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1. Background: the trade-off of sovereign ownership. January 19-25, 2008. Benevolent dictator’s SWF. Neo-mercantilist SWF. SWF as a politically oriented arm to assert the geopolitical ambitions of emerging countries. - PowerPoint PPT Presentation
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Bocconi University, November 17, 2011PBC-CAREFIN Seminar “Curbing Volatility: Financial Markets, Credit Rating Agencies, and Sovereign Investment Funds”
Taming Leviathan:a Regulatory Framework for Sovereign Wealth FundsVictoria BarbaryPaolo Baffi Center, Bocconi University
Bernardo BortolottiUniversità di Torino and Paolo Baffi Center, Bocconi University
Curbing Volatility SeminarBocconi – November 17, 20112
1. Background: the trade-off of sovereign ownership
SWF as a tool to address market failures in long term investment and domestic economic development
SWF as a politically oriented arm to assert the geopolitical ambitions of emerging countries
Benevolent dictator’s SWF Neo-mercantilist SWF
January 19-25, 2008
Curbing Volatility SeminarBocconi – November 17, 20113
2. Facts: SWF history
IPIC, Abu Dhabi
1990
Government Pension Fund - Global, Norway
2008
GIC, Singapore
BIA, Brunei
National Social Security Fund, ChinaKNF, Kazakhstan
CIC, ChinaEmirates Investment Authority, UAEADIC, Abu Dhabi
National Wealth Fund, Russia
QIA, QatarKIC, KoreaTimor-Leste Petroleum FundRIA, Ras Al KhamahState Capial Invest. Corp., Vietnam
LIA, LibyaFuture Fund, AustraliaInvestment Corp., DubaiState Oil Fund, AzerbaijanBahrain Holding, BahrainOIF, OmanDIFC, Dubai
2000
IPRF, IrelandNew Zealand Superannuation Fund, NZ
Mubadala Development Company, Abu Dhabi
Istithmar World, Dubai
KNB, Malaysia
Revenue Equalization Fund, Kiribati
National Oil Account, Sao Tomé
KIA, Kuwait
1953
Temasek Holdings, Singapore
ADIA, Abu Dhabi
1980
State General Reserve Fund, Oman
Source: Sovereign Investment Lab
1960 1970
Curbing Volatility SeminarBocconi – November 17, 20114
2. Facts: the largest SWFs by AUM, 2010
Country Source of Funds Fund Name Assets Under Management
Founding Date
Norway Commodity (Oil) Government Pension Fund-Global $560,5bn 1990
United Arab Emirates Commodity (Oil) Abu Dhabi Investment Authority $342bn 1976
China Trade Surplus China Investment Corporation $332,4bn 2007
Kuwait Commodity (Oil) Kuwait Investment Authority $296bn 1953
Singapore Trade Surplus Government of Singapore Investment Corporation $220bn 1981
Singapore Govt Linked Companies Temasek Holdings $133bn 1974
China Trade Surplus National Social Security Fund $132bn 2000
Russia Commodity (Oil) National Wealth Fund $94,3bn 2008
Qatar Commodity (Oil&Gas) Qatar Investment Authority $80bn 2005
Libya Commodity (Oil) Libyan Investment Authority $53,3bn 2006
Australia Commodity (Various) Future Fund $77,2bn 2006
United Arab Emirates Commodity (Oil) International Petroleum Investment Company $49,7bn 1984
Kazakhstan Commodity (Oil&Gas) Kazakhstan National Fund $41,9bn 2000
Republic of Korea Trade Surplus Korea Investment Corporation $37,6bn 2005
Brunei Commodity (Oil) Brunei Investment Agency $39,3bn 1983
Total Oil & Gas $1.599,1bn
Total Other $1.079,6bn
Grand Total $2.678,8bn
Source: DB Research; Peterson Institute for International Economics; SWF Institute; Nadim Kawach, “UAE’s overseas investment income to rebound in 2009,” Emirates Business 24-7, April 2009; Hadfi eld, “Kuwait Investment Authority loses $31bn in nine months,” Meed Middle East Business Intelligence, February 11, 2009; Mubadala Annual Report 2008; Brad Setser and Rachel Ziemba, GCC Sovereign Funds: Reversal of Fortune, WP, January 2009 (Council on Foreign Relations, New York: 2009).
Curbing Volatility SeminarBocconi – November 17, 20115
2. Facts: SWF Investment from MENA, 2000-2010
Since 2000, MENA SWFs have invested $172,6bn primarily in Europe (42%), within MENA (26%), and in North America (23%). Contrary to Asia, MENA balance domestic investment with international diversification.
