Victoria Barbary
Paolo Baffi Center, Bocconi University
Bocconi University, November 17, 2011
PBC-CAREFIN Seminar “Curbing Volatility: Financial
Markets, Credit Rating Agencies, and Sovereign
Investment Funds”
Bernardo Bortolotti
Università di Torino and Paolo Baffi
Center, Bocconi University

Benevolent dictator’s SWF Neo-mercantilist SWF
SWF as a tool to address market failures in long term investment and domestic economic development
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Curbing Volatility Seminar
Bocconi – November 17, 2011
January 19-25, 2008
SWF as a politically oriented arm to assert the geopolitical ambitions of emerging countries

 KIA,
Kuwait
1953 1960
 Revenue
Equalization Fund,
Kiribati
 ADIA,
Abu Dhabi
1970
 BIA,
Brunei
 State General
Reserve Fund,
Oman
1980
 Government
Pension Fund -
Global, Norway
1990
 LIA, Libya
 Future Fund, Australia
 Investment Corp., Dubai
 State Oil Fund,
 IPRF, Ireland
 New Zealand
 Istithmar
World,
Azerbaijan
 Bahrain Holding,
Dubai
Bahrain
 OIF, Oman
 DIFC, Dubai
 National
Superannuation
Wealth
Fund, NZ  National Oil Fund,
Account, Russia
Sao Tomé
2000 2008
Source: Sovereign Investment Lab
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Curbing Volatility Seminar
Bocconi – November 17, 2011
 Temasek Holdings,
Singapore
 IPIC,
Abu Dhabi
 GIC,
Singapore
 KNB,
Malaysia
 National Social
Security Fund,
China
 KNF, Kazakhstan
 Mubadala
Development
Company, Abu Dhabi


CIC, China
Emirates
Investment
 QIA, Qatar
 KIC, Korea
 Timor-Leste
Petroleum Fund
 RIA, Ras Al
Khamah
 State Capial
Invest. Corp.,
Vietnam
Authority, UAE
 ADIC, Abu
Dhabi

Country Source of Funds Fund Name
Assets Under
Management
Founding
Date
Norway
United Arab Emirates
China
Kuwait
Singapore
Singapore
China
Russia
Qatar
Libya
Australia
United Arab Emirates
Kazakhstan
Republic of Korea
Brunei
Total Oil & Gas
Total Other
Grand Total
Commodity (Oil)
Commodity (Oil)
Trade Surplus
Commodity (Oil)
Trade Surplus
Govt Linked Companies
Trade Surplus
Commodity (Oil)
Commodity (Oil&Gas)
Commodity (Oil)
Commodity (Various)
Commodity (Oil)
Commodity (Oil&Gas)
Trade Surplus
Commodity (Oil)
Government Pension Fund-Global
Abu Dhabi Investment Authority
China Investment Corporation
Kuwait Investment Authority
Government of Singapore Investment Corporation
Temasek Holdings
National Social Security Fund
National Wealth Fund
Qatar Investment Authority
Libyan Investment Authority
Future Fund
International Petroleum Investment Company
Kazakhstan National Fund
Korea Investment Corporation
Brunei Investment Agency
$560,5bn
$342bn
$332,4bn
$296bn
$220bn
$133bn
$132bn
$94,3bn
$80bn
$53,3bn
$77,2bn
$49,7bn
$41,9bn
$37,6bn
$39,3bn
$1.599,1bn
$1.079,6bn
$2.678,8bn
Source: DB Research; Peterson Institute for International Economics; SWF Institute; Nadim Kawach, “UAE’s overseas investment income to rebound in 2009,”
Emirates Business 24-7, April 2009; Hadfi eld, “Kuwait Investment Authority loses $31bn in nine months,” Meed Middle East Business Intelligence, February 11,
2009; Mubadala Annual Report 2008; Brad Setser and Rachel Ziemba, GCC Sovereign Funds: Reversal of Fortune, WP, January 2009 (Council on Foreign Relations,
New York: 2009).
2006
2006
1984
2000
2005
1983
1990
1976
2007
1953
1981
1974
2000
2008
2005
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Curbing Volatility Seminar
Bocconi – November 17, 2011

MENA to Russia & Central
Asia
16deals, $1.7bn
MENA to Europe
124 deals, $73.0bn
MENA to North America
60 deals, $40.2bn
MENA to Asia Pacific
50 deals, $7.5bn
Within MENA
145 deals, $45.2bn
MENA to Latin America
5 deals, $0.5bn
MENA to Sub-Saharan Africa
27 deals, $4.4bn
Source: Sovereign Investment Lab Transaction Database
 Since 2000, MENA SWFs have invested $172,6bn primarily in Europe (42%), within MENA (26%), and in North America (23%).
 Contrary to Asia, MENA balance domestic investment with international diversification.
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Curbing Volatility Seminar
Bocconi – November 17, 2011

