x Abu Dhabi, UAEMonday 22 January 2018

SWFs are sheep in wolves' clothing

For a brief moment sovereign wealth was seen by some western politicians as a threat to their economic independence.

David Murray, CEO of the Commonwealth Bank of Australia.
David Murray, CEO of the Commonwealth Bank of Australia.

Sovereign wealth funds (SWFs) were much in the news last year. As the first wave of the financial crisis hit, Gulf and Asian funds such as the Kuwait Investment Authority (KIA) and Singapore's Temasek, ploughed billions of dollars into recapitalising prominent Wall Street institutions such as Merrill Lynch and Citigroup. At the time, with oil riding high at more than US$100 a barrel, it seemed very much as if the balance of economic power was shifting rapidly eastward. Despite the fact that their combined value accounted for only a fraction of the size of other investor classes such as pension funds or insurers, there was a brief moment when sovereign wealth was seen by some western politicians as a considerable threat to their economic independence.

The steady steamroller of the global crunch has seen those fears substantially recede. A collapse in demand from manufacturing powerhouses such as China led to a slump in the price of oil last autumn, a downwards journey aided by the exit of speculators. Furthermore, as soon as it became apparent that the instability which began in financial institutions had infected other sectors of the economy, the size of the necessary fiscal response dwarfed the capacity of anything other than a government-led rescue. With the exception of Daimler, which received a $2.7 billion (Dh9.91bn) capital injection by selling a 9.1 per cent stake to Abu Dhabi's Aabar Investments in March, none of the recent major corporate bailouts has seen sovereign wealth riding the white horse.

As if to confirm the retreat of sovereign wealth from the basic international economic agenda, no mention of it was made in the concluding statement at the end of the Group of 20 (G20) summit of leading and emerging economies in London last month. According to German government sources, the omission was intentional. SWFs may no longer be in the spotlight but they have not gone away; moreover, the chain of events established by last year's backlash against sovereign wealth continues to play out. Following a degree of pressure from the US Congress and the EU, an International Working Group (IWG) of SWFs was established last October, under the auspices of the IMF. This group, which includes fund-holders such as the UAE as well as concerned inbound nations such as the US, published a series of investment guidelines called the "Generally Accepted Principles and Practices" (GAPP) - better known as the Santiago Principles after the city in which they were drawn up. The principles call for SWF investments to be based on "economic and financial grounds", and if not, for the alternative rationale to be clearly stated.

The wording of the accompanying statement to the principles claims they are intended to ensure transparency and accountability. Yet the decision to call the document a "voluntary code of principles", as opposed to a more binding code of conduct, is telling. According to Dr Sven Behrendt of the Carnegie Middle East Centre, a specialist in SWFs, the Santiago Principles "enable signatories to adhere to a standard, but without any monitoring or enforcement mechanisms". The result is what Dr Behrendt calls an "unsecure document" - an agreement which is not yet sufficient to prevent unilateral action further down the line from concerned governments of nations receiving inbound investments, if and when SWFs become a political issue once more.

While the Santiago Principles may, thus far, fall short of providing countries such as the US with the guarantees they would like, according to Dr Behrendt the procedure involved to agree upon them marks an innovative concept in global governance. "The IWG reflects a bottom-up approach towards regulation, and is one of the rare occasions when industrial and industrialising nations have come together on an equal footing to agree on a set of principles", he says. The contrast between the IWG and, for example, the Group of Seven (G7) or the Doha round of world trade talks is stark. Like SWFs themselves, the IWG represents an element of structural transition in the global economic system - one whereby the traditional power centres of the West are having to make room at the table for the growing financial clout of the East - a trend notably repeated at the G20 summit.

As if to confirm the permanence of this structural transition, the IWG is itself evolving into a permanent institution. Following the conclusion of its fourth meeting in Kuwait last month, the body announced it would form a permanent representative forum, with a secretariat to be staffed by the IMF. The forum will be chaired by David Murray, the head of Australia's Future Fund Board of Guardians, while Bader al Sa'ad of the KIA and Jin Liqun of the China Investment Corporation will serve as deputy chairmen. Its first meeting is planned to be held in Baku this October.

If early 2008 marked the high-water point of sovereign wealth in the media eye, what will be its ultimate long-term significance as a structural element in the global financial system? For example, does it represent as fundamental a shift in the balance of power as the creation of OPEC in the 1970s? Dr Behrendt presents three possible scenarios: first - and most pessimistic - oil prices remain so severe that funds are forced to liquidate their assets to inject liquidity domestically. This scenario would in effect mark the end of sovereign wealth as a market phenomenon. The second possibility is that SWFs remain essentially where they are, as smaller players compared with pension funds, but with the potential to create the occasional headline in sensitive markets. In this case, the permanent forum will be of most importance as a capacity building institution for the less-experienced SWFs.

The third possibility, however, is that economic recovery, and especially a recovery in the demand for commodities, results in SWFs becoming "super strong". It is in this final scenario where the Santiago Principles, and the permanent forum, will play a significant role in reconciling the concerns of inbound nations with the demands of investors. As it currently stands, achieving such a role still requires a considerable amount of work.

Oliver Cornock is regional editor of the Oxford Business Group