Sapienza Università di Roma
International Banking
Lecture Six
The Sovereign Wealth Funds (SWFs)
Prof. G. Vento
Agenda
• Introduction to
Sovereign Wealth
Funds (SWFs)
• Key aspects of SWFs
March 2013
International Banking - Prof. G. Vento
2
Introduction to the sovereign funds
• A sovereign wealth fund (SWF) is a state-owned investment
fund composed of financial assets such as stocks, bonds,
property, precious metals or other financial instruments.
• Sovereign wealth funds invest globally. Some of them have
grabbed attention making bad investments in several Wall
Street financial firms including Citigroup, Morgan Stanley, and
Merrill Lynch.
• These firms needed a cash infusion due to losses resulting
from mismanagement and the subprime mortgage crisis.
March 2013
International Banking - Prof. G. Vento
3
Introduction to the sovereign funds
• Some sovereign wealth funds are held solely by a
central bank, which accumulates the funds in the
course of its management of a nation's banking
system; this type of fund is usually of major
economic and fiscal importance.
• Other sovereign wealth funds are simply the state
savings which are invested by various entities for the
purposes of investment return, and which may not
have significant role in fiscal management.
March 2013
International Banking - Prof. G. Vento
4
Introduction to the sovereign funds
• The accumulated funds may have their origin in, or may
represent foreign currency deposits, gold, SDRs and
International Monetary Fund reserve positions held by central
banks and monetary authorities, along with other national
assets such as pension investments, oil funds, or other
industrial and financial holdings.
• These are assets of the sovereign nations which are typically
held in domestic and different reserve currencies such as the
dollar, euro and yen.
• Such investment management entities may be set up as
official investment companies, state pension funds, or
sovereign oil funds, among others.
March 2013
International Banking - Prof. G. Vento
5
Introduction to the sovereign funds
• There have been attempts to distinguish funds held by sovereign entities
from foreign exchange reserves held by central banks.
• Sovereign wealth funds can be characterized as maximizing long term
return, with foreign exchange reserves serving short term currency
stabilization and liquidity management.
• Many central banks in recent years possess reserves massively in excess of
needs for liquidity or foreign exchange management. Moreover it is widely
believed most have diversified hugely into assets other than short term,
highly liquid monetary ones, though almost no data is available to back up
this assertion.
• Some central banks have even begun buying equities, or derivatives of
differing ilk (even if fairly safe ones, like Overnight Interest rate swaps).
March 2013
International Banking - Prof. G. Vento
6
Early SWFs
•
Sovereign wealth funds have been around
for decades but since 2000, the number of
sovereign wealth funds have increased
dramatically. The first SWF was the Kuwait
Investment Authority, a commodity SWF
created in 1953 from oil revenues before
Kuwait even gained independence from
the United Kingdom. According to many
estimates, Kuwait's fund is now worth
approximately $250 billion.
•
Another of the first registered SWFs is the
Revenue Equalization Reserve Fund of
Kiribati. Created in 1956 when the British
administration of the Gilbert Islands in
Micronesia put a levy on the export of
phosphates used in fertilizer, the fund has
since then grown to $520m
March 2013
International Banking - Prof. G. Vento
7
Nature of SWFs
• SWFs are typically created when governments have budgetary surpluses
and have little or no international debt. This excess liquidity is not always
possible or desirable to hold as money or to channel it into consumption
immediately.
• This is especially the case when a nation depends on raw material exports
like oil, copper or diamonds.
• SWFs may be created to reduce the volatility of government revenues, to
counter the boom-bust cycles' adverse effect on government spending
and the national economy, or to build up savings for future generations.
• One such fund is the Government Pension Fund of Norway.
March 2013
International Banking - Prof. G. Vento
8
Purpose of SWFs
• Other reasons for creating SWFs may be economical, or
strategic, such as war chests for uncertain times. For example,
the Kuwait Investment Authority during the Gulf war
managed excess reserves above the level needed for currency
reserves (although many central banks do that now).
• The Government of Singapore Investment Corporation and
Temasek Holdings are partially the expression of a desire to
bolster Singapore's standing as an international financial
centre.
• The Korea Investment Corporation has since been similarly
managed.
March 2013
International Banking - Prof. G. Vento
9
The main SWFs
March 2013
International Banking - Prof. G. Vento
10
Concerns about SWFs
• There are several reasons why the growth of sovereign wealth
funds is attracting close attention.
• As this asset pool continues to expand in size and importance, so
does its potential impact on various asset markets.
• Some countries worry that foreign investment by SWFs raises
national security concerns because the purpose of the investment
might be to secure control of strategically-important industries for
political rather than financial gain.
• These concerns have led the EU to reconsider whether to allow its
members to use 'golden shares' to block certain foreign
acquisitions. Therefore, this strategy has largely been excluded as a
viable option by the EU, for fear it would give rise to a resurgence in
international protectionism.
March 2013
International Banking - Prof. G. Vento
11
Concerns about SWFs
• Their inadequate transparency is a concern for investors and
regulators. For example, size and source of funds, investment goals,
internal checks and balances, disclosure of relationships and
holdings in private equity funds.
• Many of these concerns have been addressed by the IMF and its
Santiago Principles, which set out common standards regarding
transparency, independence and governance.
• SWFs are not nearly as homogeneous as central banks or public
pension funds.
• However they do have a number of interesting and unique
characteristics in common. These make them a distinct and
potentially valuable tool for achieving certain public policy and
macroeconomic goals.
