Thursday, January 07, 2016

Corruption and Investment--Chinese Company ZTE Corp. Excluded From Norway Sovereign Wealth Fund Investment Universe

On 7 January 2016, the Norges Bank decided to exclude the Chinese company ZTE Corporation, one of the world’s five largest producers of telecommunications equipment and network solutions, from the investment universe of the GPFG. The company is excluded based on an assessment of the risk of severe corruption and is grounded in a Council on Ethics Recommendation of 24 June 2015.

The recommendation reflects the growing importance of corruption in investment decisions. But it may also suggest a distinction in treatment between European companies which in the past have been subject to observation the use of shareholder power by the Norwegian SWF and this company for which divestment appeared to be the better option. 
Please find a brief analysis below.

Please find Norges Bank’s decision here and below

Please find the Council on Ethics’ summary of its recommendation here and the full recommendation here and below.

ZTE Corp is a privately operated state owned enterprise with substantial private investment in its securities. At least as a formal matter, ZTE is deeply embedded in transnational soft law standards for business conduct.  It's website notes that
In February, 2009, ZTE Corporation has formally become a member of the United Nations Global Compact. ZTE will take this as a new starting pointing to bring the Global Compact and its Ten Principles into its corporate culture and business concept to make great effort to promote the harmonious development among economy, environment and society, thus committing itself to become the paragon of the Global Corporate Citizenship. . . . ZTE’s CSR strategy is to pro-actively develop, implement and improve CSR compliance throughout ZTE and its supply chain based on industry best practices, continuous learning and improvement efforts. Its objective is to develop into a global CSR leader long-term. (see Company Responsibility  here)
As typical for Chinese corporations, CSR efforts are built around charity and societal programs that work in parallel with state policy for economic, social and cultural development. (See here and here.) "Active in community programs, ZTE participated in relief efforts related to the 2004 tsunami in Indonesia, the 2008 earthquake in Sichuan, China, and the 2010 earthquake in Haiti. ZTE also established the ZTE Special Children Care Fund, the largest charity fund in China." (see Company Overview  here).

Traditionally, corruption was not necessarily viewed as at the center of CSR responsibilities, touching instead on enterprise obligations to the state and constrained by the ambiguous line between traditional relationships and illegal practices (e.g., here, here and here).  But recent changes in Chinese policy (e.g. here) and law (e.g., here,. and here) ought to have brought anti-corruption efforts to the forefront of ZTE's operations.  Corruption is now understood as a significant breach of the Chinese Communist Party basic line and has become a serious violation of law and administrative practice.  Within China itself, the government has been moving swiftly against corporate leaders in large state owned enterprises in the context of the government's broadening anti-corruption campaigns (see here, here, and here). Because most heads of Chinese SOEs are also members of the Communist Party, discipline in anti-corruption  investigations usually starts with CCP disciplinary systems (see, e.g., here).  

But at their core, these investigations and the anti-corruption standards that they are based are both domestic and based on internal policy. FU Hualing's recent work is instructive (see here).
The Central Commission for Discipline Inspection published the criticism in an article on its website yesterday. It is the first of a series on "pushing SOEs to strictly follow party discipline", as the watchdog continues cracking down on corruption.

The CCDI has identified state-owned enterprises as its focus this year. Twenty-six such businesses were visited in the agency's first round of inspections this year, and another 17 are currently under inspection. (China's state-owned enterprises slammed for 'entrapping' officials into corruption)
Still, it had never been clear that actions outside of China would produce legal effects within China (e.g., here) even with the enactment of anti-bribery laws. And while as an official matter Chinese authorities had not foreclosed that possibility, their actions suggested a focus on internal management, leaving to host states, and the international community, the obligation to police and discipline enterprises operating outside the national territory. The critical challenge that approach produces, though, and one finally brought to center stage with the Norges Bank decision, is the  extent to which China will continue to defer to such international disciplinary mechanisms when they are projected to the internal operations of a Chinese SOE (though derived form their external activities).  That is, to what extent will China be open to internationalized disciplinary mechanisms that might affect the scope and framework of CSR related conduct of enterprises with potential effect within China. The decision of the Norges Bank brings that question one step closer to the necessity of resolution. 

