Archive for October, 2008

Q&A with Roger Urwin, Global Head of Investment Consulting at Watson Wyatt

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 eleventh instalment of our segment: “Q&A with a SWF expert, stakeholder or policymaker” (see the Q&A archive). We are pleased to welcome Roger Urwin of Watson Wyatt. While Mr. Urwin’s views are his own, his perspective helps to further debate and facilitate understanding.

Ashby Monk: Thanks for joining us today, Roger. Can you briefly explain what it is Watson Wyatt does, and how you’ve come to be interested in SWFs?

Roger Urwin: Watson Wyatt is the investment adviser to large institutional funds across the world. We have around 500 people in teams located in the major financial centres: London, New York, Chicago, Hong Kong, Shanghai, Sydney and elsewhere. Our work spans asset allocation, manager selection and monitoring services. We are also experts in investment governance and how to structure the investment function. This is essentially about how to deploy a combination of investment committee, directly employed staff and outside firms.

We are advisers to a number of the sovereign funds across the world. They are often the most interesting: sophisticated, have a wide agenda, in the public eye, complex problems to address.

Ashby Monk: What impact is the current financial crisis having on SWFs? Has their behaviour changed over the past few months?

Roger Urwin: As I speak, equity markets this year are down close to 40%, most other asset classes are down in the range 10% to 25%. This has proved a very severe investment bear market and there are no obvious signs yet we are emerging from it. The obvious catalyst is the crisis in confidence in banking and credit, and the spectre of a deep protracted global recession. Of course the SWFs all have very long time horizons so they have been among the calmest voices in the industry. Many of the conversations I’ve had with them have been about ways to exploit new opportunities. But that said they have to keep their stakeholders onside and this climate is difficult to present in a positive light when you expect to perform well at all times.

It’s an interesting point as to how their behaviour has changed. Certainly, they are doing much more thinking on risk and in some cases some re-framing of risk has taken place. I’d say their macro view of what are the key drivers in the investment landscape has changed somewhat. But I have not seen much change in asset mixes beyond a limited degree of rebalancing.

Ashby Monk: As a global leader of the investment consulting business at Watson Wyatt, I’m interested to hear what advice you’ve been giving your SWF clients lately. Can you share this with us?

Roger Urwin: Our clients are getting both barrels from us on this crisis. We see it as a seminal moment for change in both practice and strategy. Most times it’s a combination of these three points.

First of all, the crisis is a financial system failure with several contributory causes and we should become more aware of this inter-connectedness of all things issue. But two things stand out as explanations: that we had developed far too much leverage in the financial system and we have outrun our ability to cope with financial complexity. Much of our advice is about leverage control and managing complexity.

Second, funds need to have a macro view of risk which blends both a quantitative model with a qualitative overlay. No models are powerful enough at present to deal adequately with regime changes so this overlay is critical. Better models and presentations of risk are certainly high up our sovereign funds’ agendas.

Third, while it is inevitable that size of certain risk premia have begun to look interesting, the visibility of most beta returns remains poor. Uncertainty is way up relative to classic risk measures. For most funds this does not yet suggest increasing risk. For most it means that they should stay put with current allocations.

Ashby Monk: Since we both also share a keen interest in pension, I’m curious to see if the current crisis has significantly impacted funding levels? Were pension funds better prepared for this crisis than they were the ‘perfect storm’?

Roger Urwin: Your reference to the perfect storm was the 2000 to 2003 period when global funding levels were hit simultaneously by falling asset prices, falling bond rates and increases to longevity. In three years funding levels fell around 40%. The fall this year is only happening from one of those causes – the falling asset prices given pension fund strategies average 56% in equities. The funding level fall during 2008 is as we speak closer to 30% but it’s a much quicker change. I view it as pretty harmful. Both corporate funds and public funds are not that resilient to deal with these new deficits. Previous answers have generally been to look for additional investment return to fill the gap, but there is a limit to how much this source can produce. I’m quite worried.

Ashby Monk: You’ve written a lot about the governance of pension funds [see here and here]. To what extent do you think pension fund governance principles offer lessons for SWFs?

