Government Pension Fund Global – Periodic evaluation of the organisation of work on observation and exclusion
14 December 2018
We refer to the Ministry of Finance’s letter to Norges Bank of 5 November 2018. In the letter, the Ministry asks the Bank to assess the division of duties between the Bank and the Council on Ethics, including how the exchange of information and co-ordination between the two are functioning and how they are working to achieve a common understanding of the criteria in the Guidelines for Observation and Exclusion from the Government Pension Fund Global (GPFG). The letter also asks for a review of work to ensure consistent communication with companies. In addition, the Ministry requests that the Bank assesses how the current structure helps address the objective of clearer lines of responsibility, better interaction between the Bank and the Council, and the most coherent use of measures possible. The Ministry asks the Bank what constitutes appropriate external communication in cases where the Bank decides to take different action to that recommended by the Council, including on the considerations given weight by the Bank in its decision. Finally, the Ministry asks the Bank for information on any other matters considered relevant to the organisation of work under the Guidelines for Observation and Exclusion. We respond to the Ministry’s questions below.
Work on exclusion and observation of companies
New Guidelines for Observation and Exclusion from the GPFG came into effect on 1 January 2015 along with various amendments to the Management Mandate for the GPFG. One consequence of the changes was that the Council on Ethics is to submit recommendations on observation and exclusion of companies to Norges Bank. In this context, the Executive Board set up a separate Ownership Committee as a preparatory and advisory body for the Board. The Committee comprises one Deputy Governor and two external members of the Board.
The division of responsibilities between the Council and the Bank is set out in the Guidelines. With the exception of the product-based coal criterion, recommendations on exclusion or observation are to come from the Council. The Council thus has a clearly defined and independent responsibility to monitor investments in the fund’s equity and bond portfolio, and to make recommendations on exclusion or observation and the revocation of such decisions. Under Section 5(2) of the Guidelines, the Council “shall develop and publish principles for the selection of companies for closer investigation. The Bank may adopt more detailed requirements relating to these principles.” Section 5(6) adds that the Council “shall describe the grounds for its recommendations to the Bank.” The Bank for its part is to ensure that sufficient information is available before making a decision and may draw up detailed expectations for the formulation of the recommendations. The Bank presented expectations of this kind in its letter to the Council of 20 March 2015, and the Council has applied them in its work.
Norges Bank’s Executive Board considers exclusion cases on the basis of recommendations from the Ownership Committee. The Guidelines set out a number of factors that the Bank itself may attach importance to in its assessment of whether a company should be excluded with reference to Section 3, including the probability of future norm violations, the severity and extent of the violations, and the connection between the norm violation and the company in which the fund is invested. During the preparatory process, opinions are obtained from Norges Bank Investment Management, including on whether active ownership might be a more appropriate measure. There is also a review of publicly available information relevant to the case. When it comes to the coal criterion, the Ministry has decided that recommendations may also be prepared internally at the Bank, partly to take advantage of the Bank’s other resources. This has resulted in efficient use of information and knowledge.
Since 1 January 2015, the Executive Board has considered recommendations for exclusion, observation or revocation for 137 companies. In 88 cases, the recommendations have come from Norges Bank Investment Management with reference to the product-based coal criterion. The other 49 recommendations have come from the Council on Ethics, including 36 for exclusion, seven for observation and six for the revocation of previous decisions. A final decision has been taken in 44 of these cases but has yet to be taken on the other five. In 37 cases, the Council’s recommendation has been followed. In four cases, the Executive Board has decided on observation rather than exclusion, and in three cases active ownership rather than observation. The decisions and recommendations are published on an ongoing basis, and there is an overview of current exclusion and observation decisions on the Bank’s website. All of the Council’s recommendations under each criterion are available on the Council’s website. Norges Bank also reports on its work in various publications, including its annual report on responsible investment.
