Sovereign Wealth Funds: Issues
and Challenges
Mukul Asher
Professor of Public Policy
National University of Singapore
Email: sppasher@nus.edu.sg
Prepared for the seminar at National Graduate Institute for Policy Studies, Tokyo, July 2008.
Organization
•
•
•
•
•
•
•
Defining Sovereign Wealth Funds (SWFs)
Size of SWFs
Benefits of SWFs
Concerns
Recent Developments
Future Trajectory
Concluding Remarks
2
Defining SWFs
• Sovereign Wealth Funds (SWFs) are one of the
separated pools of assets (primarily but not
exclusively internationally invested) owned by
governments to achieve economic, financial, and
strategic objectives.
• Usually, SWFs are separated from the country’s
foreign exchange reserves. There are wellestablished norms for investing foreign exchange
reserves, but not for SWFs.
3
Defining SWFs
• They are also separated from government financial
and non-financial corporations, purely domestic
assets, and assets owned and controlled by subnational unit.
4
Defining SWFs
• IMF (2008) classifies SWFs into 5 groups:
– Stabilization Funds (designed to insulate the budget and
the economy against commodity price swings)
– Savings Funds for Future Generations (to enable
conversion of non-renewable assets into a more diversified
portfolio of assets and mitigate the effects of Dutch
disease)
– Reserve Investment Corporations (these assets are still
counted as reserve assets and are established to increase
the return on reserves, though at a higher risk)
5
Defining SWFs
– Development Funds (designed to help fund socio-economic projects
and infrastructure. These funds usually have large domestic
component)
– Contingent Pension Reserve (particularly to finance social security and
health expenditures for rapidly ageing populations)
To the extent SWFs assets accrue because of persistent and large
structural budget surpluses, they indicate overtaxing and/or underspending by the concerned governments, which reduces current
taxpayers welfare (Nageswaran, 2008).
6
Defining SWFs
• The vastly expanded number, scale and scope of activities of
the SWFs is a relatively new phenomenon, though they have
existed for several decades. Their structure, mandates, and
objectives however vary.
• Some have termed SWFs as important symbol of state
capitalism.
7
Size of SWFs
• There are no robust databases which monitor the financial flows of the
SWFs. Therefore, the estimates of the size of the SWFs vary widely.
• Table 1 divides SWFs into non-pension funds (with assets of USD 3 trillion);
and pension funds with assets of USD 2.3 trillion for a total of USD 5.3
trillion.
• Some projections indicate that assets of SWFs will surpass the economic
output of the US by 2015, and the EU by 2016.
8
Table 1: Sovereign Market Estimates of Assets Under Management for SWFs (As of February 2008)
(In billions of US dollars)
Source: Truman (2008)
9
Size of SWFs
• The SWFs are one of the two identifiable
pools, the other being foreign exchange
reserves.
• Table 2 suggests that the reserves are larger
than the SWF assets, the combined amount
being about $ 8.6 trillion.
10
Table 2: Foreign Exchange Reserves and Sovereign Wealth Funds
Billions of U.S. dollars
Country
Foreign
Exchange
Reserves
Sept. 2007
SWF
Total
Japand
Chinad
United Arab Emiratese
Singapored,e,r
Norway
Russiar
United Statesd
Saudi Arabias
Netherlandsd
Canadad
Taiwan
Korear
India
Kuwait
Hong Konge,r
Brazil
Algeria
Malaysiad
Libyad,e
Mexico
923
1,434
43
152
59
415
44
30
9
39
263
257
240
18
141
163
100
98
74
81
974
263
724
323
357
144
299
275
291
252
–
20
–
213
127
–
46
18
40
5
1,897
1,696
767
423
416
415
344
305
300
292
263
255
240
231
165
163
146
116
114
86
Total
4,582
4,372
8,633
d = A portion of SWF holdings is in domestic assets.
e = Size of SWF is estimated.
r = Reserves include SWF in whole or in part using estimates for Singapore
and Hong Kong.
s = The "SWF" is non-reserve holdings of international securities
reported by the Saudi Arabian Monetary Agency.
Source: Truman (2007)
11
12
Figure 1: China's Foreign Exchange Reserves (1992-2006)
Percent of GDP
USD Billions
1,200
50
45
1,000
40
35
800
30
25
600
20
Percent of GDP
400
15
USD Billions
10
200
5
0
0
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Source: Truman, E. (2007), “The Management of China’s International Reserves:
China and a SWF Scoreboard”, Paper Prepared for Conference on China’s Exchange Rate Policy
Peterson Institute for International Economics, November 17.