Roger Urwin: My work has been on the governance of all types of institutional funds including SWFs. This subject has not attracted much air-time in the past. If you do a Google search on ‘great investment managers’ you get hundreds of hits. If you do the search for ‘great investment committees’ you get one solitary item linked to the research I’ve done with Professor Gordon Clark of Oxford University.

There are a lot of lessons I think. Let’s start with the fact that governance is difficult to change because of agency issues, board members’ agendas and lack of conclusions about good organisational design. But, encouragingly, our best practice models of governance are gaining some traction.

The biggest feature of this best practice model is that good fund boards, and their executive teams, operate with clearly defined areas of responsibility and authority. It pays to be very clear on who does what. Funds are not hugely complex in concept, but all the same it is very easy to have overlaps and problems with roles occurring. Preferably, the executive team has the active role, the Board has oversight and high level influence. This also leads to better accountabilities – the executive is accountable for their performance to the Board, the Boards need to measure their own results and be accountable for these results.

I’d also mention the need for having and following explicit decision-making processes. The quality of decision-making is obviously critical, and good boards work very hard – just like managers – to formalize, streamline, make as efficient as possible their decision-making.

Lastly it’s about alignment of governance budget to investment arrangements. Funds have to work out their competitive advantages and act accordingly. Good funds see governance as an enabler that can be varied significantly over time but few funds think of it this way. It was our research that defined the concept of ‘governance budget’ as a measurable resource based on time, expertise and organisational effectiveness.

Ashby Monk: So what does the future hold for SWFs.

Roger Urwin: We addressed that in our Defining Moments paper early this year. We set out in that paper the complex factors that drive the investment industry and the increasingly influential role played by SWFs. We think these funds are at the nexus of many of the critical aspects of our financial world: globalisation, effective governance, demographics. I think they can do a number of positive things to ease the inter-generational issues that we will encounter. Our 21st century society desperately needs them to be effective.

Ashby Monk: Thanks, Roger, for taking time out of your busy schedule to chat with us today. We really appreciate your insights.

A New Breed of Sovereign Wealth Fund?

By Brett Keller

The news moves fast during times of crisis. French President Sarkozy called for a more aggressive French sovereign wealth fund (SWF) to protect domestic institutions from foreign investment just a week ago. But in the midst of all this, it’s worth pausing a moment to think about how far SWFs have come. While some of the funds themselves have been around much longer, the term was invented just a few years ago and only more recently have the funds captured wider attention. SWFs have been fascinating in part because they are seen as new vehicles for the “uphill” investment of capital from developing countries into more established economies, or for “South to South” investment between low-income countries.

But now, led by French President Sarkozy, some are pushing for the development of SWFs to stabilize and protect institutions in developed economies, a role that could not be more different from what most SWFs do today. Advocates who favor investment from the SWFs of nations such as China and the Gulf states see it as a way to tie them into the global economy and create further, mutually beneficent links of interdependence. The Sarkozy Way goes against all of this by providing one more instrument to compartmentalize national economies and reduce international interdependence.

When suspicion about SWFs reached its highest point—maybe about a year ago—the unanimous calls were for nonpolitical investing, driven by fear of scary, “less democratic countries” taking over the business infrastructure of the West. Now some of the same leaders are calling for new funds with blatantly political and nationalistic raisons d’être.

French President Sarkozy’s recent calls for a sovereign wealth fund for France are not going unanswered. Leading the resistance is Germany’s Angela Merkel, who is being pressured by other governments to take a strong stance against the French president (See “EU leaders look to Merkel to stand up to Sarkozy”)

Reacting last week to Sarkozy’s sovereign wealth fund proposal, eurosceptic Czech President Vaclav Klaus — who succeeds Sarkozy as holder of the EU presidency in January — described the plan as “old socialism.”

Skepticism from non-eurozone countries (such as the Czech Republic) can be explained in part by fears that “such a format would supplant the power of the rotating EU presidency, which France holds until January 2009 when the Czech Republic…will take over.”

(Though some Europeans have been lukewarm to the idea, other voices have popped up to say that new, seemingly protectionist SWFs may be the way of the future. David Judson, editor in chief of the Turkish Daily News, notes that Turkey may find an enlarged role for OYAK, its military pension fund. See “March toward the sound of economic gunfire”.)

