In October 2008, the International Working Group of Sovereign
Wealth Funds (IWG) released a set of generally accepted principles
and practices (GAPP) for the conduct, governance, and
accountability of sovereign wealth funds (SWF).
First conceived in the 1950s by foreign governments as a means
to invest surplus foreign exchange earnings in the U.S. and markets
abroad, SWFs have been the subject of intense media and government
scrutiny after a flurry of investment deals in 2006 and 2007 caught
the public's eye. Because many SWFs lack transparency, critics have
been concerned that these government-owned investment vehicles
could be used to advance political, as well as economic,
agendas.
Some observers fear that rather than using SWFs as a means to
hold a diversified asset portfolio and earn a solid return on
investment, countries might use these funds to destabilize
financial markets, protect industries and companies, or even
expropriate technology. With little public information available on
most sovereign investors' financial objectives, countries-including
the U.S.-began to question the value of SWF benefits and whether
action should be taken against what may instead represent a threat
to their economic and national security.
In response to the rising threat of nations adopting barriers to
sovereign wealth investment, 26 countries with sovereign wealth
funds convened the IWG to collaborate with the International
Monetary Fund, the World Bank, and the OECD in drafting the GAPP
framework. The GAPP recommends 24 voluntary principles that,
if adopted, will enable countries to better manage their SWFs while
promoting investor confidence. Although the current financial
crisis has given SWFs a boost in popularity-these days nations are
happy to get capital from any source-the implementation of GAPP
practices should help prevent a return to the hostile investment
environment of the recent past.
During development of the GAPP, IWG nations collaborated with
policymakers from recipient countries. Consequently, these nations
were afforded a greater understanding of the real issues
surrounding sovereign wealth funds, which, in turn, allowed
participating countries to balance their open markets with national
security concerns. The GAPP should not only result in greater
transparency and sounder investment decisions in SWFs but also
mitigate the biggest threat to the world's economic and national
security-protectionist investment policies.
Sovereign Wealth and the GAPP
The U.S. Department of the Treasury defines a sovereign wealth
fund as a "government investment vehicle which is funded by foreign
exchange assets, and which manages those assets separately from the
official reserves of the monetary authorities." SWFs are
financed by surplus foreign exchange earnings from commodity
exports, balance of payments or government budget surpluses, and
foreign currency operations. These funds are generally established
as long-term investment vehicles designed to cover future
expenditures on pensions, smooth the effects of volatile commodity
prices on government revenue flows, or invest reserves.
Since 2000, the number of these state-owned funds has grown from
20 to almost 50 while managing an estimated $2.7-$3.2 trillion of
global assets. The size of these funds can be difficult to
estimate because governments are not required to disclose
information about the fund's assets, liabilities, or underlying
investment strategy. While such lack of information makes it
difficult to assess the impact such funds could have on the global
economy, even the higher estimate of $3.2 trillion is but a
fraction of global investment-conservatively estimated at around
$229 trillion in 2007.
GAPP Objectives
Although these funds represent only a relatively small share of
the total global financial market, the rise of sovereign wealth
funds carries implications for worldwide market stability,
corporate governance, and national interests. The GAPP helps to
address these concerns by establishing the following objectives for
SWFs :
- To invest in assets that deliver a rate of return on the basis
of sound economic and financial variables that appropriately
accounts for risk. Additionally, SWFs should implement transparent
governance structures that clearly establish the roles and
responsibilities-while enhancing the accountability-of management.
These objectives establish the importance of using economic rather
than political criteria as the foundation of an effective SWF
investment strategy.
- To comply with laws, regulations, and disclosure requirements
of the countries receiving SWF investment. This critical objective
identifies the important role that disclosure of a fund's
investment policy, asset allocation, approach to risk management,
and other financial data play in mitigating governments' and
markets' uncertainty about the purpose of that fund.
- To help maintain a stable global financial system and the free
flow of capital. By clearly stating the need and criteria for SWFs
to act as responsible players in the world's asset markets and to
promote sound macroeconomic and investment policies, the GAPP
addresses larger concerns regarding the distorting effect SWFs can
have on markets.
While market pressures are already working to prompt improved
transparency from some sovereign investors, GAPP guidance that
clearly describes methods of implementing good governance
practices, greater measures of accountability, and sound financial
investment strategies will help countries to structure and operate
their funds more effectively and responsibly. Equally as important,
these principles delineate a path for SWFs to ensure that their
investments do not distort or destabilize markets in a way that
reduces their return on investment or harms the economies in which
they invest.
Moreover, the IWG/IMF process promoted meaningful debate and
research about sovereign wealth funds. As a result, participating
nations gained an increased understanding of SWFs' impact on U.S.
and world markets in addition to sovereign investors themselves.
This forum should remain active, providing a means to discuss the
effectiveness and impact of the GAPP on SWF management and to
address new concerns that may arise from global debate on
international financial regulation or from countries receiving new
sovereign wealth investment. Keeping channels open for cooperation
will make it easier for nations to stand firm against implementing
protectionist barriers against foreign investment.
The Ties That Bind
The rise of sovereign wealth funds carries implications for
global financial market stability and the national interests of
countries receiving these funds. Newly released principles should
help to ensure that SWFs are managed effectively, make sound
investment decisions, and are more transparent. As the
collaborative process to establish the GAPP indicates, the growing
trade and investment ties that bind the economies of the world
together are more likely to promote responsible economic behavior
than to entice mayhem. Investment is about creating wealth, not
destroying it. Erecting barriers to foreign investment would stifle
that creative process, leaving all countries poorer.
Daniella Markheim is Jay Van Andel Senior Trade Policy Analyst
in the Center for International Trade and Economics at The Heritage
Foundation.