Sovereign Wealth Funds

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  • 1. Sovereign Wealth Funds Date: 12062008 Second year MiM Stream 2 Group A2

2. Executive summary Group A2 International financial marketsCurrent impact of SWF on financial markets SWFs managing the foreign assets of national states have become a significant class of global investors, with assets between $2 and 3 trillion. Sustained accumulation of foreign assets could transform several SWFs into important market players as their financial assets under management could soon exceed those of the largest private asset managers and pension funds. The policy issues arising from the emergence of SWFs as large global financial players range from concerns over a lack of transparency and a reversal in privatizations to risks to global financial stability. For example, SWFs could contribute to an unwinding of global imbalances through a diversification out of US dollar- denominated government bonds in which the bulk of traditional reserves is invested. Another concern relates to the question of whether such funds might distort asset prices through non-commercially motivated purchases or sales of securities. Over the longer run, any impact of SWFs on global financial market structure and stability will depend critically on the motives underlying the investment decisions of such funds. While fully return and risk-motivated investments may affect financial stability rather positively due to the long-term investment horizon of such funds, non-commercial motives might have a negative impact on financial stability.2 3. Agenda Group A2 International financial markets II Assets under management and latest transactions III Where the wealth is coming from and how is it grown?IV Sources of SWFs' assets VInvestment objectives vs. Risk tolerance: a comparison of different SWFs VI Transparency rating and political issuesVII The role of SWFs during the last year in the financial markets VII Analysis of a commodity SWF: ADIA IX Analysis of a non commodity SWF: TemasekXWhat can be done to enhance SWFs in the future?3 4. Introduction Group A2 International financial markets Not a new concept Legal BasisDefinition1950 Today Kuwait Investment Boardwas set up with the aim of KIA Brunei Inv.Stabilization CIC Either SWFs are separate legal entitiesFund established under specific constitutive law or aAuthority $250 b, 1953$200 b, 2007investing surplusoil (Kuwait) $30 b, 1983$200 b, 2004 (China)revenues to reduce the(Brunei)(Russia) private corporation governed by company of Kuwait on itsTemasek Norway Govt. QIA Saudi Arabian Or they are not separate legal entities and arefinite oil resource.$108 b, 1974Pen. Fund $328 b, 1990 $60 b, 2005 Funds$250 b, 2007 managed as an agency within the government or (Singapore) (Qatar) Special purpose investment (Norway)(Saudi Arabia)by the central bank.funds or arrangementsKhazanah ADIA Future Fundowned by the general $875 b, 1976 Nasional BHD$42 b, 2006government; (UAE)$18 b, 1993(Malaysia) (Australia) whose purpose is to hold,manage, or administerGIC KICLIA $200 b, 1981$20 b, 2005$40 b, 2007assets to achieve financial(Singapore) (Korea)(Libya)objectives; employ investment World presencePrimary Objectivesstrategies which includeinvesting in foreignfinancial assets; Most SWFs are set up to provide savings for are commonly establishedfuture generations or fiscal stabilization or both.out of BOP surpluses, Their primary objective is long-term returns /official foreign currencyUnited States effective management of entrusted assetsAlaska Norwayoperations, privatization Russia IrelandFor some SWFs with future expectedCanada proceeds, fiscal surpluses Azerbaijan Kazakhstanexpenditures (i.e. pension reserve funds) theSouthand/or commodity exportUnited States KoreaKuwaitIranChinaBahrain receipts. MexicoLibyaQatar UAESaudi ArabiaOmanprimary objective is to provide for these futurecosts.Vietnam Trinidad and Tobago Venezuela Malaysia Brunei Sao Tom and Princip SingaporeKiribatiPolicy objectives are usually publicly disclosed Equatorial GuineaGabon Timor Leste Chile AngolaBotswanaAustraliaNew ZealandGenerally do not engage directly in macropolices. 4 5. Assets under management and latest transactionsGroup A2 International financial markets Global Financial Assets ($ T)SWFs are in Increasingly High Profile Sovereign Wealth Funds Transactions(SWFs)areaprominent investor classAsset Management Industry AUM$48,1with their assets rivalingGlobal Hedge Funds andRetirement Funds AUM $23,6 $9.75 b, Dec 07 $8.83 b, Nov 05 $7.5 b, Nov 07 $6.88 b, Jan 08Private Equity combined * Not all SWFs are createdProjected Sovereign Wealth Funds $7.5 - $10.0 equal as they lie along aspectrum of risk appetiteForeign Exchange Reserves $5,4 SWFs are hiring best-in- Sovereign Wealth Funds $3,0 China Investment China Investmentclass investment talents Corp Corp $5.19 b, Aug 07 $5.00 b, Dec 07$4.40 b, Dec 07 $3.00 b, May 07toserve long-term Hedge Funds AUM$1,9investment