Sovereign wealth fund
Encyclopedia
A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial
asset
s such as stock
s, bonds
, property
, precious metal
s or other financial instruments
. Sovereign wealth funds invest globally. Some of them have grabbed attention making bad investments in several Wall Street financial firms including Citigroup
, Morgan Stanley
, and Merrill Lynch
. These firms needed a cash infusion due to losses resulting from mismanagement and the subprime mortgage crisis
. Most SWFs are funded by foreign exchange assets.
Some sovereign wealth funds may be held by a central bank
, which accumulates the funds in the course of its 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 that are invested by various entities for the purposes of investment return, and that may not have a significant role in fiscal management.
The accumulated funds may have their origin in, or may represent foreign currency
deposits, gold
, Special Drawing Rights
(SDRs) and International Monetary Fund
(IMF) reserve positions held by central bank
s and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings. These are asset
s of the sovereign nations that 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. Sovereign wealth funds can be characterized as maximizing long term return, with foreign exchange reserves 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 publicly 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 swap
s).
, a commodity SWF created in 1953 from oil revenues before Kuwait even gained independence from the United Kingdom
. According to many estimates, Kuwait's fund is now worth approximately $300 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.
There are two types of funds: saving funds and stabilization funds. Stabilization SWFs are created to reduce the volatility of government revenues, to counter the boom-bust cycles' adverse effect on government spending and the national economy. Savings SWFs build up savings for future generations. One such fund is the Government Pension Fund of Norway
. It is believed that SWFs in resource-rich countries can help avoid resource curse, but the literature on this question is controversial. Governments may be able to spend the money immediately, but risk causing the economy to overheat, e.g. in Hugo Chávez
's Venezuela or Shah-era Iran. In such circumstances, saving the money to spend during a period of low inflation is often desirable.
Other reasons for creating SWFs may be economical, or strategic, such as war chest
s 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.
of SWFs increased to $4.7 trillion in July 2011, increase of $700 billion from 1 year ago. There was an additional $6.8 trillion held in other sovereign investment vehicles, such as pension reserve funds, development funds and state-owned corporations’ funds and $7.7 trillion in other official foreign exchange reserves.
Countries with SWFs funded by commodities' exports, primarily oil and gas exports, totalled $2.7 trillion at the end of 2010. Non-commodity SWFs totalled $1.5 trillion. Non-commodity SWFs are typically funded by transfer of assets from official foreign exchange reserves, and in some cases from government budget surpluses and privatisation revenue. Asian countries account for the bulk of such funds.
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.
* This includes the oil stabilization fund of Russia.
** This number is a best guess estimation.
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s such as stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
s, bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
, property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
, precious metal
Precious metal
A precious metal is a rare, naturally occurring metallic chemical element of high economic value.Chemically, the precious metals are less reactive than most elements, have high lustre, are softer or more ductile, and have higher melting points than other metals...
s or other financial instruments
Financial instruments
A financial instrument is a tradable asset of any kind, either cash; evidence of an ownership interest in an entity; or a contractual right to receive, or deliver, cash or another financial instrument....
. Sovereign wealth funds invest globally. Some of them have grabbed attention making bad investments in several Wall Street financial firms including Citigroup
Citigroup
Citigroup Inc. or Citi is an American multinational financial services corporation headquartered in Manhattan, New York City, New York, United States. Citigroup was formed from one of the world's largest mergers in history by combining the banking giant Citicorp and financial conglomerate...
, Morgan Stanley
Morgan Stanley
Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations, governments, financial institutions, and individuals. Morgan Stanley also operates in 36 countries around the world, with over 600 offices and a workforce of over 60,000....
, and Merrill Lynch
Merrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...
. These firms needed a cash infusion due to losses resulting from mismanagement and the subprime mortgage crisis
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
. Most SWFs are funded by foreign exchange assets.
Some sovereign wealth funds may be held by a central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
, which accumulates the funds in the course of its 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 that are invested by various entities for the purposes of investment return, and that may not have a significant role in fiscal management.
The accumulated funds may have their origin in, or may represent foreign currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
deposits, gold
Gold
Gold is a chemical element with the symbol Au and an atomic number of 79. Gold is a dense, soft, shiny, malleable and ductile metal. Pure gold has a bright yellow color and luster traditionally considered attractive, which it maintains without oxidizing in air or water. Chemically, gold is a...
, Special Drawing Rights
Special Drawing Rights
Special Drawing Rights are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund . Not a currency, SDRs instead represent a claim to currency held by IMF member countries for which they may be exchanged...
(SDRs) and International Monetary Fund
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
(IMF) reserve positions held by central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
s and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings. These are asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s of the sovereign nations that are typically held in domestic and different reserve currencies
Reserve currency
A reserve currency, or anchor currency, is a currency that is held in significant quantities by many governments and institutions as part of their foreign exchange reserves...
such as the dollar
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
, euro
Euro
The euro is the official currency of the eurozone: 17 of the 27 member states of the European Union. It is also the currency used by the Institutions of the European Union. The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,...
