Sovereign Wealth FundsSovereign Wealth Funds

Date: 12\06\2008Second year MiM Stream 2Group A2

2

Group A2 International financial

markets

Executive summaryExecutive summary

Current impact of SWF on financial marketsCurrent impact of SWF on financial markets

p 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.

p 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.

p 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.

p Another concern relates to the question of whether such funds might distort asset prices through non-commercially motivated purchases or sales of securities.

p 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.

3

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

V Investment objectives vs. Risk tolerance: a comparison of different SWFs

VI Transparency rating and political issues

VII 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: Temasek

X What can be done to enhance SWF’s in the future?

AgendaAgenda

4

Group A2 International financial

markets

IntroductionIntroduction

World presenceWorld presence

Definition

p “Kuwait Investment Board was set up with the aim of investing surplus oil revenues to reduce the reliance of Kuwait on its finite oil resource”.

p Special purpose investment funds or arrangements owned by the general government;

p whose purpose is to hold, manage, or administer assets to achieve financial objectives;

p employ investment strategies which include investing in foreign financial assets;

p are commonly established out of BOP surpluses, official foreign currency operations, privatization proceeds, fiscal surpluses and/or commodity export receipts.

Bahrain

UAE

Malaysia Brunei Singapore Kiribati

Norway

Kuwait China

Russia

QatarLibya

United StatesAlaska

Ireland

South Korea

Canada

Chile

Iran

Australia

New Zealand

Angola

Botswana

Mexico

Azerbaijan Kazakhstan

Sao Tomé and PrincipéEquatorial Guinea Gabon

Trinidad and TobagoVenezuela

Timor Leste

United States

Saudi ArabiaVietnamOman

Not a new conceptNot a new concept

KIA$250 b, 1953

(Kuwait)

Temasek$108 b, 1974(Singapore)

ADIA$875 b, 1976

(UAE)

GIC$200 b, 1981(Singapore)

Brunei Inv.Authority

$30 b, 1983(Brunei)

Norway Govt.Pen. Fund

$328 b, 1990(Norway)

KhazanahNasional BHD

$18 b, 1993(Malaysia)

QIA$60 b, 2005

(Qatar)

KIC$20 b, 2005

(Korea)

Future Fund$42 b, 2006(Australia)

CIC$200 b, 2007

(China)

LIA$40 b, 2007

(Libya)

StabilizationFund

$200 b, 2004(Russia)

Saudi ArabianFunds

$250 b, 2007(Saudi Arabia)

1950 Today

Legal BasisLegal Basis

p Either SWFs are separate legal entities established under specific constitutive law or a private corporation governed by company law.

p Or they are not separate legal entities and are managed as an agency within the government or by the central bank.

Primary ObjectivesPrimary Objectives

p Most SWFs are set up to provide savings for future generations or fiscal stabilization or both. Their primary objective is long-term returns / effective management of entrusted assets

p For some SWFs with future expected expenditures (i.e. pension reserve funds) the primary objective is to provide for these future costs.

p Policy objectives are usually publicly disclosed

p Generally do not engage directly in macro polices.

5

Group A2 International financial

markets

Assets under management and latest transactionsAssets under management and latest transactions

p Sovereign Wealth Funds (“SWFs”) are a prominent investor class with their assets rivaling Global Hedge Funds and Private Equity combined

p Not all SWFs are created equal as they lie along a spectrum of risk appetite

p SWFs are hiring best-in-class investment talents to serve long-term investment goals

p Governments are weighing perceived threats of SWFs against potential benefits. Managing political risk in SWF-related transactions is key

$48,1

$23,6

$5,4

$3,0

$1,9

$1,3

$7.5 - $10.0

Asset Management Industry AUM

Retirement Funds AUM

Projected Sovereign Wealth Funds

Foreign Exchange Reserves

Sovereign Wealth Funds

Hedge Funds AUM

Private Equity AUM

Global Financial Assets ($ T)Global Financial Assets ($ T)

Assets Under Management($ b)Assets Under Management($ b)

$9.75 b, Dec 07 $8.83 b, Nov 05 $7.5 b, Nov 07 $6.88 b, Jan 08

*

SWFs are in Increasingly High Profile TransactionsSWFs are in Increasingly High Profile Transactions

$5.19 b, Aug 07

China InvestmentCorp

$5.00 b, Dec 07 $4.40 b, Dec 07

China InvestmentCorp

$3.00 b, May 07

6

Group A2 International financial

markets

Where the wealth is coming from and how is it grown? Where the wealth is coming from and how is it grown?

Global Current Account Balance 2007Global Current Account Balance 2007

p Surge in commodity prices

p Dramatic increase in current account surpluses in Asia

p Willingness of governments to allocate more funds from Foreign Exchange Reserves to Sovereign Wealth Funds

p A reallocation of excess reserves would trigger net capital outflows out of US assets at an order of magnitude of around USD 500 billion

p The counterpart of these net outflows from the United States and the euro area are mainly Japan and emerging economies, reflecting the relatively large weight of these countries in global capital markets compared with their negligible role as reserve currencies.

