SWFs mark structural shift in world
financial order
Kavaljit Singh
The Economic Times
11 Nov 2008
On October 11, the
International Working Group of Sovereign Wealth Funds (IWG) released the
Generally Accepted Principles and Practices (GAPP) that would guide the governance and accountability framework
of sovereign wealth funds.
The IWG was set up in May
2008 in the wake of widespread fears across the western world that investments
by sovereign wealth funds (SWFs) are largely
influenced by strategic and political objectives rather than commercial
interests. These fears sparked a heated debate within the western world about
the extent to which SWFs should be allowed to invest
in domestic markets .
At the initiative of G-7 , the IMF was asked to develop a set of voluntary
principles for the SWFs. The IMF, in turn,
established the IWG with sovereign funds and recipient countries to carry
forward the task.
Though SWFs
have been around for decades, it is only recently that they have attracted much
attention. With an estimated $3 trillion in assets, they are investment funds
owned and managed directly or indirectly by governments .
They may be funded by foreign exchange reserves, commodity exports, the
proceeds of privatisations and fiscal surpluses. The SWFs manage foreign exchange assets separately from
official reserves . They are set up to diversify and
improve the return on foreign exchange reserves or commodity revenue, besides
protecting the domestic economy from fluctuations in international commodity
prices.
The GAPP contains 24
principles covering a wide range of issues from legal framework to governance
structure to investment policies and risk management of SWFs.
Since the principles are voluntary in nature, their actual implementation would
be dependent on member-countries . The IWG has also
proposed to establish a formation committee that would explore the creation of
a permanent international body on SWFs.
One major issue which cut
across every principle of GAPP is transparency and public disclosure. True,
some SWFs (particularly from the
The varying degree of
transparency among the sovereign wealth funds have to be viewed in their
specific national context. It is hardly surprising that opaque governments tend
to operate opaque SWFs. It is not that all other
investment funds and financial institutional (barring SWFs)
are more transparent in these countries. Though both
Increasingly, SWFs are becoming more transparent and accountable. Many of
them are conducting external audits, hiring external managers and regularly
publishing financial information. However, improvements in the transparency and
governance will come gradually and organically. One should not expect all SWFs to adopt higher standards of transparency and
governance overnight.
The demand for increased
transparency of SWFs by western countries lacks
credibility in the light of poor levels of transparency and governance
standards of big private investors. Singling out SWFs for their opaqueness but overlooking similar (or even
greater) levels of secrecy and unaccountability enjoyed by hedge funds, private
equity funds and investment banks exposes the double-standards the western
policymakers. In principle, all financial institutions (public or private ) should be transparent. Why single out sovereign
wealth funds?
The second issue
underlying the GAPP pertains to the threat to market instability. Till date,
not a single incident of sovereign funds destabilising
financial markets has come into public notice. On the contrary, a number of
factors suggest that SWFs could exert a stabilising influence on global financial markets. First,
unlike hedge funds, SWFs do not use excessive
leverage to amplify market positions and returns.
Second, SWFs are typically patient investors with long-term
investment horizons. The shifts in their currency or asset portfolios happen
gradually over a longer period . Third, the funding
source of SWFs is fairly stable which makes them less
sensitive to market volatility. Fourth, unlike hedge funds and mutual funds, SWFs are not prone to sudden withdrawals by investors,
which could force them to liquidate their positions quickly. Fifth, given their
stable funding source, SWFs could go against market
trends as witnessed during the ongoing credit crisis. By injecting billions of
dollars into ailing western banks, the SWFs acted as
counter-cyclical investors.
Sixth, the SWFs contribute to the economic stability in their home
countries by acting as a buffer against volatile commodity prices and
mitigating ‘Dutch disease’ effects . The third major
component of GAPP addresses non-commercial objectives of SWFs.
Though Principle 19 falls short of an explicit pledge not to invest for
non-commercial purposes, it calls upon funds to publicly disclose investment
decisions ‘subject to other than economic and financial considerations.’
So far there is not a
single instance of mischievous behaviour by SWFs. The overwhelming majority of sovereign funds are
passive investors . In cases where SWFs
undertake direct investments, they do not seek controlling interests. Even the
large-scale direct investments made by SWFs in the
Will the GAPP succeed in
removing fears in the recipient countries? It is too early to judge.
Nevertheless, the rise of SWFs not only reflects the
global imbalances, more importantly , it represents a
structural shift in the international financial system with the comparative
decline of west and the growing financial clout of developing world.
(The author is director,
Public Interest Research Centre,