Public Footprints in Private Markets

Sovereign Wealth Funds and the World Economy

Robert M. Kimmitt

From Foreign Affairs, January/February 2008

Summary:  The massive growth of sovereign wealth funds -- pools of capital controlled by governments and invested in private markets abroad -- should not cause alarm. But it does raise legitimate questions for the United States, pointing to the need for new policy principles for both the funds and the countries in which they invest.

ROBERT M. KIMMITT is Deputy Secretary of the U.S. Department of the Treasury.

A STRUCTURAL SHIFT

The U.S. Treasury Department has played a leadership role within the U.S. government in seeking better understanding of, and communication with, SWFs. The President's Working Group on Financial Markets, which brings together key U.S. financial regulators and other members of the U.S. government under Secretary Paulson's chairmanship, has initiated a review of SWFs. The Treasury Department has also undertaken regular outreach and discussion with SWFs and market participants to better understand trends and monitor sovereign investments and acquisitions, and it has initiated in-depth analysis and regular reporting to Congress.

The Treasury Department believes that the principles outlined above can inform the development of two sets of voluntary multilateral best practices to provide an improved framework for SWFs and the recipients of their investment. The wide variety of experience and investment strategies among SWFs, combined with the wide diversity of regimes for regulating inward investment, underscores the need for broadly discussed and accepted best practices.

First, the Organization for Economic Cooperation and Development could identify best practices for countries that receive foreign government-controlled investment, including from SWFs. Recipient countries have a responsibility to maintain openness, and the OECD has a long history of promoting open investment regimes.

Second, the IMF, assisted by the World Bank, could draft a set of best practices for SWFs, building on existing best practices for the management of foreign exchange reserves. These best practices could cover the overall objectives and principles of SWFs, their institutional arrangements, their risk-management frameworks, and their transparency and accountability -- including public disclosure. These would provide guidance to new funds seeking to make sound decisions on how to structure themselves, mitigate any potential systemic risk, and help demonstrate to critics that SWFs will continue to be constructive, responsible participants in the international financial system. Even long-standing SWFs are aware that the increase in the number and size of these funds has, rightly or wrongly, raised reputational issues for them all.

To initiate high-level discussion of the impact of SWFs, Secretary Paulson hosted an outreach dinner at the Treasury Department in October 2007 with the finance ministers of the G-7 (the group of highly industrialized countries); the heads of the IMF, the OECD, and the World Bank; and finance ministers and heads of SWFs from eight countries: China, Kuwait, Norway, Russia, Saudi Arabia, Singapore, South Korea, and the United Arab Emirates. There was a shared realization of a common interest in maintaining open investment and promoting financial stability. The following day, the International Monetary and Financial Committee -- a ministerial-level committee whose members represent all 185 IMF member countries -- tasked the IMF with identifying best practices for SWFs. The OECD, meanwhile, is accelerating its own work on developing best practices for recipient countries' investment regimes.

It is hard to escape the conclusion that the ongoing increase in SWF cross-border investment represents a potential structural shift in the global economy. It is incumbent on economic policymakers in all countries to consider fully the implications of this shift and how to respond. The evidence so far suggests that SWFs are seeking to generate higher investment returns without generating political controversy. Although it is imperative that the U.S. government remain vigilant, so long as SWF activities are consistent with free and fair competition based on agreed best practices, keeping the United States' doors open to investment from SWFs will continue to promote growth and prosperity, both at home and abroad.