An international working group has adopted 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 were praised by a US Treasury official who said that they will promote a better understanding of the institutional and operational practices of the funds. Deputy Secretary of the Treasury Robert M. Kimmitt said that the principles will enhance sound inward investment policies by recipient countries and reduce protectionist pressure by helping support a stable global financial system. The working group was vetted by the IMF.
For the present, the European Commission and the SEC appear willing to allow the working group 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 funds.
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
Broadly and importantly, 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.
Being owned by a foreign government does not shield a sovereign wealth fund from liability under U.S. federal securities laws. It is a well-established principle that sovereign immunity does not extend to a state's commercial activities in another jurisdiction. While SEC enforcement cases involving a foreign entity are more complicated than those with no cross-border nexus, noted the director, the SEC staff has a strong track record of investigating such cases and working closely with its foreign counterparts in collecting evidence abroad. In 2007, the SEC sent more than 550 requests for assistance to foreign regulators, and received more than 450 in return. The SEC expects this number to grow as cross-border securities activity grows
Another core element in the principles is transparent disclosure. One principle requires disclosure of the source of SWF funding, as well as disclosure of a fund’s general approach to withdrawals. Another principle requires an annual report and accompanying audited financial statements on the fund’s operations and performance, prepared in accordance with recognized international or national accounting and auditing standards. Moreover, the sovereign wealth fund should disclose its investment policy, including risk exposures and use of leverage. The fund’s governance framework should also be fully disclosed.
Sound governance is a core function of GAPP. One principle requires the sovereign wealth fund to establish a clear and effective division of roles and duties in order to facilitate accountability and operational independence in the management of the fund to pursue its objectives. Another principle requires the owner to set the objectives of the fund and appoint the members of its governing body in accordance with clearly defined procedures. Moreover, the operational management of the fund should implement the fund’s strategies in an independent manner and in accordance with clearly defined responsibilities. More broadly, the accountability framework for the fund’s operations should be clearly defined in the relevant legislation, charter, or management agreement.