These requests, or requirements, typically fall into one or more categories: payment of specific taxes or funds to the government budget as part of the initial investment; partnering with a local entity to operate the asset; adhering to local content rules (LCRs); and making social contributions at a local level (usually as charitable donations or community investments).
These investments have traditionally created a huge corruption risk for foreign investors. Funds designed to benefit the local economy are susceptible to embezzlement or diversion. Requirements and obligations merge into social responsibility, and opaque company structures obscure the real beneficiary.
LCRs and social contributions
Often conflated, LCRs and social contributions differ in their basic operation. LCRs are mainly designed to ensure foreign investors use local workforces for projects. The rules necessitate that a percentage of services, labor, and goods is sourced from domestic suppliers or manufacturers. This isn’t without risk for the investors. The consortium or operator may be forced to engage with suppliers that are not adequately experienced. Or, and of greater concern, such suppliers may create a bribery risk under the U.S. Foreign Corrupt Practices Act, UK Bribery Act, and local anti-corruption provisions because the relevant suppliers are being used as conduits for bribes or simply do not have good ethical standards.
Social contributions are part of the broader corporate social responsibility engagement between a project investor and the affected local communities or stakeholders. Acceptance of an engagement by communities and stakeholders is commonly referred to as the investor’s “social license to operate” – i.e., the investor is seeking an informal “social acceptance” to conduct its business. As part of this, there may be agreed lists of social projects the foreign investor will engage with to achieve this confirmation. Such projects also create corruption risk, as it is not always clear who the real beneficiaries are. Further, investors may have concerns that funds will be mishandled and embezzled. For this reason, many companies offer their services and expertise as opposed to just donating cash. That way corruption risk is minimized (although not extinguished).
Corruption risks in relation to LCRs and social contributions will obviously increase where the operator or member of the consortium is a state-owned company – this will be almost unavoidable in Latin America or Africa. Where the grant of a concession agreement is required, this link between public companies and public officials is expected, and should be monitored by investors. Or, remote and underdeveloped regions may expose companies to pressure to extend investments and offer enhanced benefits to local communities. This kind of pressure can be significant.
Shift in regulation and policy
Recent corruption investigations in Latin America – such as Operation Car Wash in Brazil, which spread into other countries in Latin America – provoked a profound change in the anti-corruption landscape within the region. Following the scandals, large energy and mining projects have been put on hold. Notably, a number of Latin American countries have enacted anti-corruption legislation and increased enforcement of new laws. In response, local companies have become stricter with compliance requirements, such as reducing involvement with public officials. Interestingly, informal social contributions in the context of large-scale projects have reduced.
There’s a growing appreciation by national governments that investors will pull out of a project if they’re not satisfied with the due diligence on local partners or local investment projects. In this regard, a noticeable global shift has occurred in the frequency of regulation and transparency requirements for LCRs and social licenses. In particular, before social license government mandates, social licenses were essentially promises by extractors agreed with public officials. These arrangements were unacceptably opaque. A trend has emerged of more transparent and formal dealings by virtue of LCRs regulation and prescribed mandates of social licenses by governments.
Another trend is that these governments aren’t making these requests anymore. Research we commissioned in 2019 showed that a third of energy and minerals companies interviewed had not been asked to make social investments or social contributions as conditions of operating in African and Latin American markets. Companies are making their own choices on corporate social responsibility. Combined, these trends show a positive outcome for local economies and foreign investors alike. For instance, in Brazil we have seen a large number of foreign investments in the oil and gas sector after new anti-bribery legislation was enacted and effective enforcement by local authorities took place. This shows that foreign investors seek corruption-free environments to allocate funds.
Reputation is an asset, so companies must balance the restrictive compliance policies with their social responsibility. To provide more comfort in navigating this area, rather than ask for social contributions, governments are creating initiatives to encourage investment. Brazil, for example, is discussing the creation of a Citizen Company Certification. Such certification would be granted only on demonstration of investment capacity and integrity metrics – e.g., obligations that companies act ethically in their production activities, promote social investments through philanthropic donations, develop corporate volunteering programs, institute social marketing initiatives and community action development in the regions they operate in, establish partnerships with non-governmental organizations, offer fair working conditions, and comply with labor law. The Congress’s legal commission has approved the terms of the proposed certification, and the bill will go through the voting process to come into force.