13
Size of SWFs
• Table 3 puts these amounts in perspective in terms of global financial
assets.
• In 2006, global financial assets were $190.4 trillion, so SWF assets ($4.4
trillion from Table 2) are about 2.3 percent of the total; and 8.7 percent of
global stock market capitalization. In May 2008, the global stock market
capitalization was $85 trillion, and correspondingly value of other financial
assets are likely to be higher.
• The above figures however understate the importance (at the margin) of
government controlled pool of funds, represented by SWFs and foreign
exchange reserves.
• The SWFs are large and are projected to become more prominent in the
future. The World in general, and individual countries will therefore need
to learn to adjust to them, and minimize their possible adverse impacts. 14
Table 3: Selected Indicators on the Size of the Capital Market (2006),
In Trillions of US Dollars
Source: IMF (2008)
15
• Truman (2008) reaches the following conclusions with regard
to the impact of SWFs on the US :
1. SWFs pose little threat to US security and economic
interests.
2. SWFs are part of global economic and financial changes. It
is imperative that appropriate policies are formulated
regarding SWFs.
3. US ought to minimize economic and potential barriers to
foreign investment in all forms and various sources.
Financial protectionism is bad for the US and the world
economy.
16
•
While the US has the capacity to manage the impact of the SWFs, this may not
necessarily be the case for the other countries, particularly those with limited
financial and capital markets, and low to moderate levels of regulatory capacity.
•
The sheer size and scale of the SWFs strongly suggest that precautionary principle,
in this case assuming that non-economic considerations will apply in their
behavior, at least in some investment decisions which may be undertaken for
global influence, should be applied with respect to SWFs.
•
Emergence of China as a major creditor country may adversely impact on the
market dominance enjoyed by the US and other Western financial institutions in
the medium term; and may fundamentally alter the Bretton Woods institutions –
the IMF and the World Bank.
17
Benefits of SWFs
Main benefits of SWFs are:
For home countries,
– They facilitate intergenerational transfer of proceeds from nonrenewable resources, and assist stabilization;
– Permit consumption and tax smoothing across generations;
– Potentially enable prudent diversification of assets;
– In some countries, a national holding company is established to
manage state enterprises and oversee their acquisition of strategic
stake in key foreign companies; while ensuring that domestic state
enterprises and other strategic companies are not acquired by foreign
interests.
– Could enable a portion of excess foreign exchange reserves to be
segregated for pursuing higher risk appetite and potentially obtain
higher returns. This may help reduce the cost of sterilization.
18
Benefits of SWFs
For international financial markets,
– They facilitate a more efficient allocation of revenues from commodity
surpluses across countries;
– Help recycle current account surpluses, and enhance market liquidity
(this is of some importance currently due to global financial stress);
– Have longer time horizons which may bring stability.
– Permit more diversified partnership with other players such as private
equity and hedge funds, permitting better risk management
– They now compete with Central Banks, hedge funds, private equity as
the international capital providers of last resort.
19
Concerns
• Global Macroeconomic Stability and Sustainability
– There are global macroeconomic imbalances in which overconsumption by the United States, and mercantilist policies of NorthEast Asian countries, particularly China, play an important role.
– So, continued acquisition of excess reserves by them, combined with
policies to maintain under-valued currencies, will perpetuate such
imbalances and adversely impact on financial stability of rest of the
world.
– This is somewhat mitigated by provision of liquidity that the SWFs can
potentially provide. (This assumes that accommodating policies of the
central banks are appropriate).
20
Concerns
• The concentration of SWF investments in financial institutions
where the agency problems have been particularly acute (as
evidenced by the sub-prime crisis and exploitation by banks and
other financial institutions of regulatory loop holes) could create
greater systemic risks, and contingent liabilities for the tax payers
who are the ultimate principals.
• Transparency and Accountability
– Largest share of SWF assets is with the countries in which the state has
played a dominant role in the society and the economy; and where
representative institutions designed for checks and balances are
relatively less established.
– In these countries, information is regarded as a strategic resource,
rather than a public good.
– The transparency and accountability concerns are also relevant for
the domestic population of countries of SWF, as this may adversely
impact on their welfare.
21
Concerns
– This concern is also present for some of the other financial players
such as hedge funds, and private equities.
– Truman (2008) has ranked selected SWFs according to structure,
governance, transparency and accountability, and behavior criteria
(Table 4).
