SWF FUNDING, MANAGEMENT, AND GOVERNANCE

Funding

As we highlighted in earlier sections, SWFs are born out of an intention to prepare for the future, be it to shield national revenues from volatility or saving for future generations. Invariably, governments allocate substantial amounts as seed capital for SWF formation; an example includes Angola's FSDEA USD5 billion in 2012 (World bank, 2013). After its formation, funding modalities for SWFs differed, including a purely self-funding arrangement and some formula-based allocation from state revenues. SWFs like Mubadala of Abu Dabhi, Botswana's Pula Fund, and Temasek of Singapore are examples of state-backed SWFs with no regular government funding. At the other end of the spectrum, the Funds for Future Generations in Equatorial Guinea has a commitment from the government for a stipulated 0.5% annual allocation from oil revenues. In between the continuum exist some SWF whose continuing state support is contingent on certain conditions or the occurrence of certain events. A perfect example in this case is the Economic and Social Stabilisation Fund of Chile, which from its inception had an entitlement to an allocation from a state budget devised when copper revenues were optimal.

How an SWF is supported by a sponsoring government from time to time can be seen as linked to its broad objective or simply its type. Saving funds and stabilisation funds typically get a one-off but substantial capital and thereafter self-fund from a little portion of their returns: the portion that does not get reinvested. By contrast, development and future generations' funds typically get additional allocations for incremental investments.

Governance and management structures

The governance and management structures of SWFs are predominantly influenced by investment strategy, investment approaches, and risk appetite. The setup normally ranges from institutional arrangements supported wholly by management and governance structures of a sponsoring institution (a ministry of finance or a central bank), to a fully fledged institution with its own staff, management, and board. The former is typical with stabilisation and saving funds, which normally carry a low risk appetite, investing only in premium securities. Such an approach to investment does not call for fully fledged investment teams, because there is little monitoring beyond analysis and reporting; neither do they pursue any implementation of investment projects. Botswana's Pula Fund is an example: it was set up by the central bank (Bank of Botswana), which manages and controls it under its regular management structures. The fund is essentially a longterm investment portfolio aiming to preserve part of diamond income for future generations through global investments in low-risk instruments.

On the other end of the spectrum, we find Temasek, the Singaporean SWF. Temasek is a fully fledged corporation employing over six hundred personnel across its ten offices in different parts of the world. The SWF is governed by a fully fledged 14-member board, with a team of 25 senior executives leading the operations. Again, the relevance of such a structure stems from Temasek's approach to investment and from the risk appetite; it is an active investor that buys and holds stakes in subsidiaries and associate companies and spends time assessing other risky investments of higher long-term returns.

Between these two extremes other variants may exist, typically involving a skeletal caretaker team hosted by the sponsoring government or central bank, where such a team would be involved in outsourcing asset management services to third-party firms not owned by a government. For instance, external managers administer the equity and corporate fixed-income portfolios of Chile's SWF.

THE CHANGING ROLE OF SOVEREIGN WEALTH MANAGERS

Traditionally, sovereign wealth management seems to have concerned itself with saving up current and trade surpluses for the future. Perhaps a more structured approach to defining the role of sovereign wealth managers can be borrowed from the IMF's Global Financial Stability Report produced in October 2007, at the start of the US subprime crises. The report provides the following taxonomy: stabilisation funds, savings funds, reserve funds, development funds, and pension reserve funds.

Stabilisation funds

These are set up to cater for effects on inadequate diversification of national revenue sources, typically by countries endowed with natural resources. Surpluses from the trade of the natural resources are saved and called upon when national revenues decline, usually due to depressed commodity markets. A perfect example is the Economic and Social Stabilisation Fund (ESSF) of Chile, established in 2007 to provide fiscal spending stabilisation by reducing dependency on the global economic and copper trading cycles. The ESSF is funded from the fiscal surplus, net of allocations to the Pension Reserve Fund, and any residual public debt obligations. Periodically, budgetary constraints imposed by economic downturns are mitigated by a partial call from the fund, thus avoiding the accumulation of national debt.

