Wednesday, February 02, 2011

Part II: Developing a Coherent Transnational Jurisprudence of Ethical Investing: The Norwegian Sovereign Wealth Fund Ethics Council Model

This Blog Essay site devotes every February to a series of integrated but short essays on a single theme.  The Ruminations Series in 2009 produced a series of aphoristic (ἀφορισμός) essays, meant to provoke thought rather than explain it. The hope was that, built up on each other, the series would provide a matrix of thoughts that together might lead the reader in new directions. Ruminations continue to be produced form time to time.  For 2010, this site introduced a new series--Business and Human Rights.  The series took as its starting point the issues and questions raised by John Ruggie, the United Nations Special Representative of the Secretary-General (SRSG) on business and human rights, in a global online forum
For 2011, this site introduces a new series of integrated essays--Developing a Coherent Transnational Jurisprudence of Ethical Investing: The Norwegian Sovereign Wealth Fund Ethics Council Model.  The object of this series to to consider the work of the Ethics Council of the Norwegian Sovereign Wealth Fund.  The thesis of this series is this:  The Norwegian Sovereign Wealth Fund (NSWF) )investment program is grounded in the application of a set of Ethical Guidelines adopted by the Storting (the Norwegian Legislature) and enforced through an Ethics Council charged with determining whether a company should be excluded from investment by the NSWF.  The work of the Ethics Council has produced the beginnings of a coherent jurisprudence of ethics for corporate investment.  That jurisprudence may contribute significantly both to the development of transnational social norm standards and  affect the way domestic corporate law is understood. This is Part II of the series.

Part II: The Structure of the Norwegian Sovereign Wealth Fund.

The Norwegian Sovereign Wealth Fund, the Government Pension Fund Global (NSWF) is a peculiar commercial creature of state. It's object is to project the Norwegian state's commercial power abroad, that is to participate in private securities markets in a manner similar to that undertaken by private investment firms, but to do so in conformity with the public policy of the Norwegian state. That public policy is memorialized in statute and regulation, and implemented by its fund managers and those governmental entities charged with the management of the NSWF.   The original fund was established in 1990 in the form of the Petroleum Fund (Government Pension Fund Law (no. 36 of June 1990)). It was established "as a fiscal policy tool to support a long termn management of the petroleum revenues."  (Government Pension Fund Global Fact Sheet). The Petroleum Fund began investing in equities in 1998.  In 2000 it enlarged its investment pool to include securities form five identified emerging markets.  Bonds were added in 2002, and ethical investment principles introduced in 2004 (Id.).  The NSWF has significant assets.  By  2009 it was reported to own about 1% of global stocks (UPDATE 2-Norway oil fund surges, owns 1 pct global stocks, Reuters, Aug. 14, 2009).  The NSWF reached a milestone of 3 trillion kroner (over $500 billion) in assets in October 2010. But beyond its revues and market power, it has become an influential participant in markets for regulation and norm making for investment and corporate governance.   And the NSWF has not been shy about projecting its power to affect governance issues within private markets outside the territory of the Norwegian State.  In 2009, for instance, "Europe's biggest owner of stocks also launched an initiative aimed at fostering dialogue on environmental issues with firms in its portfolio, a blueprint for green activism by often passive institutional investors. "(UPDATE 2-Norway oil fund surges, owns 1 pct global stocks, Reuters, Aug. 14, 2009).
The NSWF was established in its present form in 2006 as one of two investment funds operated by the Norwegian state.  The object of this study is formally known as the Government Pension Fund Global, which is a continuation of the Petroleum Fund.  The other is the more domestically focused Government Pension Fund Norway (Provisions on the management of the Government Pension Fund As of 1 March 2010 (Unofficial translation from Norwegian), article 2).  Both domestic and international parts of the Pension Fund have two principal objectives.  The fist is to support programs of government savings directed to the financing of the Norwegian National Insurance Scheme's pension expenditures.  The second, and more interesting from the perspective of transnational governance,  is to "support long-term considerations in the use of petroleum revenues." (Id.,  article 1).
Neither the Petroleum Fund, nor the current form of the NSWF, were organized as conventional separate juridical corporate entities, either under the Norwegian  corporations law or under special legislation.  Rather the Fund is structured as a governmental entity operating in autonomous form but not constituted as a non-state corporate entity. As a technical matter, the NSWF exists only in the form of a record of deposits and investments deposited in and invested through the Norges Bank.  The managers of the NSWF are either autonomous state instrumentalities or other entities separately constituted.  This is similar to the organization of some but also in distinct contract to the establishment of other important SWFs.  See, Larry Catá Backer, Sovereign Investing in Times of Crisis: Global Regulation of Sovereign Wealth Funds, State Owned Enterprises and the Chinese Experience. Transnational Law & Contemporary Problems, Vol. 19, No. 1, 2009.  Indeed, the law establishing the management of the NSWF makes quite clear that the NSWF is to be treated as an instrumentality of state, with "no rights or obligations vis-a-vis private sector entities or public authorities and [with no right to] institute legal proceedings or be subjected to legal proceedings." (Provisions on the management of the Government Pension Fund As of 1 March 2010, article 6). Those limitations are effective, at least in Norway under Norwegian law.

