Ethical investing is the new buzzword with pension funds and now Norway’s Government Pension Fund – Global has taken concrete steps to define and apply a set of considerations for its investments. With a massive NKr1,783bn (€218.2bn) in assets under management at the end of 2006, the scheme’s emphasis on ethics will be no small feat.
Martin Skancke, director general of the asset management department of the Norwegian Ministry of Finance, points out that it is important to understand that the question of ethical investing has been evolving since the government took it up in 2002. The Graver Commission, which included experts in jurisprudence and ethics as well as the deputy governor of Norges Bank made proposals for ethical guidelines and a Council on Ethics was established in 2004. A concurrent emphasis on good corporate governance was also brought forward. “The main challenge became how to achieve changes in companies through active ownership,” Mr Skancke says.

The focus on corporate governance plays a role in the actual process of examining ethical questions related to a company’s activity. “Removal from the fund’s investment universe is a last resort. It happens when we don’t approve of a company’s activities and don’t think that we can work with their management on issues of concern,” says Mr Skancke.

Screening process

Exclusion also happens, and is the result of a negative screening process, and Mr Skancke emphasises that there is no positive screening. “Inclusion in the fund’s investment universe is not a recognition” or a sign of approval regarding a company’s actions. “There are specific criteria related mainly to the production of certain types of weapons, especially nuclear, biological and anti-personnel mines. These rules are based on what a company does.” Positive screening goes against the grain of the fund’s investment philosophy, which is to take as broad a position as possible, and is left to the care of “specialised niche funds, which, for instance, could specialise in renewable energy,” he points out.

How a firm operates is harder to assess. “The fund should not be complicit in gross unethical activity, especially in regards to the environment, human rights and corruption,” Mr Skancke stresses. One important aspect affecting the council’s decisions is that the guidelines are forward-looking. Prior behaviour on the part of the company in question or that company’s partners is not given weight. Active complicity in violations of the guidelines is also a necessary component in a negative decision.

This feature gives the fund a clear framework for decision-making. For example, the 14 November 2005, decision by the council on ethics to not recommend the exclusion of oil company Total from the fund’s investment universe was based on an absence of linkage between the abuse of human rights by the government of Myanmar and Total’s operations in the country at the time of the review.

Because Total neither participated in the abuse nor benefited from it directly at that time, the investment did not violate the guidelines. The council also weighed the ethical risk of Total’s immediate involvement or passive acceptance of directly-related systematic abuse and found the risk to be acceptable based on Total’s documented behaviour after the pipeline’s construction.

Despite the emphasis on ethics and good corporate governance, it should be understood that the Government Pension Fund – Global has been created, first and foremost, for the creation of a sound return based on a moderate risk. That return, over the long run, is outlined in the guidelines as “contingent upon sustainable development in the economic, environmental and social sense.” As part of that, good corporate governance is seen as a method for ensuring the rights of shareholders.

Mechanisms for change

The mechanism for making decisions is based on recommendations by the Council on Ethics after a formal request by the Ministry of Finance or on its own behalf. Recommendations are given at fixed times. If the Ministry of Finance agrees with a recommendation to exclude, Norges Bank – the fund manager – is given two months to divest the fund from the company in order to do so with the highest financial benefit.

“This is a big challenge,” Mr Skancke says. “This is not a 1 per cent ‘ethical part’ of a fund, but rather the investment into over 300 companies. This in itself is ambitious. We also want to signal that this is for financial, not strategic investing. We are not an active strategic investor.” It is the Ministry of Finance which actually makes the decisions regarding how the fund is operated. “We might come back to the issue of increasing the maximum later, but it will not signal a change in our strategy.”

Changes to the way the fund is managed include a refined focus on operational risk. Ensuring that there is sufficient liquidity to help get the fund’s money out of a given investment is becoming a factor.

Ethical risk involves another type of monitoring, though. Since the Government Pension Fund – Global does not carry large stakes in individual companies, communication with other shareholders is important when trying to affect corporate policy or get information. Norges Bank states that it will “consider participation in international networks and organisations to promote good principles for corporate governance”.

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