First, is that there is no universally accepted definition of these entities. SWFs include pension funds, social security funds, special purpose vehicles for exercising the ownership rights of State-owned enterprises, funds created out of fiscal surpluses and even foreign exchange reserves as SWFs. To address the issues of current discomfort, it may be appropriate to define SWFs as those legal entities to manage funds created out of surplus earnings from natural resources or sustained fiscal surpluses for explicit objectives. Those investments arising from pension funds should continue to be treated as institutional investors as their objectives, disclosures and accountability to their members act as reasonable disciplining framework. Those carved out of foreign exchange reserves should indeed be discountenanced for many reasons and importantly, for their inconsistency with IMF guidelines for foreign exchange reserve management. Most of the current SWFs have been created out of surpluses from natural resources, while a few have been created from fiscal surpluses.
Second. what is the relationship of the SWF with the government that has created it Does it have a demonstrable arms-length relationship with the government and its budgets Are directors and managers appointed by an objective process Such separation from the government implies that the SWF boards are independent and empowered; that the managers are able to function independently. There may be some degree of indirect assurance of this among democracies arising from parliamentary committees, government auditors, independent agencies for selection of directors and the rights to information laws. However, funds arising from other types of regimes may have to work harder to assure all that there are no concealed wirings with their governments.
Third, there are concerns relating to their standards of disclosing fully their objectives, strategy and portfolio details. International bodies have recommended such disclosure in the case of all institutional investorsthe recently issued Hedge Fund Standards in the UK cites this as an area of concern. While such standards in pension funds and hedge funds are meant to improve the confidence of investing public and to fulfill a fiduciary responsibility, in the case of SWFs the idea should be to improve perceptions in host countries regarding their honorability.
Here lies a poser to those who are complaining of signs of protectionismwhen providers of finance are making standards of corporate governance a conditionality, would it be wrong if the recipient country or company were to make such standards a conditionality for providers of finance
Even as the IMF and OECD are working on policy documents and best practices for such SWFs, a timely survey by Edwin Truman of Pieterson Institute indicates the low levels of corporate governance standards particularly in the case of non-pension SWFs. The eventual challenge for the standard-setters would be to promote them as best practice without regulationespecially if there are no market forces to penalise or discipline the non-transparent SWFs.
SWFs also pose an interesting challenge to market economistseven as many want the government to roll-back, SWFs seem to promote globalisation of state-ownership.
The author is chairman, Yaga Consulting Pvt Ltd