Ironically, SWFs, the very state-controlled entities that gave some hope that more nations would become inextricably invested in the world economy, are now being touted as the tool of choice for a new brand of economic isolationism.

It’s SAFE to Pursue Politics…

By Ashby Monk

In an article for the National Interest, Daniel Drezner made an interesting observation about one of China’s SWFs, the State Administration of Foreign Exchange (SAFE):

“Lost amid the financial chaos of the past six weeks was the revelation that China’s State Administration of Foreign Exchange used a $300 million purchase of government bonds and a $150 million grant to Costa Rica in return for that country’s decision to sever diplomatic ties with Taiwan after sixty-three years and recognize the People’s Republic of China.”

Drezner is right. This investment by SAFE received limited press considering its implications. Based on my conversations with U.S. policymakers over the summer, it seems to be exactly the type of SWF behavior that raises concerns. Here we have a foreign SWF using its financial capital to achieve political ends. As Jamil Anderlini of the Financial Times noted in September:

“The purchase of US-denominated Costa Rican government bonds by China’s State Administration of Foreign Exchange (Safe) is the clearest proof yet that Beijing regards its $1,800bn in foreign reserves – the world’s biggest – as a tool to advance its foreign policy goals, as well as a potential source of income.”

In order to better understand this specific case, I asked Dr. Yu-Wei Hu of the OECD what he thought–he’s an expert on Chinese pension funds and has been tracking the SWF debate in China for some time. Here is what he had to say:

“In fact, it is to some extent consistent with what is noted in my Q&A, i.e. the SAFE is a governmental department, therefore it should not be surprising to hear that the Chinese government uses it to achieve its national objectives. However, due to different status (and different stated objectives) it is unlikely that the NSSF and the CIC would be involved in any transactions like the cross-strait and/or diplomatic relationship (at least in the near term). It is too dangerous and unnecessary for them to do so, and if the Chinese government really wants to, they can always find alternative ways, e.g. via SAFE.”

Yu-Wei’s views and insights into the institutional differences among these funds are helpful. If I understand him correctly, SAFE can invest (…as it apparently just did…) to acheive political ends. However, because SAFE is able to pursue politics, it gives the CIC and the NSSF some space to behave in accordance with Western norms.

This raises a couple of questions: Will countries like the U.S. differentiate among China’s funds or will it use SAFE’s recent investment as a reason to make general rules about Chinese investment funds? Also, will SAFE look to adopt the Santiago Principles? To what extent will SAFE continue acting in this manner? With respect to the final question, Yu-Wei had one final point of interest here:

“An interesting note. It has been recently reported on an overseas Chinese website that officials of mainland China and those in Taiwan are discussing the possibility of stopping the ‘Money Diplomacy’ strategy from both sides, since some small countries have been taking advantage of it…

Q&A with Zheng Bingwen, Senior Research Fellow at the Chinese Academy of Social Sciences

Ashby Monk

The Oxford SWF project 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 tenth instalment of our segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Zheng Bingwen of the Chinese Academy of Social Sciences. While Dr. Zheng’s views are his own, his perspective helps to further debate and facilitate understanding.

Ashby Monk: Thanks for joining us today, Bingwen. You recently argued that the China Investment Corporation has sparked a “new round of the China investment threat theory”. Why? What is it about the CIC that makes some foreign governments uncomfortable?

Zheng Bingwen: When the CIC was set up at the end of 2007, many governments and international organizations expressed their concerns and suspicion. For instance, the U.S.-China Economic and Security Review Commission held a hearing on February 7, 2008 entitled: “The Implications of Sovereign Wealth Fund Investments for National Security”. Over dozens of invited speakers expressed suspicions about the CIC. I interpreted the testimony to suggest that SWFs from small city states that are allied with the United States are likely to generate fewer concerns than funds from countries with aspirations to be global or regional powers (such as China). While this is only one example of suspicion, it was apparent during the testimony.

Ashby Monk: You were recently quoted as saying that SWFs breed suspicion because they are unregulated. Can you explain what you meant by this?

