LONDON: In early September 2008, the International Working Group of Sovereign Wealth Funds (IWG) met for the third time in Santiago, Chile, to agree on a common set of principles covering legal frameworks; governance issues such as transparency; institutional structures; investment policies and risk management — all to guide investment practices of the so-called sovereign wealth funds (SWFs).
The 26 IWG countries of which all the six GCC countries — Saudi Arabia, Kuwait, Qatar, Bahrain, Oman and the UAE — are members, seemed to reach a basic understanding on common generally accepted principles and practices (GAPP) on SWFs which will be presented to the International Monetary & Financial Committee (IMFC) of the International Monetary Fund (IMF) during the World Bank/IMF annual meetings on Oct. 10-13 in Washington DC.
While the above principles are essentially based on collaborative and voluntary adoption, it is no secret that the recent rapid rise of SWFs — especially Chinese and GCC-owned ones — has raised political concerns in the US and some European capitals. This is in the wake of Singapore, Chinese, Abu Dhabi, Dubai, Qatar and Saudi SWFs investing billions of dollars in international banking majors such as HSBC, Merrill Lynch, Citigroup, Barclays Capital, Morgan Stanley, UBS, Deutsche Bank etc. — all of whom had to write-off billions of dollars to cover exposure in investments in dodgy subprime US mortgages which has resulted in a global credit crunch.
Underlying these concerns, despite the genuine efforts of GAPP, there is a raw jingoism and element of protectionism, which has more to do with the fact that China is the last major bastion of communism and the GCC states are Islamic countries which raises the specter of the so-called “financial war on terrorism.” The simple truth is that some reactionary factions in the US and the EU do not want Communist Chinese or Gulf Muslims to own huge chunks of their financial institutions.
This, however, does not deter from the fact that citizens of the SWF countries have a genuine stake in wanting their governments to invest the SWF trillions wisely, productively and in a transparent way so as to pre-empt mismanagement and corruption and to ensure accountability.
The IMF estimates the current total volume of assets under management by the SWFs at $2 trillion-$3 trillion, projected to rise to $6 trillion-$10 trillion within the next five years. SWFs should not be confused with official foreign exchange reserves and other such reserves. SWFs are generally defined as large pools of capital controlled and owned by governments, usually through special investment vehicles or funds, and invested in foreign assets for long-term purposes.
High oil, gas and chemicals prices have in the case of Saudi Arabia and the GCC countries contributed to a huge reservoir of liquidity — both public and private. According to the Tadawul, the total equity market capitalization at the end of August 2008 reached SR1.70 trillion ($452 billion). Saudi Arabia, as such is also a net exporter of capital because at end 2007 it had a current account surplus of 5.4 percent. In a recent report published by Bahrain-based investment bank, Gulf Finance House (GFH), oil revenues of the GCC countries, are projected to top $600 billion annually for 2008 and 2009 alone. Aggregate GCC expenditure is expected to reach $300 billion in 2008 and private sector projects currently under way and on the drawing board is valued at over $2 trillion. Private liquidity in the GCC alone, according to several estimates, is put at $1.2 trillion.
In a high liquidity environment, three trends have emerged in the GCC — more investments at home; consolidation of SWFs; and the increasing migration of liquidity into the rapidly growing Islamic finance sector.
SWFs growth and investment strategies are also transforming the government sector into an important international investor group. According to IFSL Research, part of the UK’s Department for Business, Enterprise and Regulatory Reform (BERR), “SWFs bring significant benefits to global capital markets, in terms of increasing market liquidity and financial resource allocation. Some governments have however expressed reservations about SWFs because of the limited disclosure and transparency of some SWFs.”
Saudi Arabia is currently fourth in the SWF league table in terms of assets under management, after UAE, Singapore and Norway. The Kingdom’s SWF assets totaled an estimated $314 billion at end 2007 giving it an SWF market share of 10 percent. With a GDP of $363.2 billion, its SWF assets to GDP ratio is 82.6 percent, well below the UAE’s 481.92 percent and Singapore’s 370.01 percent. Gulf One Bank in Bahrain however estimates a 300 percent increase of Saudi Arabia’s SWF assets to $900 billion by end 2008.
On a weighted average, Saudi Arabia’s SWF assets are projected to increase to $1,270.9 billion by 2013, and the global SWF potential to hit between $4 trillion and $5 trillion.
The Kingdom is also planning to launch a dedicated Saudi SWF investment vehicle with initial assets of SR20 billion. This is miniscule in comparison with existing sovereign funds. But according to Saudi Finance Minister Dr. Ibrahim Al-Assaf, the Saudi SWF will be structured as a Saudi investment vehicle under the auspices of the Public Investment Fund, and will concentrate on investments in the technology sectors, especially in those areas that can add value for inward technology transfer and skills to the Kingdom. Adopting such a limited SWF strategy, the rationale goes, will also assist the Kingdom in testing the international markets to gain valuable asset management experience and adopt appropriate governance and code of conduct standards.
However, the more pertinent questions remain how to regulate the market excesses of these financial institutions to protect the hapless taxpayers in these countries. As such it should not be the SWFs who need to be singled out for regulation, but more importantly the developed countries need to get their own regulatory houses in order and not simply rely on the market to regulate itself. This policy of self-regulation has failed monotonously over the last few decades; and yet these regulators and the politicians behind them have failed to learn the lessons of history.
