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State Investment Funds: IMF to Develop Best Practices with Sovereign Wealth Funds

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
May 2008
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The IMF’s Executive Board gave the green light for further analysis on the role of sovereign wealth funds (SWFs) in the global economy and endorsed a proposal for the IMF to work with SWFs and other relevant parties to prepare a set of best practices for the state investment institutions.

The March 21 board discussion provided an opportunity for Directors to discuss these funds and ways to facilitate the development of a set of voluntary best practices for them. This work would be coordinated with the work of the Organization for Economic Cooperation and Development (OECD) on practices for recipient countries as appropriate.

With SWFs rapidly gaining importance in the international monetary and financial system, the IMF has stepped up its work across a broad range of issues related to these state-owned funds, including their impact on global financial stability and capital flows.

Of course, SWFs have been around for a long time, at least since the 1950s. But their total size worldwide has grown dramatically over the past 10–15 years, with the IMF now estimating that they will rise from $2–3 trillion today to about $6–10 trillion within five years. At present, the United Arab Emirates, Norway, Saudi Arabia, China, Kuwait, Russia, and Singapore hold the world’s largest SWFs.

The main impetus for the growth of SWFs comes from high oil prices, financial globalization, and continued imbalances in the global financial system that have resulted in the rapid accumulation of foreign assets by some countries.

Heightened attention

As a result, SWFs are attracting heightened attention from markets, policymakers, national legislatures, and the media, in particular following their recent capital injections—totaling more than $40 billion since November 2007—into European and U.S. banks that suffered big losses from the subprime mortgage crisis. These capital injections have been welcomed by the IMF and others because they have helped to stabilize markets.

“From the viewpoint of international financial markets, SWFs can facilitate a more efficient allocation of revenues from commodity surpluses across countries and enhance market liquidity, including at times of global financial stress,” according to the IMF’s First Deputy Managing Director John Lipsky. “They also tend to be long-term investors with limited withdrawal needs, which enable them to withstand market pressures in times of crisis and dampen volatility,” he adds.

At the same time, says Lipsky, the IMF also acknowledges the concerns of recipient countries and private commentators about the impact of SWFs—reflecting their size and investment strategies—and of the home countries that have been worried about the risk of rising protectionist sentiment.

Types of SWFs

SWFs have been created for several reasons. According to IMF analysis, five types of SWFs can be broadly distinguished (see the IMF’s October 2007 Global Financial Stability Report):

  • stabilization funds, whose primary objective is to insulate the budget and the economy against commodity (usually oil) price swings;

  • savings funds for future generations, which aim to convert nonrenewable assets into a more diversified portfolio of assets;

  • reserve investment corporations, whose assets are often still counted as reserve assets and are established to increase the return on reserves;

  • development funds, which typically help fund socioeconomic projects or promote industrial policies that might raise a country’s potential output growth; and

  • contingent pension reserve funds, which provide (from sources other than individual pension contributions) for contingent, unspecified pension liabilities on the government’s balance sheet.

Benefits and concerns

SWFs offer a variety of economic and financial benefits. They help avoid boom-bust cycles in their home countries and facilitate the saving and transfer across generations of proceeds from fiscal surpluses related to commodity exports and privatizations. They also allow for greater portfolio diversification and focus more on returns than is traditionally the case for central-bank-managed reserve assets, thereby reducing the opportunity costs of reserves holdings.

“For economies with plentiful foreign reserve assets, greater and more prudent diversification reflects sound and responsible asset management,” says Udaibir S. Das, an expert on SWFs in the IMF’s Monetary and Capital Markets (MCM) Department.

The growth of SWFs has also raised several issues. In addition to official and private commentators’ concerns about the impact of SWFs—including their size and investment strategies—they also raise the issue of the expanded role of governments in international markets and industries. Some observers worry that SWF investments may be motivated, in certain cases, by political objectives.

Concerns have been raised about how SWFs fit into the domestic policy formulation of countries with such funds. At the same time, countries with SWFs are concerned about protectionist restrictions on their investments, which could hamper the international flow of capital.

What the IMF is doing

IMF staff will now start work with members and SWFs on the development of best practices, including the establishment of an international working group of SWFs to begin technical discussions and drafting work from April onward.

The set of best practices would cover issues of public governance, transparency, and accountability principles—all of which should help enhance understanding of the operations of SWFs, the IMF says.

“A better understanding of the role and practices of SWFs and the development of a set of best practices could help countries with SWFs benefit from the experience of other countries, strengthen their domestic policy frameworks and institutions, and further their macroeconomic and financial interests,” says Jaime Caruana, Director of the IMF’s MCM Department.

The IMF’s work on these funds has progressed on a number of fronts:

  • Deepening analysis. To enhance the understanding of SWFs, the IMF is organizing a survey of SWFs to help identify their investment objectives and risk management practices, as well as such institutional frameworks as governance structures and accountability arrangements.

  • Facilitating communication. The IMF organized the Roundtable of Sovereign Asset and Reserve Managers in November 2007, which included a preliminary discussion with key SWFs. The roundtable was attended by high-level delegates from central banks, ministries of finance, and SWFs from 28 countries. It helped advance the discussion on policy, institutional, and operational issues facing SWFs, allowing those present to learn from their experiences and views. Participants agreed to continue the dialogue with SWFs.

  • Following up on dialogue. The IMF is following up with further contacts with SWFs as part of a collaborative process to come up with an agreed view on best practices. “We’ve been engaged in an initial dialogue with sovereign wealth funds to help identify their current practices on issues such as governance and accountability structures, with a view to helping reach a consensus on best practices,” says the IMF’s Adnan Mazarei, who is closely involved in the discussions.

  • Coordinating with other international institutions. The IMF is coordinating its work on SWFs with the OECD and is also liaising closely with the European Commission, the World Bank, and others. The OECD is taking the lead on issues related to investment policies and regulations in recipient countries.

  • Working toward delivery. The IMF will collaborate with SWFs and other stakeholders in developing a statement of best practices. The aim is to present a draft to its Executive Board by the IMF’s Annual Meetings in October.

Best practices as a public good

The IMF expects that its work on SWFs will provide a public good that may be used by existing and new SWFs to run sound organizations, with good governance structures, robust risk management frameworks, and appropriate transparency. These practices should also help allay some of the prevailing concerns about SWFs, reduce protectionist pressures, and allow the international financial system to remain open.

In addition, the IMF’s efforts would aim to promote a better understanding of the role and significance of SWFs in their countries’ macroeconomic policy framework, as well as help the international community better assess the impact of SWF activity on global financial stability and capital flows.

The IMF has developed similar guidelines in the past, particularly in the areas of fiscal transparency and foreign exchange reserves management.

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