Zheng Bingwen: Some months ago I was interviewed by Reuters on this topic. As I said then, SWFs cause concerns not simply because they are unregulated but because they are less transparent than Sovereign Pension Funds (SPF). Moreover, their risk tolerance is much higher. It is this combination that is causing problems. I did note then (and still believe) that the supervision and regulations for SWFs are not as mature and traditional as for pension funds. So, many people are afraid that SWFs could come to Wall Street seeking mergers and acquisitions for unknown reasons. In the West, pensions have been around for almost a hundred years, so Westerns are quite used to them. In their view SPFs are angels, but SWFs are the opposite.

Ashby Monk: Given the above, you suggest that one way to overcome foreign concerns over the CIC is to launch a new fund-a sovereign pension fund-that will deflect foreign criticism. You argued that Norway’s Government Pension Fund would be the appropriate model. What are you suggesting here? Also, the implication is that the CIC is quite different from Norway’s fund. How are they different?

Zheng Bingwen: CIC is CIC. It should not copy Norway’s fund, but should maintain itself as it is now. Rather, the increasing size of China’s foreign exchange reserves suggests to me that it should be split into several investment funds, such as a SWF and (I hope) a SPF. By the end of last September forex reserves touched $1.91 trillion. Moreover, forex reserves are anticipated to surpass $2 trillion by the beginning of the coming year. So, pressure for reserves will come down and there is scope to create new funds.

Ashby Monk: What has been the response in China to your proposed sovereign pension fund?

Zheng Bingwen: Some people are interested in it. Many people read my paper on the subject in the Journal of International Review [Chinese version]. However, I am simply a researcher. This is my own view, and I do not concern myself with the views of policymakers on my proposal.

Ashby Monk: As a final question, I’m curious to hear what you see as the biggest weakness of the CIC? How should this be addressed?

Zheng Bingwen: I was interviewed by Shanghai Securities News on 2 September 2008 on this issue. The CIC’s biggest weakness is that it is confronting considerable pressure to achieve high rates of return. Because the government bonds used to finance the CIC get more than 5% per year-not to mention the expectation of an RMB revaluation-the CIC is likely facing a hurdle rate of nearly 10% per year. This requirement and the pressure to achieve high returns is the CIC’s biggest weakness.

If China follows my advice and sets up a SPF, a trust investment-style should be taken in order to lower the pressure of returns for the Fund. (The ‘trust investment-style’ means that the central bank would outsource investment management of foreign reserves.) Otherwise there is a possibility that high return strategies could result in higher, unnecessary risks. This, in turn, could raise concerns abroad about a ‘China-threat’.

Ashby Monk: Thanks, Bingwen, for taking time out of your busy schedule to chat with us today. We really appreciate getting the Chinese perspective on these issues.

Q&A with Yu-Wei Hu, Consultant on Chinese Pensions at the OECD.

By Ashby Monk

The Oxford SWF project 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 ninth instalment of our segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Yu-Wei Hu of the OECD. While Dr. Hu’s views are his own, his perspective helps to further debate and facilitate understanding.

Ashby Monk: Thanks for joining us today, Yu-Wei. What is the OECD’s interest in SWFs? How does the project at the OECD differ from the project at the IMF?

Yu-Wei Hu: Thank you for your invitation to participate in this exciting debate.

The OECD is interested in issues relating to SWFs largely due to the potential impact of investment from SWFs on national economies within (key) OECD countries as well as that on the global economy, which has been highlighted by the recently intensified attention and debate on this subject – particularly against the background of the current global financial turmoil. In saying so, the OECD is an appropriate organisation to address these issues in that it has long been regarded as a foremost inter-governmental body in developing and setting international accepted rules on across-border investment and capital movements.

Upon the request from the G7 finance ministers in the autumn 2007, the OECD and the IMF started to work on the SWFs issues albeit from different but complementary perspectives. The OECD mainly focuses on the recipient countries, specifically on providing guidance for these countries towards investment from SWFs. Main topics in which the OECD is interested and has worked on include a) SWFs and recipient country investment policy; b) SWFs and public pension reserve funds; c) SWFs and state-owned enterprises.

