Sovereign Wealth Funds: Threat or Salvation? (Peterson Institute for International Economics - Publication)

This study examines the role of sovereign wealth funds (SWFs) in the global economy and financial system. Sovereign wealth funds are not a new phenomenon in international finance. Governments of a few countries have used similar entities to manage their international financial assets for several decades. Moreover, countries have always held international reserves, and government-owned entities have made cross-border investments for many years. Sovereign wealth funds or their equivalent pose profound issues for the countries that own them with respect to macroeconomic policy and the potential for corruption. They also raise issues for countries that receive SWF investments as well as for the international financial system as a whole because government ownership introduces potential political and economic power issues into the management of these cross-border assets. This study traces the origins of SWFs. It describes the issues raised by these large governmental holdings of cross-border assets for the countries that own them, for the host countries, and for the international financial system. The study lays out what is known about the 50-plus SWFs of various countries. Some countries have more than one such entity, and a sample of government-managed pension funds is included in this analysis because they raise most of the same basic policy issues. Using publicly available information that is provided on a systematic basis, the author has previously developed a "scoreboard" for these funds involving a number of elements grouped in four categories: structure, governance, transparency and accountability, and behavioral rules. The 2008 edition contributed to the development of a set of generally accepted principles and practices, the Santiago Principles, for SWFs by the International Working Group operating under the auspices of the International Monetary Fund. This publication presents an updated scoreboard for an expanded list of funds, evaluates the Santiago Principles, and examines current compliance with those principles. The study also examines the policies of recipient countries and the role of the Organization for Economic Cooperation and Development (OECD) investment codes. Finally, the study discusses the evolving role of SWFs in the context of the global economic and financial crisis and its aftermath and will make recommendations for the policies of countries both managing such funds and those that expect to receive investments from them in the future. Cover 1 Contents 6 Preface 10 Acknowledgments 14 Ch 1 Sovereign Wealth Funds and the Global Economy 16 Sovereign Wealth Funds and the Global Financial Crisis 18 Response to Sovereign Wealth Funds 20 Structure of the Book 21 Ch 2 What Are Sovereign Wealth Funds? 24 What, When, and How? 24 Potential for Growth 38 Sovereign Wealth Funds and the International Financial System 45 Ch 3 Issues and Concerns 50 Mismanagement of Investments 51 Pursuit of Political or Economic Power Objectives 55 Financial Protectionism 59 Market Turmoil and Uncertainty 61 Conflicts of Interest 67 Concluding Comments 71 Ch 4 Possible Policy Responses to Sovereign Wealth Funds 72 Comprehensive Regulation 73 Prohibition of Specific Investments 76 Limitations on Investment Activities 78 Reciprocal Arrangements 80 Ch 5 Accountability and Transparency: The Sovereign Wealth Fund Scoreboard 84 The Scoreboard 86 Elements of the Scoreboard 93 Evidence of Progress 104 Comparison with Other Indices and Indicators 109 Arguments against the Scoreboard Approach 114 The Scoreboard and Concerns about Sovereign Wealth Funds 119 Appendix 5A Scoreboard for Sovereign Wealth Funds 121 Ch 6 The Santiago Principles 136 International Working Group 136 Assessment of the Santiago Principles 139 Discussion of the Santiago Principles 149 Next Steps 152 Ch 7 Host-Country Responses to Sovereign Wealth Funds 164 OECD Response 165 Assessment of Collective Actions 167 Actions by Individual Countries 169 Reciprocal Responsibility 174 Ch 8 The Future for Sovereign Wealth Funds 176 Upgrading the Santiago Principles 179 Augmented Reciprocal Responsibility 180 Improving Data Collection and Related Disclosures 181 A Comprehensive Investment Framework as the Ultimate Goal 183 References 184 Index 194 Sovereign wealth funds (SWPs)--investment funds overseen by one nation, funded by its foreign currency reserves but managed separately from official currency reserves--are not a new phenomenon in international finance. But recently, they have become a reoccurring headline and a topic of great interest in international economics, due in part to their signficant impact on international markets. Total holdings of international assets by SWFs have grown to at least $3.5 trillion and international reserves--which can be used for similar purposes--have risen to nearly $7 trillion. Given their significant presence, SWFs can raise national security concerns aand questions about the integrity of investment practices. This timely book first traces the origins of SWFs and the buildup of international reserves. It then describes the potential political and economic power issues raised by these large holdings of cross-border assets for three entities: the countries that own them, host countries, and the international financial system. To evaluate the integrity of these funds: Truman presents an updated "scoreboard" of the funds; the "scoreboard" comprises 33 elements, which are divided into four categories: structure, governance, transparency and accountability, and behavioral rules. This ground-breaking "scoreboard" contributed to the development of a set of generally accepted principles and practices--the Santiago Principles--used by the International Monetary Fund. Finally, Truman discusses the evolving role of SWFs in the context of the global economic and financial crisis and its aftermath. This volume offers policy recommendations for countries that manage funds and those countries that expect to receive investments from them in the future Sovereign Wealth Funds: Threat or Salvation? Neither. How long have these large pools of government-owned or-controlled funds existed? More than five decades. How are they financed? Predominantly, but not exclusively, from excess accumulations of foreign exchange reserves, often derived from the export of natural resources. What issues do SWFs raise? Multiple concerns about globalization and the role of governments in today's world. What is needed to make the world safer for these funds? A quantum leap in their accountability and transparency according to the SWF scoreboard. Has progress been made over the past several years? Yes and the Santiago Principles are a good start, but countries that host SWF investments have been slow to reciprocate with more openness to foreign investment. How do SWFs fit into the international financial system of the 21st century? Awkwardly and, potentially, contentiously. This study by one of the pioneers of independent, policy-oriented research on sovereign wealth funds elaborates on these questions and answers