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Ethos Perspectives

Sovereign Wealth Funds

Introduction
The massive growth of sovereign wealth funds (SWFs)—pools of assets controlled by governments and invested in private markets abroad—has generated concerns in the West about their potential destabilising impact on the global financial system, given their general lack of transparency and accountability. SWFs are also seen as the antithesis of the prevailing philosophy of market privatisation.

Most of the concerns in the West revolve around SWFs controlled by China and the Gulf oil producers. At the heart of these concerns is the fear that SWFs might be driven by political, rather than economic, ends and that they might evolve into tools for acquiring controlling stakes in strategic industries or assets.

This issue of Ethos Perspectives examines the major concerns surrounding SWFs. It also surveys the emerging protectionist backlash against the strengthening financial muscle of Asian and Middle Eastern SWFs.

Origin of Sovereign Wealth Funds
SWFs are special pools of global assets owned and managed (either directly or indirectly) by governments to accomplish a diversity of economic and financial goals. These goals include optimising returns, inter-generational wealth transfer and enhancing financial stability.

According to Morgan Stanley, "independent of reserves, SWFs are conservatively expected to grow to US$12 trillion by 2015—a figure that will roughly equal the entire US GDP". Thus, SWFs are no longer small enough to ignore. Indeed, the sheer size of some of these SWFs reflects the tremendous growth in reserves of many emerging Asian economies as well as major oil exporters. These reserves are well in excess of central bank requirements for monetary stability and thus could be managed separately.

The vast majority of SWFs are derived from the accumulation of reserves from the export of commodities (e.g. oil, gas, minerals, etc.). The SWFs of many Middle Eastern oil-producing countries, Norway, as well as Russia fit into this category. Most of these funds were set up against concerns that such resources were dwindling. The second category of SWFs is not based on revenue from resources but instead involves the accumulation of foreign exchange reserves derived from large balance of payments surpluses. China is a prime example in this regard. The increasing number of SWFs suggests that governments throughout the world are keen to generate higher returns on their assets than what would be yielded by bank deposits and investments in treasury bills.

Reference 1: "The world's most expensive club". The Economist (24 May 2007).
http://www.economist.com/printedition/displayStory.cfm
?story_id=9230598&fsrc=RSS

Reference 2: Rediker, D. and Crebo-Rediker, H. "Foreign investment and sovereign wealth funds". New America Foundation (3 October 2007).
http://www.newamerica.net/publications/policy/foreign_investment_and_
sovereign_wealth_funds

Emerging Financial Protectionism
SWFs are causing increasing unease amongst Western countries, whose concerns centre on the SWFs’ financial power, estimates of further exponential growth, and the lack of transparency and regulation.

With an estimated US$2.5 trillion in assets, SWFs are large enough to influence financial market movements. Furthermore, some SWFs are investing in other funds, such as hedge funds. This involves leveraging, which multiplies the SWFs’ impact on markets and can potentially destabilise markets when bets go wrong.

Another concern over SWFs, particularly in the US, is that SWFs run counter to the American philosophy of market privatisation. In fact, many raise the spectre of SWFs evolving into a form of “cross-border nationalisation” and constituting government interference in free markets—only this time, in other countries’ markets rather than their own.

 

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