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Sunday, 4 December 2011

Should the strategies of Sovereign Wealth Funds be a subject of regulation?

 

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George Osborne, the Chancellor of the Exchequer of the UK delivered financial statement on Tuesday 29 November, 2011. He announced about the extended Government's enterprise finance guarantee scheme for businesses with annual turnover of up to £44 million. The ceilings were set of £40 billion. The Chancellor also introduced a newly launched National loan guarantee scheme for new loans and overdrafts to businesses with turnover of less than £50 million. The initial £20 billion – worth fund for national loan guarantees will be available within the next two years and it is expected that those guarantees will let to reduce the borrowing interest rates by 1 percentage.

Moreover, along these measures innovative solutions to launch £1 billion business finance partnership was presented. The partnership with other investors such as pension funds and insurance companies could enable the Government to invest in funds those lend directly to mid-sized businesses. Similarly, over 500 investment infrastructure projects to support economic development were identified first time. Alongside the Government guarantee schemes and traditional fund rising through borrowing, the Government had negotiated an agreement with two groups of British pension funds which unlocked an additional £20 billion of private investment for implementation of infrastructure projects.

The Government’s launched partnerships with investors aimed to facilitate funding for development of domestic businesses suggest the following: is it a rudiment of the Sovereign Wealth Fund?

In general, Sovereign Wealth Funds are founded from central bank’s reserves those are accumulated as a result of budget and trade surpluses. Additionally, SWF may be set from the revenues received from the exports of natural resources. The purpose of established SWF may vary. Some of them possess objectives to stabilize the budget and the economy from excessive volatility and intend to diversify the sources of revenues. Others have goals to reduce excessive domestic liquidity and invest in higher return assets. The rest may have political strategies which are aimed to increase savings for future generations or fund domestic social and economic development projects.

Though Sovereign Wealth Funds tend to have longer-term investment horizons, the research made in 2008 revealed that seven least transparent Sovereign Wealth Funds were estimated to account for the half of all holdings. Thus, lack of accountability and transparency evoked concerns whether asset prices could be distorted through non-commercially motivated purchases. (The source: ECB, Occasional Paper Series, No 91/July 2008, The impact of sovereign wealth funds on global financial markets prepared by Roland Beck and Michael Fidora).

Some protective regulations against purely political investment decisions of Sovereign Wealth Funds were mentioned in the draft of Rethinking Global Investment Regulation in the Sovereign Wealth Funds Era prepared by the Dr. Efi Chalamish (02/09/09). Foreign investment may be blocked by national regulations if investment is classified as government-owned entity. Countries may also prohibit foreign investment based on the type of industry in which the invested company operates. Moreover, an individual acquisition may be screened and decisions could be made according to the commercial value and associated risks. Additionally, adopted open market policies could be pursued to ensure that made investment do not serve only to the single foreign country.

Analysing International Economic Law, it could be mentioned the Santiago Principles suggested in 2008. The aim of these principles is to protect state’s interests and increase SWFs’ transparency and accountability. The principles were prepared by the IMF jointly with the World Bank and proposed to adapt on voluntarily bases. However, the other set of rules to avoid adaption of any protectionist measures and be opened to markets policies were created and accepted voluntary by the OECD which represents states of the leading developed economies.

 

According to the Sovereign Wealth Fund Institute’s data, the 54 SWFs managed over $4.76 trillion in September 2011. The 58% of total funds were set up from oil & gas related sources. The largest owners of the Sovereign Wealth Funds by the region is Asia with 40% of total assets, the second largest region is the Middle East with 35% of total assets and 17% belong to Europe.

The 2011 Pregin Sovereign Wealth Fund Review disclosed that the financial assets under SWF’s management grew about 11% during each several years. Consequently, the rising Sovereign Wealth Funds play bigger role in rebalancing of capital flows.

The influence of the Sovereign Wealth Funds on the financial markets and improved regulations may be explored further. However, my attention is already turned on their investment strategies. The Pregin Sovereign Wealth Fund Review reveals that the Investment Portfolio division of Hong Kong Monetary Authority’s Exchange Fund has plans to move into hedge fund investment, having diversified into investments in emerging markets, private equity funds and overseas property in 2010 as a means of increasing returns while Norway’s Government Pension Fund – Global, one of the largest SWFs in the world, is set to complete its first real estate investment in early 2011 and plans to make further investments in the asset class over the course of the year.