As an instrumentality of the state, the NSWF falls under the control of the Ministry of Finance (Provisions on the management of the Government Pension Fund As of 1 March 2010, article 2).  The Ministry of Finance is charged with the management of the funds deposited under regulations it may promulgate, and the Ministry is empowered to adopt supplementary regulations to implement the act establishing the NSWF.  (Id., art. 7).  NSWF Funds are deposited with and managed from the Norges BankNorges Bank (domestic funds are managed through the Folketrygdfondet).  (Id., at 2).  The Storting allocates funds for the NSWF  from the "net cash flow from petroleum activities," as and when such may be transferred from the central government budget.  The NSWF is also permitted to fund its operations from "the results of financial transactions associated with petroluem activitiea and the return of the Fund's capital."  (Provisions on the management of the Government Pension Fund As of 1 March 2010, article 3). The term "net cash flow from petroleum activities" is specifically defined:
The net cash flow from petroleum activities consists of the gross revenues in the third paragraph minus the expenses in the fourth paragraph.

The following gross revenues are part of the cash flow from petroleum activities:
1. total tax revenues and royalties deriving from petroleum activities collected pursuant to the Petroleum Taxation Act (no. 35 of 13 June 1975) and the Petroleum Activities Act (no. 72 of 29 November 1996),
2. revenues deriving from tax on CO2 emissions due to petroleum activities on the continental shelf pursuant to Act relating to CO2 tax in the petroleum activity on the continental shelf (no. 72 of 21 December 1990),
3. revenues deriving from tax on NOx emissions due to petroleum activities on the continental shelf,
4. operating income and other revenues deriving from the State’s direct financial interest in petroleum activities,
5. Gcentral government revenues from net surplus agreements associated with certain production licences,
6. dividends from Statoil ASA,
7. transfers from the Petroleum Insurance Fund,
8. government revenues deriving from the removal or alternative use of installations on the continental shelf,
9. any government sale of stakes representing the State’s direct financial interest in petroleum activities,
The following expenses shall be deducted from the gross revenues in the third paragraph:
1. government’s direct investments in commercial petroleum activities (the State’s direct financial interest),
2. operating costs and other costs directly related to the State’s direct financial interest,
3. government expenses in connection with the Petroleum Insurance Fund,
4. government expenses in connection with the removal or alternative use of installations on the continental shelf,
5. any government purchase of stakes as part of the State’s direct financial interest in petroleum activities.
(Provisions on the management of the Government Pension Fund As of 1 March 2010, article 3).
The term "net results of financial transactions associated with petroleum activities" is also defined "gross revenues from government sale of shares in Statoil ASA less government purchase of shares in Statoil ASA, defined as the market price paid by the government for the shares, and less government capital contributions to Statoil ASA and companies attending to government interests in petroleum activities, as well as financial transactions connected to companies in the petroleum sector in which the Government has ownership."  (Id.). Beyond that, the establishing provisions  define NSWF income as the return of capital under management (id., at 4) and vests the Storting with the power, by resolution, to transfer the NSWF's capital  (Id., art. 5). 