That said, numerous African and Latin American nations still lag behind. Even the higher-achieving countries suffer exploitation risks. Despite the effort in improving regulations, a lack of political will and poor implementation and enforcement mean the onus remains on extractive industry investors. In this regard, social contributions and similar investments still cause some of the biggest corruption risks and concerns for the extractive industry. Our research has shown that over 50 percent of extractive companies will pull out of a transaction if asked to make social payments or abide by LCRs.
Practical steps to mitigate liability
Pulling out of a transaction can be an extreme solution. Under most international laws, companies can be liable for bribes paid by their agents or “associated persons” or anyone who performs a service for them. However, it can be a defense, as provided for in most anti-corruption statutes, to show that a consortium had in place adequate procedures to prevent such bribery. A crucial part of this is due diligence. Due diligence on business partners in Africa and Latin America can be challenging because shareholding records are not publicly accessible nor can they be verified. Or because a social project’s beneficiaries are not clear or easily clarified. But due diligence is possible, albeit not using traditional methods, and many law firms and investigation agencies have local expertise to help companies with these issues.
A bribery red flag doesn’t have to be the end of the road. However, if you cannot satisfy yourself that the beneficial ownership of a business partner or a social project is clear, then the risk is not worth taking. Engagement with government bodies can help. But with all the perseverance in the world, you still may not be able to conclude who your business partner really is. That’s not acceptable from a corporate governance perspective, let alone from a bribery compliance perspective.
Perhaps as important as initial due diligence is negotiating and including proper protective clauses under consortia, partnership, or joint venture agreements. These might include contractual rights to limit liability, to provide a clear and legal exit option with no penalties, for example in the event of illegal action by the partners, and audit rights. Monitoring the activities of your business partners is crucial. If you have included audit rights – which you should – you must use them. A simple example would be testing the use of subcontractors by reference to work actually done. In respect to social payments, it’s now customary to include in the agreement or social license a right to audit the flow of funds into a particular project and to inspect the use of those funds. Proper accounting records and internal controls are critical to prevent misuse of funds, including for payment of bribes.
Companies have historically insisted on investing by way of expertise – for example, oil companies drilling water wells with equipment and expertise they have close to hand. However, sometimes even this cannot escape risk. Investors must understand the local and political environment to understand who the beneficiaries of a particular project are. Is it a region represented in parliament by the state resources minister? Is the area associated with the ethnic group of important government decision-makers? These factors must be considered and documented before decisions are made to invest in particular projects.
Due diligence plus a compliance program
First, ensure the relevant social investment will genuinely advantage the local communities as opposed to simply benefiting individuals (such as local/public officials) or other project stakeholders as some kind of favor. Second, you must ensure the payments are not being diverted from their intended beneficiary or otherwise misused. In this regard, good due diligence into the project (including understanding the relevant stakeholders and all possible beneficiaries of the investment) and monitoring payment flows is essential. Of course, you should ensure there are no other compliance implications of the proposed project – e.g., that it is consistent with other human rights, environmental, or other similar commitments.
In this respect, having clear and accessible procedures on how to conduct risk assessment and due diligence on all social payments is essential. These procedures should also specify how to document the arrangements. Finally, it is vital that key business people engaged in these projects get bespoke training on the risks of these projects and how risk can be mitigated. These procedures should be built into the company’s compliance structure and culture.
The importance of putting in place a robust anti-corruption program generally cannot be understated. The UK Serious Fraud Office (SFO) recently published some internal guidance on how the SFO should evaluate corporate compliance programs (including in deciding whether to charge a corporate for past wrongdoing). It is clear that the SFO will take account of recent efforts to improve compliance even when looking at past wrongdoings. In other words, taking remedial action now can have a retrospective benefit in protecting the company.
Improvements in regulations and transparency in relation to LCRs and social benefits have improved the benefits received by local communities in the developing world. But challenges remain. Effective and risk proportionate procedures will go a long way to mitigate the continued bribery risks extractive businesses face.