Promoting Prosperity: Designing a Sovereign Wealth Fund in British Columbia

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Promoting Prosperity:
Designing a Sovereign Wealth Fund in British Columbia
Mark Levesque 301142335
Pol 499 Dr. Hira
Simon Fraser University
July 29 2014
Contents
Executive Summary ........................................................................................................................ 2
Background ..................................................................................................................................... 3
Purpose and Methodology .............................................................................................................. 4
The Five Criteria Rubric ............................................................................................................. 5
Literature Review............................................................................................................................ 5
Sovereign Wealth Funds as Macroeconomic Policy Tools ......................................................... 5
Alberta Heritage Savings Trust Fund ......................................................................................... 8
Alaska Permanent Fund ............................................................................................................ 12
Norwegian Pension Fund Global.............................................................................................. 17
Conclusion................................................................................................................................. 21
Findings......................................................................................................................................... 22
Contribution Requirements ....................................................................................................... 23
Management Agency ................................................................................................................. 24
Investment Strategy ................................................................................................................... 25
Spending Ability ........................................................................................................................ 26
Total Valuations ........................................................................................................................ 27
Conclusion................................................................................................................................. 29
Recommendations ......................................................................................................................... 29
Recommendation One ............................................................................................................... 30
Recommendation Two ............................................................................................................... 30
Recommendation Three ............................................................................................................. 31
Recommendation Four .............................................................................................................. 32
Recommendation Five ............................................................................................................... 32
Conclusion................................................................................................................................. 33
Bibliography ................................................................................................................................. 34
1
Executive Summary
The Government of British Columbia is planning to create a sovereign wealth fund
(SWF) called the Prosperity Fund, into which it will deposit the proceeds from the planned
development of liquefied natural gas. SWFs are public investment funds, and they are often
instituted as savings funds that aim to promote sustainable economic growth from the
exploitation of non-renewable natural resources. Many states have created SWFs for this
purpose, and B.C. policymakers can learn from their experience in creating the Prosperity Fund.
The Albertan Heritage Fund, the Alaskan Permanent Fund, and the Norwegian Petroleum
Fund are all examples of commodity-based SWFs that provide relevant examples for British
Columbia. They are each funded through a non-renewable natural resource, and they all share a
common goal of sharing resource wealth across generations. However, each fund is the result of
different policy approaches, and this has resulted in varying degrees of success between them.
Specifically, the Petroleum Fund exhibits the strongest principles of SWF management, while
the Heritage Fund exhibits the weakest policy framework of these three funds. The Heritage
Fund was the first SWF in Canada, but it is not a model that B.C. should attempt to follow.
Learning from the experiences of other SWFs, five principal recommendations can be
made that would contribute to a strong governance framework for the Prosperity Fund.





Stipulate that all LNG resource revenues be deposited into the fund.
Delegate management of the fund to an independent management agency.
Focus investments on maximizing long-term financial gains.
Adopt a risk-averse policy early and scale upwards as fund matures.
Place restrictions on the amount of the fund that can be spent annually.
Following these policy recommendations will help create a well-performing SWF in British
Columbia that focuses on sustaining long-term economic growth and promoting prosperity.
2
Background
British Columbia is a province with abundant natural resources, and the development of
these resources—both renewable and non-renewable—plays a major role in the British
Columbian economy. The Government of B.C. is developing plans to promote the development
of the significant liquefied natural gas (LNG) reserves in British Columbia.1 There are many
factors that the government must consider, but from a public perspective, how the resource
revenues are managed is a critical component of any plan to promote large-scale natural resource
exploitation. This is true not only because natural resources in B.C. are owned by the Crown and
are thus public resources, but also because of the governing party’s pledge to solve British
Columbia’s fiscal woes by placing the revenues received from LNG into a “Prosperity Fund”
that will be used to completely pay down the debt and create a “Debt-Free B.C.”2 This fund, as
envisioned by the government, will be a sovereign wealth fund (SWF) in which the revenues
from the LNG industry would be invested.
Sovereign wealth funds are public investment funds owned by the state, and they are
often funded through non-renewable resource revenues. Non-renewable natural resources can be
understood as a finite stock, and commodity-based SWFs attempt to convert this stock into an
income flow by investing a portion of non-renewable natural resource revenues. Many other
jurisdictions have created SWFs for this purpose, and examining how other SWFs are created
and managed can provide valuable insight for B.C. policymakers. This paper will analyze three
such funds, the Albertan Heritage Savings Trust Fund, the Alaskan Permanent Fund, and the
1
2
BC Liberal Party 2013, 7.
Ibid., 79.
3
Norwegian Pension Fund Global, in an effort to determine a set of ‘best practices’ that could be
used to inform the development of a SWF in British Columbia.
Purpose and Methodology
The principle aim of this paper will be to address the question “what principles of
sovereign wealth fund design and management can the B.C. Government include in the
development of the Prosperity Fund to ensure that the fund is able to accomplish the goals set by
the government?” To answer this question, a comparative analysis will be made between three
SWFs already in operation to understand how different jurisdictions created and managed nonrenewable natural resource revenues, and how different policy actions effect the operation, and
ultimately the success, of the funds. Each of these SWFs are funded using revenues from nonrenewable natural resources, and each employs different policy frameworks such that each one
will be able to act as a model, or paradigm, of SWF management. These models can then be
analyzed and compared for the purposes of informing the development of such a fund in B.C.
The comparative analysis conducted in this paper will be used to elucidate the elements
of well-performing SWFs, and the success of this analysis will rely on the depth and the rigor of
the criteria used to evaluate their performance. This paper will evaluate the three SWFs selected
based on five criteria commonly acknowledged as important factors of SWF management3:
Contribution Requirements, Management Agency, Investment Strategy, Spending Ability, and
Total Valuations. SWFs represent tradeoffs between current and future spending, and these
criteria are elements of SWFs that focus on promoting future spending relative current spending.
As the B.C. government is promoting the Prosperity Fund as a method to eliminate the provincial
3
Abdullah Al-Hassan 2013, 3-12; Das 2009, 9-12; Hammer 2008, 4-10.
