WASHINGTON (Reuters) – They’re rich, mysterious and increasingly feared in some Western financial circles, but state-owned investment funds may be just what wobbly financial markets need — provided everyone can agree on ground rules.
As financial leaders from the Group of Seven large industrialized countries prepare to meet on the sidelines of the International Monetary Fund’s fall meeting this week, these so-called sovereign wealth funds are getting plenty of attention, for better or worse.
G7 finance chiefs plan to discuss how these wealth funds, which control an estimated $2.2 trillion, could affect the world financial system. They will also host an “outreach” meeting, inviting countries including China, Kuwait and Saudi Arabia that control large investment pools.
Simon Johnson, the IMF’s chief economist, said sovereign wealth funds may have played a stabilizing role in this summer’s financial market turmoil by stepping in to buy assets when other investors froze.
Some G7 members are uncomfortable, however. These funds have been around for decades — Kuwait’s dates back to 1953 — but as their financial firepower grows, they are beginning to raise some tough political and economic questions.
Who will regulate these notoriously secretive wealth funds and monitor the cross-border flow of such vast sums? What if a state-owned fund sought to destabilize markets for political gain? How do you safeguard national security when government-controlled funds seek to invest in sensitive firms?
“We want to find out if there could be agreed certain rules of behavior,” German Deputy Finance Minister Thomas Mirow said, adding that such rules would foster “openness and trust towards each other.”
Trust appears to be in short supply. In May, when China’s wealth fund bought a 10 percent stake valued at $3 billion in private equity firm Blackstone Group, one U.S. lawmaker called for a federal investigation into national security implications.
For its part, the $200 billion China Investment Corp wealth fund insists that it will aim for transparency in its operations and will not be a destabilizing force. The head of the fund said earlier this week that its investment strategy would be commercially — not politically — driven.
Wealth funds serve different purposes in different countries, but are generally used either to invest current surpluses for future generations, or to generate fatter returns than through simple cash reserves.
The IMF has pushed for a voluntary disclosure system to ensure that wealth funds play by international rules. The trouble is, many of these funds have a history of carefully guarding investment strategies and won’t be eager to share their secrets.
Johnson, the IMF’s chief economist, said the recent credit market mess underscored the need for transparency, and that will likely be the buzz word in the G7’s discussions.
Proponents of a voluntary disclosure system point to Norway as a good example of how to run a profitable wealth fund without being secretive.
Norway, which invests surplus oil wealth, owns roughly 0.65 percent of Europe’s equity market capitalization, according to Merrill Lynch research. And yet, it has not generated the same level of fear and criticism that China and others have.
Merrill Lynch noted that Norway provides regular financial updates and sticks to a well-defined benchmark of global debt and equity holdings, so its moves are not a source of financial market speculation or surprise.
A voluntary disclosure system may not go far enough to quell concerns from some Western countries. However, they have been reluctant to push for tight regulation as they try to walk a fine line between protecting national interests and outright protectionism.
For the world financial markets, a few trillion in extra liquidity could come in handy, particularly in crises like the latest credit crunch, when investors are risk-averse.
Standard Chartered estimates that sovereign wealth fund assets could reach $13.4 trillion in 10 years, and predicts that a large chunk of that money will find its way into stocks, bonds, hedge funds and private equity firms in both developed and emerging markets.
“Western countries may need to accept the rise of (sovereign wealth funds) as a further sign of a shift in the world economy and should seize this as an opportunity to work with emerging economies such as China and Russia and others to find common ground rules and a code of practice,” Gerard Lyons, Standard Charter’s chief economist, wrote in a research note.