Some history of SWFs
At the height of the last boom, with the coming crash already visible for those who had eyes to see, the activities of several sovereign wealth funds (SWFs) were getting US senators in particular into a tizzy. The funds were clearly on a hunt for yield and had massive fire power. They were buying up chunks of household-name European and US companies. Hysteria and protectionism were in the air.
The International Monetary and Financial Committee (IMFC) decided to take the matter in hand and in October 2007 it came out with a statement about the necessity for further analysis of the key issues for investors and recipients of SWF capital flows, including the need for the formulation of a best practices standard. The various SWFs around the world were and are not run by idiots. They were as aware as anyone that an international mood was developing which was not exactly favourable to their activities, so there was considerable willingness in the SWF community to respond positively to the IMFC’s call.
Some months later, for two days, from April 30 to May 1 2008, a newly formed group called the International Working Group of Sovereign Wealth Funds (IWG) met in Washington DC to find a way of formulating a “Generally Accepted Principles and Practice” (GAPP) statement that both SWFs and developed markets would find appropriate. The International Monetary Fund (IMF) would form the secretariat for the IWG and the whole thing was jointly chaired by Hamad Al Hurr Al Suwaidi, the Undersecretary of the Abu Dhabi Finance Department, which controls the world’s biggest SWF, with over $900 billion, and by the IMF Monetary and Capital Markets Department Director, Jaime Caruana.
The IMF commissioned a voluntary SWF Survey on “current structures and practices in SWFs” and this formed the basis of the IWG’s work in drafting a GAPP for SWFs. At the same time the IWG listened closely to the views of “recipient countries”, i.e. the target countries which featured highest on the SWFs’ “hit list”. What emerged from all of this, not surprisingly, was a very clear message. Investment for financial gain is OK, that helps provide liquidity to markets and is, after all, what markets are about. Investment for political ends is not OK – OK?
A wee problem with the GAPP
What could the SWFs do? They had to say OK. And they did. The GAPP makes this explicit, setting out four “guideline objectives” for SWF investing. These are:
- To help maintain a stable global financial system and free flow of capital and investment
- To comply with all applicable regulatory and disclosure requirements in the countries in which they invest;
- To invest on the basis of economic and financial risk and return-related considerations;
- To have in place a transparent and sound governance structure that provides for adequate operational controls, risk management, and accountability.
Points one and two we can take as saying that SWFs are basically nice to have around and intend to play nicely. Point three is the cruncher. It specifically constrains SWF investing to the kind of thing that would be appropriate for a pension fund. It says that all investment should be based on the idea of financial reward for risks taken. And that is the only principle for SWF investing. Point four is about transparency and goes to the heart of the fear that was building up that SWFs were secret, manipulative engines of invasive destruction, chewing away at the fabric of developed markets for their own political ends.
What’s wrong with these four admirable principles? What is wrong with the GAPP, in a nutshell, is that it is simply repeating back to developed markets what developed markets want to hear. What it is leaving out of account, the unsung song, as it were, is the fact that SWFs are state-owned entities, which makes them political by their very nature. Viewed from this standpoint, the GAPP is an out-and-out attempt to placate target countries by making SWFs as akin to a vanilla pension fund or other returns-driven investment vehicle as possible. What they are in reality, of course, is a huge pot of money which can be used exactly as the politicians in the SWF’s home country decide, GAPP or no GAPP – and why wouldn’t they decide to use the SWF to further the interests of the home country?
This “masking” should be seen not so much as deliberate deceit, as an exercise in diplomacy. SWFs have realized, to an extent, that the climate of opinion is not generally in favour of Middle East petro dollars, for example, buying up all the crown jewels of Western industry – unless the SWF in question can present itself, say, as a white knight rescuing an ailing US bank or multinational. The climate of opinion is also, very strongly, not in favour of SWFs buying resources and access to resources on a grand scale. Part two looks at how the GAPP plays when viewed in the context of this far more strategic - and far less pension fund like – use of SWF purchasing power.
Further reading on SWFs and asset allocation:
- Forget Sovereign Wealth Funds, by Diana Choyleva
- Sovereign wealth funds get back to basics, by Anthony Harrington (blog)
- Sovereign Wealth Funds—Profiles of the Top 10 Players, QFinance Checklist
Tags: capital flows , GAPP , IMF , risk reward , Santiago Principles , sovereign wealth funds , SWFs