Archive for August, 2008

Taxing SWFs

By Ashby Monk

The debate as to how SWFs should be taxed continues. Building on from the recent Joint Committee on Taxation report on the issue, Victor Fleischer of the University of Illinois College of Law has just written a paper entitled, “A Theory of Taxing Sovereign Wealth“. His paper comes to some very interesting conclusions and is well worth a read:

“Thinking about sovereign wealth funds as institutional investors exposes a striking tax policy discrepancy. On the one hand, sovereign wealth funds expect to be treated like private financial investors for purposes of corporate law, banking law, and national security law. They promise to invest for purely financial purposes. On the other hand, for tax purposes we unilaterally treat them as sovereigns acting to further political, diplomatic or humanitarian agendas, and we therefore exempt them from taxation as if it were a matter of international comity. It is hardly obvious that we should allow sovereign wealth funds to enjoy the best of both regulatory worlds. As sovereign wealth funds become powerful players in the capital markets, the more logical presumption is that they should pay tax like other financial institutions. There is no compelling reason to favor state-controlled investment over private capitalism.”

I find Prof. Fleischer’s concluding arguments compelling: there is no reason that U.S. tax policy should be subsidizing sovereign wealth. Since these funds are ostensibly commercial entities, they should receive the same tax treatment as private funds.

Avoiding Local Politics By Investing Globally

By Ashby Monk

In a recent article on, Olivia Mitchell suggests that the potential influence of politics on local investment decisions may be one of the factors driving SWFs to invest overseas. She cited the experience in the U.S. in which it was deemed too difficult to insulate Social Security fund investments in private markets from politics. In the case of Social Security, the decision was made not to invest in private markets altogether. However, in countries with an existing SWF such as Australia, the desire to avoid local politics is in part responsible for the increasing tendency to invest overseas, according to Mitchell.

This position holds that local SWF investment may be more vulnerable to political interference than global SWF investments. This is an interesting point that corresponds with much of the debate on ETIs in the U.S. For some time now, U.S. public pension fund investment strategies have avoided local investing for fear of having it labelled as ‘political’. Indeed, local investments by public pension funds continue to be controversial–despite strict governance protocols some still fear that these funds are being used to advance politicians’ pet projects instead of upholding fiduciary duty by seeking returns.

There are some interesting academic papers that attempt to tease out the main problems associated with local investments by public pensions, as many would like to resolve these problems and see the goals of the local community joined up with the goals of the public pension funds. The main conclusion in this research is the following: public pension funds can invest locally, but they must do so with proper governance procedures.

In short, it appears that both SWFs and public pension funds face considerable pressure in their local investment strategies. I find this discussion to be very interesting: we might conclude that certain SWFs are looking overseas to ensure the primacy of commercial objectives over political objectives just as public pension funds look to non-local markets.

If true, should this comfort investment receiving countries who worry about SWF motives?

The Word On The Street

By Ashby Monk

I saw this morning that the CIC is looking to London based PR firms to improve its image abroad.

Since I’m visiting friends and family in San Francisco this week, I thought I might evaluate whether the CIC and SWFs more generally have an image problem in this part of the world. I broached the subject with a group of six friends this morning over brunch.

Significantly, none could immediately identify a SWF or offer up a definition, which was a reminder that outside of finance and politics, many may have missed the rapid growth of these institutions. Nevertheless, after some explanation it was clear that most had some knowledge of these funds and their origins.

In short, this brief conversation gave credence to the CIC’s plan to hire a PR firm: among this group of individuals, the perceived threat of SWFs investing in U.S. assets varied considerably by country. Australia, Norway, and Canada did not inspire any fears about foreign government ownership. However, China, Russia, and the UAE clearly stoked some fears about SWF objectives and motivations. These SWF neophytes unwittingly reiterated many of the same arguments we came across in our DC interviews: 1) context matters and 2) not all SWFs are evaluated according to the same criteria.

Summer Reading, Part 2

By Ashby Monk

August may be a slow news month, but new academic and industry reports continue to surface.

First off, State Street’s Vision Report has an issue dedicated to SWFs. The first two chapters are principally concerned with understanding and defining SWFs, which is something we have been interested in as well.  The final section details some of the impacts that SWFs are having on global financial markets. It is well worth reading.

Second, following on from our chat with Professor Gordon L. Clark about pension fund governance and how it might relate to the governance of SWFs, the OECD’s draft guidelines for pension fund governance may also be of interest. In the same vein, a paper by Fiona Stewart and Juan Yermo at the OECD details the challenges and potential solutions with respect to governing pension funds.

SWF Blog Roundup #3

By Bree Bang-Jensen

A summary of some recent blogosphere offerings on sovereign wealth funds:

SWFs Are a Natural Result of Free Trade: Felix Salmon, “SWFs vs Free Trade,” in Market Movers at

There’s no irony in US banks being recapitalized by the entities which are running a trade surplus with the US.

SWFs Underperform: Paul Kedrosky, “Sovereign Wealth Funds=> Stocks Weaken Faster,” at Infectious Greed.

There’s further evidence today why SWFs aren’t exactly seen as smart money.

Stabilization Funds, SWFs’ Poorer Cousin: “Stabilisation Funds,” from the Financial Times.

With sovereign wealth funds saving the western world, it is easy to forget about their poorer relatives. But stabilisation funds, designed to achieve medium-term macroeconomic stability rather than higher returns from excess forex reserves, are shimmying back into the limelight in some emerging markets

Q&A with Gordon L Clark, Professor at Oxford University

By Ashby Monk

This blog is a source of open discussion and engagement on the topic of SWFs. As such, we welcome and indeed seek out all views and opinions on the subject. Today, we offer the third instalment of what is becoming a routine segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Professor Gordon L. Clark of the University of Oxford. While Prof. Clark’s views are his own, his perspective helps to further debate and facilitate understanding.
NOTE: Q&A will be taking the rest of the month off. Our next Q&A is slated for September 5th, 2008.

