SWF Radar

EU internal market commissioner Charlie McCreevy yesterday asked, “What's the difference between a state-owned enterprise and a sovereign wealth fund?” This is an important question that itself raises further questions about the usefulness of the standard understanding of the term “sovereign wealth fund.”

The standard definition

Taking “sovereign wealth fund” to mean, as is standard, state-controlled funds like ADIA, KIA and CIC, then on the most superficial level, the difference between SWFs and state-owned enterprises is obvious: It is the same as that between any type of investment fund and any type of company, a few edge-cases excepted.

Go a bit deeper, and in the context of the current debate about SWFs, the difference disappears as we see state-owned companies such as China’s Chinalco acting as a conduit for their respective state’s sovereign wealth, as part either of a longer channel involving a sovereign wealth fund or of a shorter channel between the foreign reserve manager and target company.

Go deeper still, and differences emerge again, but not in a way that answer McCreevy’s question reassuringly. For while SWFs so far have shown little interest in taking on an activist role as investors, companies, by definition, manage and control their assets. Since control is one of the issues spooking the west, sovereign investment channelled via state-owned companies should perhaps be causing more of a headache than such investments channelled via dedicated state-owned funds.

And it should be noted that the two cases that heralded the beginning of the new wave of sovereign investment involved the state-owned companies CNOOC of China and DP World of Dubai, not any sovereign wealth fund as commonly understood.

Unhelpful

This must surely pose a challenge to the authors of the various codes of conduct and sets of guidelines for SWFs currently in development. An SWF code of conduct would serve little more than a public relations purpose if it encouraged sovereign investment to flow through other investment vehicles not covered by the code.

The answer to McCreevy’s question is therefore surely to suggest that, as commonly understood, there are many similarities between sovereign wealth funds and state-owned enterprises in the context of the latest wave of sovereign investment, but that the common understanding of what the term “sovereign wealth fund” means is for this very reason unhelpful.

A broader definition

It might then make sense, once this unhelpfulness is recognized, to go on to redefine sovereign wealth funds along broader lines as something like, in the recent words of Robert Kimmit, “large pools of capital controlled by a government and invested in private markets abroad,” rather than as the funds that serve exclusively as investment vehicles for these pools.

With “sovereign wealth fund” defined in this way, a code of conduct for SWFs would cover sovereign wealth at its source, regardless of the route it then took to reach any foreign investment target.

A code that settled on the more standard definition could find itself in the pointless situation of being rigorously adhered to by e.g. Norway’s Government Pension Fund - Global while Russia’s Gazprom, which Charlie McCreevy today likened to a SWF (hence his question), felt no need to take any notice of it.

Update (Feb 29; quotation updated Mar 3 to match edited source): Rachel Ziemba of RGE Monitor highlights some further problems for legislators and codifiers posed by the standard definition of “sovereign wealth fund,” writing that:

A broad definition of sovereign wealth would capture related holding companies, state owned enterprises and possibly some public pension funds as well. A narrow definition might just mean that funds are channeled through other actors. More complicatedly, it means assessing their financial actors funded by sovereign funds - private equity for one. Australia hopes its new review achieves that. The US Treasury has used such a definition since at least the summer to my knowledge - but its becoming more common in the discourse. The EC defines them as “state owned investment vehicles which manage a diversified portfolio of domestic and international financial assets.” but there is little to no discussion of other investors backed by sovereign funds.

The acquisitions by SOEs are probably more concerning than those of SWFs. By their nature, SOEs prefer significant stakes as they usually want to build market share or increasing their supply chain. Voting rights are part of the package.

Even in the same country funds might have very different governance structures and goals. Despite Gazprom's penchant for threatening cutoffs for delayed payment or resisting new market rates, it is likely that Russia's new wealth fund will be bound to more disclosure requirements than most of the Gulf funds are currently- largely because it is bound to report to the Russian people.

She finishes her article with a list of the various foreign investment channels and vehicles through which sovereign wealth could be piped.