4
debt over the long-term, it is reasonable to assume that this fund will prioritize future spending
over the longer term and thus that these criteria are appropriate selections for the purposes of the
subsequent evaluations. This list of criteria is not exhaustive, but covers the key elements of
SWFs while acknowledging the limited scope of this project. Evaluating all three models on a
common set of criteria will enable a systematic comparison of different SWF policy frameworks;
the criteria rubric that will be used is presented in the following chart.
The Five Criteria Rubric
Variable
Measure
Interpretation
Contribution Requirements
Determining if the government
is committed to depositing
resource revenues.
Existence of entity to manage
the SFW on behalf of the
government.
Set contribution requirements
will be interpreted as a
positive principle.
Accountable yet distinct
managing entity will be
interpreted as a positive
indicator.
Focusing on long-term
investments will be viewed as
a positive principle.
Management Agency
Investment Strategy
Spending Ability
Total Valuations
Level of diversity/risk targeted
by the fund, targets for
investment, environmental
targets (if applicable).
What the fund is spent on, i.e.,
budget stabilization,
endowments, or dividends.
Value of the fund in American
dollars, per capita worth.
How the fund is spent will be
interpreted based on the
principles on which it was
founded.
Higher valuations will be
positive indicators.
Literature Review
Sovereign Wealth Funds as Macroeconomic Policy Tools
In recent decades sovereign wealth funds (“SWFs”) have come to play a much larger role
in the global macroeconomic system. While there is no definitive definition of what exactly
5
constitutes a SWF, the Sovereign Wealth Fund Institute (SWFI)—an international organization
dedicated to studying SWFs—defines it as
“a state-owned investment fund or entity that is commonly established from balance of payments surpluses,
official foreign currency operations, the proceeds of privatizations, governmental transfer payments, fiscal
surpluses, and/or receipts resulting from resource exports. 4”
The SWFI also states that a SWF excludes government/employee pension funds and foreign
reserves held by a central bank for monetary policy. 5 This definition provides a very technical
and inclusive list of what constitutes a SWF, but from this a broader definition can be drawn;
simply, that a SWF is an investment fund owned by the state which is funded through any of a
variety of government actions which include commodity and non-commodity sources. The SWFI
currently lists over 70 SWFs valued at over 6 trillion USD, with more than 32 of these funds
being created since 2005.6 The increased prominence of SWFs in the global economy stems from
the macroeconomic benefits they confer onto their sovereign manager.
There has been an increasing trend towards states creating sovereign wealth funds, and
how states constitute their respective funds depends on the macroeconomic circumstances that
prompted its creation. The context of each SWF is unique, but the SWFI lists common objectives
of these funds, which includes: stabilizing government budgets from export/resource volatility,
diversifying from natural resources, and funding social programs.7 In summarizing the IMF
literature on the subject, Weiss states that there are three broad categories into which most SWFs
belong.8 SWFs that are set up with the primary purpose of shielding government revenues from
volatility in commodity markets are known as stabilization funds.9 Stabilization funds primarily
4
SWF Institute 2014, What is an SWF?
Ibid., What is an SWF?
6
Ibid., What is an SWF?
7
Ibid., What is an SWF?
8
For the complete set of IMF categories on SWFs, see Abdullah Al-Hassan 2013, 5.
9
Weiss 2009, 5.
5
6
arise in states that are setting up SWFs to manage resource revenues, and help stabilize the
government’s fiscal revenues.10 The second category of SWFs is savings funds, which are set up
as a way to manage an inter-generational wealth transfer by investing a portion of the proceeds
of non-renewable natural resources for future returns or to spur future development.11 Reserve
investment corporations are the third category of SWF categorized by Weiss, which are funds
created to “reduce the opportunity cost of holding excess foreign reserves.”12 Thus while the
specific context of each SWF varies, it can be generally stated that every SWF falls into these
one of these three broad categories.
Based on the goals of the fund there are three broad categories into which most SWFs
fall, and the circumstances that led to the creation of an SWF will influence how it is funded and
invested. The SWFI states that SWFs can have their financial basis in either commodities, such
as renewable and non-renewable resource extraction, or non-commodities, which are usually
foreign exchange reserves.13 A 2008 IMF Working Paper conducted a survey of participants to
the 2008 General Accepted Principles and Practices for SWFs, and found that the majority (67%)
of respondents managed funds that were drawn from mineral royalties.14 Budget transfers,
primarily of foreign exchange reserves, constituted the next major single category of transfers,
with the remaining transfers stemming from a variety of sources.15 Commodities thus provide the
basis for the majority of funds surveyed by the IMF, and commodity based funds are primarily
set up as either stabilization funds or savings funds.16 Budget transfers of foreign reserves are
10
Ibid., 5.
Ibid., 5.
12
Ibid., 6.
13
SWF Institute 2014, What is an SWF?
14
Hammer 2008, 4.
15
Ibid., 4.
16
Abdullah Al-Hassan 2013, 5.
11
7
non-commodity funds, and these funds are often organized as reserve investment corporations.17
The type of fund also indicates the type of investment strategy that will be employed.
Stabilization funds emphasize liquidity and primarily focus on easing the cyclical nature of
commodity prices, whereas savings funds assume a more high-risk investment stance to generate
income for future generations or for socio-economic development.18 Non-commodity reserve
investment corporations pursue high-return strategies often involving large investment in equities
and leveraging debt.19 The investment strategy is thus contingent on the type of SWF that is
created by the state, which is itself contingent on the type of funding the SWF is set up to
manage.
Alberta Heritage Savings Trust Fund
The Alberta Heritage Savings Trust Fund (“Heritage Fund”) was created in 1976 to
manage revenues stemming from Alberta’s immense non-renewable natural resource wealth,
primarily from unconventional oil. The fund’s original goals were to share non-renewable
resource wealth with future generations of Albertans, but also to support social projects and save
for a “rainy day.”20 The legislation governing the Heritage Fund states the explicit mission of the
fund as
“WHEREAS the mission of the Heritage Fund is to provide prudent stewardship of the savings from
Alberta’s non-renewable resources by providing the greatest financial returns on those savings for current
and future generations of Albertans.”21
From this definition it is clear that the Heritage Fund, as its full name implies, falls into the
savings fund category of SWFs. It was created by the Albertan government to invest a portion of
17
Ibid., 5.
Ibid., 5.
19
Ibid., 5.
20
Murphy 2013, 5.
21
Province of Alberta 2013, 1.