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
Foreign exchange reserves
Foreign-exchange reserves in a strict sense are 'only' the foreign currency deposits and bonds held by central banks and monetary authorities. However, the term in popular usage commonly includes foreign exchange and gold, Special Drawing Rights and International Monetary Fund reserve positions...
held by central banks. Sovereign wealth funds can be characterized as maximizing long term return, with foreign exchange reserves 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 publicly 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 swap
Interest rate swap
An interest rate swap is a popular and highly liquid financial derivative instrument in which two parties agree to exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a floating rate or from one floating rate to another...
s).
History
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 upward.Early SWFs
Sovereign wealth funds have been around for decades but since 2000, the number of sovereign wealth funds has increased dramatically. The first SWF was the Kuwait Investment AuthorityKuwait Investment Authority
The Kuwait Investment Authority is Kuwait's sovereign wealth fund , managing body, specializing in local and foreign investment...
, a commodity SWF created in 1953 from oil revenues before Kuwait even gained independence from the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
. According to many estimates, Kuwait's fund is now worth approximately $300 billion.
Another of the first registered SWFs is the Revenue Equalization Reserve Fund
Revenue Equalization Reserve Fund
The Revenue Equalization Reserve Fund is the sovereign wealth fund of the Pacific island republic of Kiribati.The RERF was created in 1956 to act as a store of wealth for the country's earnings from phosphate mining, which at one time accounted for 50% of government revenue.In 2009 the RERF was...
of Kiribati
Kiribati
Kiribati , officially the Republic of Kiribati, is an island nation located in the central tropical Pacific Ocean. The permanent population exceeds just over 100,000 , and is composed of 32 atolls and one raised coral island, dispersed over 3.5 million square kilometres, straddling the...
. Created in 1956 when the British administration of the Gilbert Islands
Gilbert Islands
The Gilbert Islands are a chain of sixteen atolls and coral islands in the Pacific Ocean. They are the main part of Republic of Kiribati and include Tarawa, the site of the country's capital and residence of almost half of the population.-Geography:The atolls and islands of the Gilbert Islands...
in Micronesia
Micronesia
Micronesia is a subregion of Oceania, comprising thousands of small islands in the western Pacific Ocean. It is distinct from Melanesia to the south, and Polynesia to the east. The Philippines lie to the west, and Indonesia to the southwest....
put a levy on the export of phosphates used in fertilizer
Fertilizer
Fertilizer is any organic or inorganic material of natural or synthetic origin that is added to a soil to supply one or more plant nutrients essential to the growth of plants. A recent assessment found that about 40 to 60% of crop yields are attributable to commercial fertilizer use...
, 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 into immediate consumption. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. In such countries, the main reason for creating a SWF is because of the properties of resource revenue: high volatility of resource prices, unpredictability of extraction, and exhaustibility of resources.There are two types of funds: saving funds and stabilization funds. Stabilization SWFs are created to reduce the volatility of government revenues, to counter the boom-bust cycles' adverse effect on government spending and the national economy. Savings SWFs build up savings for future generations. One such fund is the Government Pension Fund of Norway
The Government Pension Fund of Norway
The Government Pension Fund of Norway comprises two entirely separate sovereign wealth funds owned by the Government of Norway:* The Government Pension Fund - Global...
. It is believed that SWFs in resource-rich countries can help avoid resource curse, but the literature on this question is controversial. Governments may be able to spend the money immediately, but risk causing the economy to overheat, e.g. in Hugo Chávez
Hugo Chávez
Hugo Rafael Chávez Frías is the 56th and current President of Venezuela, having held that position since 1999. He was formerly the leader of the Fifth Republic Movement political party from its foundation in 1997 until 2007, when he became the leader of the United Socialist Party of Venezuela...
's Venezuela or Shah-era Iran. In such circumstances, saving the money to spend during a period of low inflation is often desirable.
Other reasons for creating SWFs may be economical, or strategic, such as war chest
War chest
In arms and armor, a war chest is a container for the personal weapons and protective gear of a citizen-soldier, kept in the household, and is the origin of the term.-In politics:...
s for uncertain times. For example, the Kuwait Investment Authority
Kuwait Investment Authority
The Kuwait Investment Authority is Kuwait's sovereign wealth fund , managing body, specializing in local and foreign investment...
during the Gulf war
Gulf War
The Persian Gulf War , commonly referred to as simply the Gulf War, was a war waged by a U.N.-authorized coalition force from 34 nations led by the United States, against Iraq in response to Iraq's invasion and annexation of Kuwait.The war is also known under other names, such as the First Gulf...
managed excess reserves above the level needed for currency reserves (although many central banks do that now). The Government of Singapore Investment Corporation
Government of Singapore Investment Corporation
The Government of Singapore Investment Corporation Private Limited is a sovereign wealth fund established by the Government of Singapore in 1981 to manage Singapore's foreign reserves...
and Temasek Holdings
Temasek Holdings
Temasek Holdings is an investment company owned by the government of Singapore. With an international staff of 380 people, it manages a portfolio of about S$193 billion at end of March 2011, focused primarily in Asia...
are partially the expression of a desire to bolster Singapore's standing as an international financial centre. The Korea Investment Corporation
Korea Investment Corporation
The Korea Investment Corporation is a global investment management company established by the Government of South Korea in 2005 by the Korea Investment Corporation Act. The company manages some of South Korea's foreign reserves, specializing in overseas investments...