March 2013
International Banking - Prof. G. Vento
12
Latest Developments
• On 5 March 2008, a joint sub-committee of the U.S. House Financial
Services Committee held a hearing to discuss the role of ‘Foreign
Government Investment in the U.S. Economy and Financial Sector’. The
hearing was attended by representatives of the U.S. Department of
Treasury, the U.S. Securities and Exchange Commission, the Federal
Reserve Board, Norway’s Ministry of Finance, Temasek Holdings and the
Canada Pension Plan Investment Board.
• On August 20, 2008, Germany approved a law that requires parliamentary
approval for foreign investments that endanger national interests.
Specifically, it will affect acquisitions of more than 25% of a German
company's voting shares by non-European investors; but the economics
minister, Michael Glos, has pledged that investment reviews would be
"extremely rare". The legislation is loosely modelled on a similar one by
the U.S. Committee on Foreign Investments.
March 2013
International Banking - Prof. G. Vento
13
Latest Developments
• On September 2-3, 2008, at a summit in Chile, the International Working
Group of Sovereign Wealth Funds - consisting of the world's main SWFs agreed to a voluntary code of conduct first drafted by IMF. They are also
considering a standing committee to represent them in international
policy debates. The 24 principles in the draft will be made public after
being presented to the IMF governing council on October 11, 2008.
• Brazilian Government announces creation of its own sovereign fund. A
document signed on December 24, 2008, by Brazil's president Luis Inacio
Lula da Silva officially introduces the fund (Fundo Soberano Nacional) that
should have an initial goal of reaching $20 billion dollars.
• The OECD is currently drafting a parallel code of conduct for recipient
countries of SWF investments.
March 2013
International Banking - Prof. G. Vento
14
Size of SWFs
• Assets under management of SWFs fell 3% in 2009 to $3.8 trillion. The
underlying value of SWFs’ portfolios probably increased by 15% in 2009 if
negative positions on equity market investments at the end of the
previous year are taken into account.
• There was an additional $6.5 trillion held in other sovereign investment
vehicles, such as pension reserve funds, development funds and stateowned corporations’ funds and $6.1 trillion in other official foreign
exchange reserves.
• Countries with SWFs funded by commodities’ exports, primarily oil and
gas exports, totalled $2.5 trillion at the end of 2009. Non-commodity SWFs
totalled $1.3 trillion and are projected to increase their 34% share of
assets in 2009 to 38% by 2012.
• Non-commodity SWFs are typically funded by transfer of assets from
official foreign exchange reserves, and in some cases from government
budget surpluses and privatisation revenue. Asian countries account for
the bulk of such funds.
March 2013
International Banking - Prof. G. Vento
15
Size of SWFs
• An important point to note is the SWF to Foreign Reserve Exchange Ratio
which shows the proportion a government has invested in investments
relative to currency reserves. According to the SWF Institute, most oil
producing nations in the gulf have a higher SWF to Foreign Exchange Ratio.
March 2013
International Banking - Prof. G. Vento
16
The strategies of SWFs
 Traditionally, national reserves were used to
protect central banks and currencies from
crises.
 Thus, the reserves used to be invested in high
liquid assets.
 Recently, some countries having commercial
surplus (i.e. China) and oil producers (i.e. Gulf
countries) increased dramatically their
reserves and are looking for longer-term
investments.
 This can generate higher returns, but higher
risks
 Higher portfolio diversification.
 Acquisition of technological know how.
March 2013
International Banking - Prof. G. Vento
17
The origins of SWFs
• The overall capitalization of SWFs reached $ 3,900
billion in 2009.
• The first operation took place in 1956 and was
arranged by the British administration of the Gilbert
Islands, which imposes a tax on export of chemical
products, which still exist.
• An evolution occurred in 1974, when Singapore
government created the Temasek Holding, having the
goal to manage the state investments. The Temasek
– and later the Government of Singapore Investment
Corporation – grow exponentially.
March 2013
International Banking - Prof. G. Vento
18
Operations blocked due to national interests
• The first operation blocked due to national interest reasons
took place in 1987. After the crash of US stock market in
October, the privatization of the last 31% wasn’t successful.
• Thus, the SWF of Kuwait bought confidentially more than
20% of BP shares.
• The British government considered unacceptable that a
foreign country could control such a strategic company.
• Thus, British Government bought back over 2 billion of the
stocks owned by the fund.
• Chinese SWFs are now considered a threat for some
strategic companies.
March 2013
International Banking - Prof. G. Vento
19
19
Peculiar Features of SWFs
• SWFs, if compared to other financial players, manage
less amount resources:
1. Banks’ capital is 19 times more;
2. Stock market capitalization is 16 times more;
• However, the SWFs’ capital is very concentrated,
among almost 20 funds!
March 2013
International Banking - Prof. G. Vento
20
20
Origin of funds and geographical distribution
March 2013
International Banking - Prof. G. Vento
21
21
Expected volumes in the future
March 2013
International Banking - Prof. G. Vento
22
22
The Role of SWFs in the subprime crisis
• In the last 3 years many SWFs rescued Western banks:
March 2013
International Banking - Prof. G. Vento
23
23
SWFs: risks for Europe
• Important companies could be controlled by SWFs in the near
future.
• The European Commission is studying how to regulate SWFs.
• In February 2008 the EC published “A Common European
Approach to SWFs”, which guidelines are based on:
1. Governance (Separation between
government and
management, clear policy objectives, etc.)
2. Transparency (annual publication of the investment owned,
dimension, financial leverage, etc.).
• Also in US stricter rules have been introduced.
March 2013
International Banking - Prof. G. Vento
24
24
Next Lecture :
PRIVATE BANKING
March 2013
International Banking - Prof. G. Vento
25