18
8
the proceeds on non-renewable natural resources—primarily oil—in order to promote long-term
economic prosperity for future generations of Albertans. This action by the Albertan government
was an acknowledgement of the finite nature of non-renewable natural resources, and an attempt
to share the wealth of their natural endowment across generations.
The Heritage Fund was created as a savings fund to provide financial stewardship for the
revenues of non-renewable natural resources in Alberta, but the government’s commitment to
allocating revenues to the fund has changed over its history. Originally the government
committed to allocating 30% of resource royalties to the fund, 22 which resulted in the Heritage
Fund being valued at $4.7 billion by March 31 1979.23 However, the Government of Alberta
slowly scaled back its contributions to the Heritage Fund and by 1987 ended completely the
transfer of resource royalties to the fund.24 As well as altering the government’s contribution to
the principal of the fund, in 1982 the fund no longer retained the income earned from its
investments.25 These changes resulted in a roughly 20 year stagnation of the value of the fund,
until a series of transfers occurred in the early 2000s, as shown in this chart.26 Since 2008 the
value of the fund has again stagnated, and as of December 2013 it was valued at $17.4 billion
22
Smith 1980, 141.
It is important to note that this $4.7 billion valuation includes a special one-time transfer of $1.5 billion from the
Province of Alberta’s General Revenue Fund in 1976 (Milke 2008, 18).
24
Ibid., 18.
25
Ibid., 20.
26
Ibid., 20.
23
9
CAD.27 However, this trend is likely to change for the positive following the Alberta
government’s decision to alter the savings policy such that the fund will once again retain its
investment income starting in 2016-2017.28 The Heritage Fund will continue without a set
contribution requirement, but the decision to allow the fund to keep its investment earnings will
likely result in the renewed growth of the fund.
While the exact funding scheme of the Heritage Fund has varied over the funds history, it
has primarily been managed as a
savings fund for the provinces natural
resource wealth. The legislation that
created the Heritage Fund stipulates
that the Crown is the legal owner of the
fund and that the Minister of Treasury
Board and Finance is responsible for the management and investment of the fund.29 Originally
the fund was almost entirely managed by Cabinet, with only a fraction of the funds invested
being debated within the legislature.30 A legislative Select Standing Committee was established
to approve the reports of the fund, but it acted only as a “post-facto” review body with no
authoritative ability.31 During the pivotal 1997 restructuring of the Heritage Fund, a new Select
Standing Committee was created that operates “at arm’s length” to ensure that the fund is
meeting its legislative goals.32 Alberta took another step towards greater independence for the
fund in 2008 by creating the Alberta Investment Management Corporation (AIMCo) as a Crown
27
Alberta Treasury Board and Finance 2014, Frequently Asked Questions.
Ibid., Frequently Asked Questions.
29
Province of Alberta 2013, 2.
30
Smith 1980, 146.
31
Ibid., 146.
32
Milke 2008, 19.
28
10
corporation that manages the Heritage Fund.33 Thus while the fund began under highly central
control, it has since gained greater autonomy in its investment management due to a series of
policy reforms.
A stated goal of the Heritage Fund was to provide future generations of Albertans with
financial returns stemming from the exploitation of natural resources, which meant that how the
funds were invested would be critical to meeting this goal. The legislative basis for investing the
funds stipulates that the “investments of Heritage Fund assets must be made with the objective of
maximizing long-term financial returns.”34 Public policy analysts have been critical of the early
investment practices of the Heritage Fund, however, and assert that during the first two decades
the fund focused on non-financial investment goals that limited the income earning capability of
the fund.35 The 1997 restructuring of the fund shifted the investment focus towards financial
gains in the long-term.36 The Heritage Fund’s asset mix as of December 2013, managed by
AIMCo, was 54% in equities—most of them global and not Canadian—27% in inflation
sensitive investments, and 19% in fixed income.37 This diversified asset mix has seen an 11.6%
net return on investment during the 2013/2014 fiscal year, earning $1.7 billion in gross income.38
The focus on long-term growth has strengthened the fund’s ability to invest for future
generations. However, while the Heritage Fund has shifted focus to maximizing long-term gains,
the value of the fund has stagnated for years because of the government’s spending practices.
33
Province of Alberta 2007, 2.
Province of Alberta 2013, 2.
35
Murphy 2013, 15.
36
Milke 2008, 19.
37
Alberta Ministry of Treasury Board and Finance 2014, 2.
38
Ibid., 2.
34
11
The Heritage Fund was established both to save for future generations and to support
government programs, and these contradictory goals have resulted in spending practices of the
Albertan government that do not reflect both of these goals equally. There are no legislative
protections on the principal of the fund, which could be spent along with any income earned at
any time by the government.39 The 1997 restructuring of the fund limited the government’s
ability to spend the funds on special projects,40 but this did not stop the government from simply
transferring any income earned by the fund to the provinces General Revenue Fund. Since the
creation of the fund it has earned a total of $31.3 billion in income, of which $29.6 billion has
been transferred to the legislature.41 The difference is kept in the fund due to legislative
requirements that mandate the inflation proofing of the fund,42 or are investment expenses. In the
2013/2014 fiscal year current to December 2013, the government transferred $1.4 billion of the
$1.7 billion income earned from the Heritage Fund to the General Revenue Fund.43 These
earnings are then used by the government to support general government program spending.44
The spending practices of the government clearly emphasize current government spending over
saving for future generations, and this has limited the ability of the Heritage Fund to act as a
savings fund for future generations of Albertans.
Alaska Permanent Fund
In 1976 the Alaskan state government created the Alaska Permanent Fund to manage a
portion of the revenues stemming from the exploitation of non-renewable natural resources,
39
Milke 2008, 20.
Ibid., 19.
41
Murphy 2013, 13.
42
Province of Alberta 2013, 5.
43
Alberta Ministry of Treasury Board and Finance 2014, 2.
44
Alberta Treasury Board and Finance 2014.
