Sovereign wealth funds

Should sovereign wealth funds be treated differently than other investors? An OECD project has set out to answer this question.

©David Rooney

When Citigroup, a major US commercial bank, sold a large stake to an investor to offset subprime-related losses in late 2007, relief could be felt across the economy. But when people focused on the fact that the investor was Abu Dhabi Investment Authority, a wealth fund owned by a government in the Middle East, questions were raised.
Public concern was perhaps inevitable, given volatile financial markets and sometimes heated debates about globalisation and protectionism.Above all, major changes in the environment for national security and the international economy in recent years have caused some governments to reassess their investment policies, and the growing prominence of foreign government-controlled sovereign wealth funds inevitably made them an important focus. A key question is should sovereign wealth funds be treated differently than other investors?Since 2007, the OECD has been working at the request of G7 finance ministers and the other OECD members to develop guidance for recipient countries’ policies towards investments from SWFs. The OECD has addressed this request as part of the Investment Committee’s project on Freedom of Investment and National Security, which was launched to help governments counter rising investment protectionism and maintain open markets. The guidance which the Committee released in April is the result of the work of the 30 OECD countries, the ten non-member countries adhering to the OECD investment instruments, four other non-members participating in the project and the European Commission. The project also benefitted from consultations with SWFs and business and social partners.Profile
Sovereign wealth funds contain assets that governments have decided to keep separate from their regular processes of government budgeting and asset management. The major SWFs from the Middle East, Norway, Russia and a few regional funds such as Alaska and Alberta, Canada, have been based largely on revenues from natural resources, mostly oil. China’s SWF draws mainly on earnings from official foreign exchange transactions. Others, such as Temasek Holdings in Singapore, have been established to reinvest budget surpluses or the proceeds of privatisation.If assets under management in SWFs vary between US$2.5 trillion and US$3.5 trillion the bulk of this amount–an estimated US$2.2 trillion–is managed by just seven entities. The biggest is the Abu Dhabi Investment Authority with more than $800 billion under management. Norway follows with over $390 billion. Singapore Government Investment Corporation holds about $330 billion dollars, while Singapore Temasek holds around $100 billion. Kuwait Investment Authority comes in at $250 billion dollars and the China Investment Corporation at over $200 billion dollars.There are about 40 main funds–the other 33 collectively hold some $300-500 billion in assets, and so many of these are quite small.SWFs have various goals or strategies. One is stabilisation, whereby the fund’s main purpose is to cushion the fluctuations in resource or commodity prices. Others include spreading wealth across longer periods of time, and mobilising otherwise idle foreign reserves.Sovereign wealth funds generally have long investment horizons, and many of the oil exporting countries invest for the benefit of future generations–effectively placing them among the most long-term investors on the planet.A relatively small number of SWFs engage in corporate takeovers, or the acquisition of significant minority shares in listed companies, the Abu Dhabi-Citigroup transaction being one example. Norway has put a 10% limit on the size of stake in any one company that its sovereign wealth fund can acquire (recently upped from 5%), essentially limiting it to the role of a portfolio investor.Fair treatment
The OECD’s experience with SWFs to date shows them to be a positive force. SWFs’ recent injections of capital into several OECD financial institutions were stabilising because they came at a critical time when risk-taking capital was scarce and market sentiment was pessimistic. They help to recycle savings internationally and generally have a good track record as long-term investors. They contribute to the economic development of their home countries. As one of the world’s main proponents of an open investment system, the OECD welcomes these benefits for home and host countries.But, as is often the case, when new actors emerge on the international financial scene, the players need to become better acquainted. The growing role of SWFs raises issues regarding the smooth functioning of financial markets as well as investment policy questions, including legitimate concerns in recipient countries about protecting national security.The OECD’s existing investment instruments already contain fundamental principles for recipient country policies that can underpin the required guidance. Through their adherence to the OECD investment instruments, OECD and other adhering governments have committed to the principles of transparency, non-discrimination and liberalisation. These instruments: express a common understanding of fair treatment of foreign investors, including SWFs; commit adhering governments to build this fair treatment into their investment policies; and provide for “peer review” of adhering governments’ observance of these commitments.The OECD investment instruments recognise the right of adhering countries to take actions they consider necessary to protect national security. Investments controlled by foreign governments, such as those by SWFs, can raise concerns based on uncertainty regarding the objectives of the investor and whether they are commercially based or driven by political or foreign policy considerations.However, adhering countries have agreed that the national security clause of the OECD investment instruments should be applied with restraint and should not be a general escape clause from their commitments to open investment policies. OECD members and other countries participating in the Freedom of Investment project have agreed on a number of key principles which should guide governments when they design and implement investment measures to address national security concerns while preserving and extending the open international investment system. Participants consider that these principles are equally relevant to addressing national security concerns that arise in the context of investment from SWFs. These principles are the following:Non-discrimination: In general governments should rely on measures of general application which treat similarly-situated investors in a similar fashion. Where such measures are deemed inadequate to protect national security, specific measures taken with respect to individual investments should be based on the specific circumstances of the individual investment which pose a risk to national security.Transparency/predictability: While it is in investors’ and governments’ interests to maintain confidentiality of sensitive information, regulatory objectives and practices should be made as transparent as possible so as to increase the predictability of outcomes.Regulatory proportionality: Restrictions on investment, or conditions on transaction, should not be greater than needed to protect national security and they should be avoided when other existing measures are adequate and appropriate to address a national security concern.Accountability: Procedures for parliamentary oversight, judicial review, periodic regulatory impact assessments, and requirements that decisions to block an investment should be taken at high government levels should be considered to ensure accountability of the implementing authorities.Investors and home countries can ease concerns through transparency. Observance of high standards by SWFs and their provision of adequate and timely information will facilitate recipient countries’ efforts to implement their OECD commitments and its recommendations for preserving open markets while safeguarding national security. Therefore the OECD also supports the work underway at the IMF on best practices for sovereign wealth funds.The next steps
The work programme will include: further clarification of best practices regarding the implementation of the guiding principles, especially “accountability”; broader consideration of government-controlled investments; and any additional work which may seem appropriate in light of the results of the IMF’s work. A final report on the Freedom of Investment project–bringing together all of the findings of the discussions–will be completed in spring 2009. Its recommendations may also contain suggestions for appropriate revisions/clarifications to existing OECD instruments.The project includes a process of regular peer monitoring within which countries report measures in place or under consideration. As part of its ongoing work, the Committee will continue to monitor developments in this regard in light of the principles of transparency/predictability, proportionality and accountability and of adhering countries’ commitments under the OECD investment instruments.The spirit of co-operation that has characterised these discussions to date will continue through consultation and dialogue between home and recipient countries and between the IMF and the OECD.
Reference©OECD Observer No 267 May-June 2008

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