministry wishes to extend the breadth of the fund further to include new types of investment or regions not covered by the current investment universe, this can be considered a development of the fund’s investment strategy.

Norges Bank has advised the Ministry to include infrastructure investments in the fund’s investment universe, because this kind of expansion could increase the spread of risk and the fund’s potential return if the operational management of investments is of sufficient quality.

These asset classes are less liquid, and investments would need to be carried out by participating in partnerships or specific projects. An investor will find it difficult to build up general market exposure quickly in these asset classes. Instead, the challenge is to build specific technical investment expertise of a standard that enables us to realise profitable investments in each particular area. A substantial proportion of infrastructure investments in the coming decades will probably be in the supply of water and energy. Norges Bank could consider establishing specific expertise in these areas based on a mandate that does not set a lower required rate of return than for other investments. The rate at which the portfolio grows would then be determined operationally based on available investment opportunities.

An expansion of the fund’s geographical universe to include areas beyond emerging markets has not been considered to date. This concerns primarily the markets of Africa and the Middle East and parts of South America and Asia.

Svein Gjedrem

Yngve Slyngstad



  1. From the Ethical Guidelines for the Government Pension Fund – Global laid down by the Ministry of Finance on 19 November 2004.
  2. Report of the Graver Committee (NOU 2003:22).