The Ministry of Finance  regulates the NSWF, but it does not manage the Fund.  Until recently, the regulatory matrix that defined the relationship between the Ministry of Finance and the Norges Bank was complex.  In 2010, after a period of regulatory review, the Ministry of Finance announced a substantially revised framework (Ministry of Finance, Press Release,  New mandate for management of Government Pension Fund Global, No. 66/2010; Nov. 10, 2010.  
One of the starting points for this review has been to elucidate the division of responsibilities and roles between the Ministry of Finance and Norges Bank, along with imposing stricter requirements for regulating risk management.
The new mandate is broader than the three sets of rules it replaces (regulations, guidelines and management agreement). The mandate regulates areas that the current framework does not cover, and the provisions are more comprehensive.
"In line with the Norwegian Parliament’s (the Storting’s) view I have emphasised that the regulation of the GPFG should continue to be framework-based, so that Norges Bank must fill out the general framework and principles with more detailed internal regulations for the operational management. This is an arrangement that works well. Micromanagement by the Ministry is neither possible nor desirable," says the Minister of Finance. (Id.).
The new regulatory framework came into force January 1, 2011.  (Id.). It replaces and refines the original set of regulatory documents and state contracts under which the Fund was operated, including (1) the regulations no. 1725 of 22 December 2005 on the management of the Government Pension Fund Global, (2) guidelines for management of the Government Pension Fund Global (supplementary provisions pursuant to the Government Pension Fund Act and the regulations on the management of the Government Pension Fund Global), (3) regulations of 24 February 2010 concerning management of the real estate portfolio in the Government Pension Fund Global, (4) the guidelines of 1 Mars 2010 for Norges Bank’s work on responsible management and active ownership of Government Pension Fund Global,  and the management agreement of 12 February 2001 along with all subsequent amendments between the Ministry and the Bank.    (See "Management Mandate for the Government Pension Fund Global" (Sec. 9-3 (entry into force)). 

The new regulatory framework "Management Mandate for the Government Pension Fund Global" is worth careful review.  It starts  through which it has vested both physical custody of the actual fund and management of the assets  represented by the Fund, in Norges Bank.  (Id., Ch. 1, Sec. 1-1).  The Norges Bank is charged not merely with the management of the Fund but with a specific set of obligations that define its relationship with the Finance Ministry.  These include a duty to inform the Finance Ministry of its strategic plan, of significant changes in the value of the Fund or in the management of the Fund by the Bank, and of any incidents that trigger a duty to inform.  (Id., sec., 8-1; 8-2). The Norges Bank is also obligated to provide the Ministry of Finance with "any information the Ministry requests. . . submittable in machine readable form,."  (Id.).   The Norges Bank is required to meet with the Ministry formally at least once per quarter to discuss agendas set by the Ministry.  (Id., sec. 8-3). And, like other governmental instrumentalities, the Bank is required to produce a series of public reports on its management of the Fund.  (Id., Ch. 7).   The contents of the annual report are specified by regulation with some specificity.  (Id., sec. 7-1).  Other information is also made public, including  regulatory and governance rules developed by the Norges Bank.  (Id., Sec. 7-2).
The management charge from the Finance Ministry consists of two parts:  first, the obligation to achieve the highest possible return  and second, the requirement that investment decisions be made independently of the Ministry.  (Id. sec. 1-1). Both can be undertaken by the Norges Bank directly or to some extent through  retained outside managers (Id., Sec. 1-4).
Approximately 12 percent of the fund’s assets were under external management at the end of 2009, down from 13 percent a year earlier. There were a total of 75 mandates managed by 45 different institutions, 70 of which were equity mandates. The market value of externally managed equity mandates was 286 billion kroner at the end of 2009, equal to 17 percent of the fund’s equity investments. Externally managed fixed-income mandates had a market value of 32 billion kroner at the end of 2009, equal to about 3 percent of the fund’s fixed-income investments.  (Norges Bank Investment Managers (NBIM), External Mandates).
The "highest possible return" obligation is not left to the discretion of the Norges Bank but is defined in the regulation as an amount net of management costs  "measured in the currency basket of the actual benchmark index."  (Management Mandate for the Government Pension Fund Global, sec. 1-1).  Management costs are regulated as well. (Id., Ch. 6).  The process for the determination of management costs is specified in the regulations and requires the submission of a substantiated proposal  for an upper limit on costs (Id., sec. 6-1) beneath which actual costs may be reimbursed.    The Fund is to be maintained in a separate account  to be invested in the name of Norges Bank (Id., Sec. 1-2).  The Norges Bank is charged to develop a strategic plan, updated and evaluated regularly.  (Id., Sec. 1-3).  Though the Norges Bank is expected to make investment decisions independently of the Finance Ministry, those decisions must be made in conformity with an investment strategy approved by the Ministry and to some extent reflected in "Management Mandate." With respect to that strategy, the Norges Bank is accorded  the right to advise the Ministry on its initiative or that of the Finance Ministry.  (Id., Sec. 1-5). 

