Bocconi-17-11FINAL - BAFFI Center on International Markets

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Taming Leviathan:
a Regulatory
Framework for
Sovereign Wealth
Funds
Victoria Barbary
Paolo Baffi Center, Bocconi University
Bernardo Bortolotti
Università di Torino and Paolo Baffi
Center, Bocconi University
Bocconi University, November 17, 2011
PBC-CAREFIN Seminar “Curbing Volatility: Financial
Markets, Credit Rating Agencies, and Sovereign
Investment Funds”
1.
Background: the trade-off of sovereign ownership
Benevolent dictator’s SWF
Neo-mercantilist SWF
January 19-25, 2008
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
SWF as a politically oriented
arm to assert the geopolitical
ambitions of emerging
countries
2.
Facts: SWF history
ADIA,
Abu Dhabi
State General
Reserve Fund,
Oman
KIA,
Kuwait
1953
BIA,
Brunei
1960
Revenue
Equalization Fund,
Kiribati
1970
Temasek Holdings,
Singapore
1990
1980
IPIC,
Abu Dhabi
GIC,
Singapore
Source: Sovereign Investment Lab
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Curbing Volatility Seminar
Bocconi – November 17, 2011
Government
Pension Fund Global, Norway
LIA, Libya
Future Fund, Australia
Investment Corp., Dubai
State Oil Fund,
Azerbaijan
Istithmar
Bahrain Holding,
World,
Bahrain
Dubai
OIF, Oman
DIFC, Dubai
IPRF, Ireland
New Zealand
National
Superannuation
Wealth
Fund, NZ
National Oil
Fund,
Account,
Russia
Sao Tomé
2000
KNB,
Malaysia
National Social
Security Fund,
China
KNF, Kazakhstan
2008
Mubadala
Development
Company, Abu Dhabi
CIC, China
Emirates
Investment
Authority, UAE
ADIC, Abu
Dhabi
QIA, Qatar
KIC, Korea
Timor-Leste
Petroleum Fund
RIA, Ras Al
Khamah
State Capial
Invest. Corp.,
Vietnam
2.
Facts: the largest SWFs by AUM, 2010
Country
Source of Funds
Fund Name
Assets Under
Management
Founding
Date
Norway
Commodity (Oil)
Government Pension Fund-Global
$560,5bn
1990
United Arab Emirates
Commodity (Oil)
Abu Dhabi Investment Authority
$342bn
1976
China
Trade Surplus
China Investment Corporation
$332,4bn
2007
Kuwait
Commodity (Oil)
Kuwait Investment Authority
$296bn
1953
Singapore
Trade Surplus
Government of Singapore Investment Corporation
$220bn
1981
Singapore
Govt Linked Companies
Temasek Holdings
$133bn
1974
China
Trade Surplus
National Social Security Fund
$132bn
2000
Russia
Commodity (Oil)
National Wealth Fund
$94,3bn
2008
Qatar
Commodity (Oil&Gas)
Qatar Investment Authority
$80bn
2005
Libya
Commodity (Oil)
Libyan Investment Authority
$53,3bn
2006
Australia
Commodity (Various)
Future Fund
$77,2bn
2006
United Arab Emirates
Commodity (Oil)
International Petroleum Investment Company
$49,7bn
1984
Kazakhstan
Commodity (Oil&Gas)
Kazakhstan National Fund
$41,9bn
2000
Republic of Korea
Trade Surplus
Korea Investment Corporation
$37,6bn
2005
Brunei
Commodity (Oil)
Brunei Investment Agency
$39,3bn
1983
Total Oil & Gas
$1.599,1bn
Total Other
$1.079,6bn
Grand Total
$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).
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Curbing Volatility Seminar
Bocconi – November 17, 2011
2.
Facts: SWF Investment from MENA, 2000-2010
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 $172,6bn primarily in Europe (42%), within MENA (26%), and in North America (23%).
 Contrary to Asia, MENA balance domestic investment with international diversification.
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Curbing Volatility Seminar
Bocconi – November 17, 2011
2.
Facts: Barbarians at the Gate?
SWFs foreign investment by sector, 2000-2010
Automotive
10%
Other
16%
Real Estate
13%
Telecoms, 1%
Aircraft, 1%
Natural Resources, 11%
Strategic Sectors
21%
Transport, 1%
Utilities, 7%
Banking, Insurance,
Trading
40%
Source: Sovereign Investment Lab Transaction Database
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Curbing Volatility Seminar
Bocconi – November 17, 2011
2.
