The Carnegie Endowment On Sovereign Wealth Funds

BY: GLOBALIZATION101.ORG

One of the biggest and most controversial developments in the field of international investment is the increasing power of sovereign wealth funds (SWFs) in world financial markets. These funds will play an extremely important role in the future as more and more governments are creating and investing these funds.

Sovereign wealth funds are “assets held by governments in another country’s currency,”  hence a Russian SWF could buy U.S. treasury bonds or stock shares in an EU company. Sovereign wealth funds are not central banks, they are separate state-run entities designed to accumulate assets for the future. These funds hope to bring in high rates of return on their foreign currency holdings. Most are in long-term, relatively stable investments. There are no rules governing public disclosure of these funds.

Sovereign wealth funds represent an estimated $2-3 trillion dollars and have the potential to grow to $10 trillion dollars by 2011. These funds are not new and most were started from funds gained from energy (natural gas and oil) exports and many of the funds are financed from the country’s foreign reserves. There are 29 known SWFs; Japan, Brazil, and Libya are considered starting ones as well.  In a globalized world where there is a blurring of national boundaries, these funds represent even further integration of national economies.

Morgan Stanley released a list of the top SWFs and their estimated assets as of March 2007.

The funds most transparent in terms of their size, portfolio composition, and investment returns are Norway, Temasek, Alaska, Malaysia, Azerbaijan, and Alberta, Canada and the least transparent are UAE funds, Kuwait, China, Qatar, Brunei, Venezuela, Taiwan, and Oman.

Recent SWF examples include:

• Singapore’s Temask Holdings 2006 purchase of a stake of Shin Corp, a company owned by the Thaksin Shinawatra, Prime Minister of Thailand, for 73.3 billion baht. This deal fueled anti-government demonstrators and may have been responsible for the ouster of the PM in a military coup in 2007. 
  
  
• China’s investment fund’s $3 billion dollar purchase of a ten percent, non-voting stake in Blackstone, a U.S. private equity firm.
  
  
• Qatar’s fund acquired a large stake in the London Stock Exchange and the Nordic Exchange Operator, OMX.
  
  
• Abu Dabi fund gained 7.5 percent of the management operations of the Carlyle Group, a U.S. private equity firm.

Why are these funds controversial?

The fears in the U.S. and EU do not relate to a Norwegian or Australian funds, but SWFs from China, Russia, and from Middle East countries. One major fear is that SWFs will be used to buy stocks in companies that are of vital interest to national security, such as energy, IT, telecom, and defense. Similar debates were brought up in the US during the failed ports acquisition by Dubai World.

Another fear is that SWFs represent government interference in free markets of other countries. Stuart Eizenstat and Alan Larson wrote in a Wall Street Journal editorial:  “More broadly, transparency, preservation of free markets and fair competition are all legitimate issues for policy makers to take up in assessing investments by sovereign wealth funds and SOEs.” 

A similar fear is expressed in an article in The Economist, “Sovereign-wealth funds could soon become the most important buyers of such assets, and many others besides. If so, the world will witness the intriguing spectacle of its largest private companies being owned by governments whose belief in capitalism is often partial.” 

A related fear is that the funds, due to their sheer size and wealth, might precipitate a crisis in global financial markets. An International Herald Tribune article highlights this fear: “Though sovereign wealth funds do not appear to have played a role in the recent turmoil of global markets, experts say they could in the future, in favorable or unfavorable ways - by selling assets abruptly and precipitating a crisis, or by bailing out funds or companies that are in trouble.”

Edwin Truman, a senior fellow at the Peterson Institute for International Economics says that since foreign governments are now not only holding treasury securities, but also stocks and bond, it is reasonable to ask whether they will be a stabilizing or destabilizing force.

Policy Responses and Recommendations

One response has been to set up barriers against SWFs and other state acquisitions. In July 2007, Germany debated new legislation to block foreign-state controlled acquisition. Just one week later, the European Commission started an inquiry into SWFs potential threat to EU’s single market. 

In the U.S., reforms were passed with bipartisan support in Congress to clarify the national security review process for foreign acquisitions and mergers, which is administered by the Committee on Foreign Investment in the United States (CFIUS). The new law requires more transparency for the U.S. government, as well as for investors. Transparency is a key issue addressed in nearly all of the news articles on SWFs. Eizenstat and Larson note: “Sovereign wealth funds and SOEs should disclose financial results, investment strategies and the limits of any government role in decision making.”

Additionally the G-7 countries called upon the World Bank and IMF to identify transparency and accountability best practices to be adopted by SWFs and the G-7 also asked the OECD to identify best practices for the recipient countries to ensure transparency and non-protectionist policies.

Edwin Truman, senior analyst for the Peterson Institute for International Economics calls for international agreed-upon standards for cross-border investments by sovereign entities:

The standard should apply to the gamut of international investments of governments, including traditional foreign exchange reserves, stabilization funds, nonrenewable resource funds, sovereign wealth funds, and government-owned or controlled entities such as pension funds. The standard should ensure that international investments of governments are based on clearly stated policy objectives and investment strategies. It should set out the role of the government and the managers of the investment mechanism/entity and ensure that the operations of the investment mechanisms are as transparent as possible.

The fears and concerns of recipient countries of SWFs investments are valid and understandable. Nonetheless if protectionist policies are created and bitter acrimony follows – the potential for a real volatile situation may arise. Teh Kok-Peng, President of GIC Special Investments, a unit of Singapore’s Government Investment Corporation warned of negative consequences for all if there are over-politicized reactions in the U.S. and EU.15  Countries might just decide to invest their funds in country with a more friendly investment climate, taking away needed capital for growth and development. As long as the U.S. maintains such a high trade deficit and energy prices continue to rise, SWFs will continue to grow in size and power and will remain a force to be reckoned with in the future.