The Ministry of Finance has  macro investment strategy further refines the instruction of the Norges Bank to achieve the "highest possible return".  The principal  macro strategy is denominated "Responsible Investing". (Id., Sec. 2-1).  The importance of responsible management in the operation of the NSWF was emphasized by the enactment of the Guidelines for Norges Bank’s work on responsible management and active ownership of the Government Pension Fund Global (GPFG) (Adopted by the Ministry of Finance on 1 March 2010 pursuant to Act no. 123 of 21 December 2005 relating to the Government Pension Fund, section 2, paragraph 2, and section 7) that modified portions of the Management Mandate.  It starts with an acknowledgement of the  principal goal of "highest possible return" and then  suggests that the term is embedded in the notion of a "good return in the long term."  That, in turn, "is regarded as being dependent upon sustainable development in economic, environmental and social terms, as well as well functioning, legitimate and effective markets."  (Id., Sec. 2-1).  For real estate investment, investments in which were permitted form 2010, the Bank shall give "priority to i.e. considerations of energy efficiency, water consumption and waste management."  (Id.). It is also affected by a legislated time horizon for evaluating investment decisions--"the bank shall give priority  to a long term horizon for investments." (Id.).  In effect, the economic objective of highest return is in turn made to depend on the conformity of investment with the policy objectives of the Norwegian state, now transformed into a set of investment criteria suitable for application for interventions in private markets. In addition, the Ministry of Finance incorporates corporate governance objectives in the determination of investment  policy charged the Norges Bank.  For this purpose, the Norges Bank is charged with the development of internal guidelines  for "integrating considerations of good corporate governance and environmental and social issues  in investment activities."  (Id.).  these are to be constructed in "line  with internationally recognized principles for responsible investment."  (Id.).  The effect is interesting--the Ministry of Finance has effectively created a regulatory environment in which the Norges Bank, as fund manager, is required to incorporate state policy in investment decisions that obligate it to achieve the highest possible return on investment.  But what is possible now turns on what is required to comply with state policy, including the incorporation of international standards.  The result is to convert hortatory notions of responsible investment into regulatory commands that, when effectuated in the form of market transactions, can affect corporate governance behaviors of foreign corporations, irrespective of the internally applicable law of the jurisdictions  that have chartered them. Core notions of responsible investing, as thus described, are to form the basis for the Norges Bank's investment strategy and its otherwise autonomous investment decisions.  (Id.).  

But responsible investing is not limited to a set of policy objectives that effectively modify the factors that determine the value of investments.  It also includes an obligation to "active ownership,", required to safeguard the Fund's financial interests.  (Management Mandate for the Government Pension Fund Global, sec. 2-2).  Active ownership incorporates within understandings of economic welfare maximization a set of key international soft law norms governing behavior expectations  of enterprises.  These include the U.N. Global Compact, the OECD Guidelines for Multinational  Enterprises and the OECD Principles of Corporate Governance.  ((Id.).  This is not meant to be a set of passive principles in making investment decisions.  Instead, it is meant to set the tone for the sort of ownership role the Fund is to play as an economic stakeholder in foreign chartered corporations in which it has invested.  "Shareholders primarily do this by voting at the annual general meeting. In addition to such voting, Norges Bank uses several other instruments as part of its owner-ship activities:
Voting at annual general meetings, Shareholder proposals, Dialogue with companies, Legal steps, Contact with regulatory authorities, [and] Collaboration between investors."  Ministry of Finance, Government Pension Fund Global:  Responsible Investment (Brochure) at 22).  Currently, Norges Bank focuses  on issues of equal treatment of shareholders, shareholder influence and board accountability, standards for well functioning and efficient markets, children's rights,climate change and water management.,  (Id., at 24). "Norges Bank has developed publicly available principles for voting. It is Norges Bank’s aim to vote at all annual general meetings. Each year, Norges Bank votes at about 10,000 general meetings. The number of resolutions voted on every year now exceeds 85,000. Norges Bank votes on all issues, including those that fall outside the focus areas. The voting records are made public every year." (Id.).

