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Overview

Sovereign Wealth Funds: Current Standards, Practices, and Reforms Peter Kunzel, IMF Trinidad & Tobago, November 5, 2008. Overview. What are SWFs – definition and characteristics Current practices – the SWF Survey

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Overview

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  1. Sovereign Wealth Funds:Current Standards, Practices, and ReformsPeter Kunzel, IMFTrinidad & Tobago, November 5, 2008

  2. Overview • What are SWFs – definition and characteristics • Current practices – the SWF Survey • Standards – Generally Accepted Principles and Practices and the International Working Group of SWFs (IWG) • Recent reforms and future developments

  3. 1. What are SWFs • Definition: • Special purpose investment funds or arrangements owned by the general government; • whose purpose is to hold, manage, or administer assets to achieve financial objectives; • employ investment strategies which include investing in foreign financial assets; • are commonly established out of BOP surpluses, official foreign currency operations, privatization proceeds, fiscal surpluses and/or commodity export receipts.

  4. United States Norway Alaska Russia Ireland Canada Azerbaijan Kazakhstan South United States Korea China Iran Kuwait Bahrain Libya Qatar UAE Saudi Arabia Oman Mexico Vietnam Trinidad and Tobago Venezuela Malaysia Brunei Singapore Kiribati Sao Tomé and Principé Equatorial Guinea Gabon Timor Leste Angola Botswana Australia Chile New Zealand 1. Characteristics of SWFs • 38 SWFs matching definition with assets over $0.5bn in 34 countries • per capita incomes vary considerably

  5. 1. Characteristics of SWFs • many operating for a long time, but more than half established since 2000

  6. 1. Characteristics of SWFs • Public Sector Financial Assets in EMKts: $800 bio to $1 tio per year • SWF activities one such manifestation: assets under management $2.2-3 trillion

  7. 2. Current Practices 2. Current Practices Source: SWF Survey.

  8. 2. Current Practices – Legal Basis • Legal basis varies: • Either SWFs are separate legal entities established under specific constitutive law or a private corporation governed by company law. • Or they are not separate legal entities and are managed as an agency within the government or by the central bank.

  9. 2. Current Practices - Objectives • Primary Objectivesof SWFs differ: • Most SWFs are set up to provide savings for future generations or fiscal stabilization or both. Their primary objective is long-term returns / effective management of entrusted assets • For some SWFs with future expected expenditures (i.e. pension reserve funds) the primary objective is to provide for these future costs. • Policy objectives are • usually publicly disclosed • Generally do not engage • directly in macro polices.

  10. 2. Current Practices - Rules • Funding and withdrawal rules are specific to the SWF • for pension reserve funds these are specified in relation to future pension expenditures • for other funds funding and withdrawal rules are usually tied to the source of the funds (i.e. revenue contingent rules for fiscal stabilization funds or reserve adequacy requirements for reserve investment funds). • Other differences exist • retention of capital and returns versus dividend payments • local investment

  11. 2. Current Practices - Statistics • Economic and financial statistics are produced on a regular basis • either to the public or relevant national agency • A majority of SWFs make data available to compilers of macroeconomic statistics • most SWFs indicate that data is included in BOP, IIP and/or GFS statistics • though SWF data cannot be distinguished as a result of consolidation

  12. 2. Current Practices – Institutional • Investment policies are often centralized within the SWF

  13. 2. Current Practices – Institutional • Many SWFs indicate need for operational independence while ensuring accountability. How? • separate legal entity with comprehensive disclosure requirements • ensure independent Board • long term Board appointments • limiting seats of officials on Boards • removal from Board under exceptional circumstances • require any Ministerial direction to SWF to be reported to Parliament

  14. 2. Current Practices – Institutional • Financial statements are prepared according to prescribed accounting standards, though these may differ • Auditing practices also differ • internal auditing may be carried out by internal division or independent auditor • external audits carried out by independent commercial auditors or by statutory auditors

  15. 2. Current Practices – Institutional • Public disclosure varies significantly • for non-separate legal entities, asset, revenues and expenses are usually published • separate legal entities publish more detailed information

  16. 2. Current Practices – Investment/Risk • Most SWFs have specific investment objectives

  17. 2. Current Practices – Investment/Risk • Investment Strategies vary: • SWFs that are not separate legal entities have relatively traditional asset allocations (i.e., highly rated government securities). • Others use more alternative asset classes

  18. 2. Current Practices – Investment/Risk • Risk management practices are in line with modern practices

  19. SWFs generally do not use leverage, and have • other investment constraints

  20. Operational risk is controlled through • separation of responsibilities (front, middle, and back office) • back up facilities • operational guidelines • regular review of guidelines

  21. 2. Current Practices – Summary • Current practices of SWFs vary considerably, reflecting the diversity of these institutions. • Practices within various groupings or types of SWFs tend to be more similar (i.e., pension funds vs stabilization funds, legally-separate vs non-legally separate) • SWFs as a group also share some broader common practices (i.e., macro-policies, data for statistical compilation, audit arrangements, public disclosure of institutional structure) • Fundamental objectives of different types of SWFs will continue to shape their practices going forward

  22. 3. Standards and the IWG The International Working Group of SWFs (IWG) • Growing importance of SWFs: In October 2007 IMFC expresses needto engage in dialogue with SWFs, including on establishing best practices • In May 2008high level officials from countries with SWFs establish IWG and begin work on Generally Accepted Principles and Practices (GAAP) – “Santiago Principles” • Guiding principles for SWFs: • ensure free flow of capital and investment • comply with regulatory requirements in recipient countries • invest on economic and return-related basis • ensure transparent and sound governance structures • IWG comprised of26 IMF member countries with SWFs. Development of Principles facilitated by the IMF in close coordination with recipient countries. • On October 11 2008: Santiago Principles presented to the IMFC and published