But the allegations that brought ZTE to the attention of the Norway SWF were not corruption within China but corruption allegations in ZTE's overseas operations. These countries included Algeria, Kenya, Papua New Guinea, Zambia, Philippines (Ethics Council Recommendation, pp. 6-10). Lesser weight was given to corruption allegations in a number of other states, including Malaysia, Myanmar, Nigeria, and Liberia (Ibid., pp. 10-12). This was not ZTE's first conflict with Norwegian business and investment organs.  In 2009 "Norwegian telecommunications giant Telenor banned for six months Chinese company ZTE Corp. from participating in tenders and new business opportunities because of an alleged breach of its code of conduct in a procurement proceeding,” international news agencies reported" (Norway's telco giant bans ZTE for 6 months). It was reported in the financial press that the issue leading to the action was tied to corruption: "an industry source has told Light Reading that ZTE representatives attempted to bribe Telenor officials in the course of a recent business tender. ZTE says the problem was caused by a rogue employee. In a statement emailed to Light Reading and attributed to the vendor's CEO Yin Yimin, the company noted: "ZTE has a very clear Code of Conduct and, as a listed company, our employees have to adhere to the highest business standards."(Telenor Bans ZTE From New Deals).

As has been its habit from the beginning of its operations, the Ethics Council has sought to apply an internationalized standard, interpreted through the lens of Norwegian state policy (see here).  It chose not to apply the laws of the states in which the corruption allegations were alleged, but rather, as has become customary in the context of managing conduct within transnational production chains outside of the home states of enterprise systems (see, e.g., here), it applied an internationalized governance framework drawn from international and transnational sources.  
The UN anti-corruption portal TRACK (Tools and Resources for Anti-Corruption Knowledge), Global Compact: A guide for anti-corruption risk-assessment (2013), and the OECD’s Good Practice Guidance on Internal Controls, Ethics and Compliance (2010), provide useful guidance in these matters. In Business Principles for Countering Bribery, Transparency International (TI) has listed a number of general recommendations for building robust compliance systems. (Ethics Council Recommendation, pp. 12).
But the Ethics Council also sought to legitimate its approach by a passing reference to Chinese state policy and law (Ibid., pp. 12-13).  The Council did not, however, purport to apply Chinese law to the external operations of ZTE. This preference for a single and coherent harmonized international law represents a consistent approach by the Ethics Council and contributes to the construction of a transnational governance legality that is intermeshed with but autonomous of the national systems within which portions of transnational actions are taken.  It is in this sense that the Ethics Council continues to contribute to the construction of transnational legal orders, however characterized (see, e.g., here, and here).  