MENA to Asia Pacific50 deals, $7.5bn
MENA to Sub-Saharan Africa27 deals, $4.4bn
MENA to Russia & Central Asia
16deals, $1.7bn
Within MENA145 deals, $45.2bn
MENA to Latin America5 deals, $0.5bn
MENA to North America60 deals, $40.2bn
MENA to Europe124 deals, $73.0bn
Source: Sovereign Investment Lab Transaction Database
Curbing Volatility SeminarBocconi – November 17, 20116
2. Facts: Barbarians at the Gate?
Source: Sovereign Investment Lab Transaction Database
Utilities, 7%
Transport, 1%
Natural Resources, 11%
Banking, Insurance, Trading
40%
Other16%Automotive
10%
Real Estate13%
Telecoms, 1%Aircraft, 1%
21% Strategic Sectors
SWFs foreign investment by sector, 2000-2010
Curbing Volatility SeminarBocconi – November 17, 20117
2. Facts: SWF activity by type of political regime
Percentage of SWF Assets under Management by Political Regime, 2010
Authoritarian Regime
54%
Hybrid Regime17%
Full Democracy
27%
Flawed Democracy
2%
Source: Sovereign Investment Lab; 2010 EIU Democracy Index
SWF Investment Flows, 2000-2010
$-
$10.000
$20.000
$30.000
$40.000
$50.000
$60.000
$70.000
$80.000
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
US$ Mn
AuthoritarianFlawed DemocracyFull DemocracyHybrid
Source: Sovereign Investment Lab Transaction Database
Curbing Volatility SeminarBocconi – November 17, 20118
2. Facts: Foreign exchange reserves and political regimes
$0
$1.000
$2.000
$3.000
$4.000
$5.000
$6.000
$7.000
$8.000
$9.000
$10.000
1999
M1
1999
M5
1999
M9
2000
M1
2000
M5
2000
M9
2001
M1
2001
M5
2001
M9
2002
M1
2002
M5
2002
M9
2003
M1
2003
M5
2003
M9
2004
M1
2004
M5
2004
M9
2005
M1
2005
M5
2005
M9
2006
M1
2006
M5
2006
M9
2007
M1
2007
M5
2007
M9
2008
M1
2008
M5
2008
M9
2009
M1
2009
M5
2009
M9
2010
M1
2010
M5
US$
Mn
Total Global ReservesFull DemocraciesFlawed DemocraciesHybrid RegimesAuthoritarian States
Source: International Monetary Fund, International Finance Statistics Database; EIU Democracy Index 2010
Curbing Volatility SeminarBocconi – November 17, 20119
3. SWF investment and political risk
Does it matter?Yes. Political risk could affect the risk and return properties of SWF targets via:
Upheaval risk, transforming the country’s wealth management from savings towards divestiture and public spending to assuage protestors
Geopolitical risk, events could trigger the use of targeted financial sanctions freezing SWF assets (e.g. Libya)
SWF metamorphosis: from patient, long-term investor providing capital over the business cycles to a short-term player with unpredictable liquidity needs.
Curbing Volatility SeminarBocconi – November 17, 201110
3. The financial performance of SWF targets
Source: Bortolotti et al. (2010), “Quiet Leviathans: Sovereign Wealth Funds Investments, Passivity, and the Value of the Firm”, mimeo.
0,00%
-1,67%
-3,96%
-6,25%
-11,83%
0,00%
-2,15%
-1,51%
-8,35%
-10,47%
-12,00%
-11,00%
-10,00%
-9,00%
-8,00%
-7,00%
-6,00%
-5,00%
-4,00%
-3,00%
-2,00%
-1,00%
0,00%
Investment 6 months 1 year 2 years 3 years
Adju
sted
Per
form
ance
Abnormal Return
Return-on-Equity
Curbing Volatility SeminarBocconi – November 17, 201111
3. The EUI Index of political unrest for SWF countries
% OF POPULATION
UNDER 25
GOV'T YEARS IN POWER
CORRUPTION INDEX
DEMOCRACY INDEX
CENSORSHIP INDEX
GDP PER CAPITA PPP ILLITERACY RATES
INTERNET PENETRATION
RATE
TOT.
