Corporate & Securities Law

By Jim Hamilton

A working group vetted by the IMF has agreed to a voluntary set of principles for sovereign wealth funds that embody sound governance, transparency, and risk management. The principles, called globally accepted principles and practices (GAPP) for sovereign wealth funds will be formally unveiled in October. For the present, the European Commission and the SEC appear willing to allow the IMF to take the lead in developing voluntary best practices for sovereign wealth funds. Ethiopis Tafara, Director of the SEC?s International Affairs Office, has praised the international effort to develop best practices for sovereign wealth fund, citing the IMF?s ongoing campaign to develop a set of voluntary best practices and principles.

Sovereign wealth funds are the investment arms of governments. For example, several sovereign wealth funds are directly managed through the central bank or the finance ministry, such as in Norway and Qatar, while others are incorporated as private companies with at least
some degree of independence

Belying any notion that sovereign wealth funds are generic, the IMF has identified five distinct types of such funds: 1) stabilization funds that insulate against commodity price swings; 2) generational funds that convert non-renewable assets into diversified assets; 3) reserve investment corporations designed to increase the return on reserves; 4) development funds that help fund projects; and 5) pension reserve funds that provide for the contingent pension liabilities of governments.

Broadly and importantly, noted the IMF, the GAPP will enhance the free flow of cross-border investment and sustain open and stable financial systems. Both the sovereign wealth funds and the recipient countries recognize that the GAPP will work to their mutual advantage by improving the understanding of these funds and allowing newly-established sovereign wealth funds to benefit from the experience of others. Further, the IMF believes that sovereign wealth funds that embrace the new principles and practices could reduce concerns and thereby help mitigate the risk of protectionist pressures on their investments and restrictions on international capital flows.

In the IMF?s view, the role of sovereign wealth funds in the context of the past year's financial markets turmoil has been notably positive. The funds' actions have shown that they can play a shock-absorbing role in global financial markets, at least in terms of dampening short-term market volatility. This is a reflection of their typically long-term investment horizons, limited immediate redemption needs, and mainly unleveraged positions.

Specifically, the IMF believes that the funds must have well-framed corporate governance arrangements, including the government as its owner setting the fund's objectives, its governance structure, and an effective accountability framework. Governance structures typically articulate clear roles, duties, and interrelationships between the different bodies involved in the fund?s management with the goal of facilitating operational independence in making investment decisions. In addition, clear accountability procedures among the different levels of fund governance are important in order to prevent misuse of public resources and to gain public support for the fund and its objectives.

Transparency arrangements will entail regular public disclosure of the investment objectives of the sovereign wealth fund, its funding, the withdrawals and spending on behalf of the government, the governance framework, and the fund's asset size and its allocation, and return. Moreover, funds must have well-designed funding and withdrawal rules that are consistent with their stated goals.

Full post as published by Jim Hamilton's World of Securities Regulation on September 03, 2008 (boomark / email).