Sovereign Wealth Funds: Love and Loathing in the Financial Markets

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Excerpts

SWFs are "pools of money derived from a country's reserves, which are set aside for investment purposes that will benefit the country's economy and citizens.... The money for investment "comes from central bank reserves that accumulate as a result of budget and trade surpluses, and even from revenue generated from the exports of natural resources."

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In the 2000s, a large number of new funds came into existence and SWFs started gaining prominence in the international financial markets (Refer Exhibit I for the growth in the number of SWFs). The growing number of SWFs in the emerging economies reflected the remarkable shift of emerging market economies from having current account deficits to having surpluses. In contrast, the developed countries like the US and the UK were recording current account deficits.............

While the size and influence of SWFs were growing, concerns were voiced about their lack of transparency. The fact that it was difficult to differentiate a foreign institutional investor (FII) from an SWF was also a matter for discussion. While FIIs were driven by the profit maximizing objective, the real investment objectives of SWFs were not clear to many.......

However, the growth in the size and number of SWFs led to more calls for regulation. "Best practices and principles could help ease the concerns about SWFs in recipient countries,"said Jaime Caruana, Director of the Monetary and Capital Markets Department of the IMF. In February 2008, Australia officially came up with a set of principles that SWFs would have to follow when they invested in that country. In March 2008, the US Treasury officials met with executives from two SWFs, ADIA of UAE and GIC of Singapore. Both parties reached an agreement regarding the norms that the funds would have to follow to invest in the US...

According to IMF forecasts in 2008, the combined current account surplus of China and oil-exporting countries would be around $800 billion over the next three years. The IMF estimated that SWF assets could grow to US$ 6-10 trillion within the next five years. According to Morgan Stanley, the world's SWFs would grow from US$ 2.5 trillion in 2008 to almost US$ 12 trillion by 2015. As SWFs were controlled by governments, their growth seemed to strengthen the role of government in business and in making investment decisions...

Exhibit I: Number of Sovereign Wealth Funds: 1950s-2000s
Exhibit II: Some Sovereign Wealth Funds
Exhibit III: Capital Injection by SWFs in Different Institutions: 2007-2008
Exhibit IV: Structure of Some SWFs