The effect is to provide the Fund with another avenue for extending its governance role to  the corporations within its investment pools, irrespective of the policy of the states in which those corporations are chartered and their determination of the value and importance of the international instruments now incorporated into Norwegian Fund management regulation.   To that end, the "Bank shall have internal guidelines for its exercise of ownership rights that indicate how those principles are integrated."  ((Management Mandate for the Government Pension Fund Global, Sec. 2-2). The Norges Bank has been aggressive in meeting its obligation in this regard.  See, e.g., Norges Bank Investment Management, Pension funds urge chocolate industry to end child labour, May 31, 2010 ("The recent cocoa industry meeting in Utrecht showed companies are still far from fulfilling their 2001 pledge to eliminate child labour in the sector. Industry leaders must take concrete action to remedy this, say pension fund managers Norges Bank Investment Management and APG Asset Management.").

The Management Mandate for the Government Pension Fund Globalsuggests the complex relationship between law and norm, between state regulatory policy and state projections of power through active participation in private markets, through which state policy is effected by the exercise of the rights of private ownership, and between national legal structures and the internationalization of behavior standards.  Responsible investing is not constructed merely to produce the highest achievable returns, but also to bend that objective to other Norwegian political objectives.   It suggests the determination by the Norwegian state that private power is critical to achieving global economic objectives, and that this private power ought to be managed through law--state law to be sure, but state law which itself incorporates international norms.  As such the NSWF serves as both bridge and framework.  It is a bridge between the public and private governance efforts of the state, and it is a framework through which the law-state can project its power inward into private governance across borders and outward into the construction of governance norms at the international level.  Norway means to stand at the center of this web, and the NSWF provides thew vehicle through which such a complex and interactive system might be constructed.  Consider in this regard the role of private entyerprises in development, one of the elements of responsible investing:  "Through knowledge, experience, presence and influence, the private sector can help address the many challenges facing developing countries. . . . However there is no automatic convergence of the interest of foreign companies and the needs of the local population. . . .  Norway is seeking to persuade developing countries to accede to international conventions and to implement and enforce them nationally. . . . . Norway is . . . actively participating in efforts to strengthen international guidelines for CSR." (Norway Ministry of Finance, Report No. 10 (2008-2009) to the Storting, Corporate Social Responsibility in a Global Economy, at 5.5).

This assessment is not to suggest judgment, but it does suggest the way in which indirect regulation can be extended extra territorially through the expedient of a well executed strategic program implemented through projections of financial power (and state policy) in private markets.   This objective is made directly by the Finance Ministry.  "The Bank shall actively contribute to the development of good international standards in the area of responsible investment and active ownership,"  (Id., sec. 2-3). This reflects a state policy determination that Norwegian law ought to reflect international standards, and that international standards ought to be incorporated into the governance framework of all entities touched by NSWF investment.  For the Ministry of Finance, of course, the notion is plain enough.  The internationalization of its policy choices incorporated into the investment strategies of the NSWF serve as a defense of its policies--they are not extraterritorial in the sense of advancing the parochial policy goals of the Norwegian people.  Rather, the responsible investing and active management principles reflect the Norwegian state's international obligations to implement international standards,  obligations shared by all states.  In this sense, then Norwegian extraterritorial intervention does not serve the state but rather the international community. All states should be working toward the same ends.  These notions will be tested, of course, in the materials that follow.  They will be found wanting to some extent as well--both in the sense that Norway all too readily gives in to national aspirations and policy preferences in their determinations of the meaning and form of the international rules they champion,  and in the sense that Norway's strategic investment goals may sometimes  trump its economic investment goals.

