Risk-based due diligence is the foundation of how companies prevent corruption. Its logic implies that companies proactively manage their risk exposure, avoiding the most problematic third parties and deals, and mitigating risks associated with others.
NRGI’s research into state-owned enterprise (SOE) corruption in the extractives sector reveals some of the practical limitations of this approach. Because international oil and mining companies may be less able to avoid or influence SOEs, these state enterprises pose a challenge to standard compliance measures. Their private sector partners should, therefore, adopt a further set of precautionary measures. (For the purposes of this post, private sector companies that partner with SOEs are referred to as “companies” and state-owned enterprises, while also companies, are referred to as “SOEs.”)
Companies – including producers, commodity traders, and extractive sector suppliers—often have fewer options for transactions with SOEs. In many countries, partnering with the SOE is required, particularly for companies that produce oil and gas. Some SOE partnerships are decades old and characterized by outdated compliance systems. Extractive industry SOEs are typically very powerful and often play pervasive roles, meaning companies hesitate to raise politically sensitive concerns about SOE governance. Others are willing to exploit these weaknesses to secure commercial advantages. Due to these and other factors, some companies accept SOE corruption risks rather than avoiding or mitigating them.
As a result, some extractive sector companies have ended up engaging in or enabling corruption. Recent enforcement cases reveal how a number of companies have bribed SOE officials. In other instances, companies have made payments to SOEs that were then misappropriated or misused, or have worked with partners with inappropriate political connections. SOE corruption creates problems for the industry’s players and for citizens of resource-rich countries. It increases industry costs and inefficiencies, creates an uneven playing field, wastes public resources, and helps sustain corrupt political regimes in some countries.
In these instances, risk-based due diligence failed to prevent companies from moving forward or establishing sufficient mitigation, despite ample evidence of the prevailing corruption risks. Given the misalignment between standard risk-based due diligence practices and many SOE transactions, NRGI set out to identify what additional measures would better prevent these harmful corruption trends from re-occurring.
We analyzed over 100 past corruption cases and consulted widely across the industry, including with 18 large oil, gas, and mining companies and anti-corruption experts and activists. The resulting guidance recommends a series of concrete measures that build upon positive changes already happening in the industry.
Three key messages stand out about how standard due diligence systems should evolve:
Not everything can be left to case-by-case decision-making. Given the risks, companies should draw red lines from the start.
Company personnel frequently face complex and high-pressure decisions about whether their company has the appetite for the corruption risks identified. In these decisions, they often weigh corruption risks against profit opportunities. The volume of recent corruption cases in the oil, gas, and mining industry demonstrates that this approach is not adequately protecting the public interest in resource-producing countries. For instance, some companies decided to partner with politically exposed persons (PEPs) because it opened up profitable opportunities while also allowing those persons to capture outsized wealth from the deals.
Companies should adopt and publish a limited set of upfront restrictions on the types of third parties they will work with, such as those that refuse to provide beneficial ownership information or whose owners create conflicts of interest. (See the full proposed list here.) There are very few instances in which parties matching such descriptions should represent viable partners. Rather than unduly tying a company’s hands, the prohibitions will send important signals to prospective partners about the company’s integrity standards, fend off pressure to take on problematic partners, and relieve the company’s personnel the commercial pressures to accept such clear corruption risks.
The prevailing risk-based approach is too inward-looking. Company executives should also weigh the risks of enabling corruption and its societal harms.
The risk-based approach chiefly aims to protect companies from legal, regulatory, and reputational costs. Bribery risks receive the most attention, given active law enforcement in that area. Other forms of corruption prompt less concern, including those which inflict severe harm on producing countries. Echoing others (see, for instance, the OECD Due Diligence Guidance for Responsible Business Conduct), NRGI’s new guidance urges companies to systematically consider the potential harm of their operations on host countries and the risk their activities could aggravate corruption issues. To do so, companies should explicitly include questions about the risk of enabling corruption in their due diligence frameworks and avoid transactions where these risks exist. For example, they should avoid engaging with politically exposed entities where the transaction might help the PEP to unduly acquire wealth, and avoid SOE engagements where the payments they make face a clear risk of being misappropriated.
In SOE transactions that carry high risks, companies should invest more, not less, in controls and building a nuanced picture of risk.
Given the inevitability and sensitivity of some SOE engagements, some companies leave important anti-corruption tools on the table. While many companies undertake thorough due diligence on SOEs, others do only basic checks, especially for short-term transactions, when the SOE is a client or when the company considers the SOE as an unavoidable entity. SOEs do not fit easily into standard due diligence frameworks. But companies can and should invest in gathering a full picture of corruption risks by adopting additional due diligence approaches. These include assessing the SOE against leading governance benchmarks and looking beyond the transaction at hand to examine the SOE’s full record.
In high-risk partnerships, companies should also make use of the available good practices, especially ahead of a new engagement. These measures, such as many detailed in the NRGI guidance, include payment and contract disclosures, requirements that suppliers provide beneficial ownership information, strict agent controls, payment controls to reduce misappropriation risks, and collaboration with other stakeholders to bolster reform.
Risk-based due diligence will continue to play a core role in helping companies avoid corruption, but certain scenarios – such as partnerships with extractive SOEs—make clear the need for supplemental approaches. By learning from past challenges and embracing additional safeguards, companies can rise to meet this challenge.
Alexandra Gillies, pictured above left, is an advisor at the Natural Resource Governance Institute (NRGI) and author of the book Crude Intentions: How Oil Corruption Contaminates the World.
Thomas Shipley, above right, is a consultant to NRGI and a researcher at the Sussex Centre for the Study of Corruption.