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Sovereign wealth to the rescue

Updated Tuesday, 29th July 2008

In a time of dwindling credit, should companies take money from investment funds backed by foreign governments? Uncover their motives in sovereign wealth to the rescue.

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Globalisation of trade has resulted in huge trade surpluses in many countries, particularly in Japan, China and other Asian nations. If you combine this with the build-up of foreign reserves in oil exporting countries, thanks to soaring prices, then you find some countries sitting on piles of US dollars, Euros and Sterling. The flag of East Timor painted on a wall Copyrighted  image Icon Copyright: Carsten Reisinger | East Timor offers a Sovereign Wealth Fund

What do the governments of such countries do? They set up Sovereign Wealth Funds (SWFs) as vehicles for investing their foreign currency reserves. And looking for investing opportunities, they turn their attention to western European and the US financial markets (that provide a wide range of investment opportunities in financial and real assets). The main objective of most SWFs is to maximise returns on their investments.

In theory we can explain the phenomenon of state owned SWFs investing in foreign securities and assets in fairly simple terms. The financial markets exist to bring together the funds surplus units and the funds deficit units.

The recent crisis in banking industry illustrates this well. The consequences of sub-prime and credit crunch left many multinational and large banks needing fresh capital to bolster their capital base. In the UK, for example, HBOS and Royal Bank of Scotland tried to raise capital through rights issues. Both could not get enough subscription from their existing investors.

SWFs have stepped in, and are injecting large amounts of money in multinational banks, including the British bank Barclays. Since the US sub-prime mortgage crisis their investments have helped stabilise the situation in global financial markets.

A turbulent international financial system has an impact on the economic growth of the developed world. The developed world is the major market for manufactured goods (exported from China, Japan, South Korea) and oil (exported from the Middle-East, Russia and Nigeria). So an unstable global financial system can seriously threaten the economic progress in developing countries. And, of course, the investments that bring this stability are in the interests of source countries’ interest!

SWFs are not new, but they’ve attracted more attention in recent years. The Kuwait Investment Authority (KIA) was set up in 1953 and the Norwegian government set up their Global Pension Fund in 1990 to manage the surplus revenue from oil and gas exports to provide for future generations. So SWFs are not the preserve of fast growing countries such as China or South Korea. They’re been set up by Australia, Canada, Angola, Russia, some states of the USA, Ireland and even East Timor.

However, the western world is becoming concerned about the lack of transparency of SWFs, and the possibility of SWFs gaining control of domestic companies. Advised by the US, the International Monetary Fund is engaging with the major SWFs to agree on voluntary standards for transparency and governance mechanisms in order to allay these fears.

“governments are not known to be good managers of assets”

It seems worth bearing in mind that governments are not known to be good managers of assets, be it financial assets or public enterprises. And SWFs are essentially state owned financial institutions. Will sovereign wealth funds prove to be exceptional in the long-term? Data about these funds is scarce, so it won’t be easy to find reliable empirical evidence on their performance. Meanwhile, we can only watch and wait.







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