Until a couple of years ago, few laymen had ever heard of Sovereign Wealth Funds (SWFs), and others had not bothered that much. But such funds have actually been in existence for more than half a century.
As this financial species continues to multiply, and the pool of their total resources keeps swelling, their visibility could hardly escape the radar screen of the general public, particularly in developed recipient countries. For a while, speculation about what SWFs were up to was running rampant and, paradoxically, the beneficiaries' unease about the capital inflows was all too palpable.
The launch of China Investment Corporation (CIC) and the SWFs of other emerging markets seems to have added to their angst. Two issues seem to have ruffled feathers in the mature economies in the West. One is state ownership and the other is size. Indeed, these two issues are quite irrelevant. By definition, any SWF is state-owned. While the sovereign feature is its glaring hallmark, management is independent of ownership. SWFs have made it very clear that they have no political agendas to pursue, their mandate being to achieve satisfactory returns on their investment in the long term.
Does size matter? The significance of size should not be overstated. Behavior is far more relevant than size. Being long-term investors, SWFs aim at maximizing the return on investment for their shareholders, under a risk management framework consistent with their investment strategy and portfolio requirements.
Furthermore, SWFs are just a minority in the investor community. The resources under their management are worth roughly about $3 trillion in total, against the backdrop of capital movement about the same size moving around the global on a daily basis. SWFs are not in a position to shore up the entire financial industry when it goes woefully awry, even if they do pick up the slack when other investors are excessively risk averse and markets tumble.
Ironically, when financial resources are urgently needed under volatile circumstances, so-called national security concerns prevail. Capital injection into the companies in distress could be eerily resisted when this issue is blown out of all proportion. The political sensitivity is usually not an issue until it is made out to be one. Frankly speaking, SWFs are generally passive investors, with no intention whatsoever to meddle with the management of the companies in which they put their money. To communicate better with the advanced economies, in April 2008 a group of 26 SWFs formed the International Working Group (IWG), with the support of the IMF, to work on an agreement on general principles guiding their governance and code of conduct. Consensus was reached quickly, and by October the Santiago Principles were agreed upon and endorsed by all the SWFs members and observer countries.
Hailed as a landmark achievement, the Santiago Principles represent a giant step forward in the efforts towards best practices by SWFs. These principles reflect an appropriate governance and accountability framework, and require that SWFs should contribute to maintaining a stable global financial system through their long-term investment on the basis of economic and financial risk and return-related considerations. Adherence to the principles of transparency, accountability, and adequate risk management should be consistently observed.
Shortly after the publication of the Santiago Principles, SWFs established the International Forum of Sovereign Wealth Funds (IFSWF) in April 2009. This forum serves as a platform for sharing views on the application of the Santiago Principles. Progress towards full implementation has been encouraging. As an illustration, just one year into operation, CIC circulated its first annual report, providing rich information about its corporate governance, investment strategy, etc. This is the best indication of CIC's transparency and willingness to disclose information.
It is an ill wind that blows nobody any good. The financial crisis this time around speaks volumes about the importance of cross-border capital flows. SWFs behave differently from hot money. Prior to the outbreak of the crisis, a lot of people in advanced economies did not feel comfortable to see external investors move in on their turf as if capital flows were Trojan horses. A vestige of appreciation for SWFs could be felt as the crisis continued to fester. SWFs have stayed where private investors quit.
This mood swing is certainly welcome. During the crisis, SWF inflows provided a reliable source of funding for the financial sector and other industries in many Western countries. As a kind of reciprocation, those countries have rolled back some of the barriers to foreign capital flows, at least temporarily. It is gratifying to note that SWFs have been increasingly recognized as mature, credible institutional investors, a stabilizing force in the international monetary and financial system. However, misgivings about SWFs are likely to rekindle as economies recover and the credit crunch becomes less of a problem. The mood would probably swing back. It may sound a bit weird, but it is true that SWFs' relevance to global stability does not guarantee their status as a guest of honor in some of the economies where they have proved to be part of the solution, not part of the problem.
Undoubtedly, it will take quite a while for some countries to walk out of the long shadow cast by the financial crisis, and their governments will have to deal with a number of issues under public pressure. Keeping economies open is a challenge. Short-termism tends to get the upper hand in difficult times, when protectionism may be perceived as a convenient policy instrument for the government and the best diet for domestic consumption for the public.
A case in point is that many of the countries relaxing SWFs' inflows also introduced support measures that discriminate against external competitors. Obviously, financial protectionism will not blithely take a backseat.
Communication with representatives from the EC and OECD indicates that the advanced economies are committed to remaining a strong advocate of free cross-border capital movements in the long-term interests of all the parties concerned. This policy stance is expected to be translated into a statement without fine print, and a commitment they will deliver.
The global economy is still fragile, and Europe is being haunted by the specter of the sovereign debt default. Nobody wants to see the second dip, but the situation warrants a round-the-clock alert. Any mismanagement would send the economies to hell in a handcart. Under these circumstances, it is crucial to keep cross-border capital flows free from disruption. SWFs are willing to serve as a stabilizing force. However, they could only do part of the job, and the rest is left to the recipient countries.
Jin Liqun is chairman of the Supervisory Board of China Investment Corporation and deputy chairman of the International Forum of Sovereign Wealth Funds.
(China Daily 06/09/2010 page14)