Exchange of information and co-ordination
Norges Bank believes that the exchange of information and co-ordination with the Council on Ethics are functioning well. Procedures and practices have evolved over time. The Council performs investigations and assessments independently of the Bank. At the same time, there is a requirement for the most coherent use of measures possible in the work on observation and exclusion of companies. We believe that the established lines of communication provide appropriate interaction between the Bank and the Council.
To ensure efficient use of resources and flows of information, specific procedures have been agreed on the exchange of information and co-ordination between the Bank and the Council, in line with Section 7(4) of the Guidelines. These procedures include the exchange of information on the portfolio and ongoing work with individual companies, cf. Section 7(1) and Section 7(3) of the Guidelines. The procedures also cover co-ordination of contact with individual companies, with the aim that the fund is perceived as consistent, cf. Section 7(2) of the Guidelines, and process management to ensure efficient handling of cases. In accordance with these procedures, the Bank sends a list of companies in the fund’s equity and fixed-income portfolio to the Council at the end of each month. From time to time, the Council may need information on holdings in individual companies, for example when drawing up recommendations and corresponding with companies. The Council then contacts the Bank and requests information on holdings in the company in question.
A number of steps have been taken to ensure the most consistent communication possible with companies. After each of its meetings, the Council sends a list of companies that it is investigating to the Bank. Once a quarter, the Bank sends over an overview of its ongoing contact with companies on relevant topics. In 2018, in consultation with the Council, we increased the level of detail on our contact with companies in this overview, so that it now provides information on specific environmental and social issues, such as deforestation and corruption. The Bank also regularly shares information from external parties on individual companies or issues that might be relevant to the Council’s work.
When the Council wishes to contact a company for the first time, for example to request information or a meeting, it asks the Bank whether it wishes to co-ordinate contact with the company. In most cases, the Bank finds that contact can be handled by the Council alone. In some cases, however, ongoing dialogue or other company-specific factors might lead the Bank to conclude that it should participate in this communication or be copied into it. Occasionally, the Bank will also contact companies where the Council has not had a response to its enquiry. Where the Bank participates in the dialogue, we attach importance to making the respective roles of the Bank and the Council in these matters clear to the companies.
The Bank and the Council hold a liaison meeting each quarter. The aim of these meetings is to exchange information on our work with companies. The Council provides information on ongoing cases, and the Bank on holdings and topics in its ownership dialogue. The two agree on the agenda ahead of each meeting, and the Bank keeps minutes. There are also regular – and, where necessary, separate – meetings between the Council and the Ownership Committee and Executive Board. The Council’s secretariat and the Bank’s ownership department also meet to exchange information on the specific topics they are working on. In 2018, there have, for example, been meetings of this kind on children’s rights, deforestation and anti-corruption. Finally, the Council and the Bank hold an annual meeting with the Ministry.
Understanding of the criteria
The criteria for exclusion and observation are issued by the Ministry of Finance and endorsed by the Storting. A high threshold for exclusion has been established, based on companies producing specific products or contributing to, or being responsible for, serious norm violations. The Guidelines require Norges Bank to ensure that sufficient information is available before a decision is taken, and set out requirements for a variety of analyses to be performed.
Official Norwegian Report NOU 2003: 22 “Forvaltning for fremtiden” [Investing for the future] provides further background that has been relevant to assessments under a number of the criteria, especially when applied for the first time. The application of the criteria has evolved over time through the recommendations and decisions made. In this context, there may sometimes be a need to expand the background to the criteria in the Guidelines. This may also be relevant in situations where there are changes in international standards for responsible business conduct and in corporate practices, including technological advances. These factors are pertinent when assessing whether a company is doing what can reasonably be expected to reduce the risk of future norm violations within a reasonable time frame.
The Bank initiates dialogue with the Council on relevant issues. Some may require analysis or written clarification. There may also be a need to ask the Ministry for further guidance on matters before the Executive Board decides a case. Since 2015, the Bank has asked for more extensive analysis or clarification in its work on two of the criteria.
