1.         Introduction

The exercise of ownership rights is subject to section 11 of the Regulation on the Management of the Government Petroleum Fund, which states that "Norges Bank shall not exercise ownership rights linked to shares unless this is necessary in order to safeguard the financial interests of the Fund."

A number of developments over the past few years have given added relevance to the question of how Norges Bank as operational manager of the Petroleum Fund exercises its ownership rights in the Fund's equity portfolio. The scandals in connection with poor management of large companies, which have been brought to light in particular in the US, have clearly shown that there is need for owners to take a more active role in management and control in order to safeguard their long-term financial interests. In parallel with the requirement for greater involvement by owners, the authorities, stock exchanges and others have strengthened legislation and the oversight of corporate systems and procedures for management, control and accounting. Priority has also been given to this issue in Norway, as reflected in the Government's report concerning State ownership (Report No. 22 (2001-2002): Reduced and Improved State Ownership), which identifies the main corporate governance principles on which the Norwegian State's ownership should be based.

Another important aspect of international developments is that large institutional owners have formed closer links in order to play a more influential role in safeguarding their financial interests. Most large pension funds have laid down guidelines for the exercise of ownership rights based on shared fundamental values, which are very similar to the principles of good corporate governance adopted by the OECD in 1999.

Along with these developments, the substantial inflow of capital to the Petroleum Fund in recent years has increased average equity holdings in global equity markets, particularly in Europe. Average equity holdings have increased in the past year from 0.28 to 0.40 per cent in Europe, from 0.08 to 0.13 per cent in the Americas and from 0.26 to 0.32 per cent in Asia/Oceania.

The increase in ownership interests and the possibility of exerting influence through cooperation with other institutional investors implies a greater likelihood that Norges Bank will be able to contribute to protecting and developing the Petroleum Fund's financial interests by exercising its ownership rights.

This submission/memorandum presents a description of how Norges Bank has exercised its ownership rights so far and the Bank's plans for the near future. It also includes a proposal for a reformulation of the Regulation.

2.         Exercise of ownership rights so far

The equity portfolio was exclusively managed by external managers during the first years the Petroleum Fund invested in equities. The contracts between Norges Bank and these managers have regulated the right to exercise ownership rights along the same lines as laid down in the Regulation. Norges Bank has reviewed the individual managers' proxy voting guidelines and has monitored how ownership rights have been exercised. Generally, the managers have only to a moderate extent made use of the opportunity to vote at companies' General Meetings.

Norges Bank receives monthly reports from JP Morgan Chase (custodian bank) showing how external managers have voted at companies' GMs. Reporting started in March 2001, and as from December 2001 the reports include all countries. The following table shows voting at meetings in 2001:

a) Abstained or voted against at least one proposal.

Of 1108 reported GMs, external managers voted at 348 meetings (31 per cent). The managers voted in favour of the proposals presented at most of the meetings (293). The managers abstained or voted against at least one proposal at only 55 meetings (5 per cent).

The submission of data has posed some problems in 2002. In spite of the fact that background data for 2002 are incomplete, the data provide, in Norges bank's opinion, an adequate general picture of managers' voting. Voting was recorded as follows:

a) Abstained or voted against at least one proposal.

The table indicates that voting activity was somewhat higher in 2002 than in 2001. This may be due to an increase in the number of more specialised external active equity mandates. Of 2081 reported GMs, external managers voted at 892 meetings (44 per cent). The managers voted in favour of the proposals presented at most of the meetings (698). The managers abstained or voted against at least one proposal at 194 meetings (9 per cent).

Over the past few years, Norges Bank has also managed equity portfolios in-house for the Petroleum Fund and, as from 2001, the long-term portion of the Bank's foreign exchange reserves. A substantial share of the Bank's management involves low active risk and is closely in line with the benchmark portfolios defined by the principals. Because of the Bank's internal management of equity portfolios, internal regulations for the exercise of ownership rights were required. This regulation was laid down in March 2002 by the executive director of Norges Bank Investment Management after the main principles had been established by the Executive Board of Norges Bank. The recently revised guidelines are enclosed with this letter for your information.