Facts: SWF activity by type of political regime
Percentage of SWF Assets under Management by Political Regime, 2010
SWF Investment Flows, 2000-2010
US$ Mn
Hybrid Regime
17%
$80.000
Authoritarian
Flawed Democracy
Full Democracy
Hybrid
$70.000
$60.000
$50.000
Full
Democracy
27%
$40.000
Authoritarian
Regime
54%
$30.000
$20.000
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
2010
2009
2008
2007
2006
2005
2004
2003
2002
$-
2001
Flawed
Democracy
2%
2000
$10.000
2.
Facts: Foreign exchange reserves and political regimes
$10.000
Total Global Reserves
Full Democracies
Flawed Democracies
Hybrid Regimes
Authoritarian States
$9.000
$8.000
$7.000
US$ Mn
$6.000
$5.000
$4.000
$3.000
$2.000
Source: International Monetary Fund, International Finance Statistics Database; EIU Democracy Index 2010
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Curbing Volatility Seminar
Bocconi – November 17, 2011
2010M5
2010M1
2009M9
2009M5
2009M1
2008M9
2008M5
2008M1
2007M9
2007M1
2007M5
2006M9
2006M5
2006M1
2005M9
2005M5
2005M1
2004M9
2004M5
2004M1
2003M9
2003M5
2003M1
2002M9
2002M5
2002M1
2001M9
2001M5
2001M1
2000M9
2000M5
2000M1
1999M9
1999M1
$0
1999M5
$1.000
3.
SWF investment and political risk
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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Bocconi – November 17, 2011
3.
The financial performance of SWF targets
0,00%
0,00%
-1,00%
-1,67%
-2,15%
-2,00%
-1,51%
Adjusted Performance
-3,00%
-3,96%
-4,00%
-5,00%
-6,00%
-6,25%
-7,00%
-8,00%
-8,35%
-9,00%
Abnormal Return
-10,00%
Return-on-Equity
-10,47%
-11,00%
-11,83%
-12,00%
Investment
6 months
1 year
2 years
3 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
3.
The EUI Index of political unrest for SWF countries
% OF
POPULATION
UNDER 25
COUNTRY
%
share
GOV'T YEARS IN
POWER
yrs
DEMOCRACY
INDEX
indexval
CENSORSHIP
INDEX
share
indexval
share
GDP PER CAPITA PPP
value
ILLITERACY
RATES
share
%
share
INTERNET
PENETRATION
RATE
%
TOT.
share
indexval
share
share
-
6,80
0,09
-
-
-
-
52.013
0,18
-
-
94,80
1,25
2,33
0,18
-
-
51,90
0,65
79,50
1,00
56.522
0,17
5,60
0,45
77,80
1,03
4,24
-
38,30
0,48
44,90
0,56
73,40
0,91
14.670
0,64
8,10
0,65
64,60
0,85
5,32
0,21
53,40
0,66
86,00
1,08
94,20
1,17
7.519
1,25
6,70
0,54
34,40
0,45
6,30
-
26,70
0,34
12,70
0,16
34,90
0,44
29.836
0,31
-
-
81,10
1,07
3,08
Norway
31,90
0,81
Singapore
29,80
0,76
Malaysia
47,80
1,23
China
36,80
0,94
Korea
29,80
0,76
Bahrain
35,00
0,89
12,00
0,36
32,80
0,41
77,20
0,96
79,60
1,00
26.852
0,35
11,20
0,90
88,80
1,17
6,04
Libya
49,00
1,25
42,00
1,25
100,00
1,25
100,00
1,25
100,00
1,25
13.805
0,68
13,20
1,06
5,50
0,07
8,06
Oman
49,00
1,25
41,00
1,20
28,00
0,35
90,50
1,13
79,60
1,00
25.439
0,37
15,60
1,25
41,70
0,55
7,10
Qatar
28,00
0,71
16,00
0,48
13,00
0,16
86,00
1,00
76,00
0,95
88.559
0,11
6,90
0,56
60,90
0,79
4,76
Kuwait
37,00
0,94
5,00
0,15
37,00
0,46
72,10
0,90
60,00
0,75
37.849
0,25
5,50
0,48
39,40
0,52
4,45
UAE
34,00
0,87
7,00
0,21
19,00
0,24
93,60
1,17
79,60
1,00
56.580
0,17
10,00
0,80
75,90
1,00
5,46
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Curbing Volatility Seminar
Bocconi – November 17, 2011
n/a
CORRUPTION
INDEX
6,00
n/a
7,00
n/a
3.
11
The stock return of SWF targets: assessing political instability
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
4.
Pecunia non olet? Market failure considerations
 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
5.
Towards a smart regulation of SWF
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
5.
Towards a smart regulation of SWF
 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
5.
Towards a smart regulation of SWF
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
5.
Towards a smart regulation of SWF
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
5.
Conclusions
 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
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