Lastly, the Guidelines for Norges Bank’s work on responsible management and active ownership of the Government Pension Fund Global (GPFG) require the preparation of an annual report on the Norge Bank's work on active ownership and integration of good corporate governance and environmental and social issues." (Id., Sec. 4).
a) a report on the Bank’s work integrating good corporate governance and environmental and social issues into its management, cf. section 1.

b) a report on the Bank’s exercise of ownership rights and other aspects of its active ownership activities. The report should describe how the Bank has acted as the owner’s representative in safeguarding the goals of sections 1 and 2. The Bank’s voting record at annual general meetings and the Bank’s guidelines for voting shall be made public.

c) an account of the Bank’s contribution to the development of good international standards in activities concerning responsible investment and active ownership, cf. section 3.  (Id., Sec. 4).
The tension between state policy goals and the economic objectives of the fund (as well as the efforts of the state to harmonize them) is evident in the provisions for the management of the equity and fixed income portfolios, as well as risk management  and performance valuation, which are articulated in conventional economic terms.  (Id., Ch. 3 and Ch 5).  This is particularly apparent  with respect to portfolio management restrictions. (Id., sec. 3-7).  There are a few  important caveats.  First, the Norges Bank may not acquire more than 10% of the voting shares of an enterprise.  (Id., sec. 3-7(7).  Unlike other SWFs, the NSWF is not in the business of being a controlling  shareholder, merely an influential one.  Additionally, the NSWF may not invest in domestic companies or in foxed income instruments issued by governments.  Most importantly, the economic effects of responsible investing is felt by a provision prohibiting investment in companies excluded from the NSWF investment universe, principally for failure to comply with the policy and behavior thresholds now built into the macro investment strategy of the NSWF. (Id., sec. 3-7(9)).  The mechanics of that exclusion, and the operationalization of the responsible investor strategy through ethics guidelines and the adjudicatory role of the Ethics Council will be discussed in a later part of this essay.  Approved investment instruments include
a) tradable debt securities and other tradable debt instruments, and depository receipts for such fixed income instruments
b) equities listed on a regulated and recognised market place, listed securities that are equivalent to listed equities, and depository receipts for such equities
c) securities as mentioned in letter b in unlisted companies in which the board has expressed an intention to seek a listing on a regulated or recognised market place
d) financial derivatives and fund units that are naturally linked to equities, fixed income instruments or commodities. (Id., sec. 3-6(1)).
In addition, the Fund may own financial instruments and derivatives, but only when received as a result of corporate activity.  (Id.).  Similar rules apply to the management of the real estate portfolio.  (Id., Ch. 4).

The Norges Bank manages the NSWF through its asset management unit, the Norges Bank Investment Management (NBIM). Established in 1998, NBIM is an integrated global organisation with about 290 employees from 25 nations, with offices in Oslo, London, New York, Shanghai and Singapore. (Norges Bank Investment Management (NBIM) About Us).  "Our global presence brings us closer to the markets we invest in, helping form stronger ties with partners in different parts of the world. NBIM has more than 290 employees from 25 nations."  (NBIM's Organization). With a nod to the realities of globalization, the working language of the NBIM is English.  (Id.).  "The Executive Board is responsible for Norges Bank’s operations. It has seven members appointed by the King in Council. The Governor and Deputy Governor of Norges Bank are chairman and vice-chairman. NBIM’s governance model differs from other parts of Norges Bank. NBIM’s Executive Director has the responsibility and authority of CEO of the unit. He reports directly to the Executive Board and is subject to continuous oversight by the Governor on behalf of the board."  (NBIM, About Us, Executive Board).

NBIM uses external managers to handle parts of the Government Pension Fund Global.  Lastly, oversight of the NBIM is vested in a supervisory council.  "The Supervisory Council has 15 members appointed by Norway's parliament. It supervises Norges Bank's operations and compliance with the rules for these operations." (NBIM, About Us, Supervisory Council).

The focus on responsible investments is not solely the province of the Norges Bank in its managerial and investment functions. In addition to the obligations of the Norges Bank as Fund manager, the Storting has created a set of Ethical Guidelines. Guidelines for the observation and exclusion of companies from the Government Pension Fund Global’s investment universe, Adopted by the Ministry of Finance on 1 March 2010 pursuant to Act no. 123 of 21 December 2005 relating to the Government Pension Fund, section 7.  These Guidelines bind on the Ministry of Finance and the Norges Bank, but administered through an Ethics Council.  It is to the place of the Ethics Council and the Ethical Guidelines that we turn to next.

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