In 2016, the Bank received recommendations to exclude four companies under the product-based weapons criterion and continue to exclude a further company under the same criterion. In these recommendations, the weapons criterion was applied to the production of nuclear weapons. The Bank initiated a dialogue with the Council to shed further light on these cases. The Council also commissioned an external report on the matter. The Executive Board’s decision on these cases was taken in October 2017 and published in January 2018.
The conduct-based climate criterion was incorporated into the Guidelines in 2016. Following the introduction of this criterion, observation or exclusion may be decided on where there is an unacceptable risk of a company contributing to, or being responsible for, acts or omissions that, on an aggregate company level, lead to unacceptable greenhouse gas emissions. Compared with other criteria in the Guidelines, the climate criterion does not provide a very precise definition of what kinds of conduct constitute grounds for a decision on exclusion.
In Report to the Storting No. 26 (2016-2017), the Ministry stresses that “a thorough preparatory effort to interpret the criterion is a priority, thus enabling it to be applied across industries and companies”. In its letter to the Council of 2 May 2018, the Bank requested a more detailed assessment of the principles that are to be employed when applying the climate criterion, including which aspects of a company’s specific conduct should be considered unacceptable in connection with the recommendations given on 30 May and 29 June 2017 and 15 March 2018. The Executive Board’s Ownership Committee and the chair and deputy chair of the Council met on 6 September. The Executive Board considered the Council’s recommendations on 24 October. The Board did not decide on any exclusions of companies at this meeting. This must be seen in the light of there still seeming to be differences in how the Council and the Bank view how the conduct-based climate criterion should be applied. The Bank considers the dialogue with the Council on this matter to have been productive, but also believes that the current basis for assessment makes it difficult to apply the climate criterion in practice. The Executive Board therefore resolved to ask the Ministry for more detailed clarification of certain aspects of the application of the climate criterion, cf. our letter of 7 November 2018.
Assessment and communication of measures
The Guidelines state that the Bank may also consider whether other measures, such as the exercise of ownership rights, may be more suited to reduce the risk of continued norm violations or more appropriate for other reasons. The Bank is to consider the full range of measures at its disposal and apply them in a coherent manner. In some cases, this broader assessment may mean that the Bank decides on a different course of action to that recommended by the Council. The Council itself cannot recommend active ownership.
The Ministry asks the Bank to assess what constitutes appropriate external communication in such cases, including on the considerations given weight by the Bank in its decision. The Bank’s point of departure is that this communication must be sufficient for the reasons for the Executive Board’s decision to be understood. Observation or active ownership must address the same issue presented by the Council in its recommendation. When deciding on observation or active ownership, the Council’s recommendation is still published as the principal basis for the decision. In the Bank’s opinion, there is not therefore normally a need for further information on the extent and severity of the norm violation or the company’s contribution or responsibility.
On the other hand, it is often appropriate to communicate other aspects of the company assessment. Observation may be relevant where there is doubt about whether the criteria for exclusion have been met, or where there is uncertainty about future developments. It is natural for decisions on observation to explain the reasons for this doubt, or what has been given weight in the forward-looking assessment. With decisions on active ownership, it is the possibility of bringing about a change in the balance of risks that is pivotal. Factors in these assessments include whether the Bank has an established relationship with the company and the size of its holding. Norges Bank would stress that decisions on active ownership are not to be considered a less powerful measure than exclusion or observation. The aim of active ownership in these cases is to bring about actions and changes that indicate that the risks presented by the Council are reduced. To ensure efficient use of resources, importance may also be attached to how large the investment is in relation to the fund’s portfolio, and to whether the issue raised in the recommendation from the Council is also covered by the Bank’s focus areas for active ownership, for example in its expectation documents. Information on corporate governance, strategy and risk management may also form part of an overall assessment. The Bank communicates which factors are given weight in its decision.
Observation cases are followed up by the Council, which sends an annual observation letter to the Bank. These letters are made public. The follow-up of decisions on active ownership is communicated annually in the Bank’s report on responsible investment.