In contrast, the IMF’s work concentrates on the SWFs themselves, i.e. developing a voluntary code of conduct for SWFs in the areas of legal framework, governance structure and investment strategies. This was reflected by the recent release of the General Accepted Principles and Practices (GAPP) of SWFs in Santiago in October 2008.

Ashby Monk: Based on your extensive research on the Chinese pension systems, I wonder if you have some insight as to why the CIC has attracted so much attention in the West vis-à-vis other Chinese investment funds.

Yu-Wei Hu: Yes, in addition to the CIC the Chinese government also owns and controls several other big investment vehicles, e.g. the National Social Security Fund (NSSF) and SAFE (State Administration of Foreign Exchange) Investment Company. However, it is the CIC which has received the most media coverage and political attention since its creation in 2007. I think there are three reasons for it.

First, it is a new and large SWF. It is new in that it was created just one year ago, therefore no record of history is available to evaluate its performance and particularly its real objectives and investment strategies. It is large, as reflected by its mere size of USD 200bn assets under management and its potential to expand to a much larger fund given China’s fast growing foreign reserves (which is currently approaching to USD 2 trillion).

Second, owing to the fact that the CIC is wholly owned by the Chinese government, the Western countries – particularly the United States are worried that the Chinese government may use the CIC to achieve their geopolitical strategy, thus threatening the national security and interests of the West.

Thirdly, if we look at this issue from a broader perspective, I think this concern in fact lies on the traditional West’s perception on China as a potential threat. In other words, the CIC is just one of the many Chinese things Western politicians are suspicious about.

Ashby Monk: In terms of investment policies, governance and financial decision-making, how is SAFE different from CIC different from the NSSF?

Yu-Wei Hu: As noted in a recent OECD paper (Blundell-Wignall, Hu and Yermo 2008) and by Prof. Clark earlier in this series, there are different types of government-controlled investment vehicles, which is also the case for China. The three major ones in China are SAFE, CIC and NSSF, which, however, demonstrate differences in several areas.

In terms of legal framework, the SAFE is a governmental department within the Chinese central bank and in charge of administering and managing foreign reserves. However, it is noted that in 1997 the SAFE Investment Company was established in Hong Kong, and its principal objective is to invest in (overseas) equities, largely due to dissatisfaction of the government on the conservative investment strategy, i.e. mainly on treasury bonds in the past.

The CIC was established in the same purpose as the SAFE Investment Company but different in the sense that it reports directly to the State Council, rather than the central bank. Meanwhile, it has an independent legal status as an incorporate entity, i.e. not a governmental department. Its board of directors consists of senior officials from various ministries, and the Ministry of Finance is playing a much bigger role than others. In terms of investment strategy it is relatively aggressive for two reasons. First, it has a real pressure to pay back huge amount of interests to the Ministry of Finance, which is approximately USD 9bn annum. Second, good profits earned by its wholly owned subsidiary, i.e. Central Huijin Company allow the CIC to focus on fundamental and long-term investment.

As China’s strategic pension reserve fund the NSSF was created in 2000. Although supervised by both finance and labour ministries the National Council of Social Security Fund (NCSSF) – administrator of the NSSF reports directly to the State Council. Therefore the NCSSF is equivalent to the ministerial level. NSSF’s investment strategies were initially rather conservative; however, in recent years it has started to invest in risky assets, including equities, foreign assets and now it is also considering investment in private equities.

Ashby Monk: The CIC reports directly to the State Council. This seems to be an idiosyncratic hierarchy within Chinese political establishment. Why do you think this is?

Yu-Wei Hu: It is idiosyncratic in the sense that it should be currently the only firm in China which directly reports to the State Council. Although in China there are many other large state-owned financial institutions or enterprises, where heads of these firms are frequently considered as equivalent to the ministerial level (indeed most of them were senior government officials), they are normally subject to supervision of relevant governmental agencies which in turn report to the State Council, e.g. the China Banking Regulatory Commission (CBRC) on regulation and supervision of the Chinese banking industry, including the largest state-owned banks.

On the other hand, this arrangement, however, might be sensible due to the crucial importance of a well-functioning CIC for the performance of China’s huge stock of foreign reserves (particularly if more reserves are transferred to the CIC in the future) and potential relationship with the outside world.