  23. 3. Standards – Santiago Principles The Santiago Principles • Comprised of 24 Broad Principles and additional Sub-principles Broad Categories • Legal Framework, Objectives and Macroeconomic Linkages • Institutional Framework and Governance • Investment Policies and Risk Management Frameworks

  24. 3. Standards – Santiago Principles Main Issue: Governance and Accountability • Checks and balances are important to ensure that an SWF is run efficiently and in accordance with the policy objectives of their owners. GAPP elements: Efficient Governance is promoted by • A clear policy objective for the SWF (GAPP 2) • A sound legal framework which sets out clear allocation and separation of responsibilities (GAPPs 1 and 6-9) • Adequate reporting systems—including audited annual reports and financial statements (GAPPs 7, 10-12, and 23) • Professional and ethical standards, and clear rules for dealing with third parties to ensure integrity of operations (GAPPs 13, 14) • Public disclosure of the SWF’s policy objective, legal and governance framework to enhance checks and balances and promote a clear understanding of the SWF (GAPPs 1, 2, 16).

  25. 3. Standards – Santiago Principles Main Issue: Macroeconomic Policy Challenges • SWFs’ assets, returns, and operations can have a significant impact on a country’s macroeconomic framework. GAPP elements: SWF operations’ consistency with macro promoted by • Appropriate coordination between the SWF’s operation and macroeconomic authorities (GAPP 3) • Clear rules on the SWF’s funding and withdrawal that are consistent with its policy objective (GAPP 4) • Macroeconomic datasets incorporating SWF data to facilitate economic policy analysis (GAPP 5).

  26. 3. Standards – Santiago Principles Main Issue: Management of the Nation’s Wealth • Robust investment strategies and risk management frameworks guard against the mismanagement of funds and poor portfolio performance GAPP elements: SWF performance is enhanced by • A clear investment policy showing commitment to disciplined investment plan and practices (GAPP 18) • Prudence and diligence in SWF’s investment practices (GAPP 19) • Execute ownership rights in a manner consistent with the SWF’s investment policy (GAPP 21) • A robust framework to identify, assess, and manage the risks of its operation (GAPP 22) • Public disclosure of the key elements of the SWF’s investment policies and risk management framework to promote accountability (GAPPs 18, 21, 22).

  27. 3. Standards – Santiago Principles Main Issue: Commercial Behavior • Recipient countries want reassurance that SWFs invest on a commercial basis and not for political objectives or in areas perceived to be of strategic importance. GAPP elements: SWFs aim to reassure commercial orientation by • Public disclosure of its policy purpose and governance framework, and relevant financial information (GAPP 2, 16,17) • Refraining from pursuit of objectives other than maximization of risk-adjusted financial returns (GAPP 4, 19) • Public disclosure of its overall approach to voting in public companies it invests in (GAPP 21)

  28. 3. Standards – Santiago Principles Main Issue: Fair competition in markets Other investors are interested in ensuring that SWFs do not have an unfair advantage for example from privileged access to information. GAPP elements: SWFs commit to not gaining unfair market advantage by • Respecting and complying with all applicable host country rules, laws, and regulations (GAPP 15) • Not seeking advantages of privileged information or government’s inappropriate influence (GAPP 20).

  29. 3. Standards – Santiago Principles Main Issue: Financial market stability Actual or rumored shifts in asset allocations of large, and unclear, positions of SWFs could cause volatility in certain markets and asset classes. GAPP elements: SWFs promote financial market stability by • Disclosing relevant financial information and key elements of its investment policy (GAPP 17, 18) • Describing the use of leverage or disclosing other measures of financial risk exposures (GAPP 18) • Exercising voting rights (GAPP 21) • Having in place a transparent and sound operational control and risk management systems (GAPP 22).

  30. 3. Standards – Santiago Principles Summary: Santiago Principles • Improves transparency and understanding • Provides for a better informed and globally oriented sovereign investment community • Strengthens domestic policy framework and institutions • Furthers macroeconomic and financial stability interests • Helps ease concerns about SWFs in recipient countries

  31. 4. Recent Reforms SWFs practices are evolving as we speak: • SWF Survey shows that 1/3 are reviewing or adapting organizational structure or operational practices • Some SWFs are changing legal frameworks as a result (i.e. Qatar). • Upgrades have come in terms of transparency as well: • new or improved websites (CIC, ADIA, KIA…) • GIC publishing Annual Report for first time

  32. 4. Future Developments Some outstanding Issues: • Some areas could still be strengthened • public disclosure • ex post disclosure of how ownership rights are exercised • Santiago Principles may need to be revisited as operations evolve and markets and recipient country policies develop • Importance of monitoring implementation A Standing Group for SWFs: • To address some of these outstanding issues • Formation Committee looking into constitution and terms of reference • Proposal expected by year-end

  33. 4. Future Developments Some concluding thoughts: • Impact of profound changes in global economy and financial markets • Are high commodity prices and revenues sustainable? • What will be impact of current crisis on foreign exchange reserves? • Exchange rate policy—will reserves continue accumulating? • Implications for Strategic Asset Allocation • SWF’s role in public sector balance sheet management are key to domestic and international financial stability • SWFs will continue to play an important role in the global financial system

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