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1. Background: the trade-off of sovereign ownership

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.

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1. Background: the trade-off of sovereign ownership

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  1. 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 SWF as a tool to address market failures in long term investment and domestic economic development 1

  2. 2. Facts: SWF history • LIA, Libya • Future Fund, Australia • Investment Corp., Dubai • State Oil Fund, Azerbaijan • Bahrain Holding, Bahrain • OIF, Oman • DIFC, Dubai • Istithmar World, Dubai • ADIA, Abu Dhabi • BIA, Brunei • IPRF, Ireland • New Zealand Superannuation Fund, NZ • National Wealth Fund, Russia • Government Pension Fund - Global, Norway • State General Reserve Fund, Oman • KIA, Kuwait • National Oil Account, Sao Tomé 1953 1990 2000 2008 1960 1970 1980 • Revenue Equalization Fund, Kiribati • KNB, Malaysia • CIC, China • Emirates Investment Authority, UAE • ADIC, Abu Dhabi • Mubadala Development Company, Abu Dhabi • IPIC, Abu Dhabi • Temasek Holdings, Singapore • National Social Security Fund, China • KNF, Kazakhstan • GIC, Singapore • QIA, Qatar • KIC, Korea • Timor-Leste Petroleum Fund • RIA, Ras Al Khamah • State Capial Invest. Corp.,Vietnam Source: Sovereign Investment Lab 2

  3. 2. Facts: the largest SWFs by AUM, 2010 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). 3

  4. Facts: SWF Investment from MENA, 2000-2010 MENA to Russia & Central Asia 16deals, $1.7bn MENA to Europe 124 deals, $73.0bn MENA to North America 60 deals, $40.2bn MENA to Asia Pacific 50 deals, $7.5bn Within MENA 145 deals, $45.2bn MENA to Latin America 5 deals, $0.5bn MENA to Sub-Saharan Africa 27 deals, $4.4bn Source: Sovereign Investment Lab Transaction Database • 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. 4

  5. Facts: Barbarians at the Gate? Other Automotive 16% 10% Real Estate Telecoms, 1% 13% Aircraft, 1% Natural Resources, 11% Strategic Sectors 21% Transport, 1% Utilities, 7% Banking, Insurance, Trading 40% SWFs foreign investment by sector, 2000-2010 Source: Sovereign Investment Lab Transaction Database 5

  6. 2. Facts: SWF activity by type of political regime Percentage of SWF Assets under Management by Political Regime, 2010 SWF Investment Flows, 2000-2010 US$ Mn Hybrid Regime $80.000 17% Authoritarian Flawed Democracy $70.000 Full Democracy Hybrid $60.000 $50.000 Full Democracy 27% $40.000 Authoritarian Regime $30.000 54% $20.000 $10.000 $- Flawed 2000 2006 2007 2008 2009 2010 2001 2002 2003 2004 2005 Democracy 2% Source: Sovereign Investment Lab Transaction Database Source: Sovereign Investment Lab; 2010 EIU Democracy Index 6

  7. 2. Facts: Foreign exchange reserves and political regimes $10.000 Total Global Reserves Full Democracies $9.000 Flawed Democracies Hybrid Regimes $8.000 Authoritarian States $7.000 $6.000 US$ Mn $5.000 $4.000 $3.000 $2.000 $1.000 $0 2002M1 2002M5 2002M9 2003M1 2003M5 2003M9 2004M1 2004M5 2004M9 2005M1 2005M5 2005M9 2006M1 2006M5 2006M9 2007M1 2009M1 2009M5 2009M9 2010M1 2010M5 2008M9 1999M1 1999M5 1999M9 2000M1 2000M5 2000M9 2001M1 2001M5 2001M9 2007M5 2007M9 2008M1 2008M5 Source: International Monetary Fund, International Finance Statistics Database; EIU Democracy Index 2010 7

  8. 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. 8

  9. 3. The financial performance of SWF targets 0,00% 0,00% 0,00% -1,00% -1,51% -1,67% -2,00% -2,15% -3,00% -3,96% -4,00% -5,00% Adjusted Performance -6,00% -6,25% -7,00% -8,00% -8,35% -9,00% Abnormal Return -10,00% Return-on-Equity -10,47% -11,00% -11,83% -12,00% Investment 6 months 1 year 2 years 3 years Source: Bortolotti et al. (2010), “Quiet Leviathans: Sovereign Wealth Funds Investments, Passivity, and the Value of the Firm”, mimeo. 9

  10. 3. The EUI Index of political unrest for SWF countries 10

  11. 3. The stock return of SWF targets: assessing political instability 11

  12. 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 12

  13. 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 13

  14. 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 14

  15. 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 15

  16. 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. 16

  17. 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. 17

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