The Hindu Business Line : Taming sovereign wealth funds

The value of Sovereign Wealth Funds is reaching dizzy heights
and this is making the West jittery. Developed country
governments are keen to oversee and regulate SWFs even as
they allow hedge funds and private equity to operate without
any transparency or accountability.

K. Subramanian

Two developments followed close on the heels of each other. The US Treasury issued a press release on March 20 announcing its agreement on principles for Sovereign Wealth Funds (SWF) with Singapore and Abu Dhabi. Next day, the IMF announced that its board had endorsed work agenda on SWFs.

These are not fortuitous. In fact, they reflect the two faces of a strategy pursued by the Treasury to tame SWFs.

Dizzy values

No issue has agitated G7 countries, especially the US, more than the rise of SWFs in recent years. It is rather strange that a recent phenomenon like the emergence of SWFs should have led to contentious debates. Perhaps, size matters!

The value of SWFs is reaching dizzying heights. It is said to have grown at 18 per cent last year and reached $3.3 trillion and is expected to hit $13 trillion in the coming decade.

The chorus voicing concern over SWFs includes governments, senators, academics and journalists. Not a day passes without a major paper carrying an article on the threat posed by SWFs. Most of them allege that they are state-owned, ergo, are not commercially driven and their motives questionable. Prof. Lawrence Summers led the charge arguing that they “shake capitalist logic” (Financial Times, July 29, 2007) as they seek non-economic objectives. Mostly, the attacks harp on the issue that SWF operations are clothed in secrecy and lack transparency.

Rising numbers

The debate acquired higher decibels when China’s reserves crossed $1.5 trillion late last year and the PRC set up the China Investment Corporation (CIC) with a capital of $200 billion.

The CIC has been spreading its wings far and wide.

Oil exporting countries had an older record and some of them had already established investment agencies. With the phenomenal rise in crude prices, their reserves swelled and their operations became more visible. Abu Dhabi Investment Authority (ADIA) became the largest global investor with an estimated capital of $900 billon. With the spurt in commodity prices, commodity exporters are joining their ranks.

Singapore had set up Temasek long before current controversies. It established another agency, viz. Government Investment Corporation (GIC). Russia joined the club with its National Wellbeing Fund. At present, there are around 40 SWFs in developed as well as emerging economies.

Indeed, it is a menagerie of funds. Even as they copy the model from others, their investment objectives and strategies differ. They do not act in concert.

Rating the funds

Mr Edwin Truman of Peterson Institute for International Economics, Washington D.C., has done valuable studies on the SWFs. In one detailed study (A scoreboard for Sovereign Wealth Funds, October 19, 2007), he rated 32 SWFs in 28 countries applying four criteria: structure, governance, transparency and accountability, and behaviour. His study suggested a divide between older funds in developed countries and newer funds in emerging economies.

The latter secure low grades in his rating, especially on transparency. He did however note, “All sovereign wealth funds are not equally opaque.” While ADIA and Singapore GIC were rated poorly in his scoreboard, Kuwait’s Investment Authority and Temasek Holdings were above average.

In another study, he explained the concerns of governments owning SWFs, adding how they would want to “protect their sovereignty, confidentiality and capacity to make ‘strategic’ investments” and not like to “compromise their room to manoeuvre in managing their international investments.”

Taking note of the recent trends in SWF operations, he observed certain positive trends which could help build a new framework for their future. One option was to continue with the present trends in an ad hoc manner responding to domestic and international pressures.

The other was for a group of governments to establish a standard for SWFs and similar vehicles. “They might ask the IMF or the World Bank to assist them in the effort.” Peterson Institute is a powerful lobby of US banks and it is not surprising that its ideas influence US government policies.

European reaction

The responses of European governments have varied. Most voice opposition to their rising role. Germany has reacted strongly. The UK policy is Janus-faced: it wants the SWFs to operate and strengthen its stock markets; and, it would protect its strategic industries from take over by foreign funds.

The EU has also raised alarmist voices, including threats to bring about legislation. Even as these funds grow in size and power, there is growing demand for regulation. Rachel Ziemba details the responses of governments in a detailed paper in her blog in RGE Monitor. (Responses to Sovereign Wealth Funds: Are ‘Draconian’ Measures on the Way? November, 2007.)

Another, more balanced, view has been expressed in these debates. Some economists do not look upon SWFs as creatures from outer space spoiling the global game, but rather as products thrown up by the imbalances in the global market. In this view, the build-up of reserves is a reflection of the US’ growing dependence on expensive oil and its current account deficit. They feel that SWFs are recycling US petro-dollars. They cannot be wished away unless the US sets its house in order by correcting its trade and budget deficits.

IMF view

The IMF has examined the rise of SWFs in some of its financial stability reports. The quintessential one was in the Global Financial Stability Report (GFSR), September 2007. It noted two views raised by SWFs.

One is that they enhance market liquidity and financial resource allocation. Large SWFs operate efficiently by drawing on expertise of their own managers and by engaging reputed external fund managers. They have longer investment horizons that can accommodate short-term volatility. As a result, their operations may dampen asset price volatility and lower risk premia.

The contrary view is about the lack of public information on some funds, “their multiplicity of objectives, and a lack of clarity on their institutional structures and investment management” which make it difficult to assess the role of SWFs and their impact on capital markets. By and large, it is public ownership which terrifies them most.

In the Global Economic Forum held at Davos in January this year, there was ‘tension in the air’ when issues relating to SWFs were discussed. It was an occasion for the owners of SWFs to hit back. Muhammad Al Jassar, Vice-Governor of Saudi Arabian Monetary Agency, wondered why SWFs were singled out for scrutiny even though more than 60 per cent of their assets were held in fixed-income securities and the rest invested in minority stakes in public companies.

As he explained, the criticism of SWFs was based on concerns about actions they might take in future, rather than any actual abuses. “The attitude seems to be that sovereign investors are guilty until they are proven innocent.”

Hedge funds and PE

In the same Forum, some members raised the issue why western governments were keen to oversee and regulate SWFs even as they had allowed hedge funds and private equity to operate without any transparency or accountability. They also argued that unlike hedge funds or other major operators, they had not played any political role on currency issues.

Stephen Roach of Morgan Stanley who reported the debate in his blog (Financial Times, ‘SWFs: Can beggars really afford to be choosy?’ January 25, 2008) clinched the issue thus: “It is simply the fear of foreign ownership posed by this increasingly powerful group of state-controlled asset managers. Sadly, it boils down to nothing more than a thinly veiled manifestation of financial protectionism.”

It was financial protectionism which had invaded their psyche and led to latter day Orwellian double-talk about SWFs and the need to regulate them.

The idea is to formulate a code of conduct, if practicable, or to prepare a manual of “best practices” governing their operations. The lead was taken by the US and no wonder the members of G7 were glad to be in toe. Will they succeed in their efforts? That is our next story.

(The author has extensive experience in international, trade and finance affairs. E-mail: subrabhama@gmail.com)

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