1997 1999 2001 2003 2005 2007

-1,200

-800

-400

0

400

800

1,200

US

Euro

Asia

Oil exporters

World current account balance trends ($ b)World current account balance trends ($ b)

Global Current Account Balance 2007Global Current Account Balance 2007Global Current Account Balance 2007

Deficits Surpluses

Western Hemisphere

Asia (ex-Japan) $480B

Asia (ex-Japan) $480BMiddle

East $227B

Middle East

$227B

Japan $195BJapan $195B

Russia / CIS

$77B

Russia / CIS

$77B

Other Advanced

US$784B

US$784B

C & E Europe$120B

C & E Europe$120B

Eurozone

$20B$20B

$21B$21B

$19B$19B

7

Group A2 International financial

markets

Sources of SWFs’ assetsSources of SWFs’ assets

SWFs of resource rich countriesSWFs of resource rich countries

This group of countries that have established SWFs are having benefits from high oil and commodity prices. The function of SWF of these countries are:p stabilizing government and export revenues

which would otherwise mirror the volatility of oil and commodity prices.

p the accumulation of savings for future generations as natural resources are non-renewable and are anticipated to be exhausted after some time.

High Net Worth

Individu-als

39%

SWFs48%

Central Banks

reserve assets13%

Chart Title

0%

20%

40%

60%

80%

100%

Oil Other

Oil exporting countries’ foreign investments assets (% share, end-2007)Oil exporting countries’ foreign investments assets (% share, end-2007)

SWFs of FX currency rich countriesSWFs of FX currency rich countriesOfficial foreign exchange reserves% share, end-2007Official foreign exchange reserves% share, end-2007

This group of countries, most notably in Asia, has established SWFs because reserves are being accumulated in excess of what may be needed for intervention or balance-of-payment purposes. The source of reserve accumulation for these countries is related to the management of inflexible exchange rate regimes. As the authorities have become more comfortable with reserve levels, foreign assets have been moved to specialized agencies which often have explicit return objectives and may invest in more risky assets than central banks.

Asian official FX reserves not in Sov-

ereign Wealth Funds44%

Rest of world official FX reserves

37%

SWFs19%

Chart Title

0%

20%

40%

60%

80%

100%

FX Reserves

Other

Total: USD 6,5 trillion

Total: USD 4,1 trillion

8

Group A2 International financial

markets

Investment objectives vs. Risk tolerance: a comparison of different SWFsInvestment objectives vs. Risk tolerance: a comparison of different SWFs

Stabilization

Risk Tolerance

Investm

en

t O

bje

cti

ve

Examples

Cash /

Gov’t Bond

sFixed

Income Equity

Strategic Stake

BuildingReal

EstateHedge Funds

Private Equity

Leveraged

Buyouts

Russian Stabilization Fund

Norwegian Government Pension Fund

Abu Dhabi Investment Authority

Kuwait Investment Authority

Temasek

Qatar Investment Authority

Low

Wealth Accumulation

High

Strategic Behaviors

p SWFs have undertaken substantial investments across national borders

p The great majority of sovereign funds are passive investors.

p unlike hedge funds and private equity funds, SWFs typically are not highly leveraged institutions

p The bulk of SWF investments have been concentrated in developed countries; Southern countries (particularly in Asia) are a relatively new investment destination

p since SWFs have no explicit liabilities, they usually have a long-term investment horizon combined with a high tolerance for risk. They therefore tend to invest in illiquid and higher-yielding risky instruments property and securities that are not actively traded

9

Group A2 International financial

markets

Transparency rating and political issuesTransparency rating and political issues

The growing importance of SWFs raises a number international policy issues:p State-controlled

foreign investments may be sensitive both from a political and economical perspective, as the lack of transparency of SWFs causes concerns about the motivation of these funds’ investments, aggravating protectionist pressures.

p The G7 stated that any restrictions on SWF investments should be minimized and only “apply to very limited cases which primarily concern national security”.

How to improve transparencyHow to improve transparency

p Imposing reporting requirements on holdings thresholds

p Applying market integrity rules to govern insider trading, fiduciary responsibility, and the like

p Subjecting investments in supervised financial institutions (e.g., banks, insurance companies) to prudential rules

p Imposing possible restrictions or approval requirements on funds that attempt to increase holdings beyond some level

p Using special agencies to review investments based on national security considerations (e.g., Committee on Foreign Investments in the U.S.)

p Restricting investments based on national security or public order

p Subjecting investments in certain sectors of social importance to special laws

p Scrutinizing SWFs for anti-monopoly or take-over restrictions

It is possible to classify SWFs by analyzing 4 their main features:p Structure (information about funds provenience, goals, strategy, fiscal treatment, separation from national reserves)p Governance (role of government and management, presence of corporate responsibility policies,p Transparency and Accountability (annual and quarterly report, information on investments and their returns)p Behavior (information on the speed and nature of change of strategy caused by market changes)

How to evaluate a SWF: the Truman’s scoreboardHow to evaluate a SWF: the Truman’s scoreboard

10

Group A2 International financial

markets

The role of SWFs during the last year in the financial marketsThe role of SWFs during the last year in the financial markets

p At the beginning of 2007 Western banks were the undisputed leaders of global finance.

p ABN AMRO was bought by a consortium of leading European banks led by RBS

p Barclays escaped to be nationalized it now has a consortium of government affiliated investment vehicles from Qatar and UAE as its controlling shareholder.

p Citigroup has received numerous capital injections from SWFs in Asia and the Middle East.

p The central role these large financial intermediaries has been taken over by governments and SWFs

p They have provided the lifeline without which many of these intermediaries, and indeed the global financial system, may well have collapsed.