40
12
particularly oil. To establish a SWF in Alaska required a constitutional amendment, so the
Alaska citizens were asked by their government to vote on such an amendment that read:
"At least twenty-five percent of all mineral lease rentals, royalties, royalty sale proceeds, federal mineral
revenue sharing payments and bonuses received by the State shall be placed in a permanent fund, the
principal of which shall be used only for those income-producing investments specifically designated by
law as eligible for permanent fund investments. All income from the permanent fund shall be deposited in
the general fund unless otherwise provided by law.”45
Alaska voters approved this constitutional amendment by a wide-margin,46 firmly placing the
Permanent Fund within the constitutional fabric of the state. The Permanent Fund as created by
this amendment was designed as a savings fund, and it featured set contribution minimums as
well as strict rules governing the use of the principal and the earnings of the fund. As well,
because the provisions of the fund are constitutionally entrenched, the state legislature cannot
make major changes to the operation of the fund without further amendment to the constitution.
The Alaska Permanent Fund is constitutionally mandated to receive a minimum of 25%
of a range of revenues stemming from non-renewable natural resources in the state. This
minimum contribution limit, when coupled with the constitutional prohibition of the state
legislature to transfer money from the principal of the fund to the general fund of the legislature,
has resulted in a very stable growth
trend for the value of the fund. The
government’s contributions to the
principal of the fund include the transfer
of a portion of non-renewable resource
royalties, special legislative appropriations of earned income, and transfers to maintain the real
45
46
State of Alaska 1976.
Alaska Permenant Fund Corporation 2013, FAQ.
13
value of the fund (inflation proofing).47 This graph illustrates the growth of the constitutionally
protected principal of the fund from its creation until 2001,48 which shows an unambiguous
upward trend in the value of the fund’s principal. As a result of the steady flow of revenues into
the fund, it is currently valued at $51.7 billion USD, making it the largest fund of its kind in the
United States.49 The constitutional requirements for allocating revenues to the fund has resulted
in fund managers receiving steady flows and, barring investment losses, an ever increasing
principal with which to invest for future generations of Alaskans.
A major impetus behind the creation of the Permanent Fund was the concern over how
the potential revenue from the large-scale exploitation of oil in Alaska was going to be managed.
The constitution of Alaska declares that all natural resources belong to the citizens of Alaska,
and the discovery of oil in 1968 quickly became a key issue for the public.50 The first auction of
oil leases raised $900 million, and with no guidelines in place to manage these revenues, the state
government had spent the entirety of these funds by 1976.51 The Permanent Fund was thus
created as an entity that would ensure a portion of the revenues from non-renewable natural
resources would be shielded from being spent immediately by the legislature.52 In the years
following the creation of the Permanent Fund the legislature further decided that the fund should
primarily be managed as a savings fund for future generations, rather than a fund used to
promote current economic development.53 Having decided that the Permanent Fund was to be an
intergenerational trust fund, in 1980 the legislature created the Alaska Permanent Fund
47
Milke 2008, 15.
Anderson 2002, 63.
49
Alaska Permenant Fund Corporation 2013, FAQ.
50
Anderson 2002, 58.
51
Ibid., 59.
52
Ibid., 59.
53
Ibid., 59.
48
14
Corporation (APFC), a state-owned entity that would manage the assets of the fund.54 The
Alaska legislature decided that entrusting a state-owned entity to manage the fund would
increase the independence of the fund by reducing political interference, while at the same time
holding the management of the fund accountable to the legislature and thus the people of
Alaska.55 Since 1980 the AFPC has managed the investment of the Permanent Fund’s assets in
accordance with the goals established by the Alaskan legislature.
The Alaska Permanent Fund Corporation manages the assets of the fund, which are
constitutionally bound to being invested in income-producing investments. Originally the fund
was limited to only investing in fixed income investments, but the approved list of incomeproducing investments has since been expanded to enable the AFPC to invest in real estate and
stocks.56 The investment goal of the AFPC is to “produce an average annual real rate of return of
5 percent over the long term” by investing in a broad portfolio diversified across different types
of assets.57 Three pillars underlie the investment philosophy of the AFPC: 1) follow prudent
investor guidelines in terms of investment risk; 2) assume enough risk to maximize returns in the
long-run; and 3) use portfolio diversification as a method to both lower risk and maximize
returns.58 Operating under these guidelines the AFPC invests in a diversified portfolio—of which
the majority is equities—which in 2013 saw an overall 10.9% return across the entire portfolio,
an income of $4.6 billion.59 The investor guidelines which the fund follows have resulted in a
positive real rate of return, albeit of varying magnitudes, in every year since 1985.60 Maximizing
54
Alaska Permenant Fund Corporation 2013, About the APFC.
Murphy 2013, 19.
56
Anderson 2002, 60.
57
Alaska Permenant Fund Corporation 2013, Investments.
58
Ibid., Investments.
59
Alaska Permanent Fund Corporation 2013, 4.
60
Ibid., 7.
55
15
long-term growth rates is critical to the success of any savings fund, but this is especially true for
the Alaskan government because the constitutional basis for the fund allocates all income back
into the state’s general revenue for general spending purposes.
The constitutional amendment that created the Permanent Fund prohibits the legislature
from allocating funds from the principal of the fund and instead transfers all income earned from
the fund’s investments into the state’s general revenues. The income may be spent in any manner
by the state government, but a major spending priority has been the Permanent Fund Dividend
(PFD). Created by the legislature in 1982, the PFD is a unique element of the Permanent Fund.
It is exactly what its name implies—it is a dividend from the investment income of fund payable
to eligible Alaskan residents.61 Each year Alaskan residents receive a dividend from the income
of the fund—giving every resident both a direct benefit from and a direct stake in the
management of Alaska’s resource wealth.62 PFD payments constitute the single largest spending
element of the Permanent Fund, and by 2009 had paid $17.5 billion to Alaskan residents.63 In
recent years the average individual dividend payment has ranged between $1,000 and $1,500,
which has helped make Alaska the most economically equal state in America while coinciding
with robust economic growth.64 By paying dividends the Permanent Fund produces an
immediate benefit to Alaskans, and by protecting the principal for future investments the fund
will continue to act as a savings fund for future generations.
61
Widerquist 2012, 4.
Widerquist 2012, 4.
63
Alaska Permenant Fund Corporation 2013, Dividend.
64
Widerquist 2012, 3.
