The Institutional and Governance Structure
In last week’s edition, a brief history was presented on the origins of SWFs, along with a definition and the purpose of establishing a SWF, having regard to its role in a country’s economy. Also, a list of the world’s top five SWFs, measured in terms of asset size, was presented, with the Norwegian SWF being the largest, reaching close to one trillion U.S. dollars. Today’s article deals with the institutional and governance structures of SWFs.
Firstly, with respect to the objectives and governance structures of SWFs, it must be recognized that the policy objectives of SWFs vary, depending on the broad macrofiscal objectives that they aim to address. As such, the organizational structure needs to have a clear separation of responsibilities and authority. Thus a well-defined structure builds a decision-making hierarchy that limits risks viz-à-viz ensuring the integrity of, and effective control over, SWF management activities (IMF Working Paper, 2013).
The institutional frameworks of SWFs differ from one country to another. Irrespective of the governance framework, in order to minimize potential political influence that could hinder the achievement of its policy objectives, the operational management should be conducted on an independent basis. The “manager model” and the “investment company model” are the two dominant forms of institutional setup.
Citing IMF Working Papers (2008 & 2013), the legal owner of the pool of assets constituting the SWF (usually the Ministry of Finance) gives an investment mandate to an asset manager – that is, in the manager model. Within this model, there are three main sub- categories:
1. The Central Bank manages the assets under a mandate given by the Ministry of Finance (e.g., Botswana, Chile and Norway). In this case, the Central Bank may choose to use one or more external (private) funds for parts of the portfolio.
2. A separate fund management entity, owned by the Government, is set up to manage assets under a mandate given by the Ministry of Finance, such as the Government Investment Corporation (GIC) of Singapore. In this case, the manager may also have other asset management mandates from the public sector. For example, the GIC manages parts of the reserves of the Monetary Authority of Singapore.
3. The Ministry of Finance gives mandates directly to one or more external (private) fund managers. This model is generally not recommended, since awarding contracts to external fund managers is in itself an investment decision that should be carried out at arm’s length from a political body; and the evaluation, monitoring, and termination of management contracts require specialized skills, more likely to be found in a dedicated investment organization. However, for countries with severe human capital constraints, it can be the only feasible solution.
In the second model; that is, the investment company model, the Government establishes an investment company that in turn owns the assets of the fund. This model is usually employed when the investment strategy implies more concentrated investments and active ownership in individual companies (Temasek, Singapore), or the fund has a development objective in addition to a financial return objective.
In the organizational structure of SWFs, it is important to distinguish between governing and supervisory bodies. The governing bodies constitute a system of asset management responsibilities. The authority to invest is delegated from the top entity of the governance system down through the various governing bodies to the individual managers of assets. The delegation implies a gradual increase in the granularity of regulations pertaining to responsibilities as we move down the ladder of the organizational system. The role of the supervisory body is to verify the supervised unit is acting in accordance with the regulations set by the governing body immediately above it in the governance structure.
It is also helpful to distinguish between those bodies that are internal and external to the organization. The table below illustrates the SWF government structure:
Notwithstanding the divergence in the governance models of SWFs, inter alia, due to differences in political institutions, there are some common principles that should be considered essential to any well-governed SWF. To this end, it must be recognized that the principal aim in the establishment of a governance structure for the SWF is that the bodies established to manage the assets of the SWF are essentially trustees on behalf of the people of the country. Therefore, one of the fundamental concerns is to establish a structure that would underpin the legitimacy of the SWF’s operations, and ensure that the decisions taken in the management of the SWF reflect the best interest of the owners of its assets. (To be continued next week).
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.