Savings funds

These are 'intergenerational funds' that are based on monetising existing natural resources for the benefit of both present generations and future generations. As observed by the IMF, these funds effectively transfer nonrenewable assets into a diversified portfolio of international financial assets to provide for future generations or other long-term objectives. An example in this case is the Equatorial Guinea's Fonds de Reserves pour Generations Futures (Funds For Future Generations) formed in 2002. While a full picture on the fund's performance remains largely obscure, the government's pronounced intention at the fund's inception was to commit transferring to it 0.5% of its oil revenues for the benefit of the future generations.

Reserve funds

Unlike the surplus-driven funds, which have tended to stabilise government budgets during times of constrained revenue inflows, reserve funds are set up to pursue savings objectives, usually with increased latitude to actively pursue higher returns but still within the scope of a conservative risk appetite. According to the IMF, assets held under reserve funds count towards total fiscal reserves and can be liquidated in times of need. A typical example is Botswana's Pula Fund - established in 1994 and managed by the central bank of Botswana. The fund manages foreign exchange reserves that are more than what is expected to be needed in the medium term. Significant calls were made from the fund in 2001, when a Public Officers' Pension Fund was set up, and in 2008, due to a slump in national revenues that was induced by the global financial crisis of that time.

Development funds

These are mostly development corporations, set up to pursue socioeconomic objectives. Typically, these corporations invest in projects with demonstrable development outcomes and in industries and sectors that do not have adequate private sector participation (mainly due to high risk but low returns). Increasingly, development funds are becoming vehicles for public-private partnership (PPP) transactions. Dubai Investment Capital (DIC), a subsidiary of Dubai Holding, is a corporate SWF with an investment strategy that incorporates well the concept of looking beyond financial returns for wider socioeconomic development. DIC played, and continues to play, a pivotal role in the development of the boating and marine sector in the UAE region through its investment in ART Marine Holdings. The company is also at the forefront of importing aerospace technology from the world into Dubai, through its investments.

Pension reserve funds

These funds cater for pension liabilities, and the objective is often to ensure that pension liabilities always remain below funded assets without having to resort to some politically unacceptable mechanisms, for example cutting back on pension entitlements. The largest known SWF that can be classified into this category is the Norwegian Government Pension Fund-Global, set up in 1990 to invest surpluses driven by a well-performing petroleum sector. Its stated mission is 'to safeguard and build financial wealth for future generations', and its AUM had accumulated an estimated USD1 trillion by early 2018.

Therefore, the original objective of sovereign wealth management has really been to put aside, and grow over time, some financial assets to cater for a future occurrence. However, the evolution of sovereign wealth management has by itself influenced a gradual evolution of objectives and consequently the role of sovereign wealth managers. Rapid wealth accumulation by SWF in surplus economies, which is at times way beyond precautionary levels, has attracted attention of critics given the transparency concerns around some of the larger SWFs.

Modern-day sovereign wealth managers' tasks are much broader, and they aremore proactive in nature; although traditionally SWFs have evolved in reaction to fiscal surpluses, today SWFs proactively pursue the socioeconomic (and sometimes geopolitical) ambitions of their respective countries. Next we explore a suite of newer objectives of sovereign wealth managers, and this does not that claim any of the older objectives has been subordinated or replaced.

A role in the capital and financial markets

Sovereign funds quite often have opportunities to operate a lean cost structure not riddled with debt issuance, service costs, and expected returns from equity holders. This is because SWFs are generally funded from state funds. In addition to this, sovereign funds are seldom operating companies; most take the form of investment-holding companies with lean operational structures. Compared to other financial institutions, the substantially lean cost structure of SWFs brings two possibilities, among others.