Norges Bank has so far not exercised its right to vote in any of the internally managed equity portfolios. However, Norges Bank has regularly exercised other forms of ownership rights as a shareholder.  These rights include having the right or duty to respond to corporate proposals, or voluntary corporate actions. Such proposals may involve making a choice between (normally) two alternatives, for example a choice between receiving dividends in the form of equities or cash, using subscription rights, responding to acquisitions/mergers, share buy-backs, issues, etc.

3.         Exercise of ownership rights by large institutional investors

As mentioned earlier, increased focus on weak corporate governance has had the effect of raising awareness among large institutional investors, such as pension funds, of the necessity of safeguarding ownership rights. There are a number of reasons why institutional investors are placing more emphasis on this aspect:

• It would not be a feasible alternative to sell/dispose of holdings in particularly large companies because the size of the funds necessitates being involved in a large share of the investment universe (to spread risk). When disposing of holdings to exert influence over a company is not an option, exercise of ownership is a better alternative.
• There are synergy effects between the exercise of ownership rights and other financial assessments in connection with management. In the ongoing management of the Fund, information is received and choices have to be made. A more systematic method of collecting information concerning corporate governance can be important to investment decisions. Similarly, information and management analyses will provide the basis for decisions on issues concerning corporate governance.

4.         Future plans

In 2002, Norges Bank increased its potential for increased activity as the owner's representative. The most important step the Bank has taken is to sign an agreement with a US consultancy firm, Institutional Shareholder Services (ISS), which is the world's largest company offering support to investors in the exercise of ownership rights.  ISS is owned by institutional investors. The company has 350 employees (most are based in Washington DC) and around 900 customers, with about 30 in Europe.  ISS monitors companies in all the countries where the Petroleum Fund is invested.

Norges Bank will primarily buy the following services from ISS: Information and analysis of matters to be raised at GMs, advice on voting, carrying out voting (according to decisions taken by Norges Bank) and reporting of results. The voting itself will be based on guidelines adopted by Norges Bank, cf. annex. These guidelines were recently modified with the prior approval of Norges Bank's Executive Board. The adjustment permits somewhat greater activity within the limits set by the Regulation. For example, it will be possible to express general viewpoints in international fora concerning good principles for the exercise of ownership rights, provided these principles are consistent with the objective of safeguarding financial interests.

Norges Bank will submit an annual report about voting to the Ministry of Finance.

5.         The Regulation

The adjustment of the Bank's internal guidelines does not, in the view of Norges Bank, require any change in the text of the Regulation. A minor change in the wording may, nevertheless, be justified. The expression "unless it is necessary" could be interpreted as a negative objective - that ownership should primarily not be exercised. This may raise doubts as to whether Norges Bank will only exercise ownership rights in very special cases. As indicated by the above, Norges Bank bases its decisions on a far less restrictive interpretation.

A possible reformulation of this part of section 11 might read as follows: Norges Bank shall exercise ownership rights when deemed necessary to safeguard financial interests. This wording does not imply that Norges Bank shall exercise ownership rights in every case where safeguarding financial interests is involved, but that resources must be focused on the cases where this is considered to be most important.

In Norges Bank's view, it is important that each performance-based portfolio manager must be entitled to take decisions on a case-by-case basis based on their own analyses and perceptions of what best safeguards the portfolio's financial value. The delegation of such authority to external managers has also been based on this view. Portfolio managers have to handle a large volume of corporate information - and they have to take financial decisions concerning payment of dividends in cash or equities, allotting newly issued shares, etc. In some markets, shareholdings are required to be "locked in" for a period if the shareholder is going to vote at a GM. It must be up to each portfolio manager to make this choice. In most decisions on voting at GMs, the Bank's internal guidelines, which are largely in accord with those of large pension funds in other countries, will provide a basis for the portfolio manager's decision.

An important reason for basing the exercise of ownership rights on safeguarding financial interests is that this creates predictability as to Norges Bank's behaviour as the owner's representative. Such predictability is probable a precondition for establishing good case-to-case relations with other institutional investors so as to exert more influence* in matters considered to be important. 

For the Petroleum Fund¨, as a very long-term investor, it is natural that "financial interests" are defined as "long-term financial interests". A feature that is common to the many examples of poor corporate governance we have witnessed over the past few years is that neither corporate managers nor investors have focused sufficiently on long-term value generation. The exercise of ownership rights is also necessary to safeguard shareholders' financial interests in the short term, but is to an even greater extent a key instrument for long-term investors.

Svein Gjedrem

Knut N. Kjær