SWFs foreign investment by sector, 2000-2010
Automotive
10%
Other
16%
Real Estate
13%
21%
Telecoms, 1%
Aircraft, 1%
Natural Resources, 11%
Transport, 1%
Utilities, 7%
Strategic Sectors
Banking, Insurance,
Trading
40%
Source: Sovereign Investment Lab Transaction Database
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Curbing Volatility Seminar
Bocconi – November 17, 2011

Percentage of SWF Assets under Management by Political Regime, 2010
Hybrid Regime
17%
Full
Democracy
27%
Authoritarian
Regime
54%
SWF Investment Flows, 2000-2010
US$ Mn
$80.000
$70.000
$60.000
$50.000
$40.000
$30.000
$20.000
$10.000
$-
Authoritarian
Flawed Democracy
Full Democracy
Hybrid
Flawed
Democracy
2%
Source: Sovereign Investment Lab; 2010 EIU Democracy Index
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Curbing Volatility Seminar
Bocconi – November 17, 2011
Source: Sovereign Investment Lab Transaction Database

$10.000
$9.000
$8.000
$7.000
$6.000
$5.000
$4.000
$3.000
$2.000
$1.000
$0
Total Global Reserves
Full Democracies
Flawed Democracies
Hybrid Regimes
Authoritarian States
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Curbing Volatility Seminar
Bocconi – November 17, 2011
Source: International Monetary Fund, International Finance Statistics Database; EIU Democracy Index 2010

Does it matter?
Yes. Political risk could affect the risk and return properties of SWF targets via:
 Upheaval risk, transforming the country’s wealth management from savings towards divestiture and public spending to assuage protestors
 Geopolitical risk, events could trigger the use of targeted financial sanctions freezing SWF assets (e.g.
Libya)
SWF metamorphosis: from patient, long-term investor providing capital over the business cycles to a short-term player with unpredictable liquidity needs.
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Curbing Volatility Seminar
Bocconi – November 17, 2011

0,00%
-1,00%
-2,00%
-3,00%
-4,00%
-5,00%
-6,00%
-7,00%
-8,00%
-9,00%
-10,00%
-11,00%
-12,00%
Abnormal Return
Return-on-Equity
-1,67%
-2,15%
-1,51%
-3,96%
-6,25%
-8,35%
Investment 6 months 1 year 2 years
Source: Bortolotti et al. (2010), “Quiet Leviathans: Sovereign Wealth Funds Investments, Passivity, and the Value of the Firm”, mimeo.
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Curbing Volatility Seminar
Bocconi – November 17, 2011
-10,47%
-11,83%
3 years

COUNTRY
% OF
POPULATION
UNDER 25
% share
GOV'T YEARS IN
POWER yrs share
CORRUPTION
INDEX indexval share
DEMOCRACY
INDEX indexval share
CENSORSHIP
INDEX indexval share
GDP PER CAPITA PPP value share
ILLITERACY
%
RATES share
INTERNET
PENETRATION
RATE
% share
TOT.
Oman
Qatar
Kuwait
UAE
Norway 31,90
Singapore 29,80
Malaysia
China
47,80
36,80
Korea
Bahrain
Libya
29,80
35,00
49,00
49,00
28,00
37,00
34,00
0,81
0,76
1,23
0,94
0,76
0,89
1,25
1,25
0,71
0,94
0,87
41,00
16,00
5,00
7,00
6,00 n/a -
0,18
7,00 n/a -
0,21 n/a -
12,00 0,36
42,00 1,25
1,20
0,48
0,15
0,21
-
6,80
38,30
53,40
26,70
32,80
100,00
28,00
13,00
37,00
19,00
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Curbing Volatility Seminar
Bocconi – November 17, 2011
-
51,90
44,90
86,00
12,70
77,20
100,00
90,50
86,00
72,10
93,60
-
0,09
0,48
0,66
0,34
0,41
1,25
0,35
0,16
0,46
0,24
-
79,50
73,40
94,20
34,90
79,60
100,00
79,60
76,00
60,00
79,60
-
0,65
0,56
1,08
0,16
0,96
1,25
1,13
1,00
0,90
1,17
52.013
56.522
14.670
7.519
29.836
26.852
13.805
25.439
88.559
37.849
56.580
-
1,00
0,91
1,17
0,44
1,00
1,25
1,00
0,95
0,75
1,00
-
5,60
8,10
6,70
-
11,20
13,20
15,60
6,90
5,50
10,00
0,18
0,17
0,64
1,25
0,31
0,35
0,68
0,37
0,11
0,25
0,17
94,80
77,80
64,60
34,40
81,10
88,80
5,50
41,70
60,90
39,40
75,90
-
0,45
0,65
0,54
-
0,90
1,06
1,25
0,56
0,48
0,80
2,33
4,24
5,32
6,30
3,08
6,04
8,06
7,10
4,76
4,45
5,46
1,25
1,03
0,85
0,45
1,07
1,17
0,07
0,55
0,79
0,52
1,00