62
16
Norwegian Pension Fund Global
The Norwegian Pension Fund Global (hereafter referred to as the Petroleum Fund65) was
created by the Norwegian national government in 1990 to manage revenues from the country’s
oil industry. Oil was discovered in Norway in 1969, and the government had to decide how to
manage the potentially large revenues that would be flowing into the state coffers.66 A committee
of the legislature was created, and it recommended the creation of a state-owned fund that would
both act as a savings fund for non-renewable natural resource revenues on behalf of future
generations as well as insulate the domestic economy from the “resource curse” known as the
“Dutch Disease.”67 In 1990 the government enacted the Government Petroleum Fund Act, which
the Governor of the Norwegian central bank described as having four primary goals:
“First: The totality of government petroleum revenues is transferred to the Fund. Second: The Fund is
integrated into central government budgets and accounts. The non-oil deficit is covered by an annual
transfer from the Fund. The government cannot borrow to finance current expenditure as long as there is
capital in the Fund. Third: The capital in the Fund can only be used for domestic spending via general
budget transfers, and not for earmarked transfers. Fourth: The Fund’s capital must be invested abroad.”68
This act created a SWF that has qualities of both savings funds and stabilization funds. It is a
savings fund because it acts as an intergenerational wealth transferring vehicle for finite natural
resources, but it is also a stabilization fund because it seeks to mitigate volatility in commodity
markets from unduly affecting the domestic economy. It was created significantly later than the
other two funds here examined, but it often regarded as the pinnacle of contemporary SWF
management.
65
The Global Pension Fund Global was originally called the Petroleum Fund. The new name is a bit misleading,
because the fund actually draws its revenues from oil revenues and not pensioners (SWF Institute 2014, Norway
Government Pension Fund Global). The fund will be referred to as the Petroleum Fund in this paper for clarity.
66
Gjedrem 2010, Perspectives on managing the Government Pension Fund Global.
67
Chambers 2012, 68.
68
Ibid., Perspectives on managing the Government Pension Fund Global.
17
The Petroleum Fund is a commodity based SWF, and it receives the majority of its
revenues from the proceeds of a non-renewable natural resource, oil. The complete list of
funding includes oil revenues, proceeds from emissions taxes, as well as dividends from Statoil
and revenue agreements.69 A distinguishing element of this fund is that all net proceeds from
these revenue sources are deposited into the fund, not just a portion.70 This is known as an
integrated budget model, where all revenue is initially deposited into the government’s general
revenue, and then the net amount—the amount not used to cover the state’s non-oil deficit—is
transferred to the Petroleum Fund.71
The first net-transfers occurred in
1996, and because the government
had committed to transferring the
entire net amount to the fund, the
value of the fund quickly rose. This
chart shows the staggering rise of the
value of the Petroleum Fund,72 now the world’s largest SWF valued at $828 billion USD.73 Due
to the large transfers to the fund, the Petroleum Fund has become a major component of the
budget, despite the fact that oil production likely peaked in 2011.74 Managing the assets of the
Petroleum Fund has thus become a critical matter for the Norwegian economy.
The governance structure of the Petroleum Fund is designed to clearly delegate the
responsibility for its management to different entities while maintaining democratic
69
Norway Ministry of Finance 2012, 1.
Murphy 2013, 28.
71
Norges Bank 2014, About the Fund.
72
Norway Ministry of Finance 2014, 5.
73
SWF Institute 2014, Norway Government Pension Fund Global.
74
Chambers 2012, 68.
70
18
accountability. The Petroleum Fund is managed by two principal actors: the Norwegian
government and Norges Bank, the Norwegian central bank. The Minister of Finance is
accountable for the management of the Petroleum Fund to the legislature, the responsibility for
which is delegated to the central bank.75 Originally the fund was managed by the central bank
similar to its foreign exchange reserves,76 but in 1998 Norges Bank Investment Management
(NBIM) was created as a sub-entity within the central bank charged with managing the assets of
the fund.77 The governance structure is such that the Ministry of Finance is responsible for
providing the goals, acceptable risk levels, as well as the rules and investment criteria for the
Petroleum Fund while the everyday management occurs within NBIM.78 This relationship
between the Ministry of Finance and NBIM determines the investment activities of the fund.
The Norges Bank Investment Management unit invests the considerable assets of the
Petroleum Fund based on guidelines established by the government. The core beliefs of the
fund’s investment scheme are summarized as: maximizing long-term gains through
diversification and earning risk premiums while maintaining a “commitment to responsible
investing.” 79 The first guidelines focus on maximizing long-term gains by leveraging the fund’s
large worth to generate significant income for future generations.80 The majority of the funds are
in equities (60%), with the remaining funds investment in fixed-income activities (35-40%) and
real estate (5%), all invested outside of Norway to avoid distorting the domestic economy.81 The
commitment to responsible investing states that along with maximizing long-term gains,
75
Norges Bank 2014, Governance Structure.
Gjedrem 2010, Perspectives on managing the Government Pension Fund Global.
77
Murphy 2013, 28.
78
Chambers 2012, 69.
79
Chambers 2012, 70.
80
Norges Bank 2014, Investment Strategy.
81
Ibid., Investment Strategy.
76
19
investments must also follow clear ethical guidelines.82 Responsible investing means prioritizing
investments in companies that promote sustainability and follow established ethical guidelines,
as well as excluding companies that do not meet the ethical criteria established by the
government from the fund’s investment practices.83 The fund posted a nominal return rate of
15.9% in 201384, and since 1998 has earned a real return rate of 3.7%.85 The income earned by
the fund has become a significant element of the budget, and it is estimated that by 2020 income
from the fund alone will equal 8.45% of domestic GDP.86 The large principal and long-term
investment strategy provide income which can be used to cover the non-oil deficit.
Using the integrated budget method to manage the Petroleum Fund, the Norwegian
government can use a portion for general spending. Unlike other SWFs which often transfer a
portion or all of the income earned by the fund into the government’s general revenue, the
Norwegian government first takes a portion of the gross revenues destined for the fund and
withdraws an amount to cover the non-oil deficit.87 The amount that the government can spend
from the gross proceeds is governed by the fiscal guidelines known as the budgetary rule. The
budgetary rule states that the government may only spend 4% of the fund’s value annually,
which is the fund’s anticipated long-run real return.88 This 4% has become a central element of
the government’s budgets, and the Ministry of Finance estimates—albeit with considerable
uncertainty—that the Petroleum Fund will cover 15% of government expenditure by 2020.89
These fiscal guidelines allow the government to spend considerable portions of the fund to
82
Norway Ministry of Finance 2014, 44.
Norges Bank 2014, Responsible Investing.