Ashby Monk: Prof. Clark, what is your interest in SWFs? How do they fit into your research agenda?

Gordon Clark: I am very interested in the governance of financial institutions whether they be sovereign wealth funds, pension funds, or for that matter rate-setting organisations such as the Bank of England and the European Central Bank. In this respect, sovereign wealth funds are extremely important albeit new players in the global financial world. They may play a pivotal role in galvanizing resources for future investment at a time when the developed economies’ financial resources are constrained as they seek to recover from the current crisis. Sovereign wealth funds are simultaneously a reflection of global economic integration and an instrument for further global economic development should they be tamed and focused upon long-term rates of return. Equally, sovereign wealth funds have the potential to be significant players in global political intrigue and hostilities.

Ashby Monk: You’ve done a remarkable amount of research on the governance of pension funds. Can you briefly tell us what your research tells you about how SWFs might be governed?

Gordon L. Clark: My interest in the governance of pension funds is both a theoretical question and intensely practical issue. Understanding the design and structure of such institutions and how those elements affect performance are the crucial issues involving myself but also others such as Roger Urwin from Watson Wyatt. With Roger, we have developed principles of best practice governance (see the recent paper published in the Journal of Asset Management). We are concerned with enhancing investment performance, considering how the organization of a pension fund including the allocation of roles and responsibilities may affect the rate of return as well as the long-term variance in returns. We believe a well-governed pension fund like a well-governed sovereign fund can affect the long-term performance of institutions such that nominated beneficiaries have their welfare enhanced and protected.

Ashby Monk: That raises an interesting point: we’ve seen a lot of different definitions for SWFs in varying literatures. How would you define a SWF, and how is it different from a public pension fund?

Gordon L. Clark: In defining a sovereign wealth fund and comparing it to pension funds lets begin with what a pension fund is and then let’s work back to what a sovereign fund is and is not. In general, a pension fund is a beneficial institution, with an intended beneficiary who often claims a property right to a promised benefit or expected benefit. Furthermore, the pension fund is often underwritten by a sponsor such that the institution guarantees the payment of benefit should the pension fund fail to deliver. Pension funds are governed by boards that combine representation with expertise with an underlying fiduciary duty to the intended beneficiary. Granted, this sounds idealistic. Nonetheless, these principles are accepted as determining the intended purpose of pension funds as we know them.

By contrast, we can say what sovereign wealth funds are not. That is, they are not beneficial institutions with an intended recipient: no one, whether beneficiary or citizen, has a property right to an expected benefit, and more often than not the government sponsor does not underwrite its performance except where the sovereign wealth fund writes a private contract with other investors wherein its promised performance is in some way or other underwritten by the government as a commercial entity. This means that sovereign wealth funds are quite different institutions than pension funds (as we know them).

I think we can identify a number of common characteristics among sovereign funds notwithstanding the many differences. For example, sovereign wealth funds are typically an operational arm of government, held within the boundaries of the sponsoring government in some form or another. Sovereign wealth funds are often subject to government policy whether in terms of the intended purpose of specific investments or an overarching strategy as regards to the deployment of assets locally and globally. Sovereign wealth funds are often managed internally, albeit with contracts with external investment providers. Sovereign wealth funds often seek investment opportunities in the rest of the world; perhaps paradoxically, because of the transparency, security of investment, and promised rate of return of developed financial markets and economies. Sovereign wealth funds are often long term investors, operating far beyond the ups and downs of markets, market cycles, and intermediate financial crises. Nonetheless, it is difficult to determine the time horizons of sovereign wealth funds. It might be said that one reference point might be endowment funds or charities and public institutions. This issue is very important in understanding the motives and operation of sovereign wealth funds.

Ashby Monk: Take us out 10 years – what is the status of SWFs?

Gordon L. Clark: It seems inevitable that sovereign wealth funds will be much larger in terms of the volume of assets held by those institutions. Granted, their growth in assets will depend, in part, upon the price of commodities. Likewise, the growth of assets may well depend upon the global rate of economic growth and the continuing demand from the developed economies’ for developing economies products and services. That a number of sovereign wealth funds have been reliant upon trade and commerce for the accumulation of foreign currency reserves suggests that there is an intimate relationship between trade, exchange, and the accumulation of sovereign wealth fund assets.

That these institutions will have more assets need not translate into being effective in the global economy. Here I can see two issues that will need to be resolved. First, their influence will depend on how well they are governed and whether their governance is effective and professional as regards the rate of return or whether their governance is a product of political opportunism. If it is the latter, if political opportunism is the driving force, then I can see the rest-of-the-world putting-up barriers against sovereign wealth funds and effectively neutering their impact upon developed economies. There is a second issue that is related. Will sovereign wealth funds be incorporated into global capital markets? Here, the answer may well rest with the degree to which those institutions are able to attract and retain skilled investment professionals. If they are unable to recruit talented financial professionals, at least against the terms and conditions that drive global financial markets, sovereign wealth funds may be forced to retreat from playing an active and continuing role in the flux and flow of global finance. They will be forced into economic and political leverage which may or may not be reap the benefits intended by their government sponsors.

Ashby Monk: Thanks, Professor Clark, for taking time out of your busy schedule to chat with us today.

We continue to seek out guest bloggers and question & answer participants. Please contact Brett Keller for details on doing either.


This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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