Ashby Monk: Some have suggested that CIC’s human resources policies have left it without the industry’s top talent. What’s your view?

Yu-Wei Hu: According to the current governance structure of the CIC, all members of the top management – including the chief investment and chief operation officers, were senior government officials, and mainly form the Ministry of Finance and the central bank. However, it was noticed that rather than relying on junior government officials the CIC is recruiting from the wider job market for its various key positions, e.g. investment, analysis and research. It is at least a good start at the right direction for this new institution which I believe will try to attract the talented candidates – if not for the top management team, though.

Ashby Monk: How has the recent financial turmoil affected the CIC?

Yu-Wei Hu: The CIC so far has two well-known investments in the US market, one in Blackstone Group and the other one in Morgan Stanley. However, due to the current global financial crisis both investments have suffered significant losses. This has prompted criticism in China regarding CIC’s investment strategies and risk management mechanism, which therefore is likely to lead to a hold-off of further large investment abroad in the near term. Meanwhile, the sensitivity of buying the US or other Western financial institutions by SWFs at this moment could also arouse further protectionist reactions. Thus, the CIC alongside other SWFs might be more sensible to take a wait-and-see position on its overseas investments in the near term, although it was noticed that the CIC is considering slightly increasing its shareholding in Blackstone.

As far as I’m concerned loss per se is not a problem particularly given that the CIC is a long-term institutional investor, and it should be more concerned about the fundamental values of a firm and less about the temporary market volatility. However, what most matters is whether the internal decision making process is prudentially and professionally sufficient, i.e. not influenced by factors other than financial considerations. Unfortunately in terms of governance structure, transparency etc the CIC underperforms when compared to some other SWFs. It is hoped, however, that the active participation of the CIC in the IWG of SWFs and the recent release of the Santiago Principles will help it in becoming a “world-class investment institution” as being committed by the CIC.

Ashby Monk: Thanks, Yu Wei, for taking time out of your busy schedule to chat with us today. We really appreciate getting the Chinese perspective on these issues.

Deputy US Treasury Secretary Robert Kimmitt on GAPP / Santiago Principles

By Brett Keller

Mondo Visione has posted remarks by Deputy US Treasury Secretary Robert M. Kimmitt the recently released Generally Accepted Principles and Practices (GAPP), which are referred to by the IMF as the “Santiago Principles.” Kimmitt was speaking to the United States Council For International Business, and much of what he said concerns recipient country policies.

After urging open investment policies through the current financial crisis, Kimmitt said that transparency, proper risk management, and regulatory frameworks that protect investors and maintain stability are all important in capital markets:

In this context, the work of the IMF-sponsored International Working Group of Sovereign Wealth Funds offers timely guidance for SWFs as they become increasingly significant actors in global markets. Similarly, as recipient countries consider policies to address capital market vulnerabilities, we are well-served to remember that openness to capital from abroad is a source of economic strength not economic vulnerability.

Earlier this year, I wrote an article for Foreign Affairs [“Public Footprints in Private Markets“] in which I laid out our “operating assumptions” with regard to sovereign wealth funds… SWFs as a group, but particularly the more longstanding funds, have a track record of making investment decisions on sound economic and financial grounds… As part of [Treasury’s] efforts, Secretary Paulson reached agreement with Singapore and Abu Dhabi on a set of broad policy principles for SWFs and recipient countries in March of this year… While bilateral efforts are essential, Treasury has consistently taken the position that policy issues surrounding sovereign wealth funds – as well as recipient country inward investment regimes – are best addressed in a multilateral context.

On the significance and impact of the Santiago Principles:

The result is the Generally Accepted Principles and Practices or “Santiago Principles,” which were drafted and agreed in less than half a year. This agreement represents a milestone in enhancing the openness and transparency of the global financial system and in promoting open investment worldwide…. The Santiago Principles address many of the key macroeconomic, financial market, and investment issues raised by the rapid growth in the size and number of SWFs, as well as specific concerns highlighted by recipient countries, such as transparency and commercial orientation of SWFs… Even before the Santiago Principles were released this week, they had already produced tangible results. The Government of Singapore Investment Corporation released its first public report a month ago on how it manages the Government’s portfolio, including key information on its governance framework, investment processes, asset mix, and long-term returns. Temasek, Singapore’s SWF, already publishes detailed information annually. The Abu Dhabi Investment Authority has disclosed its broad asset allocation and is engaged in an ongoing process to enhance disclosure in all these areas, including compliance verification.

