Santiago and beyond: sovereign wealth funds take to self-regulation

Sovereign Wealth Funds (SWFs) are special purpose investment funds that are owned by states or governments. Globally, SWFs are estimated to have assets under management of between US$2–3 trillion with estimates that this could grow to US$10 trillion by 2012.

Although they have been around since the 1950s, in recent years SWFs have been the subject of criticism from some quarters for their lack of transparency and accountability. Concerns have also been raised about the ability of SWFs to destabilise global markets and the free flow of funds, along with questions as to whether their investment motives are purely economic, or may also involve political or strategic considerations.

Earlier this year it seemed that all was forgiven. SWFs injected billions of dollars of urgently needed capital into various financial institutions. Since then, they have seen the return on these investments halve or worse, in some cases resulting in criticism in their home states.

However, given the size of their war chests and with global and Australian equities significantly down from 12-month highs, it is difficult to imagine SWFs staying on the sidelines, so public concern about their investment motivations is likely to remain.

This article examines the response by SWFs to those concerns.

Key Points

New voluntary principles

SWFs (which includes Australia’s Future Fund) have formed an International Working Group which has recently released a set of 24 voluntary principles known as the Santiago Principles (principles). These principles cover the following areas:

1. legal framework, objectives, and coordination with macroeconomic policies
2. institutional framework and governance structure, and
3. investment and risk management framework.

The stated purpose of the principles is to:

• have in place a transparent and sound governance structure that provides for adequate operational controls, risk management and accountability
• ensure compliance with applicable regulatory and disclosure requirements in the countries in which SWFs invest
• ensure SWFs invest on the basis of economic and financial risk and returnrelated considerations, and
• help maintain a stable global financial system and free flow of capital and investment.

These principles are aimed at increasing the understanding of SWFs and address the key concerns that are most commonly raised—a lack of transparency, accountability and operational independence—concerns which, if not addressed, could lead to the rise of protectionist policies.

The OECD has welcomed the principles and is preparing a voluntary code of conduct to identify best practice guidelines for countries that receive SWF investments. This is likely to focus on avoiding protectionism and upholding fair and transparent investment frameworks.

Australian approach to SWFs and other foreign government investment

On this note, while SWFs were being welcomed as major investors in United States banks, the Australian Treasurer was issuing a set of Guidelines for Foreign Government Investment Proposals (FGI Guidelines) for investment by foreign governments in Australian assets. These FGI Guidelines will be used by the Treasurer when determining whether a proposed investment is consistent with Australia’s ‘national interest’ under the Foreign Acquisitions and Takeovers Act 1975 (Cth) (Act).

The FGI Guidelines reflect some traditional concerns with SWFs mentioned above—a lack of transparency, accountability and operational independence—and at the time, were seen to be aimed squarely at Chinese Government investment through State Owned Enterprises (SOEs) and China’s SWF, the Chinese Investment Corporation. Other funds have also been active in Australia.

The FGI Guidelines set out six considerations to which the Australian Government will have regard when assessing proposed investments by foreign governments and their agencies (which would include SWFs and SOEs). In summary, when assessing a proposal, the Australian government will assess the extent to which:

1. the investor’s operations are independent from the relevant foreign government
2. the investor has clear commercial objectives and has been subject to transparent regulation and supervision in other jurisdictions
3. the investment may impact on competition policy
4. the investment may impact on tax revenue and policy
5. the investment might impact on Australia’s ability to protect its strategic and security interests, and
6. the investment might impact on the particular Australian business, as well as its effect on the Australian economy and broader community.

The February 2008 edition of the Freehills M&A Newsletter comments on these guidelines, including the fact that the requirement to notify on investments below the thresholds in the Act is only a matter of policy and has no legal basis.

Although compliance with the principles will not address all of these considerations, it will be interesting to see whether, and if so to what extent, compliance with the principles becomes a focus in Australia’s assessment of SWF investment in Australia.

It will also be interesting to assess the FGI Guidelines against the OECD’s voluntary code of conduct for recipient countries once finalised.

Conclusion

The Santiago Principles represent a welcome step forward in helping to improve the understanding of SWFs and in addressing the most commonly raised concerns that arise in relation to SWFs—a lack of transparency, operational independence and accountability.

As with all voluntary codes, time will tell whether they are observed and the success of these principles will depend on the level of compliance by SWFs with the letter and the spirit of these guidelines.

More information

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