84
Norway Ministry of Finance 2014, 5.
85
Norges Bank 2014, Returns.
86
Norway Ministry of Finance 2014, 5.
87
Murphy 2013, 31.
88
Chambers 2012, 69.
89
Norway Ministry of Finance 2014, 7.
83
20
support current generations, while at the same time transferring considerable sums of money to
the Petroleum Fund to save for future generations. The balance of spending priorities between
current and future generations is a key element of well-performing commodity-based SWFs.
Conclusion
This survey of the literature has provided a wealth of information which will be used to
inform the comparative analysis of these three funds. All three of these funds fall into the
category of commodity-based savings funds, with the goal of promoting sustainable economic
growth from the exploitation of non-renewable natural resources. However, while all of the
funds have the same primary goal, they each follow a different policy approach. Alberta’s
Heritage Fund, valued at $16.4 billion USD, was the first SWF created in Canada. The Alberta
model has no set contribution requirements and no restrictions on the government’s ability to
spend the fund’s wealth. It is currently managed by the Crown corporation AIMCo, and is
legislatively committed to focusing on maximizing long-term financial gains. The Alaskan
Permanent Fund, valued at $51.7 billion USD, is the largest SWF in the United States. The
Alaskan model commits the government to contributing at least 25% of resource revenues to the
fund, and the government may only spend the income earned from its investments for general
budgetary spending. APFC manages the fund, and is constitutionally committed to investing in
income-producing investments. The Petroleum Fund of Norway, valued at $878 billion USD, is
currently the largest SWF in the world. The Norwegian model has all resource revenues
deposited into the fund, and fiscal guidelines that restrict the government’s ability to spend the
wealth of the fund. The fund is managed by NBIM, which focuses on maximizing long-term
gains while remaining committed to principles of responsible investment. These funds share
common goals, are funded from the same natural resource, and yet have achieved varying
21
degrees of success. A major cause of this variation stems from the different policy frameworks
that each government employed to manage their fund. This review of the literature will provide
the information needed to analyze these competing models and to elucidate best practices.
Findings
The Literature Review has examined the SWFs with a primary focus on the five criteria
established in the Purpose and Methodology section of this paper. The survey of the literature
revealed that while the funds often share common goals, the different policy approaches taken
towards SWFs by their respective governments has resulted in varying institutional frameworks,
and ultimately, degrees of success. A summary of the three SWFs in relation to the Five Criteria
Rubric is presented in the following chart. The information presented in this chart will be used in
analyzing each criterion independently in an effort to examine how different policy frameworks
have affected the relative success of each fund.
Heritage
Fund
90
Contribution
Requirements
No set
contribution
requirements.
Management
Agency
Crown
corporation
(AIMCo) as
of 2008,
previously
government
committee.
Investment
Strategy
Legislation
requires focus
on maximizing
long-term
gains; equities
major element.
Spending
Ability
No protection
of principal,
currently all
income
transferred to
general
revenue.
Total
Valuations
$16.4
billion,
~$4,500
per
capita.90
SWF Institute 2014, Heritage Fund Profile.
22
Permanent
Fund
Minimum
25% of
resource
royalties
deposited
annually.
State-owned
Entity
(APFC) as of
1980.
Petroleum
Fund
All resource
revenues are
deposited
annually.
Branch of
central bank
(NBIM) as of
1998,
previously
general
central bank
management.
Constitutionally
bound to invest
in incomeproducing
investments,
primarily
equities.
Set by
government,
with focus on
maximizing
long-term gains
and responsible
investments.
Principal is
constitutionally
protected, only
income may be
spent,
primarily done
so on dividend.
Set by fiscal
guidelines;
government
may spend 4%
of the funds
value annually
for general
spending.
$51.7
billion,
~$70,000
per
capita.91
$878
billion,
~$173,000
per
capita.92
Contribution Requirements
Resource revenues transferred to an SWF act as the principal for long-term investments,
which can further increase the value of the fund. Two of the funds examined have set
contribution requirements, while the other fund, Alberta’s Heritage Fund, does not. The lack of
set contribution requirements has resulted in a very different outcome for the Heritage Fund
when compared with the other funds. A 2013 Fraser Institute study found that if Alberta had
followed the Alaskan model the principal of the fund would be worth nearly 4.5 times as much
as it is currently valued at, and if it had followed the Norwegian model the principal of the fund
would be approximately 18.5 times larger than it was at the time of the survey.93 As the growth
of the principal is not dependent on a successful investment strategy but rather government
contributions, the underfunding of the Heritage Fund relative to the other funds examined is
primarily a result of the lack of a formal commitment on behalf of the government to contribute
91
Ibid., AFPC Profile.
Ibid., GPFG Profile.
93
Murphy 2013, 35.
92
23
resource revenues to the fund.94 The exact level will depend on the circumstances of the SWF,
but setting a contribution requirement will better enable a savings fund SWF to share resource
wealth by promoting stable principal growth. This paper views contribution requirements as a
positive principle of SWF governance, and thus in terms of the established criteria the Permanent
Fund and the Petroleum Fund satisfy the requirement for a strong SWF governance framework
and the Heritage Fund does not.
Management Agency
Sovereign wealth funds are primarily managed either within the government or by an
independent management agency, and for the purposes of this analysis such an agency will be
interpreted as a positive principle of SWF management. Properly instituted independent
management agencies are beneficial because they limit political interference into the fund’s
management while still remaining accountable to the government.95 The more political influence
is allowed to intrude into the management of the fund, the more likely it is that the investment
strategy will favour short-term investment projects that satisfy government economic policy
rather than long-term financial gains.96 All three of the funds examined are currently managed by
an independent agency of some form, and this is a clear indication that independent management
agencies are key elements of any SWF policy framework.
Another key distinguishing variable between the three funds is at what point they created
their management agency. Both the Alaskan and Norwegian governments created management
agencies within years of the creation of the fund, while the Alberta government took decades to
94
Ibid., 5.
Das 2009, 13.
96
Bernstein 2013, 220.
95
24
do so, instead opting to manage the fund through a Select Standing Committee of the legislature.
This resulted in significant political inference in the management of the fund in the early years
that affected its performance.97 Thus while all three funds currently satisfy the rubric’s criterion
for possessing a management agency, the experience with the Heritage Fund illustrates that a
government creating a SWF should also plan to create a management agency early so as to
minimize the risk of political interference negatively affecting the management of the fund.