goals GovernmentsarePrivate Equity AUM $1,3 weighingperceivedthreats of SWFs against Assets Under Management($ b)potential benefits.Managing political risk inSWF-relatedtransactions is key 5 6. Where the wealth is coming from and how is it grown? Group A2 International financial marketsWorld current account balance trends ($ b) Surge in commodity prices Dramaticincrease incurrent account surpluses 1,200in Asia800 Willingnessofgovernments to allocate400 USmore funds from ForeignExchange Reservesto Euro0Sovereign Wealth FundsAsia 1997199920012003 2005 2007 A reallocation of excess -400 Oil exportersreserves would trigger netcapital outflows out of US -800assets at an order ofmagnitude of around USD -1,200500 billion The counterpart of these Global Current Account Balance 2007net outflows from theUnited States and the euroarea are mainly Japan andemerging economies, DeficitsSurplusesreflecting the relativelylarge weight of thesecountries in global capital Western Hemispheremarkets compared with $20BRussia /their negligible role asOtherAdvancedCIS reserve currencies.US $77BAsia (ex-$19B $784BJapan) Middle $480B C&EJapanEurozoneEastEurope$195B $227B$120B$21B Global Current Account Balance 2007 6 7. Sources of SWFs assets Group A2 International financial marketsOil exporting countries foreign investments SWFs of resource rich countries assets (% share, end-2007)CentralBanksHigh Net This group of countries that have established SWFs are reserveWorth100% having benefits from high oil and commodity prices. TheassetsIndividualfunction of SWF of these countries are: Total: USD 4,1 trillion 13%s 80% stabilizing government and export revenues which 39%60% would otherwise mirror the volatility of oil andcommodity prices.40%the accumulation of savings for future generations as20%natural resources are non-renewable and areanticipated to be exhausted after some time. 0% SWFs 48% Oil OtherOfficial foreign exchange reserves SWFs of FX currency rich countries % share, end-2007100%This group of countries, most notably in Asia, has established Asian official SWFs because reserves are being accumulated in excess of SWFsFX reserveswhat may be needed for intervention or balance-of-payment80% 19%not inpurposes. The source of reserve accumulation for theseSovereignWealthcountries is related to the management of inflexible exchange60%Funds rate regimes. As the authorities have become more 44%comfortable with reserve levels, foreign assets have been40% moved to specialized agencies which often have explicitreturn objectives and may invest in more risky assets than20% central banks.Total: USD 6,5 trillionRest ofworld0% official FXreservesFX Reserves Other37%7 8. Investment objectives vs. Risk tolerance: a comparison of different SWFsGroup A2 International financial markets Strategic Behaviors SWFs have undertaken LowRisk ToleranceHigh substantialinvestments Stabilization Cash across national borders / StrategicThe great majority of GovtFixedStakeRealHedge Private Leveraged sovereign fundsareExamplesBonds Income Equity BuildingEstate Funds Equity Buyouts passive investors. Russianunlike hedge funds andStabilization private equity funds, SWFsFund typically are not highlyInvestment Objective Norwegian leveraged institutions GovernmentThebulkofSWFPension Fund investments have been concentrated in developed Abu Dhabi Investment countries; Southern Authority countries (particularly in Asia) are a relatively newKuwait investment destinationInvestment Authoritysince SWFs have no explicitliabilities,they usually have a long-termTemasek investment horizon combined with a high Qatar tolerance for risk. TheyInvestment therefore tend to invest in Authority illiquid and higher-yielding risky instruments property and securities that are not actively traded WealthAccumulation 8 9. Transparency rating and political issuesGroup A2 International financial marketsHow to improve transparencyThe growing importance ofSWFs raises a numberinternational policy issues:Imposing reporting requirements on holdings thresholds State-controlled foreignApplying market integrity rules to govern insider investments may betrading, fiduciary responsibility, and the like sensitive both from aSubjecting investments in supervised financial political and economicalinstitutions (e.g., banks, insurance companies) to prudential rules perspective, as the lack of transparency of SWFsImposing possible restrictions or approval requirements on funds that attempt to increase holdings beyond causes concerns about some level the motivation of theseUsing special agencies to review investments based on fundsinvestments, national security considerations (e.g., Committee on aggravating protectionist Foreign Investments in the U.S.) pressures.Restricting investments based on national security or The G7 stated that any public order restrictions onSWF Subjecting investments in certain sectors of social investments should be importance to special laws minimized and only Scrutinizing SWFs for anti-