Sovereign Wealth Funds: From Dubai to Oslo, Politics Meets Business

Originally published by the Carnegie Endowment for International Peace
Participants: Edwin Truman, Sven Behrendt, Jennifer Harris, Uri Dadush

As the recent mini-panic caused by Dubai World has shown, Sovereign Wealth Funds (SWFs) remain a prominent issue for investors and policy makers alike.

How has the landscape for SWF’s been altered by the Great Financial Crisis? Edwin M. Truman, former assistant secretary of the U.S. Treasury for International Affairs and senior fellow at the Peterson Institute of International Economics, Sven Behrendt, a visiting scholar at Carnegie’s Middle East Center, and Jennifer Harris, member of the Office of Policy Planning Staff at the U.S. Department of State, reviewed the nature, purpose, role, and future of SWFs in the wake of the crisis in an event moderated by Carnegie’s Uri Dadush.

SWFs Dimensions

SWFs are separate pools of government-owned or government-managed financial assets, including some international assets. These funds take many forms and are designed to achieve a variety of economic, financial, and political objectives, both domestically and internationally.

According to Truman, at the end of 2007, the total asset holding of these funds was more than $5 trillion, of which more than $4 trillion was in international assets. Approximately 40 countries have non-pension SWFs. An additional 13 countries manage pension funds that could be considered SWFs.

Sovereign wealth funds are not a new phenomenon, but their recent growth and expansion have brought them substantial, generally unwelcome, attention.

Do Sovereign Wealth Funds Pose Threats to Recipient Nations?

Policy makers and analysts have been watching the recent rise of SWFs with considerable unease. There are concerns that an investment by a SWF might be used a backdoor for the government who owns or manages it, to influence the economy or politics of the country the SWF is investing in.

Behrendt listed some of the arguments against SWFs:

• SWFs have been said to challenge the autonomy of recipient economies to make foreign policy decisions, provide investors with a significant geopolitical tool, and challenge national security.
• SWFs have been said to erode the governance standards of the companies that they invest in, and threaten the competitiveness of recipient countries by using their corporate power to steal knowledge and technology to investor economies.
• There funds have also been said to potentially challenge the global capitalist system itself, by using large investments in companies or other financial instruments to destabilize another nation’s economy for political motives.

Behrendt noted that SWF recipients and investors have taken a variety of actions in response to these perceived threats:

• Some recipients have passed regulations, like Germany’s special reviewing procedures for SWFs that would allow the government to block takeovers in strategic sectors, while others, like France, have established their own SWFs to defend strategically important assets.
• SWF Investors have engaged in self-regulation and institution building, revised investment strategies, and taken collective action, most notably by establishing the Santiago Principles.
• Truman also noted that SWFs became increasingly controversial in investor countries in 2008/2009, as they absorbed losses of 20 to 30 percent of their portfolios due to the financial crisis. As a result, some pulled back into domestic investments.

Harris argued that fears about SWFs threatening national security are overly simplistic and largely unfounded. Noting that SWFs are only one part of the broader trend of states increasing their presence in business, Harris addressed some of the claims often raised against SWFs:

• SWFs are political: Beyond the fact that they are all government owned or managed, there is little tying SWFs together. Some may be political, while others are not; Iranian SWFs, for example, are not the same as Canadian ones. Before anyone jumps to national security conclusions, it is important to examine whether the investor returns from “political” SWFs are outperforming the “nonpolitical” ones.
• SWFs are destabilizing: While the funds in the gulf did act in a pro-cyclical manner during the crisis, they were no more so than Wall Street firms. Nor were SWFs necessarily created to play a counter-cyclical role, so critiquing them for not acting in a stabilizing manner may be disingenuous.

SWFs, of themselves, need not be seen as a threatening development. Truman noted that most SWFs do not take controlling stakes in corporations. For instance, Russian SWFs invest only in bonds.

While questions about SWFs remain, information flow has improved and there is considerably less mystery surrounding these funds today than there was a few years ago.

Accountability, Transparency and Compliance to the Santiago Principles

Both Truman and Behrendt summarized research they have conducted on SWF governance, accountability and transparency. Truman’s research included a scoreboard, constructed in order to develop a code of conduct for SWFs, which looks at 33 elements of accountability and transparency and includes all 53 existing SWFs.

• No fund scored a perfect score (100 percent) on each of the 33 elements. Norway and New Zealand get the top scores.
• Against a median score of 63, seventeen funds, including 6 non-pension funds, scored above 80. Eleven funds score better than the pension funds. Sixteen funds score below 35.
• There are 11 SWFs in the Gulf Region, including 6 in the United Arab Emirates. The average score for the Gulf States is just 32. Truman noted that Kuwait’s relatively strong performance, with a score of 63, at the sample median, is the result of lobbying by domestic constituencies, not international pressure.

Behrendt’s research focused on those SWFs which signed on to the Santiago Principles and examined why some SWFs comply better with them than others. The Principles require countries to establish a legal framework and to set objectives consistent with macroeconomic policies, develop a clear institutional framework and governance structure, and create an investment and risk management framework.

• For the purpose of his presentation, Behrendt clustered SWFs into four groups:
  1. highly transparent SWFs from industrialized economies.
  2. transparent SWFs from emerging economies.
  3. SWFs from countries with a high degree of geopolitical ambition.
  4. SWFs from the Arab world, which display low levels of transparency and governance standards
• No meaningful correlation exists between a country’s GDP per capita and the compliance of its SWFs. Similarly, an SWF’s year of establishment is not correlated with compliance.
• A SWF’s compliance correlates strongly with its country’s ranking in the Economist Intelligence Unit’s Democracy Index, suggesting that a country’s general approach towards transparency and accountability has an impact on compliance. SWFs from industrialized economies, such as Norway and New Zealand, are most compliant while those from the Arab world display low levels of both transparency and good governance.
• Behrendt and Truman both agreed that it is hard to assess compliance so soon after the Principles were passed in September 2008.
• Harris wondered if these are even the right standards to which SWFs should be held, and asked what exactly SWFs should be. Truman argued that more transparent, accountable funds will be better off in the long run, suggesting that Dubai’s recent troubles are partially due to the fund’s failure to be transparent.