Investment Strategy
For SWFs created as savings funds, having an investment strategy that focuses on
maximizing long-term financial gains is critical to the success of the fund. All three governments
have committed to following long-term investment strategies, either by means of legislation or
constitutional amendment. As a result of this long-term focus, all three funds currently have a
majority of their portfolio invested in equities, which exhibit strong long-term financial gains.
However, there are several other major factors that affect the ideal investment strategy, and one
of them is the acceptable level of risk. The level of tolerated risk will impact the investment
strategy of the SWF, and a fund focused on a long-term investment horizon should be willing to
accept assuming a modest amount of risk.98 Assuming risk can be challenging for newly created
SWFs though, for negative returns early on can be detrimental both financially and politically.99
Newly created funds can mitigate this risk by adopting low risk strategies early, and slowly
increase the levels of risk as the funds ‘buffer’ increases.100 Adopting a risk-averse investment
97
Mumey 1990, 32.
Das 2009, 14.
99
Ibid., 15.
100
Ibid., 15.
98
25
strategy early and assuming more risk as the fund matures allows states to mitigate the potential
ramifications of early losses.
Another key benefit of commodity SWFs is that by investing the revenues of commodity
booms outside of the domestic economy the country can help alleviate the negative effects of the
resource curse. Thus along with accepting moderate levels of risk, a savings fund SWF should
also prioritize long-term investments in global markets to help the domestic economy from being
afflicted by the ‘Dutch Disease.’101 All three funds examined in this paper currently follow
investment strategies that satisfy the criteria established, and provide evidence that a good SWF
investment strategy should focus on maximizing long-term gains rather than short-term policy
goals.
Spending Ability
A major goal of many commodity SWFs is to promote sustainable economic growth from
the development of natural resources, and how states decide to spend the wealth generated from
a SWF is critical to ensuring sustainability. The wealth of commodity SWFs can be spent on
anything from endowments to dividends, and the exact spending practices of a SWF depend
heavily on the circumstances of its sovereign manager. However, while the spending ability of an
SWF might be more contextual than the other factors here examined, the survey of the literature
did illuminate several general guidelines of SWF management. First, the experiences of the
Heritage and Permanent Funds highlight the importance of protecting the principal of the fund
from being spent. The Alaskan model constitutionally protects the principal of the fund, whereas
the Albertan model currently has no protection for the fund’s principal. This lack of protection,
101
Bernstein 2013, 223.
26
coupled with the absence of resource revenue contributions and the complete withdrawal of all
income has contributed to the stagnation of the value of the Heritage Fund.102 Along with
protecting the principal, the Norwegian experience indicates that governments should exercise
restraint and commit to only spending a portion of the fund’s wealth annually. While there is
some concern that the Norwegian fiscal guidelines allow slightly too much to be spent
annually,103 it is still an improvement from the volatile spending practices the Norwegian
government followed with respect to its petroleum revenue windfalls prior to the creation of its
SWF.104 Thus while the spending ability of the SWF will depend heavily on the circumstances of
the sovereign manager, creating legislative protections on the government’s ability to spend the
fund’s value, either by protecting the principal or committing to spending a sustainable amount
of the fund’s wealth annually, is a principle of strong SWF management which only the
Permanent Fund and the Petroleum Fund follow.
Total Valuations
The total valuation of a SWF is in itself a function of the other principles of SWF
management, and evaluating a fund’s total worth is analytically similar to evaluating the fund
itself. How much the fund is worth depends on a vector of variables, such as how much the
government contributes to the fund, how the fund is invested and how successful the investments
are, how the government decides to spend the income earned by the fund, and a host of other
factors. The danger of using the total valuation of the fund as a measure of the success of a
policy model is that some of the most important variables affecting commodity SWFs depend not
on the model itself but on the nature of a state’s resource endowment and the performance of the
102
Milke 2008, 20.
Chambers 2012, 69.
104
Bernstein 2013, 222.
103
27
commodity market. However, given that all the funds examined here are funded through the
same commodity, and given that all of them have ample resource endowments—albeit some
states more so than others—this paper will interpret the total value of the SWF as a measure of
its success, with the caveat that the total value is a function of many factors some of which are
outside the analytical scope of this paper.
The three funds evaluated examined in this paper have each followed different policy
frameworks, and these frameworks have contributed to varying levels of success as measured by
net worth. The Heritage Fund, valued at $16.4 billion USD, is the lowest valued of the three
funds. The low total valuation relative to the other funds can be contributed to several factors, the
most important of which are the lack of contribution requirement and the constant raiding of the
fund’s investment income. While the fund has—eventually—adopted sound management and
investment strategies, the twin afflictions of low to zero contributions and revenue raiding are
serious faults of the Alberta model. The Permanent Fund, valued at $51.7 billion USD, is the
middle-ranked SWF evaluated and has achieved this status as a result of a strong policy
framework. It has set contribution requirements, follows sound management and investment
policies that promote long-term growth, and ensures stable spending practices through the
constitutional protection of the principal. Overall the Alaskan model of SWF management is
robust, and even superior to the Norwegian model in key areas, such as the protection of the
principal. However, the Petroleum Fund, valued at $878 billion USD, is the highest valued SWF
in the world and the best preforming SWF examined in this paper. Like the Alaskan model, the
Norwegian model follows prudent management and investment strategies, and is legislatively
committed to only spending a portion of the funds worth annually. The key difference between
the two models is the level of resource contributions made to the funds. While committing at
28
least 25% has resulted in stable growth of the Permanent Fund, the Norwegian model of
committing all resource revenues has resulted in the phenomenal growth of the Petroleum Fund.
The growth of the Petroleum Fund has been such that the fund will continue to be a major
element of the government’s annual budget for decades to come.105 This is the type of economic
sustainability that saving fund SWFs aspire to, and it is why this paper views the Norwegian
model as the strongest model of SWF management examined.
Conclusion
Each of the three SWFs examined in the paper have followed different policy approaches,
and this Findings sections has evaluated each of the funds based on five criteria with the goal of
determining the strongest principles, and ultimately models, of SWF management. While each of
the funds has its strengths, it is the Norwegian model that best satisfies the criteria of this paper,
and thus it is the principles that define this model, as well as the best principles of the other
models, that will be used to inform the development of a SWF in British Columbia.