ZTE contributed to its own difficulties because, like many other multinational enterprises, and SOEs it underestimates the authority of actions undertaken by  hybrid organs like the Ethics Council.  It chose not to respond extensively to Ethics Council inquiries.
In September, the Council had a telephone meeting with an employee from ZTE’s Security & Investor Relations Department and an employee from the company’s legal department. The company also subsequently replied to an email containing follow-up questions. In its replies, the company did not comment on any of the specific corruption allegations, discussing only its internal compliance and anti-corruption systems. (Ethics Council Recommendation, pp. 13-14).  
There might well have been good reason for this evasion.  ZTE executives might well have been considering  the risks of giving any evidence to a foreign organ like the Ethics Council for at least two reasons.  First, it is not clear that such participation beyond purely judicial organs might trigger investigation in China for violation of secrets laws.  Second, the extent to which ZTE official provide evidence might be taken into account by the Chinese Central Commission for Discipline Inspection and its investigations of possible corruption in ZTE within China.  This later risk would carry substantial adverse consequences for high ZTE officials, and they would likely err on the side of caution.  The difficulty, though, is that now that the Norges Bank has acted--and caused embarrassment to an economic organ of the Chinese state--it is as likely to trigger a CCDI investigation.  ZTE will suffer double consequences, then--for failure to comply with an increasingly coherent internationalized normative order on corruption, and the likely internal investigations that may follow in China.   
The extensiveness of the corruption, the ambiguity of corrective measures, and the changes in Chinese policy all contributed to the determination of an unacceptable risk supporting exclusion from the investment universe ((Ethics Council Recommendation, pp. 15-16). But this determination should raise eyebrows as well.  And it should raise eyebrows precisely because the determination is potentially inconsistent with the approach to bribery and corruption--and the role of the Norwegian Global Pension Fund--in the case of Siemens, a company whose predilection for bribery as a sound business strategy was also the subject of extensive consideration by Norges Bank, the Norway Finance Ministry and the Ethics Council. On the other hand it mirrored the action taken with a Chinese SOE--China Railway Group Ltd. In that context I noted:
The former Ethics Council recommended the exclusion of China Railway Group Ltd because of an unacceptable risk that the company is involved in gross corruption.   The issue of corruption has been a sensitive one for the Ethics Council.  It's most well known efforts in this regard touched on the corruption and bribery scandals of Siemens. See, Siemens AG: Ministry of Finance Press release 24/2009; The recommendation from the Council on Ethics; The letter from the Council on Ethics; discussed HERE. See also Alstom, SA HERE (standard for gross corruption).  The most interesting part of the recommendations was  the recognition by the Ethics Council of the Chinese government's recent anti corruption campaigns.  Indeed, the corruption allegations arose out of the Chinese government's investigation  of a disastrous accident that occurred on its high speed rail lines in 2011. The Chinese government's efforts to deal with the corruption that may have contributed to the accident were noted with approval, but those efforts did little to aid CRG in avoiding exclusion (Recommendation pp. 8-10). More interesting still was that evidence relied on by the Council included "information relating to legal rulings and internal disciplinary processes in the Communist Party published in the Chinese Press." (Recommendation pp. 1). This might have raised eyebrows in the West, because the Council specifically referenced the Chinese Communist Party's system of shuanggui (Recommendation pp. 9), a practice that has been criticized in the West.  But see discussion here.  For the Council on Ethics’ recommendation and subsequent correspondence with the Ministry of Finance see HERE. (Change Comes to the Norwegian Sovereign Wealth Fund Global).
But exclusion may reflect a pragmatic determination. That pragmatism might be grounded in an assessment of thew willingness of the enterprise to respond favorably to observation status and to the exercise of shareholder rights by an instrumentality of the Norwegian Crown. It appears clear that Siemens was amenable to that exercise of private shareholder activism--but unlikely that a Chinese SOE or a Chinese hybrid entity, like ZTE, would be as compliant. That suggests not so much discrimination on the basis of enterprise origin as a hard headed assessment of corporate willingness to cooperate. But this trend bears watching

One wonders, however, why thjis approach makes any sense in the case of corruption.  This would have presented an opportunity for Norges Bank to robustly exercise its shareholder power in ways that are directly tied to the long term maximization of the value of the enterprise in which investment is made.
 In effect, Siemens permitted the Norwegian state to become an important monitor and standard setter for the scope, content and operation of its monitoring and surveillance regimes. This marks a substantial departure form the traditional arrangement in which corporations, subject to the legal constraints of the state of incorporation, at least with respect to its internal organization, operation and management, now subjects those core organizational features to regulation by a foreign state through interventions in private markets. What once was the province of the state through law  has now become the  province of the state through market interactions producing governance principals with the functional effect of law. (Backer, Larry Catá, "Governance Without Government: An Overview and Application of Interactions Between Law-State and Governance-Corporate Systems," in Beyond Territoriality: Transnational Legal Authority in an Age of Globalization 87-123 (Günther Handl, Joachim Zekoll, Peer Zumbansen, editors, Leiden, Netherlands & Boston, MA: Martinus Nijhoff, 2012). )
And it might have permitted the Norwegian State, through the Norges Bank to reach deeply into the conduct of production chains in those developing states where legal and governance internationalization is most clearly targeted.  And it might have been used to align Chinese approaches to corruption to the international standards with which it is, in some respect, quite similar.  But all of these opportunities were lost by the determination to take the traditional approach, to retreat from a more positive exercise of investor power and greater fidelity to the project of legal internationalism within production chains that much of the effort of the Ethics Council is directed. 

