Insights

Norm-based Screening May Not Be What You Think It Is

Almost two years ago, I drew your attention[1] to a widespread misconception about the role of due diligence for responsible business conduct in investment decisions. At the time, I noted that most investors appeared to believe that due diligence for responsible business conduct was just one of several potential ESG strategies, and pointed out that this was not the case. This misconception remains the popular view, and a similar misconception persists with regard to norm-based screening.

To illustrate this, let me paraphrase a statement heard at the PRI in Person Conference held in Paris in mid-September: “Norm-based screenings are about values. We don’t like that. We prefer to focus on ESG risks.” The term “ESG risks” can be substituted by almost anything: SDGs, impact, best-in-class strategies… We come across such statements time and again. Putting it bluntly, many investors see norm-based screening as a slightly more sophisticated version of stone-age exclusion strategies, or as a Scandinavian tradition.

The general philosophy behind norm-based exclusion is about much more than institutional or national values, although such values can supplement screening strategies: norm-based exclusion aims to ensure compliance with relevant standards. “Norm” is a broad concept. What matters here is that, among other important things, norms establish acceptable and unacceptable standards of behavior, including rules for private transactions.

Norm-based exclusion builds on international standards that encompass such norms. Private-sector companies, including financial institutions, should take international standards seriously, as they provide useful, and not surprisingly, internationally recognized minimum standards for business conduct.

International standards are approved or adopted by governments and multinational organizations. From a risk or legal perspective, compliance with such norms is a baseline expectation all over the world. Norms are therefore particularly relevant in court.

The belief that norm-based screening belongs in the “value corner” also ignores the dynamics of the relevant frameworks:

  • Many international standards are evolving – some rapidly, such as human rights-related due diligence requirements – and are more commonly incorporated in national regulations.
  • The OECD is constantly expanding its set of guidelines on due diligence for responsible business conduct (RBC; [2]), and builds on a broad set of norms. We are often surprised at how little attention this work receives, as the OECD guidelines detail government-backed due diligence expectations. The OECD has already produced guidance for investors,[3] will publish a version for commercial banks and investment banks in late October,[4] and start working on a third document soon afterwards (scope to be determined). The OECD guidelines go significantly beyond norm-based screening in terms of both scope and operational expectations.
  • The scope of sustainability issues in the current public draft of the EU Disclosures relating to sustainable investments and sustainability risks[5] is practically identical to the RBC scope of the OECD. Many investors may ignore the OECD, but lawmakers do not.

In short, it is no coincidence that the term is not value-based screening. In our view, it is essential that investors conduct due diligence for RBC (or extended norm-based screenings) across their portfolios if they wish to meet international due diligence expectations.

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