Recommendations
The Government of British Columbia’s plans to develop the significant LNG reserves in
the province will have large impacts on the British Columbian economy, and the plans to create a
SWF funded through a portion of the revenues from LNG could help promote sustainable
economic growth from the exploitation of a non-renewable natural resource. Many resource rich
states have begun creating SWFs to act as savings funds, and British Columbian policymakers
have the benefit of being able to learn from the successes, and failures, of other SWFs. B.C.
should adopt the best practices of SWF governance when creating the Prosperity Fund, and the
105
Norway Ministry of Finance 2012, 7.
29
preceding comparative analysis of the Albertan, Alaskan, and Norwegian SWFs have illuminated
some of these best practices that B.C. should consider.
Recommendation One
Set contribution requirements in legislation that commit the government to contributing
all LNG revenues annually.
The Government of B.C. has ambitious plans for the Prosperity Fund, and these plans are
possible only if the government establishes firm contribution requirements. The government
plans to use the fund to pay down the provincial debt, reduce the tax burden on B.C. families,
and provide funding for government programs.106 As well, the government has claimed that over
the next 30 years the Prosperity Fund will grow to $100 billion CDN.107 Only one fund examined
in this paper, the Norwegian Petroleum Fund, is valued over $100 billion CDN, primarily
because the government has committed to depositing all resource revenues into the fund. A
modified Alaskan model that contributes 50% or above of resource revenues could also be a
solution, but given the more volatile nature of the LNG market relative to the petroleum market,
the safest method to ensure the government’s policy target is achieved is to commit all LNG
revenues to the Prosperity Fund.
Recommendation Two
Delegate the authority to manage the Prosperity Fund to an independent and accountable
management agency, such as a Crown corporation.
The Government of B.C. must take actions that will serve to insulate the management of
the Prosperity Fund from political interference. All three funds examined have delegated the
management of their respective SFWs to management agencies. The major difference between
106
107
Province of BC 2013, New British Columbia Prosperity Fund Will Ensure Lasting Benefits.
Ibid., New British Columbia Prosperity Fund Will Ensure Lasting Benefits.
30
the three funds is that the Heritage and Permanent Funds are managed by state-owned
corporations, whereas the Petroleum Fund is managed by the Norwegian central bank. Having
the fund managed by the central bank may actually be advantageous relative to a state-owned
enterprise, as they can utilize existing resources and in doing so minimize the fixed costs
associated with creating a new entity.108 However, the Government of B.C., as a subnational
government, cannot externalize the costs of its management onto a national central bank and
must instead follow the Albertan and Alaskan model of creating a state-owned entity. B.C. can
limit its expenses, however, by delegating the management of the Prosperity Fund to an already
existing Crown corporation. The British Columbian Investment Management Corporation
(bcIMC) is a Crown corporation that manages a variety of public sector funds valued over $100
billion CDN.109 Independent management agencies are beneficial elements of SWF governance,
and tasking bcIMC to manage the Prosperity Fund would serve to both minimize potential
political interference and minimize the capital costs of creating a new Crown corporation.
Recommendation Three
Ensure the investment guidelines for the Prosperity Fund prioritize long-term financial
gain.
Saving fund SWFs can promote long-term economic growth from short-term resource
exploitation by investing resource revenues for future generations. However, a key element to
ensuring that the fund can fulfill its inter-generational wealth-sharing purpose requires an
investment strategy that focuses on maximizing long-term gains over short-run policy goals. The
Albertan, Alaskan, and Norwegian funds all have investment strategies that focus, to varying
degrees, on maximizing long-term financial gain. While this does mean assuming more risk,
108
109
Das 2009, 13.
British Columbia Investment Management Corporation 2013.
31
focusing on long-term gains will increase the potential for investment income to further raise the
value of the fund in line with the government’s goals. Thus including requirements for the fund
to pursue income-earning activities, similar to the other funds, is a policy approach that should
be included in the creation of the Prosperity Fund.
Recommendation Four
Adopt a risk-averse investment stance during the first years of the Prosperity Fund to
allow the fund to accumulate wealth, and slowly include more risk into the investment
strategy so as to meet the requirements for maximizing long-term gains.
Assuming risk is a necessary part of an investment strategy that focuses on long-term
gains; however, a newly created fund does not need to adopt such an investment strategy from
the very beginning. Adopting a risk-averse strategy in the formative years will allow the fund
time to accumulate wealth and ease the public in to the newly created SWF. Hosting the fund
within an existing Crown corporation, such as bcIMC, will also help limit the fixed costs of
establishing the new fund. As the fund matures, the government can decide when to begin
assuming more risk in order to maximize long-term financial gains.
Recommendation Five
Establish a set of fiscal guidelines that limit the amount of annual spending that can be
made from the Prosperity Fund.
The Prosperity Fund envisaged by the government serves two primary purposes: enable
future saving and current spending. Saving for the future requires investing revenues, and current
spending requires allocating revenue from the fund to the government’s annual budget. To
ensure that both goals are met, the government must commit to only spending a sustainable
portion of the fund annually while leaving the remainder to be invested. The Heritage Fund
highlights the dangers of a government failing to restrict its ability to spend the fund’s wealth, as
32
constant revenue raiding has contributed to the multi-year stagnation of the value of the fund.
Either the Alaskan model of protecting the principal or the Norwegian model of restricting
spending to 4% of the funds worth annually could be followed in B.C. to allow for sustainable
spending of the fund’s wealth. Enabling governments to spend portions of the fund annually is
important, but the government must ensure that any annual spending done is sustainable and
contributes to the long-term goals of the fund.
Conclusion
Developing British Columbia’s vast LNG reserves has tremendous potential for the B.C.
economy, and the government’s decision to invest LNG revenues into the Prosperity Fund can
help alleviate the negative effects of resource windfalls while at the same time save for future
generations. Many states in the world have created SWFs for similar purposes, and the
experience of other states can inform the development of such a fund in British Columbia. The
five recommendations presented here have come from a comparative analysis of three
contextually relevant SWFs, and are intended to help inform the development of the B.C.
Prosperity Fund. While these recommendations are not authoritative, they provide insight into
the best practices of SWF management that could be used in B.C. to promote long-term
economic prosperity.
33
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