Brussels, 27 February 2008
What are Sovereign wealth funds (SWFs)?
Sovereign Wealth Funds (SWFs) are generally defined as state-controlled investment vehicles funded by foreign-exchange assets.
Who controls SWFs?
Traditionally, SWFs were the preserve of major commodity exporters, particularly oil-rich countries like Kuwait or Norway. Sovereign Wealth Funds have existed since the early 1950s. Since then, more than 30 countries have established SWFs, although their asset holdings are concentrated in a relatively small number of funds. The biggest funds are sponsored by the United Arab Emirates (two funds), Norway, Saudi Arabia, Kuwait, China and Singapore (two funds).
What have been the recent developments in SWFs?
How much are SWFs worth?
SWFs are today estimated to control assets of $1.5-2.5 trillion – more than all the world's hedge funds. The rise in commodity prices and current account imbalances has fuelled the argument that SWFs will continue to grow – one estimate has put the possible scale of SWFs at $12 trillion by 2015.
What makes SWFs different from other categories of investments, such as Hedge Funds?
The distinguishing feature of SWFs from other categories of investment vehicles, such as pension funds, investment funds and trusts, hedge or private equity funds, is that they are state-owned. In general, SWFs are funded from accumulated foreign-exchange reserves in their sponsor countries, but are managed separately from the official reserves.
What do SWFs invest in?
Typically, SWFs have a diversified investment strategy, with a higher level of risk accepted in search of higher returns. SWF portfolios include a wider range of financial assets, including fixed-income securities but also equities, real estate and alternative investments. In their purpose and investment behaviour, SWFs are therefore not much different from other privately-owned investment vehicles.
Although SWFs have diverse investment objectives, most can be broadly classified as either stabilisation funds or savings funds. Stabilisation funds are typically established by commodity-producing countries to help counter the effects of volatile commodity prices. Savings funds focus on longer-term wealth creation and policy objectives. However, the investment behaviour of SWFs can vary significantly within these two broad categories.
Sovereign Wealth Funds have been operating in the internal market for almost fifty years and they have never created problems. During the recent financial turmoil, they have injected liquidity in the system at the time it was most needed, helping stabilise the markets. Their investments are often long-term and contribute to providing funds for European companies, contributing to growth and jobs. Another contribution of potential relevance for the EU is the importance of their investments for the international role of the euro.
What about the risks?
As SWFs are foreign state-owned investment vehicles, their investments may raise concerns for the recipient State. Among the concerns most often aired is the preoccupation that SWFs' investments may be driven by considerations other than maximisation of return. For example, investment targets may reflect a desire to obtain technology and expertise to benefit national strategic interests, rather than being driven by normal commercial interests in expansion to new products and markets. More generally, business and investment decisions could be influenced in the political interest of the SWFs' owners. Concerns about SWFs' operations are inevitably fuelled by the opaque way in which some of them operate.
What is the Commission proposing to the Spring European Council as the EU approach to SWFs?
The Commission is proposing a common EU approach to respond to concerns over SWFs and enhance the transparency, predictability and accountability of SWFs' investments while maintaining an open investment environment.
It lays out principles which should shape that approach:
How will these principles be applied in practice?
These elements should contribute both to arriving at a common EU approach on this issue and to discussions taking place at international level, such as in the IMF and the OECD.
Those discussions should result in a voluntary code of conduct prepared at international level The Commission asks the European Council to endorse this approach and make it the basis to encourage recipient countries and SWF owners to reach agreement on such a code of conduct, preferably by end 2008.
Does the Communication also include more specific details of what SWFs should do to ensure transparency and good governance?
Yes. In line with the above principles, the Communication spells out some basic governance and transparency standards.
On governance these can be summarised as follows:
And on transparency as follows:
Is the Commission proposing new legislation in the Communication?
No, the Communication does not propose any legislative initiatives at this stage, though President Barroso has made clear that the Commission reserves the right to do so if it becomes necessary in the future.
What could the EU do at European level to protect its interests if it were necessary in the future?
Investments by SWFs are subject to the same rules and controls as other investments in the EU, based on the principles of free movement of capital. However, that freedom is not absolute. The Council may adopt by qualified majority measures on the movement of capital from third countries involving direct investment. Secondly, it is not excluded that the EU can introduce by a unanimous decision of the Council measures that restrict direct investments.
It is also important to note that the application of both European and national regulatory systems applying to all investors, including therefore sovereign wealth funds, can be amended to protect the public interest in the light of changes in financial markets.
Do Member States have additional capacity for action at national level?
Yes. Member States also have legislative and regulatory instruments available. The Merger Regulation allows them to take measures to protect legitimate interests other than competition. Public security, plurality of the media and prudential rules are regarded as legitimate interests, while others may be so considered on a case by case basis on notification to the Commission. Member States can also take other measures if specific needs arise, as long as those are compatible with the Treaty, proportionate and non-discriminatory and do not contradict international obligations. The European Court of Justice has stressed that purely economic grounds can never justify obstacles prohibited by the treaty.
Is the Commission envisaging the creation of a mechanism for controlling or conditioning foreign direct investment, similar to the US mechanism “CFIUS (Committee on Foreign Investment in the US)?
No. The Commission does not envisage proposing any legislative instrument on investment from sovereign wealth funds. In addition, the Commission recalls that there is a predictable, transparent and reliable legal framework for investors from our Member states and from third countries in the internal market.
How does the Commission see the balance between action at international, European and national level?
In Europe, between the EU and Member State level, there exists a comprehensive regime to regulate the establishment and the actions of foreign investors, which covers SWFs in the same way as any other investors. Member States, by and large, already possess adequate instruments to monitor foreign investment and react if considerations of public policy or public security raise.
However, the EU and Member States are not alone in facing the current questions raised by sovereign wealth fund investments. In this light, Europe must avoid any uncoordinated responses that give the wrong message about the EU stepping back from its commitment to be a welcoming environment for investment. Equally, it must avoid uncoordinated actions that could hamper the functioning of the single market and damage the EU economy.
That is why the approach proposed is to promote a cooperative effort between recipient countries and SWFs owners. This can best be done at international level and that is why the suggested approach is to consolidate a coordinated EU position, through which to influence the international debate and facilitate the establishment of a voluntary code of conduct guiding the SWFs operations.
What is currently being done at international level?
In recent months, the issue of SWFs has climbed the political agenda. In particular:
Sovereign wealth funds also invest on the African continent and in other emerging economies. What is their role in the economic development of these countries?
Improving transparency and disclosure by SWFs will benefit also developing countries in which they might be investing.
There are currently no comprehensive or accurate data on where those investments are taking place, either geographically or by sector. This is exactly why the Commission insists on further transparency from funds and their sponsor countries. From what we know today, it is not possible to say to what extent investment is flowing to Africa and other developing countries or goes to investment in extractive industries.
However, SWFs seem to invest their capital largely in their own economies, as well as in mature markets in Europe, US and Asia. Little investment seems to go to Africa and developing countries. Furthermore, investment plays also a critical role in fostering growth and development of developing countries. The Commission seeks to contribute to fostering investment flows to developing countries, including through its bilateral agreements, where they include investment chapters.