Sovereign Wealth Funds: Law and Policy

Sovereign wealth funds (SWFs) have become topics of heated debate in the global market in recent years. Both the United States (U.S.) and the European Union have seen proposals of imposing further regulation of SWF investments increase. Even the International Monetary Fund (IMF) and Organization for Economic Cooperation and Development (OECD) have presented drafts of best practices addressing the SWF transactions. However, opponents of these proposals claim that SWFs have acted as model investors in international capital market to date, and that imposing unnecessary restrictions would only discourage normal investments and harbor protectionism. SWFs are generally government investment vehicles funded by foreign exchange assets and managed separately from official reserves. SWFs have existed since the 1950s, but face severe scrutiny today due to rapid growth in number of funds, average size of funds, prominence, and changing investment strategy. According to the IMF, SWF assets in the global market will reach $6 to $10 trillion by 2013. Historically, SWFs typically invested in low risk and low return instruments such as treasury bonds and other national government bonds. Recently, however, SWFs accumulate their stakes in company equities of developing economies to seek higher return. This deviation from the traditional investment concept gave rise to concerns regarding a foreign government’s potential influence over the company. Furthermore, foreign government owned SWFs may contain significant strategic purposes; SWFs may allow these foreign governments to gain access to natural resources, obtain technology or other expertise, or improve competitive positions of these governments’ domestic companies. Despite these concerns, most countries have existing regulations to guard against foreign investors’ acquiring control of domestic companies only. For example, in the U.S., a foreign acquisition of control over U. S. companies undergoes review from the Committee on Foreign Investment in the United States. The Committee can recommend blocking the transaction if it poses a threat to national security. Taiwan, with even looser regulations, does not have specific regulation applied to investments controlled by foreign investors; a foreign investment is simply subject to black lists that publish items prohibiting the foreign investment. Therefore, a foreign government investment such as a SWF transaction, acquiring a significant, but non-controlling, stakes in domestic companies is not subjected to regulation. Yet, a foreign government’s portfolio investments in even a minority stake may pose a risk to national security if the investors wield their influence over the company to seek other strategic objectives other than profits maximization. As a result, the U.S., the European Union, the United Kingdom, and Germany have all called for a regulatory regime change. Propositions ranged from increased disclosure and transparency, suspended voting rights, limiting SWF investment to financial intermediaries only, to investing only in global index funds. In 2008, IMF, working in conjunction with 26 SWF sponsor countries, conducted an effort to create SWF best practices, commonly known as the “Santiago Principles.” Santiago Principles include 24 principles “identify a framework of generally accepted principles and practices that properly reflect appropriate governance and accountability arrangements as well as the conduct of investment practices by SWFs on a prudent and sound basis.” Nevertheless, these 24 principles are only guidelines with voluntary adherence. The government investment of foreign reserve’s transformation from government debt instrument to equity should not be problematic. Equity investment can serve to recycle trade surplus and increase the supply funds to equity market, thus reducing cost of capital. Furthermore, equity investments are more stable than the debt investments. However, SWFs as an investment arm of sovereign entity may use business resources in pursuit of political purposes or other governmental interests, such as acquiring sensitive technologies or expertise through the purchase of a significant stake in a company. Therefore, appropriate SWF regulation should be implemented to mitigate concerns regarding SWFs transactions. This research paper outlines the SWFs investment phenomenon, investigates the important role of regulatory regimes, analyzes the function of different regulations, and recommends the appropriate legal frameworks for SWFs transaction.

Project ID:PF10107-1563
External Project ID:NSC101-2410-H182-006