Global Complications for Sovereign Wealth Funds

It is gradually becoming clear that western countries on the receiving end of Sovereign Wealth Fund money are going to be looking at more than whether they should allow takeovers and major investments from these national treasure troves. They will want to know if the funds are managed transparently and according to rules that meet the disclosure standards and independence from political pressures that are supposed to exist in the West.

The shape of things to come was laid out in testimony to the US Senate given by Edwin Truman, a senior fellow of the US-based Peterson Institute for International Economics. Truman is not an obvious promoter of protectionist causes, but he seems to have done more research into SWFs than anyone. In particular, he has focused not just on the size of the funds but how they are managed.

Truman sees one danger in the protectionist reaction of recipient countries and another in the problems created by investing countries if they mismanage their capital, as some have obviously done, or allow it to be inappropriately leveraged or become a source of corrupt acquisitions. There are broader dangers to a market-based international system when governments invest in order to obtain political rather than economic objectives.

Singapore has responded quickly to try to get back ahead of the curve. More transparency from the GIC was promised January 27 by its deputy chairman Tony Tan. In a rare interview Tan also offered Singapore's support for a a set of standards for SWFs which could help head off the raising of protectionist financial barriers. At the very least, Singapore hopes that by making the right noises it can at least be exempted from any future restrictions applied to bigger countries or those with more opaque management and objectives.

Most specifically Truman has devised a methodology for assessing the extent to which the funds meet four criteria: Structure, Governance, Behavior and Transparency and Accountability. His performance table has a maximum 25 points, 12 for transparency and accountability and the rest for structure, governance and behavior. At the top of the Truman table is New Zealand’s Superannuation Fund, with almost full marks of 24 points. It is closely followed by Norway, Timor-Leste, Alberta (Canada), Alaska (US), Australia, Azerbaijan and Chile. (The California Public Employees Retirement System (Calpers) rates 21.75 on the chart).

Meanwhile languishing almost at the bottom with 2.25 points is Singapore’s Government Investment Corporation (GIC), along with the funds of the United Arab Emirates (mainly Abu Dhabi) Brunei and Qatar. China is low on the scale too, in the company of the likes of Sudan, Iran and Venezuela. China is new to this business and with US$140 billion in recent injections from its foreign exchange reserves into the new China Investment Corporation fund, there are signs that the sheer size of its acquisitions – including of US financial institutions hoist on their own follies – is making a degree of transparency inevitable.

But if the likes of the GIC and Saudi Arabia’s Monetary Agency continue to acquire foreign assets on a large scale they will likely have to move towards the semi-transparency provided by Singapore’s Temasek Holdings, which scores an above-average 13.5 on the Truman scale. Although Temasek’s control – by the prime minister’s wife – hardly suggests independence, the transparency of most of its investments and the publication of fairly detailed balance sheets earns it good marks.

Transparency can be embarrassing for the governments controlling the funds if they show incompetent or dubious investment practices, or if funds have been used to disguise fiscal imbalances or create tax loopholes.(The Pacific island of Nauru squandered most of its nests egg and now that its phosphates are exhausted, it lives largely on charity)

Countries may also face pressure to be generally more forthcoming about the distinction between foreign exchange reserves and SWF holdings. Temasek is clear enough. It is an investment holding company with clearly-delineated local and foreign equity assets. However, the GIC is extraordinarily opaque. Truman estimates its size at between US$100 and US$330 billion depending on what proportion of the official foreign exchange reserves is included in the GIC total. All that is known is that GIC has a large but well-spread equity and real estate portfolio in addition to its holdings in foreign bonds and short term instruments.

The Saudi Arabia situation is even more opaque. Officially it does not have an SWF and its foreign exchange reserves are supposedly a mere $22 billion. But the Saudi Monetary Authority has another $259 billion in assets. The breakdown between is unknown. Billions more are also thought to be in funds controlled by the royal family.

Kuwait is another country with only small reserves ($20 billion) but $213 billion in assets held by the Kuwait Investment Authority, one of the oldest funds (dating to 1960) and partly transparent.

The name SWF covers a multitude of different types of funds. Australia and New Zealand Funds have local and foreign equity holdings which are broadly spread. Both countries are huge international debtors so their SWFs are of minor significance. Malaysia’s Khazanah was largely a product of the government’s need for corporate rescues at the time of the 1997 Asian crisis. Its assets are largely domestic. Most foreign investment by Malaysian state enterprises has been by the likes of Petronas rather than by SWFs.

The funds of Alaska and Alberta reflect state/province oil wealth and are not technically sovereign at all. On the other hand Taiwan has a Stabilization Fund in addition to its reserves of $256 billion – though most of that is thought to be in local assets and used to influence the stock market.

Russia too has a Stabilization Fund, of US$148 billion, but that is held in foreign assets as a cushion against an energy price collapse and accounts for part of its US$397 billion total reserves.

Some countries with high reserves at present such as India and Brazil also have large overseas debts and histories of sharp fluctuations in trade balances and capital flows. Talk of them creating significant SWFs are probably premature.

Hong Kong is never mentioned a having an SWF but its Exchange Fund has net assets of $140 billion, including about $20 billion in foreign equities.

At the end of the day, it will be easier for Singapore and Abu Dhabi, even if they do not become more transparent, to continue to buy in the West if only because they are small countries that are not seen as threats. (Their investments in Asian neighbors are another matter). Saudis and Kuwaitis may be allowed – so long as they also continue to keep their surpluses down by spending heavily on western armaments.

China is another matter. And Russia will become one too once it starts to use its wealth to buy non-energy assets abroad. (There is not much the West can do to stop it buying into its central Asian backyard and thereby strengthening its strategic position in gas supply to Europe as well as China).

Yet pressure is going to be on all these funds – and the new ones growing with oil wealth – to open up if they are to continue to have ready access to equity markets.