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Sovereign Wealth Funds: political they are, political they stay. Part 2

SWFs | Sovereign Wealth Funds: political they are, political they stay. Part 2 Anthony Harrington

Part 1 covered the origins of the Sovereign Wealth Fund GAPP (Generally Accepted Principles and Practice, also known as “the Santiago Principles”) which was issued in 2009. The opening blog on this theme looked at the pressures on SWFs to present themselves as pure investment vehicles driven by the usual risk returns investment criteria. However, part 1 ended by reaffirming the fact that SWFs are state-owned entities with a mission that can extend well beyond simply generating decent returns.

The GAPP itself recognizes this, though it does its best to downplay “extra-curricular” activities. GAPP Sub-principle 19.1 states: “If investment decisions are subject to other than economic and financial considerations, these should be clearly set out in the investment policy (of the SWF) and be publicly disclosed” – yes, sure. Notice the ambiguity here. When exactly, is an investment by a SWF not about returns but solely about furthering some strategic interest of the “owner”, i.e. the government concerned? If China’s SWF buys a £1 billion stake in, say, the Mozambique coal sector, that can be viewed both as a sound investment decision and as a very good way of securing coal reserves for China’s power-hungry economy. In fact, arguably every significant investment a SWF makes in an industry outside of its own domestic borders extends the economic footprint of the country which set up the SWF.

The inherent politics of SWFs

In addition to being a handy, less obvious way for a resource-rich developing economy to target strategic assets, SWFs serve two other purposes that are quintessentially political in nature. They are about safeguarding the wealth the country is accumulating by depleting its natural resources, for generations to come. Those generations will not have the resources, which will have been largely sold off, but at least they’ll have a share in the wealth that was created. Second, by investing abroad in assets denominated in a foreign currency, the SWF enables its home country to sterilize foreign fund flows generated from the sale of the natural or agricultural resource. Instead of flooding the home country a significant proportion of those funds can be channeled back out for foreign investment through the SWF.

This is generally, of course, no bad thing, either for the home country or for foreign markets abroad where the SWF invests. This is also the same thing as saying that there need not be any particular harm in a SWF behaving in something other than a purely investment and returns driven fashion. Of course, if a particular SWF set out to amass a very significant stake in a key market, such as aerospace or IT, or looked like becoming a dominant factor in such a market there would be a huge outcry. The more low profile a SWF attempted to be in entering what advanced economies would regard as sectors of strategic importance to them, the more of a stink there would be when its activities were discovered.

Call for greater transparency and openness

This, ultimately, is the anxiety that the Santiago Principles are designed to address. The principles put transparency, good governance and regular reporting high up the agenda, which is all to the good, but it does not eliminate the fact that SWFs are quasi-government entities. On May 10-12 this year the International Forum for Sovereign Wealth Funds had its third annual meeting in Beijing, where a review of SWF progress in implementing the Santiago Principles was one of the main items on the agenda.

The review found that SWFs were “generally pursuing pragmatic and commercially orientated investment strategies”. Members had seen real benefits in terms of greater trust out there in the wider community from more transparency by SWFs and in the interests of greater transparency Forum members committed to publishing a report of SWF operations on the Forum website by July 2011. That report will be keenly scrutinized, as will the outcome of the decision by Forum members to look at how SWFs, as long-term investors, can play a “countercyclical role in providing global financial and economic stability”. What is clear is that the SWFs are now a highly sophisticated investor class with an intriguing and developing sense of having interests in common. Definitely one to watch, particularly in the light of the Forum’s Beijing Communique, which urges “recipient countries to utilize the Santiago Principles to maintain openness towards foreign investment, and to guard against discrimination (against) SWFs compared to other institutional investors…”  The next meeting of the Forum is scheduled for May 2012, in Mexico.

Further reading on SWFs:

Tags: GAPP , Santiago Principles , sovereign wealth funds , SWFs
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