A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments. Sovereign wealth funds have gained world-wide exposure by investing in several Wall Street financial firms including Citigroup, Morgan Stanley, and Merrill Lynch. These firms needed a cash infusion due to losses resulting from the subprime mortgage crisis.
Some sovereign wealth funds are held solely by central banks, who accumulate the funds in the course of their fiscal management of a nation's banking system; this type of fund is usually of major economic and fiscal importance. Other sovereign wealth funds are simply the state savings which are invested by various entities for the purposes of investment return, and which may not have significant role in fiscal management.
The accumulated funds may have their origin in, or may represent foreign currency deposits, gold, SDRs and IMF reserve positions held by central banks and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings. These are assets of the sovereign nations which are typically held in domestic and different reserve currencies such as the dollar, euro and yen. Such investment management entities may be set up as official investment companies, state pension funds, or sovereign oil funds, among others.
There have been attempts to distinguish funds held by sovereign entities from foreign exchange reserves held by central banks. The former can be characterized as maximizing long term return, with the latter serving short term currency stabilization and liquidity management. Many central banks in recent years possess reserves massively in excess of needs for liquidity or foreign exchange management. Moreover it is widely believed most have diversified hugely into assets other than short term, highly liquid monetary ones, though almost no data is available to back up this assertion. Some central banks have even begun buying equities, or derivatives of differing ilk (even if fairly safe ones, like Overnight Interest rate swaps).
The term Sovereign wealth fund
was first used in 2005 by Andrew Rozanov in an article entitled, 'Who holds the wealth of nations?' in Central Banking journal. The previous edition of the journal described the shift from traditional reserve management to sovereign wealth management; subsequently the term gained widespread use as the spending power of global officialdom has rocketed upwards.
Most of the savings of SWFs originate in accumulated foreign currency reserves. These were formerly held only in gold, as official gold reserves. But under the Bretton Woods system, the United States pegged the dollar to gold, and allowed convertibility of dollars to gold. This effectively made dollars appear as good as gold. The U.S. later abandoned the gold standard, but the dollar has remained relatively stable as a fiat currency, and it is still the most significant reserve currency. In the 1990s and early 2000s, central banks began to hold ever more vast numbers of assets in multiple currencies. Given the sizes (beginning to surpass the total outstanding of domestic bond and stock markets), these amounts have been increasingly often invested in non-traditional banking assets by entities with a specific mission, set by the public authorities.
The traditional investment vehicles for sovereign wealth in the form of foreign currency reserves have been the debt instruments such as government bonds from the industrialized nations. The low returns on these investments, however, have prompted nations with excess foreign reserves to invest in equities to achieve a higher return. The expanded activities of the SWFs over the past several years as well as the increased amounts available to the funds have created concern that the SWFs can destabilize financial markets and the global economy if their investments are motivated by political rather than economic considerations.
Sovereign Wealth Funds have been around for decades but since 2000, the number of Sovereign Wealth Funds have increased dramatically. The first SWF was the Kuwait Investment Authority
, a commodity SWF created in 1953 from oil revenues before Kuwait even gained independence from Great Britain. According to many estimates, Kuwait's fund is now worth approximately $250 billion.
Another of the first registered SWFs is the Revenue Equalization Reserve Fund of Kiribati. Created in 1956 when the British administration of the Gilbert Islands in Micronesia put a levy on the export of phosphates used in fertilizer, the fund has since then grown to $520m .
Nature and purpose
SWFs are typically created when governments have budgetary surpluses and have little or no international debt. This excess liquidity
is not always possible or desirable to hold as money or to channel it into consumption immediately. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. To reduce the volatility of government revenues, counter the boom-bust cycles' adverse effect on government spending and the national economy or build up savings for future generations, SWFs may be created. One example of such a fund is The Government Pension Fund of Norway
Other reasons for creating SWFs may be economical, or strategic, such as war chests for uncertain times. For example, the Kuwait Investment Authority during the Gulf war managed excess reserves above the level needed for currency reserves (although many central banks do that now). The Government of Singapore Investment Corporation and Temasek Holdings are partially the expression of a desire to bolster Singapore's standing as an international financial centre. The Korea Investment Corporation has since been similarly managed.
Concerns about SWFs
There are several reasons why the growth of sovereign wealth funds is attracting close attention.
- As this asset pool continues to expand in size and importance, so does its potential impact on various asset markets.
- Some countries worry that foreign investment by SWFs raises national security concerns because the purpose of the investment might be to secure control of strategically-important industries for political rather than financial gain. These concerns have led the EU to reconsider whether to allow its members to use "golden shares" to block certain foreign acquisitions. Therefore, this strategy has largely been excluded as a viable option by the EU, for fear it would give rise to a resurgence in international protectionism. In the U.S., these concerns are addressed by the Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act of 1988, Pub. L. No. 100-418, § 5021, 102 Stat. 1107, 1426 (codified as amended at 50 U.S.C. app. § 2170 (2000)), as administered by the Committee on Foreign Investment in the United States (CFIUS).