Norges Bank Decision

The Executive Board’s decision on exclusion was made on the basis of the recommendation of the Council on Ethics. The Executive Board has not conducted an independent assessment of all aspects of the recommendation, but is satisfied that the exclusion criteria have been fulfilled (see § 3, subsection d, of the Guidelines for observation and exclusion from the Government Pension Fund Global).

Before deciding to exclude a company, Norges Bank shall consider whether the use of other measures, including the exercise of ownership rights, may be better suited. The Executive Board concludes that it is not appropriate to use other measures in these cases.

Hovedstyres beslutning om utelukkelse ble tatt på bakgrunn av tilrådninger fra Etikkrådet. Hovedstyret har ikke på selvstendig grunnlag vurdert alle enkeltheter i tilrådningen, men finner det tilstrekkelig godtgjort at kriteriene for utelukkelse er oppfylt, jf Retningslinjer for observasjon og utelukkelse fra Statens pensjonsfond utland § 3 bokstav d).

Før utelukkelse skal banken vurdere om andre virkemidler, herunder eierskapsutøvelse, kan være bedre egnet. Hovedstyrets vurdering er at det ikke er hensiktsmessig å bruke andre virkemidler i disse tilfellene.

Ethics Council Recommendation 24 June 2015 to exclude ZTE Corp.

The Council on Ethics recommends the exclusion of ZTE Corporation (ZTE) from the Government Pension Fund Global (GPFG) due to the risk of gross corruption. In its assessment, the Council has emphasised the company’s involvement in corruption allegations in 18 countries, as well as the fact that it is currently or has previously been under investigation in a total of 10 of these. Weight has also been given to the fact that the company has been convicted of corruption in one instance, that a corporate penalty was imposed and that the company has been temporarily barred from public competitive tenders. The Council has concluded that the company has failed to demonstrate satisfactorily that internal anti-corruption procedures are being effectively implemented in its business. In conjunction with previous corruption cases and the fact that the company operates in a sector and in many countries associated with a high risk of corruption, this finding indicates that there is an unacceptable risk that the company may once again become involved in gross corruption.

Etikkrådet Tilrådning 24. juni 2015 om utelukkelse av ZTE Corp.

Etikkrådet tilrår å utelukke selskapet ZTE Corporation (ZTE) fra SPU på grunn av risikoen for grov korrupsjon. I sin vurdering har rådet lagt vekt på at selskapet er involvert i korrupsjonsanklager i totalt 18 land, og at det er og har vært under etterforskning i totalt 10 av disse. Det er også vektlagt at selskapet ved ett tilfelle er domfelt for korrupsjon, at det er ilagt foretaksstraff, og at det har vært midlertidig utestengt fra offentlige anbudskonkurranser. Rådet er kommet frem til at selskapet ikke i tilstrekkelig grad har godtgjort at interne korrupsjonsforebyggende prosedyrer implementeres effektivt i virksomheten. Dette, sett i sammenheng med tidligere korrupsjonssaker og at selskapet har virksomhet i en sektor og i mange land hvor risikoen for korrupsjon er høy, gjør at det foreligger en uakseptabel risiko for at selskapet på nytt kan bli involvert i grov korrupsjon.

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