First, a lower cost base allows SWFs to accept lower returns and sometimes in riskier investments that would ordinarily find it difficult to attract purely private capital. Thus, SWFs are increasingly becoming an important source of capital for strategic or even risky investments with a huge potential on the upside.

Second, SWFs generally do not have operational cashflow pressures, as a direct result of a low-cost base. This enables them to provide the much-needed capital in projects with a long payback profile. These are typically much-needed infrastructure projects in developing economies, and SWFs occasionally support these under some form of bilateral agreements.

Third, sovereign wealth funds typically hold excessive relative liquidity, with increased capacity to withstand credit losses. This, coupled with the fact that SWFs have 'patient capital' (i.e. can invest in longer-term horizons for conservative returns), makes them crucial sources of liquidity in the wake of credit crunches and widespread financial crisis. What we saw in the aftermath of the 2007/2008 financial crisis is a case in point; when severe credit losses, combined with a slump in property prices, threatened the existence of large financial institutions, and consequently the global financial markets themselves, SWFs came to the rescue. Between 2007 and 2008, in the US alone, a total of 30 rescue transactions were recorded, wherein SWFs invested a combined USD40 billion in capital into financial institutions. SWFs such as Kuwait Investment Authority, Abu Dhabi Investment Authority, and Temasek injected capital, thereby acquiring stakes in banks like Merrill Lynch and Citigroup.

222 Mbako Mbo and Charles Komla Delali Adjasi

A policy tool

In a rather controversial emerging practice by some nations, SWFs are gradually playing a policy role. Some SWFs have in recent times been relied on as vehicles through which countries adopt a carrot-and-stick approach to achieve their broader policy objectives, a practice that has attracted some scepticism and heightened calls for transparency. In 2008, the Chinese government, acting through its own SWF the State Administration of Foreign Exchange (SAFE), invested USD300 million of government bonds issued by Costa Rica. Following a constitutional court case, the Costa Rican government was compelled to release documents, initially meant to be confidential, that were widely interpreted to mean that China was investing in Costa Rican bonds, in order to open diplomatic relations between the two nations, in return for which Costa Rica was to cease its recognition of Taiwan. Interestingly, the purchase of the bonds was followed by Costa Rica's swiftly cutting its long-standing diplomatic ties with Taiwan.

Often geopolitical concerns seem to arise when SWFs act with less transparency, particularly with respect to their intentions. For policy intentions to be achieved, it is almost preconditional that the two or more nations involved are fully agreeable and all suspicion is erased. In 2006, Dubai Ports World (DP World, or DPW) attempted to acquire a British-owned company, which held seaport management contracts for six major ports in the US. Despite the US's having been presumably comfortable with the ports remaining under a British-owned management company, the US Congress blocked the planned takeover, citing security concerns over the unknown intentions of the UAE.

Bilateral and multilateral international economic cooperation

Despite the scepticism and geopolitical concerns that emerge when SWFs are projected as tools for policy objectives, documented cases show mutual benefits between nations whose SWFs engage in strategic cross-border investments. In fact, SWFs can perfectly enhance bilateral economic and development cooperation instead of igniting political apprehension and uncertainties. A well-cited case is the role of SWFs in the South-South cooperation, a phenomenon seen as a real game changer in replacing North- South Overseas Development Assistance (ODA) and foreign aid flows to south-south investments for mutual benefit. Under the auspices of the South-South cooperation, the China-Africa Development Fund (CAD), a Chinese sovereign fund, was formed in 2007 with an investment focus on Africa. As of 2018, CAD held no fewer than USD10 billion available for additional African investments. The fund's existing portfolio, as of March 2018, was spread across 36 African countries in sectors that include energy, agriculture, manufacturing, and infrastructure. From this arrangement, CAD will achieve portfolio diversification, value growth for Chinese enterprises, and growth in exports. While otherwise, at least in theory, African states are to benefit from improved infrastructure, a gradual transfer of skills, and the importation of technologies.

 
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