- Their inadequate transparency is a concern for investors and regulators. For example, size and source of funds, investment goals, internal checks and balances, disclosure of relationships and holdings in private equity funds.
- SWFs are not nearly as homogeneous as central banks or public pension funds. However they do have a number of interesting and unique characteristics in common. These make them a distinct and potentially valuable tool for achieving certain public policy and macroeconomic goals.
Meetings & latest developments
- On 5 March 2008, a joint sub-committee of the U.S. House Financial Services Committee held a hearing to discuss the role of ‘Foreign Government Investment in the U.S. Economy and Financial Sector’. The hearing was attended by representatives of the U.S. Department of Treasury, the U.S. Securities and Exchange Commission, the Federal Reserve Board, Norway’s Ministry of Finance, Temasek Holdings and the Canada Pension Plan Investment Board.
- On August 20, 2008, Germany approved a law that requires parliamentary approval for foreign investments that endanger national interests. Specifically, it will affect acquisitions of more than 25% of a German company's voting shares by non-European investors; but the economics minister, Michael Glos, has pledged that investment reviews would be "extremely rare". The legislation is loosely modelled on a similar one by the U.S. Committee on Foreign Investments.
- On September 2-3, 2008, at a summit in Chile, the International Working Group of Sovereign Wealth Funds - consisting of the world's main SWFs - agreed to a voluntary code of conduct first drafted by IMF. They are also considering a standing committee to represent them in international policy debates. The 24 principles in the draft will be made public after being presented to the IMF governing council on October 11, 2008.
The OECD is currently drafting a parallel code of conduct for recipient countries of SWF investments.
Size of SWFs
Assets under management of SWFs increased 18% in 2007 to reach $3.3 trillion. Most of this growth stemmed from an increase in official foreign exchange reserves in some Asian countries and rising revenue from oil exports. There was also an additional $6.1 trillion held in other sovereign investment vehicles, such as pension reserve funds, development funds and state-owned corporations and $5.3 trillion in official foreign exchange reserves not held in other sovereign
The largest SWFs with assets over $100 billion are designated the Super Seven funds: Abu Dhabi Investment Authority (ADIA) ($875 billion); The Government Pension Fund of Norway ($350 billion); Government of Singapore Investment Corporation ($330 billion); Kuwait Investment Authority ($250 billion); China Investment Corporation ($200 billion); Singapore's Temasek Holdings ($159.2 billion); and the Stabilisation Fund of the Russian Federation ($158 billion).
As a proportion of GDP, the five largest funds are: Abu Dhabi Investment Authority, Brunei ($30 billion), Kuwait Investment Authority, Qatar Investment Authority ($60 billion) and Singapore's GIC. Smaller funds, such as those held by Azerbaijan, Trinidad & Tobago, Ecuador and Nigeria account for $0.1 trillion of the world's $2.2 trillion total of SWFs.
An important point to note is the SWF to Foreign Reserve Exchange Ratio which shows the proportion a government has invested in investments relative to currency reserves. According to the SWF Institute, most oil producing nations in the gulf have a higher SWF to Foreign Exchange Ratio - for example, the Qatar Investment Authority (5.89x) compared to the China Investment Corporation (.12x) - reflecting a more aggressive stance to seek higher returns.
Largest sovereign wealth funds
- Temasek Holdings does not consider itself a sovereign wealth fund and was excluded from an agreement between Singapore and the United States in 2008 requiring greater disclosure and transparency in transactions involving sovereign wealth funds. Only the Government of Singapore Investment Corporation was involved in the agreement.
Specific references and footnotes:
- * ExcessLiquidity.org: A blog about Sovereign Wealth Funds - News, Commentary, Analysis
- * SWF Institute Organization dedicated to Studying Sovereign Wealth Funds
- * Who holds the wealth of nations?, from State Street Corp.
- * Sovereign wealth funds brim with money from Reuters
- Peter Mandelson interview on sovereign wealth funds with PublicAffairsAsia - 18 August 2008
- The impact of sovereign wealth funds on global financial markets - European Central Bank, Occasional Paper No 91. July 2008.
- Linaburg-Maduell Transparency Index - Point system on grading sovereign wealth fund transparency
- Sovereign wealth funds and the 2500bn question, Financial Times, 25 May 2007
- Gulf states Sovereign wealth fund reserves swell, Financial Times, 31 May 2007
- The $2.5 trillion wave of cash heading our way, The Daily Telegraph, 16 July 2007
- Singapore's GIC: a tough act to follow, Reuters, 01 August 2007
- Sovereign Wealth Funds: The Need for Greater Transparency and Accountability, Peterson Institute for International Economics, 20 October 2007
- How big could sovereign wealth funds be by 2015, from Morgan Stanley
- The rise of sovereign wealth funds, coverage from 2006 - today. Includes outline of 6 of the top funds' investment strategies. Euromoney.,