11

Group A2 International financial

markets

Analysis of a commodity SWF: ADIAAnalysis of a commodity SWF: ADIA

HistoryHistory Where does it take funds from?Where does it take funds from?

p Established in 1976 as a replacement of the Financial Investments Board created in 1967 part of the then Abu Dhabi Ministry of Finance.

p It is rumored to be the largest of the Sovereign Wealth Funds.

p It is wholly owned and subject to supervision by the government of Abu Dhabi.

p The fund is an independent legal identity with full capacity to act in fulfilling its statutory mandate and objectives.

p The Abu Dhabi National Oil Company (ADNOC) and its subsidiaries pay a dividend to help fund ADIA and its sister fund Abu Dhabi Investment Council (ADIC)

p About receiving 70% of any budget surplus is sent to ADIA, while the other 30% of surplus goes to the Abu Dhabi Investment Council (ADIC).

Main featuresMain features

Assets under management: USD 627 billionOrigin: OilEntity structure: FundFirm investment style: Mixed*Transparency rating: 3

De

ve

lop

ed

Eq

uit

ies

Em

erg

ing

ma

rke

ts e

qu

itie

s

Sm

all

cap

eq

uit

ies

Go

ve

rne

me

nts

bo

nd

s

No

n g

ov

ern

me

nts

bo

nd

s

Alt

ern

ati

ve

Inv

est

me

nts

Re

al E

sta

te

Pri

va

te E

qu

ity

Infr

ast

ruct

ure

Ca

sh

0%

10%

20%

30%

40%

50%

Asset classes

Investments by assets classesInvestments by assets classes

12

Group A2 International financial

markets

Analysis of a non commodity SWF: Temasek (1 of 2)Analysis of a non commodity SWF: Temasek (1 of 2)

Shareholders returnShareholders return Investment strategyInvestment strategy

p Transforming Economies   - We invest in industry sectors that correlate with the economic transformation of   the country    

p Growing Middle Class   - We find opportunities in companies and industries whose growth is fuelled by the   increasing purchasing power of the middle class    

p Deepening Comparative Advantages   - We tap the potential of competitively-positioned companies    

p Emerging Champions   - We identify companies proving to be best-in-class, be it regionally or globallyMain featuresMain features

Assets under management: USD 85 billion

Origin: Non commodity

Entity structure: Corporate

Firm investment style: Portfolio

Transparency rating: 10

Moody’s rating: Aaa

Investments by assets classesInvestments by assets classes

13

Group A2 International financial

markets

Analysis of a non commodity SWF: Temasek (2 of 2)Analysis of a non commodity SWF: Temasek (2 of 2)

Attributes

p The success of the Singapore model can be ascribed to its proactive investment style that emanates from aligning its investment strategy with its socioeconomic strategy.

p They are run on a commercial basis receiving no special privileges because they are state-owned. Government ownership is exercised through Temasek Holdings, a state company, whose board members and chairman are appointed, and performance-based rewards are sanctioned, by government

p Temasek Holdings-managed state enterprises account currently for about 60 percent of Singapore’s GDP.

14

Group A2 International financial

markets

What can be done to enhance SWF’s in the future?What can be done to enhance SWF’s in the future?

Transfer Knowledge through Investments

Transfer Knowledge through Investments

Mitigate Economic DownturnsMitigate Economic Downturns

Enhance Regional and International Cooperation

Enhance Regional and International Cooperation

Leverage SOEsLeverage SOEs

p Support of local economic growth strategies through international and domestic investments.

p International investments the understanding of new business models, operations, and strategies.

p Investments in multinational corporations help bring in sought-after technologies and knowledge

p Use their wealth in slow economic times to spur economic growth and maintain funding of critical strategic investments.

p Norway’s SWF, for example, is supporting infrastructure projects in light of the global financial crisis in order to sustain Norway’s economic growth.

p Establishment of joint funds both at the regional and at the international levels.

p Regionally, benefits from joint funds include sharing of risk and increased investment opportunities.

p Internationally, joint funds can facilitate market penetration and enhance knowledge transfer mechanisms.

p State owned enterprises dominate the economies

p Opportunities may exist to manage groups of SOEs under one holding.

p This will allow governments to reap important business synergies, as well as economies of scale and scope.

15

Group A2 International financial

markets

Thank for your attentionThank for your attention