Sovereign wealth funds have exploded into the regulatory consciousness and the result has been a call from the Treasury and the SEC for best practices for these opaque vehicles. US regulators will work through the vehicle of the President's Working Group on Financial Markts to develop bi-lateral and multilateral initiatives to achieve greater transparency for these sovereign investment pools.
The accumulation of official reserves far beyond established benchmarks of reserve adequacy has led an increasing number of countries to establish sovereign wealth funds. Thus, SWFs represent a large and rapidly growing stock of government-controlled assets, invested more aggressively than traditional reserves, with implications for the international financial system.
While there is no single, universally accepted definition of a SWF, a Treasury report defines them to mean a government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from the official reserves of the monetary authorities. Because relatively little is known about most SWFs, market estimates of their size vary widely. Treasury estimates aggregate assets of known SWFs from $1.5 – 2.5 trillion. And the IMF projects that sovereigns will continue to accumulate foreign assets at a rate of $800-900 billion per year. Currently, SWF holdings are larger than the total assets under management by either hedge funds or private equity funds, and are set to grow at a much faster pace. Some private analysts project that aggregate SWF assets could grow to $7-8 trillion by 2012 and to $12-15 trillion by 2015.
Like many things, SWFs are a double-edged sword. On the one hand, they have the potential to promote financial stability because they are, in principle, long term, stable investors providing significant capital to the system. Moreover, they are typically not highly leveraged and cannot be forced by capital requirements or investor withdrawals to liquidate positions rapidly.
On the other hand, SWFs raise potential concerns. On the investment side, SWFs could provoke investment protectionism since transactions involving SWF investment may raise legitimate national security concerns. On the financial markets side, SWFs may raise concerns related to financial stability. They can represent large, concentrated, and often non-transparent positions in certain markets and asset classes.
The Treasury, in coordination with the SEC and other U.S. regulators, is working to shape an appropriate international policy response to financial market and investment issues raised by SWFs. For example, Treasury has asked the international community to develop a code of best practices for SWFs. The IMF should take the lead in developing best practices for SWFs, building on existing best practices for foreign exchange reserve management. These would provide guidance to new funds on how to structure themselves, reduce any potential systemic risk, and help demonstrate to critics that SWFs can be responsible, and constructive participants in the international financial system.
Treasury has also created a working group on SWFs that draws on the expertise of Treasury's offices of International Affairs and Domestic Finance. More broadly, the President's Working Group on Financial Markets, which also includes the SEC and the FED, will review SWFs. Finally, there has been bilateral outreach to ensure an ongoing dialogue with countries with significant SWFs and their management, including the United Arab Emirates, Norway and the Kingdom of Saudi Arabia.