3.
The stock return of SWF targets: assessing political instability
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Curbing Volatility Seminar
Bocconi – November 17, 2011
Variable: Buy and Hold
Adjusted Returns |
Political Unrest Index |
|
Govt Involvement |
|
SWF passivity |
|
Strategic Target Dummy |
|
SWF Age |
|
Capital Infusion |
|
SWF Stake |
|
Foreign Target Dummy |
|
Target Market Value|
|
Target Leverage |
|
Target Liquidity |
|
SWF in the Board|
|
Buy and Hold Returns |
(previous year)|
Constant |
|
Number of Obs |
R2 |
1 Year from
Investment
-.31309864
0.0284
.05410613
0.9327
-.19614493
0.2138
.020129
0.7333
-.01018229
0.6413
-.62466721
0.7566
.21320963
0.8604
-.62759119
0.0000
-3.622e-06
0.3285
.10698612
0.4606
.01115337
0.2823
.13625312
0.2150
-.05082958
0.0090
19.691.506
0.0237
293
.04359465
2 Years from
Investment
-.32604307
0.0747
-1.4061047
0.3018
-.50469912
0.1473
.04296757
0.7322
-.07029254
0.1436
1.9326637
0.4157
-.8246279
0.1488
-1.1820403
0.0000
-.00001155
0.0173
-.23162654
0.2909
-.00152727
0.9656
.04482498
0.7342
-.05358762
0.0104
4.4301511
0.0119
144
.22252844

 Under laissez faire, increased political risk will restrict capital flows and investment opportunities in recipient countries.
Contraction of international SWF investment will cause excessive
FOREX accumulation, inflationary and exchange rate pressures in emerging countries, impinging economic development.
 Political stability in emerging countries is a global public good.
Decentralized, market-based systems will not provide efficient solutions. Market sanctioning by SWF targets will not trigger a socially efficient democratic transition abroad.
Market failure considerations provide a rationale for SWF regulation
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Curbing Volatility Seminar
Bocconi – November 17, 2011

The current regulatory framework on foreign investment
 Not targeted to SWF, varies by countries, generally protects national security and strategic sectors
 US: mandatory clearance by CFIUS in case of acquisition by sovereign investor
 EU: free movement of capital enshrined in Treaty, but legal barriers are widespread in most member countries
The Santiago principles
 24 (voluntary) Generally Accepted Principles and Practices (GAPP) on governance, accountability and transparency
 Sponsored by IMF, OECD, and World Bank, undersigned signed by
23 SWF
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Curbing Volatility Seminar
Bocconi – November 17, 2011

 The current regulatory framework at the national and multilateral level generally fails to address political risk
 Targeted sanctions: the UN can adopt resolutions involving restrictive measures (such as asset freeze) to target the political elite in case of violation of international laws
 Financial targeted sanctions are extreme solutions and operate ex post, not effective in preventing and mitigating ex ante political risks
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Curbing Volatility Seminar
Bocconi – November 17, 2011

Complementary non-legal measures
 GAAP 25: "While members consider being in the mutual interests of recipient countries and sovereign investors to maintain free movement of capital, they also realize that social inequality and political instability in the investing country represent critical risk factors in the international allocation of capital. Upon these considerations, members agree that sovereign investment abroad will be associated with commitments to foster economic prosperity, social progress and political reforms in the investing country".
 Amendment of the code of conduct of stock exchanges inviting listed companies to disclose SWF presence as a risk factor
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Curbing Volatility Seminar
Bocconi – November 17, 2011

Complementary legal measures
 A CFIUS-style preventive mechanism, requiring a mandatory clearance of SWF acquisitions of the basis of a case by case review of countries' political outlook.
 Establishment of the Sovereign Investment Office within a recognized international organization. On the basis of independent assessments, the Office could publish a list of
“politically risk neutral” SWFs with a blanket authorization to operate globally, or establish a conditionality on investments based on case-by-case undertakings in the space of human rights, political freedom, constitutional reform and democratic transition.
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Curbing Volatility Seminar
Bocconi – November 17, 2011

 Recent revolts in the Arab region are causing a metamorphosis of
SWF from long-term, patient investors to short-term operator carrying political risk, affecting negatively the performance of target firms.
 SWFs assets subject to political risk are worth $2 trillion and thus systemic.
 Market failure considerations suggest that a SWF-specific regulatory framework may be desirable.
 Self-enforcing solutions could be agreed upon at the multilateral level, given the countries’ mutual interest in open capital markets, peace and security.
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Curbing Volatility Seminar
Bocconi – November 17, 2011