22
Concerns
(Table 4)
Source: Truman (2008)
23
Table 5: SWF Scorecard
Source: Truman (2008)
24
Table 5 (Continued)
Source: Truman (2008)
25
Table 5 (Continued)
Source: Truman (2008)
26
Table 5 (Continued)
Source: Truman (2008)
27
Concerns
• It is interesting to observe that pension SWFs score substantially
higher than the non-pension SWFs.
• The score for behavior is especially low for non-pension SWFs.
• The top-twelve SWFs are all from industrial countries, while the
bottom-twelve are from oil-producing countries.
28
Concerns
• There has been a debate about the desirability of reciprocity. Some
have argued that providing SWFs access to recipient countries is
advantageous (subject to prudential safeguards) even if there is no
reciprocity. Thus, Rachman (Financial Times, April 29, 2008) argues
that “China, Russia, and the Middle East have large investments in the
US and the EU, then they also have a direct stake in the continuing
prosperity of America and the EU”. Truman (2008) has also made
similar arguments.
• The others have observed that many countries with the SWFs have
restrictive investment, and service sector regimes. They are therefore
accessing more liberal regimes abroad while denying the other
countries corresponding access to their economies.
29
Concerns
• Conflicts of Interest, Potential Insider Trading,
and Regulatory Effectiveness
– Conflicts of interest could arise when
governments which are regulators and protect
public interest from fraudulent and anticompetitive behavior, become investors.
– SWFs as government agencies could have access
to commercial and security sensitive information.
This could also lead to insider-trading.
30
Concerns
• As SWFs are controlled by the governments,
prosecuting officials of foreign governments could
pose a diplomatic dilemma, reducing effectiveness of
domestic regulation.
31
Recent Developments
• As the SWFs are likely to be important players in the international financial
and capital markets, Code of Governance is needed. The SWFs are simply
too big and their definition is too imprecise to be formally regulated.
• As data on SWFs are not systematically collected, national and
international efforts are also needed in this area. Similar data gathering
efforts are also needed for hedge funds and private equity.
• The IMF, The World Bank, and the OECD have been asked by G-7 to
examine SWF issues and to draw up broad guidelines for both the home
and recipient countries. The aim is to reap the benefits of SWF
investments, while safeguarding national security and other concerns but
without harmful protectionism.
32
Recent Developments
•
IMF’s Global Financial Stability Report has been covering SWFs, hedge funds and
private equity funds
•
IMF (2008) has set up a Work Agenda, primarily for fund surveillance for
developing a draft of SWF principles and practices, including disclosure, reporting,
transparency and governance. IMF board has endorsed the work agenda on
March 21, 2008.
•
In March 2008, US Treasury reached agreement with SWFs of Abu Dhabi and
Singapore on policy principles for SWFs and for countries receiving SWF
investments. Abu Dhabi’s Mubadala fund has already applied for credit rating, and
is arguing that it should not be labeled as SWF.
•
In April 2008, representatives of two dozen SWFs met at the IMF for discussions.
•
U.K . Hedge Fund Working group and Private Equity Working Group are also
developing transparency and disclosure codes on voluntary basis.
33
Recent Developments
• Germany has decided to create an agency similar to
Committee on Foreign Investments in the US (Cfius) (Financial
Times, April 10, 1008, p.6).
• The Committee will have the right to review and possibly veto
acquisitions by SWFs which may pose a threat to national
security or public order.
• Acquisitions involving a stake in a German company of more
than 25 percent will potentially come under scrutiny.
34
Recent Developments
• SWFs from other European Union countries are excluded.
• OECD concurs with the German approach arguing that it strikes
reasonable balance between need to protect strategic sectors from
investors with non-commercial objectives and need to keep markets for
investments open.
• The US treasury is considering reviewing the provision that if an SWF has
less than 10% investment in US financial firms, the investment does not
need to be reviewed by CFIUS (WSJ, April 23, 20008).
• China Investment Corporation (CIC) is China’s USD 200 billion SWF. It plans
to invest up to 90 billion dollars on assets abroad. It has been appointing
global managers to manage some of the CIC funds.
35
Recent Developments
• Russia’s National Wealth Fund (Assets of USD 33 billion as of May , 2008)
plans to take riskier equity position outside of Russia. Its assets are
projected to grow to USD 250 billion by 2012. (White et al., 2008).
• Russia also has other SWFs and such as the reserve funds (assets USD 130
billion on May 1, 2008) which is invested in more conservative securities
outside Russia.