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 shareGolden ShareA Golden Share is a nominal share which is able to outvote all other shares in certain specified circumstances, often held by a government organization, in a government company undergoing the process of privatization and transformation into a stock-company....
s" to block certain foreign acquisitions. This strategy has largely been excluded as a viable option by the European UnionEuropean UnionThe European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...
, 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 StatesCommittee on Foreign Investment in the United StatesThe Committee on Foreign Investment in the United States is an inter-agency committee of the United States Government that reviews the national security implications of foreign investments in U.S. companies or operations. Chaired by the Secretary of the Treasury, CFIUS includes representatives...
(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. Many of these concerns have been addressed by the IMF and its Santiago PrinciplesSantiago PrinciplesThe Santiago Principles are a set of 24 voluntary guidelines that assign "best practices" for the operations of Sovereign Wealth Funds . The principles were proposed in 2008 through a joint effort between the International Monetary Fund and the "International Working Group of Sovereign Wealth Funds"...
, which set out common standards regarding transparency, independence, and governance.
- SWFs are not nearly as homogeneous as central banks or public pension fundPension fundA pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
s. 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.
Developments in 2008
- On 5 March 2008, a joint sub-committee of the U.S. House Financial Services CommitteeUnited States House Committee on Financial ServicesThe United States House Committee on Financial Services is the committee of the United States House of Representatives that oversees the entire financial services industry, including the securities, insurance, banking, and housing industries...
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 TreasuryUnited States Department of the TreasuryThe Department of the Treasury is an executive department and the treasury of the United States federal government. It was established by an Act of Congress in 1789 to manage government revenue...
, the U.S. Securities and Exchange Commission, the Federal Reserve Board, Norway's Ministry of Finance, Singapore's 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. To be specific, 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 also considered a standing committee to represent them in international policy debates. The 24 principles in the draft (the Santiago PrinciplesSantiago PrinciplesThe Santiago Principles are a set of 24 voluntary guidelines that assign "best practices" for the operations of Sovereign Wealth Funds . The principles were proposed in 2008 through a joint effort between the International Monetary Fund and the "International Working Group of Sovereign Wealth Funds"...
) were made public after being presented to the IMF governing council on October 11, 2008.
Size of SWFs
Assets under managementAssets under management
Assets under management is a financial term used denote the market value of funds being managed by a financial instutition on behalf of its clients, investors, depositors, etc. This metric is a sign of size and success against competition...
of SWFs increased to $4.7 trillion in July 2011, increase of $700 billion from 1 year ago. There was an additional $6.8 trillion held in other sovereign investment vehicles, such as pension reserve funds, development funds and state-owned corporations’ funds and $7.7 trillion in other official foreign exchange reserves.
Countries with SWFs funded by commodities' exports, primarily oil and gas exports, totalled $2.7 trillion at the end of 2010. Non-commodity SWFs totalled $1.5 trillion. Non-commodity SWFs are typically funded by transfer of assets from official foreign exchange reserves, and in some cases from government budget surpluses and privatisation revenue. Asian countries account for the bulk of such funds.
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
EWLINE
|
* This includes the oil stabilization fund of Russia.
** This number is a best guess estimation.
See also
- National wealthNational wealthNational wealth also net wealth , national net worth, gross national wealth , and total national wealth is the total sum value of monetary assets minus liabilities of a given nation, also National wealth” refers to the total value of wealth possessed by the citizens of a nation at a set point in...
- Central bankCentral bankA central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
- Pension fundPension fundA pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
- Sovereign investment fundSovereign investment fundA sovereign investment fund is an investment fund created or controlled by a government, usually of a country with trade surpluses and abundant foreign monetary reserves....
- Global financial systemGlobal financial systemThe global financial system is the financial system consisting of institutions and regulators that act on the international level, as opposed to those that act on a national or regional level...
External links
- SWF Institute Organization dedicated to Studying Sovereign Wealth Funds
- Sovereign wealth funds brim with money from ReutersReutersReuters is a news agency headquartered in New York City. Until 2008 the Reuters news agency formed part of a British independent company, Reuters Group plc, which was also a provider of financial market data...
- International Forum of Sovereign Wealth Funds IFSWF is a voluntary group of SWFs - Set up by IMF
- The impact of the global economic crisis on sovereign wealth funds
- The so-called "Sovereign Wealth Funds": regulatory issues, financial stability and prudential supervision - European Economy, Economic Papers, April 2009.
- 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
- Santiago Principles