In its letter of 5 November, the Ministry asks the Bank for information on any other matters considered relevant to the exchange of information and co-ordination in the work on observation and exclusion. As mentioned above, the Bank believes that the organisation of this work is generally sound and fit for purpose, with clear lines of responsibility and good interaction between the Bank and the Council on Ethics. There are, however, a couple of aspects of the current division of responsibilities that could be clearer.
Under Section 5(5) of the Guidelines, the Council is to assess regularly whether there is still a basis for observation or exclusion. Under the procedures for the exchange of information and co-ordination, the Council performs such an assessment annually and sends a letter on this to the Bank. At the same time, the Bank itself has a duty under Section 6(6) of the Guidelines to assess regularly whether there is still a basis for observation and exclusion. Under Section 6(1), however, the Bank may not revoke a decision on observation or exclusion without a recommendation from the Council. The issue is thus whether the current setup for monitoring whether there is still a basis for observation or exclusion results in a sufficiently clear division of responsibilities between the Council and the Bank. A clearer model might be where the Council monitors excluded companies and, on the basis of new information, recommends to the Bank that an observation or exclusion decision is revoked, but the Bank itself does not play a role in the actual monitoring other than for exclusions under the coal criterion. This would be in keeping with the division of responsibilities elsewhere in the Guidelines. Under Section 6(5), the Bank will still be responsible for sufficient information being available before a decision is taken to revoke an observation or exclusion decision. The Bank can also at its own instigation ask the Council to review cases or forward relevant information to the Council.
Observation is an appropriate measure when there is doubt as to whether the conditions for exclusion are met or as to future developments, or where observation is deemed appropriate for other reasons. The established practice is for the Council to follow up observation decisions. Operationally, however, it is somewhat unclear where observation ends and active ownership begins. For example, for observation purposes it will be natural for the Council to contact a company regularly with questions about the implementation of various actions in response to a norm violation. However, the company will still be part of the fund’s portfolio. This follow-up by two different parties may prove inefficient, in terms of both resources and relations with the company.
New Guidelines for Observation and Exclusion from the GPFG came into effect on 1 January 2015 along with various amendments to the Management Mandate for the GPFG. One consequence of the changes was that decisions on observation and exclusion would no longer be taken by the Ministry of Finance but by Norges Bank. As before, the Council on Ethics would issue recommendations on observation and exclusion and be independent of the Bank.
The co-ordination and exchange information between the Council and the Bank largely reflect the division of responsibilities in the Guidelines. The Bank and the Council have also agreed on specific procedures for the exchange of information and co-ordination. In addition, the Bank has clarified its expectations for the principles used for the selection of companies and formulation of recommendations. Operationally, this work has evolved over time, and we believe that the breadth and frequency of communication ensures appropriate interaction between the Bank and the Council. A number of steps have been taken to ensure the most consistent communication possible with companies. The current division of responsibilities largely supports the objective of coherent use of measures and a division of duties that ensures efficient use of resources.
The Guidelines require the Bank to ensure that sufficient information is available before a decision is taken, and set out requirements for a variety of analyses to be performed in this context. The application of the criteria has evolved over time through the recommendations and decisions made. There may sometimes be a need to expand the background to the criteria in the Guidelines. In these cases, Norges Bank will initiate dialogue with the Council on relevant issues. Since 2015, the Bank has asked for more extensive analysis or clarification in its work on two of the criteria.
The Guidelines state that the Bank may also consider whether other measures, including the exercise of ownership rights, may be more suited to reduce the risk of continued norm violations or more appropriate for other reasons. When deciding on observation or active ownership, the Council’s recommendation is published as the principal basis for the decision. At the same time, Norges Bank communicates which factors have been given weight in its decision. The Council on Ethics follows up observation cases and publishes an annual letter on this work. The follow-up of active ownership decisions is also communicated annually. Norges Bank does not consider active ownership to be a less powerful measure than exclusion or observation. The aim of active ownership is to bring about actions and changes that indicate that the risks presented by the Council are reduced.
Norges Bank believes that the exchange of information and co-ordination with the Council on Ethics are functioning well.
Øystein Olsen Yngve Slyngstad