COUNTRY % share yrs share indexval share indexval share indexval share value share % share % share
Norway 31,90 0,81 n/a - 6,80 0,09 - - - - 52.013 0,18 - - 94,80 1,25 2,33
Singapore 29,80 0,76 6,00 0,18 - - 51,90 0,65 79,50 1,00 56.522 0,17 5,60 0,45 77,80 1,03 4,24
Malaysia 47,80 1,23 n/a - 38,30 0,48 44,90 0,56 73,40 0,91 14.670 0,64 8,10 0,65 64,60 0,85 5,32
China 36,80 0,94 7,00 0,21 53,40 0,66 86,00 1,08 94,20 1,17 7.519 1,25 6,70 0,54 34,40 0,45 6,30
Korea 29,80 0,76 n/a - 26,70 0,34 12,70 0,16 34,90 0,44 29.836 0,31 - - 81,10 1,07 3,08
Bahrain 35,00 0,89 12,00 0,36 32,80 0,41 77,20 0,96 79,60 1,00 26.852 0,35 11,20 0,90 88,80 1,17 6,04
Libya 49,00 1,25 42,00 1,25 100,00 1,25 100,00 1,25 100,00 1,25 13.805 0,68 13,20 1,06 5,50 0,07 8,06
Oman 49,00 1,25 41,00 1,20 28,00 0,35 90,50 1,13 79,60 1,00 25.439 0,37 15,60 1,25 41,70 0,55 7,10
Qatar 28,00 0,71 16,00 0,48 13,00 0,16 86,00 1,00 76,00 0,95 88.559 0,11 6,90 0,56 60,90 0,79 4,76
Kuwait 37,00 0,94 5,00 0,15 37,00 0,46 72,10 0,90 60,00 0,75 37.849 0,25 5,50 0,48 39,40 0,52 4,45
UAE 34,00 0,87 7,00 0,21 19,00 0,24 93,60 1,17 79,60 1,00 56.580 0,17 10,00 0,80 75,90 1,00 5,46
Curbing Volatility SeminarBocconi – November 17, 201112
3. The stock return of SWF targets: assessing political instability
Variable: Buy and Hold Adjusted Returns |
1 Year from Investment
2 Years from Investment
Political Unrest Index | -.31309864 -.32604307| 0.0284 0.0747
Govt Involvement | .05410613 -1.4061047| 0.9327 0.3018
SWF passivity | -.19614493 -.50469912| 0.2138 0.1473
Strategic Target Dummy | .020129 .04296757| 0.7333 0.7322
SWF Age | -.01018229 -.07029254| 0.6413 0.1436
Capital Infusion | -.62466721 1.9326637| 0.7566 0.4157
SWF Stake | .21320963 -.8246279| 0.8604 0.1488
Foreign Target Dummy | -.62759119 -1.1820403| 0.0000 0.0000
Target Market Value| -3.622e-06 -.00001155| 0.3285 0.0173
Target Leverage | .10698612 -.23162654| 0.4606 0.2909
Target Liquidity | .01115337 -.00152727| 0.2823 0.9656
SWF in the Board| .13625312 .04482498| 0.2150 0.7342
Buy and Hold Returns | -.05082958 -.05358762(previous year)| 0.0090 0.0104
Constant | 19.691.506 4.4301511| 0.0237 0.0119
Number of Obs | 293 144R2 | .04359465 .22252844
Curbing Volatility SeminarBocconi – November 17, 201113
4. Pecunia non olet? Market failure considerations
Under laissez faire, increased political risk will restrict capital flows and investment opportunities in recipient countries. Contraction of international SWF investment will cause excessive FOREX accumulation, inflationary and exchange rate pressures in emerging countries, impinging economic development.
Political stability in emerging countries is a global public good. Decentralized, market-based systems will not provide efficient solutions. Market sanctioning by SWF targets will not trigger a socially efficient democratic transition abroad.
Market failure considerations provide a rationale for SWF regulation
Curbing Volatility SeminarBocconi – November 17, 201114
5. Towards a smart regulation of SWF
The current regulatory framework on foreign investment Not targeted to SWF, varies by countries, generally protects
national security and strategic sectors US: mandatory clearance by CFIUS in case of acquisition by
sovereign investor EU: free movement of capital enshrined in Treaty, but legal
barriers are widespread in most member countries
The Santiago principles 24 (voluntary) Generally Accepted Principles and Practices (GAPP)
on governance, accountability and transparency Sponsored by IMF, OECD, and World Bank, undersigned signed by
23 SWF
Curbing Volatility SeminarBocconi – November 17, 201115
5. Towards a smart regulation of SWF
The current regulatory framework at the national and multilateral level generally fails to address political risk
Targeted sanctions: the UN can adopt resolutions involving restrictive measures (such as asset freeze) to target the political elite in case of violation of international laws
Financial targeted sanctions are extreme solutions and operate ex post, not effective in preventing and mitigating ex ante political risks
Curbing Volatility SeminarBocconi – November 17, 201116
5. Towards a smart regulation of SWF
Complementary non-legal measures
GAAP 25: "While members consider being in the mutual interests of recipient countries and sovereign investors to maintain free movement of capital, they also realize that social inequality and political instability in the investing country represent critical risk factors in the international allocation of capital. Upon these considerations, members agree that sovereign investment abroad will be associated with commitments to foster economic prosperity, social progress and political reforms in the investing country".
Amendment of the code of conduct of stock exchanges inviting listed companies to disclose SWF presence as a risk factor
Curbing Volatility SeminarBocconi – November 17, 201117
5. Towards a smart regulation of SWF
Complementary legal measures
A CFIUS-style preventive mechanism, requiring a mandatory clearance of SWF acquisitions of the basis of a case by case review of countries' political outlook.
Establishment of the Sovereign Investment Office within a recognized international organization. On the basis of independent assessments, the Office could publish a list of “politically risk neutral” SWFs with a blanket authorization to operate globally, or establish a conditionality on investments based on case-by-case undertakings in the space of human rights, political freedom, constitutional reform and democratic transition.
Curbing Volatility SeminarBocconi – November 17, 201118
5. Conclusions
Recent revolts in the Arab region are causing a metamorphosis of SWF from long-term, patient investors to short-term operator carrying political risk, affecting negatively the performance of target firms.
SWFs assets subject to political risk are worth $2 trillion and thus systemic.
Market failure considerations suggest that a SWF-specific regulatory framework may be desirable.
Self-enforcing solutions could be agreed upon at the multilateral level, given the countries’ mutual interest in open capital markets, peace and security.
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