On recipient country policies for foreign investment:

I will begin with what is perhaps the foundational open investment principle: non-discrimination between domestic and foreign investors. This principle holds that countries should treat similarly domestic and foreign investors in like circumstances… Governments, of course, must be mindful of particular risks that may arise in some investments from abroad… Some countries employ extensive investment screening mechanisms, which consider broad factors such as “net benefit,” “national interest,” industrial policy, or other broad economic factors. In our view such expansive measures are too easily susceptible to, and sometimes actually serve, protectionist sentiment or goals… CFIUS [Committee on Foreign Investment in the US] continues to focus solely on genuine national security concerns and reviews annually only a small portion of transactions – fewer than 10% of transactions involving a foreign investor and a U.S. business. In 2007, for example, there were over 2,000 cross-border deals, of which only 125 came before CFIUS, none of which was blocked.

And on recipient country transparency principles:

The transparency principle holds that governments should explain clearly how the investment review process works and what its objectives are, and then implement measures fairly and in a predictable manner… We have maintained CFIUS’ procedural efficiency, including strict timelines, which increases predictability for investors. In 2007, CFIUS maintained the pace of concluding action on over 80% of transactions within one 30-day review.

Will the Santiago Principles be effective?

The Santiago Principles’ effectiveness in helping to reduce protectionist pressures and contribute to global financial stability ultimately will depend on their widespread adoption and implementation by SWFs. We expect that the successor to the IWG – an international Standing Group of SWFs – will address implementation issues and proposals for further work. Ultimately, SWFs will be judged on how they apply the Principles in practice, especially in their investment decisions.

Santiago Principles: “It is all about trust”

By Ashby Monk

The International Working Group of Sovereign Wealth Funds (IWG) released the Santiago Principles on Saturday–also referred to (confusingly for anyone with an accounting background) as GAPP, or the generally accepted principles and practices.

The IWG–and by extension the GAPP-is based on building mutual understanding between SWFs and SWF investment receiving countries. The latter have generally been concerned about the influence of government sponsorship on the former’s investment policies–this concern has led some to consider new, protectionist policies geared towards dealing with a perceived ‘SWF threat’.

The release of these principles is an important step towards resolving any remaining distrust or confusion surrounding SWFs (and their agendas). Indeed, according to IWG Co-Chair Hamad al Suwaidi, of the Abu Dhabi Investment Authority, “this process is about one word, it is all about trust.” This was echoed by David Murray of Australia’s Future Fund, the Chair of the IWG’s Drafting group, who noted, “…we had to establish trust in recipient countries that the activities of sovereign wealth funds were all based on an economic orientation.” Recipient countries need to trust that SWFs are investing in their economies to achieve economic and financial ends; political ends would be perceived as illegitimate.

The 24 principles have four general goals: First, they ask sovereign wealth funds to meet local recipient regulatory requirements and make certain public disclosures in a variety of areas; these disclosures are nevertheless mindful of the competitive position of SWFs in the marketplace. Second, the principles seek to ensure that SWFs invest on the basis of economic and risk and return considerations. Third, the principles seek to instill transparent and sound governance structures. Finally, the principles will contribute to stable financial markets and avoid any protectionist policies targeting SWFs.

The GAPP is voluntary, and its implementation is subject to the application of home country laws. Nevertheless, the ADIA has already indicated that they fully support the GAPP and will begin implementation. They have even established an inter-departmental committee to oversee compliance with the GAPP and further suggested that an independent auditor to verify compliance is under consideration. Singapore has also indicated that it supports the principles in full.

Given the state of financial markets and a clear need for long-term investors with ample liquidity, it is in the interest of all parties to make the Santiago Principles a success. The outlook is positive; even funds that have inspired some concern in the West–such as the China Investment Corporation–participated in this process and thus should (by extension) be willing to implement GAPP.


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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