Growing concerns over sovereign wealth funds

  • Business
  • Wednesday, 17 Oct 2007

PETALING JAYA: Sovereign wealth funds (SWFs) have been drawing criticism since late July when it emerged that Temasek Holdings Pte Ltd and China Development Bank would invest US$18.5bil and US$13.5bil respectively in Barclays. 

The investments would, at the time, help finance the British bank's bid to take over Dutch financial group ABN Amro Holding. 

The US pushed for the International Monetary Fund and World Bank to set guidelines for SWFs while Germany and France urged for a joint European response. 

Nonetheless, Barclays' bid was unsuccessful when 85% of ABN Amro shareholders voted on Oct 6 to accept a 70 billion euro bid from a consortium led by Royal Bank of Scotland instead. 

More recently, European Central Bank president Jean-Claude Trichet on Sept 29 said “that the global economy may suffer if sovereign wealth funds were not transparent.” 

The criticism continued yesterday with Japan's Finance Minister Fukushiro Nukaga saying that the G7 “finance leaders” meeting Friday would discuss the transparency of government investment funds, among other issues. 

Reuters reported Nukaga as saying: “Unlike other funds that make short term, speculative investments using leverage, sovereign funds basically make long-term investment decisions and that is not a bad thing for market stability. 

“But there are also concerns that sovereign wealth funds are making more speculative investments recently.” 

Standard Chartered Bank in a report released yesterday, estimated that the SWFs were currently valued at US$2.2 trillion and, if their current rapid pace of growth could be sustained, then SWFs could in 10 years soar to US$13.4 trillion. 

Its chief economist Gerard Lyons said in the report: “If any of these figures are not spot on it is a reflection of the secrecy of the SWFs themselves. 

“Overall, it is calculated that the estimated size of the top 20 SWFs is US$2.1 trillion. 

“If you add in recent smaller funds, such as Azerbaijan, Trinidad & Tobago, Ecuador, Nigeria and others, US$2.2 trillion is the likely scale.” 

Lyons said he expected the influence of SWFs on financial markets to grow. 

“Expect these government-controlled funds to take bigger financial stakes in equity and bond markets across emerging economies; feed more money into alternative investments such as hedge funds and private equity; boost strategic links with countries that have not shared fully in globalisation or which have been shunned by the West; and take more strategic stakes in sensitive areas within developed countries. 

“It is these last two areas, which I call State Capitalism, that is the most problematic aspect of sovereign wealth funds,” he said. 

The report found that the biggest SWF was Abu Dhabi Investment Authority (ADIA), but it was not a transparent fund and the estimated size of US$625bil “may not be spot on.” 

“The uncertainty about some funds is highlighted by some of the wide guesstimates that exist. 

“Take Kuwait as an example. The figure of US$213bil cited in this report is based on a reply to a parliamentary question and seems to be more reliable than most other estimates, which vary widely,” it said, highlighting the difficulties of obtaining accurate data on SWFs. 

The report also highlighted that there was a strong case for SWFs to adopt the best practice of open funds like Norway's Government Pension Fund - Global, which managed US$625bil. 

“Future generations” funds with high levels of transparency, such as the SWFs in Norway, Alberta and Alaska, had a high level of diversification and held only small stakes, it said. 

Norway's fund owns shares in about 3,500 companies, but holds stakes that are typically below 1%. 

“But many governments will argue that it is their money and why should they be so transparent when so many other areas of financial markets are not,” said Standard Chartered's report. 

It said it was “surprising” that it found Russia's Stabilisation Fund, which managed US$127.5bil, “relatively transparent and also less strategic than other funds.” 

In terms of operations, the Stabilisation Fund was tasked with delivering stable and low-risk returns, and so were limited to investment in AAA-rated sovereign bonds, with a given currency composition to manage currency risk. 

Meanwhile, it said that low-transparency funds, such as ADIA, usually preferred investing in small stakes to avoid disclosure requirements. 

The funds that have acquired significant stakes in foreign companies include the China Investment Corp, GIC, Temasek, the Kuwait Investment Authority, the Qatar Investment Authority, and Dubai's Istithmar and DIC. 

The report highlighted that there was a strong case to be made to encourage the opening up of markets where the SWFs came from to create “the so-called level playing field.” 

“If not, then protectionist pressures will come to the fore, risking a clash between Western governments and SWFs,” it said, adding: “Already this is happening in the US, with more signs of a hardening of stances across Europe.” 

Malaysia was among countries that had been identified as transparent in SWFs in terms of their size, portfolio composition and investment return, it said. 

Lyons also cited Norway, Singapore, Alaska, Alberta and Azerbaijan as countries or regional state governments that were transparent. 

Those with a relatively low level of transparency in the report included the United Arab Emirates funds, Kuwait, China, Qatar, Brunei, Venezuela, Taiwan and Oman. 

The Aims of SWFs 

Oxford Analytica, the co-author of Standard Chartered's report titled “State Capitalism: The rise of sovereign wealth funds”, has tabulated the aims of such funds. 

Sovereign wealth funds (SWFs) are typically established with a primary focus on one or more of the following aims: 

  • Macroeconomic stabilisation. Countries that are highly dependent on commodity exports are exposed to swings in global prices. The primary aim of the fund in these cases can be to smoothen short- and medium-term fluctuations. 

  • Higher returns. Countries that have surplus funds are increasingly seeking to maximise returns. This is motivated by the opportunity cost associated with funds being invested in risk free assets. 

  • Future generations. Several funds were created with the objective to create a reserve of wealth for the future, when natural resources will have been depleted. 

  • Domestic industries. Some of the funds have also been used to restructure and encourage domestic industries. 

    Governance of SWFs 

    According to research outfit Oxford Analytica, management responsibility for SWFs varies widely, from finance ministries and central banks to separate entities that often have executive boards to make decisions. 

    External money managers are typically contracted to manage funds on the basis of policies set by the board. 

    A limited number of funds, including the Norwegian fund, provide detailed information on their operations and performance. 

    Among newer funds, there is a divergence between those that have sought to adopt best practices, and those where arrangements seem to have emerged on an almost ad hoc basis and where little is known of formal codes. 

    Most obviously in the latter category is the new Chinese fund, and this is partly why China's SWF investments are causing most concern in recipient markets.

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