• In addition, Russia has many state-controlled companies which also have
been aggressive in acquiring assets abroad.
• The Russian SWFs and state companies have raised concerns in US and
Europe (White et al., 2008).
36
Recent Developments
• The Brazilian government plans to use revenues from
newly discovered oil fields to create a SWF
containing US$200-300 billion in next 3-5 years
(Financial Times, June 9, 2008).
• It will initially resemble a fiscal stability fund, setting
aside 0.5 percent of GDP as a counter-cyclical
contingency reserve. It will buy locally issued
government debt, thus reducing the debt held by the
private sector.
37
Future Trajectory
Source: Miracky et al. (2008), p.58
38
Concluding Remarks
• SWFs are large, growing, and will continue to play an important role
in global financial and capital markets.
• Their growth reflects relative increase in share of global wealth of
resource-rich and some Asian exporters. The traditional industrial
countries will need to accommodate those countries from which
major SWFs originate.
• International community has a stake in ensuring that SWFs Code of
Governance is compatible with global stability; while SWFs have a
stake in predictable behavior of the recipient countries.
39
Concluding Remarks
• While US may be able to manage the rise of the SWFs, some of the
developing countries may feel more vulnerable. All countries,
however have little choice but to strengthen their internal data
gathering capabilities, and monitoring of FDI and portfolio flows.
• The global nature of the financial and capital markets has outpaced
the patchwork of financial regulation which is still primarily
domestic.
• As world financial authority is not on the cards, there is little choice
but to rely on committee-based international cooperation and code
of conduct (Davies and Green, 2008).
40
Concluding Remarks
• The SWFs will also have a political impact. James (2008) has argued
that “both the rise of the SWFs and the new importance of big
countries as the last backstop of the financial system have changed
the way electorates and politicians view globalization. The
pendulum is indeed away from the marketplace, which has
inherently democratic qualities, and toward big states and big
power. And, in many parts of the world that means a new
authoritarianism”
41
References
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•
•
•
•
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Davies, H. and Green D. (2008), Global Financial Regulations, The Essential Guide.
El-Erian, M. (2007), “Foreign Capital Must Not be Blocked”, Financial Times, October
3.
IMF (2008), “Sovereign Wealth Funds – A Work Agenda”, Washington DC: IMF, Feb.
29.
James, H. (2008), “The Future of Globalization: A Transatlantic Perspective”, Foreign
Policy Research Institute [http://www.fpri.org]
Johnson, S. (2007), "The Rise of Sovereign Wealth Funds”, Vol. 44, No. 3, Finance
and Development, pp. 56-57.
Kimmitt, R.M. (2008), “Public Footprints in Private Markets”, Foreign Affairs, 87, 1,
pp. 119-130.
McKinsey Global Institute (2007), “The New Power Brokers: How Oil, Asia, Hedge
Funds, and Private Equity Are Shaping Global Capital Markets”, October.
Miracky, W., Dyer, D., Fisher, D., Goldner, T., Lagarde , L. and Piedrahita, V. (2008),
Assessing the Risks: The Behaviors of Sovereign Wealth Funds in the Global
Economy, New York: Monitor Group.
Morgan Stanley (2007), “How Big Could Sovereign Wealth Funds Be by 2015?”, May
3.
Nageshwaran, A. (2008), “Risk from Sovereign Funds”, MINT – June 9 2008
42
References
• Rachman, G. (2008), “Do not panic over foreign wealth”, Financial Times,
April 29, 2008.
• Summers, L. (2007), “Sovereign Funds Shake the Logic of Capitalism”,
Financial Times, July 30.
• Truman, E.M. (2008),“A Blueprint for Sovereign Wealth Fund Best
Practices.”, Peterson Institute for International Economics, Washington
D.C. , Policy Brief, PB 08/3, April.
• Truman, E.M. (2007), “Sovereign Wealth Fund Acquisitions and Other
Foreign Government Investments in the United States: Assessing the
Economic and National Security Implications”, Testimony before the
Committee on Banking, Housing, and Urban Affairs, United States Senate,
November 14, 2007.
• Tucker, S. (2007), “The Politics of Sovereign Wealth Funds”, Financial
Times, September 28.
• White G., Davis Bob and Walker, Marcus (2008), “Bear market: Russian
wealth funds rattles U.S. and Europe”, The Wall Street Journal, May 8.
• Wolf, M. (2007), “We Are Living in a Brave New World of State Capitalism”,
Financial Times, October 17.
43