Last week’s edition on the forgoing topic – a proposed framework for Guyana’s Sovereign Wealth Fund (SWF) – was more or less an introductory piece of a series of forthcoming articles on the subject matter (including today’s piece). In the interest of simplicity for the readers of this column, hereunder stated is an outline of the structure of the articles that will be featured on the SWF proposed model.
Following a definition of SWFs – an examination of the institutional structure and governance framework will be conducted; the legal framework, objectives and macroeconomic linkages; investment policies and risk management frameworks; these together with an overview of the SWFs of other established oil producing countries will be examined, including both the Uganda and Norway models – the final component of the article will then conclude with recommendations in the context of a developing economy.
“The emergence of SWFs has signalled a major reshaping of the world’s economy: financial actors from developing countries playing on an equal footing with the financial giants of the OECD countries. Rising financial centres such as Singapore, Dubai or Shanghai have nurtured leading financial institutional and asset managers independent of the traditional Western financial centres of New York, Boston or London”, cited from OECD Working Paper (2008).
SWFs are defined by the US Treasury as “government vehicles funded by foreign exchange earnings but managed separately from foreign exchange reserves” (Lowery,1) cited by Balin (2008). Together with financing, SWFs also differ from other Government vehicles in their objectives, terms and holdings: though foreign reserves have historically invested in sovereign fixed income notes for the purpose of intervention on the foreign exchange market, SWFs usually take a longer-term approach, where international equities, commodities, and private fixed income securities are used to achieve the long-run strategic and financial goals of sovereign (Balin, 2008).
The first SWFs were established alongside the initial oil strikes in the Persian Gulf states in the 1950s. In 1953 for example, the Kuwaiti Investment Board began in 1953 for the purpose of managing the ‘excess’ oil revenues Kuwait was expected to garner. The next set of SWFs were established during the oil boom of the 1970s. Oil exporters such as the United Arab Emirates, Saudi Arabia, and Alberta used their SWFs as a way to absorb excess liquidity that could potentially overheat their economies (the term ‘overheat’ is used to describe a situation where the aggregate demand is increasing so fast that it cannot be met by the economy’s productive capacity and is, thus, liable to cause or fuel inflation).
Top 5 largest Sovereign Wealth Funds in the world:
Source: Sovereign Wealth Fund Institute (SWFI) – updated December 2017.
Why do countries establish SWFs?
Generally, countries establish SWFs for four primary reasons. Firstly, SWFs act as intergenerational transfer mechanisms, where future government pensions, asset liquidity and fiscal revenues are guaranteed by today’s export earnings such that, future generations can continue to live prosperously when the countries natural resources are exhausted – using the earnings of their forefathers. Secondly, most SWFs of all country types are created to diversify a country’s income so that it can respond to shocks to the country’s comparative advantages. In the event of a competitiveness crisis faced by a country, it can utilise its SWF assets to reinvest in new sectors of the economy that can revive the country’s competitive advantages. Thirdly, SWFs are established to increase the return on assets held in their central bank reserves. They can raise returns above the three to five per cent annual returns garnered by most foreign exchange reserve holdings, by investing in securities other than US or European sovereign bonds. In recent times, this desire has become prevalent with the rapid expansion of foreign exchange stocks in many emerging markets and the decline of the US dollar – and thus lower returns on dollar denominated debt (Balin, 2008).
And finally, the fourth is that some SWFs seek to promote investment from multinational corporations and technological transfer to domestic industries. In so doing, a fund would have to acquire a majority stake in a company or form a coalition with shareholders. Henceforth, with its voting power the SWF can appoint corporate board members who could direct a company to invest in the SWF’s home country and especially, establish research and development facilities there (Balin, 2008).
*The author is the holder of a MSc. Degree in Business Management, with concentration in Global Finance, Financial Markets, Institutions & Banking from a UK university of international standing.
