Accord needed for opaque Sovereign Wealth Funds

By Neil Behrmann


December 2007:- Developed and emerging nations urgently require an unambiguous international agreement on sovereign wealth fund (SWF) investment.

If there is no accord, concerns about SWF investments could lead to protectionism, especially in Europe. The chances of restrictions being imposed on SWF investment are likely to increase as assets of SWFs will grow from the current $2.5 trillion to $10 trillion within five years, forecasts the International Monetary Fund (IMF).

Woolly Group of Seven (G-7) statements about transparency and governance are inadequate as security, energy and other national strategic issues could hinder the free flow of international capital.

Last week, the Organisation for Economic Cooperation and Development (OECD) called for greater SWF openness. It complained that SWF 'secrecy is at odds' with global financial market detailed disclosure requirements. The OECD's suggestions are bland and vague.

It suggests that nations should 'develop certain codes of conduct for their SWFs which clarify their objectives, investment strategy and governance'. There is a fat chance of this happening in Russia, China and Middle Eastern nations. Fearful of SWFs, Germany, France and Italy are already moving towards legislation to limit large-scale stake building in defence, energy and other corporations they consider to be strategic.

Worries about Russia and China

Their main worry is Russia, which has already used its natural gas supplies against Ukraine. Germany is worried that Gazprom and other Russian state concerns could purchase European pipelines and energy infrastructure and squeeze Europe into accepting political concessions.

A draft law would give the German federal government the right to veto any foreign investment that exceeds 25 per cent or more of a company's shares; the government would have four weeks to either approve or veto it and could delay an impending acquisition or scuttle it.

Thus Chancellor Angela Merkel and other European leaders talk the talk of anti protectionism, but simultaneously send veiled messages that they could block SWF investments in certain instances.

They are concerned that there are only a few transparent SWFs, such as New Zealand, Norway, Timor-Leste, Canada, Alaska, Australia, Azerbajan, Chile, Botswana, Kazakhstan and Singapore's Temasek. On the other hand the US and Europe needs capital injections from foreign investors, especially in the current credit crisis. Singapore's GIC is to invest US$9.7 bn in  UBS, which has announced further writedowns of around US$10 billion due to the US sub-prime mortgage crisis.Abu Dhabi provided a $7.5 billion lifeline for Citigroup and China’s Citic Securities has pumped money into ailing Bear Stearns.  SWFs are bound to pick up corporate and real estate bargains during the US and European credit crunch and stock market downturn.

                                       Sovereign Wealth Fund Ratings

Size     $ bn

Structure

Governance

Transparency

Total

Most Transparent

New Zealand Superannuation

    10

8.00

4.00

12.00

24.00

Norway Government Pension

  329

7.50

4.00

11.75

23.00

Canada Alberta Heritage Trust

   18

7.50

3.00

  9.00

19.50

US Alaska Permanent Fund

   40

7.50

2.00

  8.50

18.00

Australia Future Fund

   49

8.00

2.00

  7.00

17.00

Chile  Stabilization Fund

   10

7.00

2.00

  6.50

15.50

Botswana Pula Fund

      6

5.50

2.00

  7.00

14.50

Kazakhstan National Oil Fund

   19

6.00 

2.00

  6.50

14.50

Singapore Temasek Holdings

  108

4.00

1.50

  8.00

13.50

Kuwait Investment Authority

  213

6.00

3.00

  3.00

12.00

Least Transparent

Abu Dhabi Investment Authority

690

0.50

0.00

  0.00

  0.50

Qatar Investment Authority

  50

2.00

0.00

  0.00

  2.00

Singapore Government Investment Corporation (GIC)

 215

1.50

0.00

  0.75

  2.25

Brunei Investment Agency

   35

1.00

0.50

  1.00

  2.50

Algeria Revenue Fund

  43

3.00

1.00

  0.50

  4.50

Oman State General Reserve

  10

3.00

0.00

  2.00

  5.00

Iran Oil Stabilization Fund

  10

4.00

1.00

  0.50

  5.50

Venezuela  Stabilization Fund

  16

1.50

0.50

  4.00

  6.00

China Central Huijin Investment

  68

5.50

0.00

  0.50

  6.00

Russia Stabilization Fund

148

4.00

2.00

  3.50

  9.50

Source: Peterson Institute for International Economics

 

What should be covered in an accord

So what are the main issues that should be considered in an agreement that encourages the free flow of capital across borders, but allays concerns about SWFs?

US Securities and Exchange Commission (SEC) chairman Christopher Cox explained the essence of the conundrum in a speech last week. It is not a question of foreign ownership, but rather government control of the funds that are investing in companies in the US, Europe, Asia and other emerging markets. As a result of state control of these huge funds (see table), there is potential for numerous conflicts of interest:

The SEC can almost always expect the full support of foreign governments in investigating corporations that are violating US securities laws. But the foreign government would control the SWF under investigation. It would be both the regulator and the regulated - the referee and the player.

When individuals with government power also possess enormous commercial power and exercise control over large amounts of assets that must be invested, the risk of misuse of those assets, and the possibility of corruption, rises markedly.

SWFs may not always direct their affairs in furtherance of investment returns. They could use their financial power in pursuit of the foreign government's interests. This is the current worry about the SWFs and other state- owned companies in Vladimir Putin's Russia.

China, Middle Eastern and several emerging market SWFs may require unfettered access to foreign markets, but their own political systems are undemocratic and restrictive.

When it comes to transparency, the track record of most SWFs does not inspire confidence, says Mr Cox. If individual and institutional investors come to believe that they are at an information disadvantage when they compete head to head in markets with foreign governments, confidence in markets could be damaged. Governments have at their disposal the vast amounts of covert information collection that are available through their national intelligence services. The SEC is thus focused on full and fair disclosure for all market participants, and the prevention of fraud and unfair dealing such as insider trading. Full disclosure should become a prerequisite for an SWF.

Thus, the key issues are not so much debate surrounding international investment of SWFs but the foreign government's control of the fund and conflicts of interest. An international accord has to demand full transparency, independent regulation and de-politicising of investment decisions.

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