barriers to entry foreign direct investment and the regulation of sovereign wealth funds

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Barriers to entry foreign direct investment and the regulation of sovereign wealth funds ns&i investment account withdrawal

Barriers to entry foreign direct investment and the regulation of sovereign wealth funds

The time needed to obtain licenses depends on the type of approval and ranges from two to eight weeks. Fiscal incentives granted to both foreign and domestic investors historically have been subject to performance requirements, usually in the form of export targets, local content requirements and technology transfer requirements.

Performance requirements are usually written into the individual manufacturing licenses of local and foreign investors. However, the government appears to have some flexibility with respect to the expiry of these periods, and some firms reportedly have had their pioneer status renewed. Government priorities generally include the levels of value-added, technology used, and industrial linkages. If a firm foreign or domestic fails to meet the terms of its license, it risks losing any tax benefits it may have been awarded.

Potentially, a firm could lose its manufacturing license. The New Economic Model stated that in the long term, the government intends gradually to eliminate most of the fiscal incentives now offered to foreign and domestic manufacturing investors. More information on specific incentives for various sectors can be found at www. Malaysia also seeks to attract foreign investment in the information technology industry, particularly in the Multimedia Super Corridor MSC , a government scheme to foster the growth of research, development, and other high technology activities in Malaysia.

For further details on incentives, see www. To date, Malaysia has had some success in attracting regional distribution centers, global shared services offices, and local campuses of foreign universities. In , McDermott moved its regional headquarters to Malaysia and Boston Scientific broke ground on a medical device manufacturing facility.

Malaysia seeks to attract foreign investment in biotechnology but sends a mixed message on agricultural and food biotechnology. The amendments also included a requirement that no person shall import, prepare, or advertise for sale, or sell any food or food ingredients obtained through modern biotechnology without the prior written approval of the Director.

The labeling requirements only apply to foods and food ingredients obtained through modern biotechnology but not to food produced with GMO feed. The labeling regulation was supposed to go into force in , but remains to date with no date announced. Bank Negara Malaysia has amended its recent Outsourcing Guidelines to remove the original data localization requirement and shared that it will similarly remove the data localization elements in its upcoming Risk Management in Technology framework.

The government has provided inducements to attract foreign and domestic investors to the Multimedia Super Corridor but does not mandate use of onshore providers. Companies in the information and communications technology sector are not required to hand over source code. Land administration is shared among federal, state, and local government. State governments have their own rules about land ownership, including foreign ownership.

Malaysian law affords strong protections to real property owners. Real property titles are recorded in public records and attorneys review transfer documentation to ensure efficacy of a title transfer. There is no title insurance available in Malaysia. Malaysian courts protect property ownership rights.

Foreign investors are allowed to borrow using real property as collateral. Foreign and domestic lenders are able to record mortgages with competent authorities and execute foreclosure in the event of loan default. Malaysia ranks 29th ranked 42nd in in ease of registering property according to the Doing Business report, right behind Finland and ahead of Hungary, thanks to changes it made to its registration procedures.

While some amendments are expected to bring it in closer adherence to global standards under proposed compulsory license provisions, Malaysian private enterprises would be able to export products produced under a compulsory license to foreign markets that also have compulsory licenses in place. Capacity building remains a priority for the SIFU.

Coordination with the Malaysian Communications and Multimedia Commission MCMC , which has responsibility for overall regulation of internet content, has been improving according to many rights holders in Malaysia. The Malaysian Communications and Multimedia Commission MCMC is proactively combatting illegal streaming sites which provide content that breaches copyrights and is taking action against owners of non-certified Android TV boxes that are used to stream illegal content.

There is relatively widespread availability of pirated and counterfeit products in Malaysia and there are concerns that the Royal Malaysian Customs Department RMC is not always effectively identifying counterfeit goods in transit. According to U. Limited interagency cooperation and a lack a knowledge of IPR laws among RMC officers remain impediments to effective enforcement. The September authorization of a compulsory license for U. USTR conducted an Out-of-Cycle Review of Malaysia in to consider the extent to which Malaysia is providing adequate and effective IP protection and enforcement, including with respect to patents.

During this review, the United States and Malaysia have held numerous consultations to resolve outstanding issues. Additionally, the United States urges Malaysia to provide effective protection against unfair commercial use and unauthorized disclosure of test or other data generated to obtain marketing approval for pharmaceutical products, and an effective system to address patent issues expeditiously in connection with applications to market pharmaceutical products.

Foreigners may trade in securities and derivatives. Malaysia provides tax incentives for foreign companies issuing Islamic bonds and financial instruments in Malaysia. However, foreign issuers remain subject to Bumiputera ownership requirements of Listing requirements for foreign companies are similar to that of local companies, although foreign companies must also obtain approval of regulatory authorities of foreign jurisdiction where the company was incorporated and valuation of assets that are standards applied in Malaysia or International Valuation Standards and register with the Registrar of Companies under the Companies Act or Malaysia has taken steps to promote good corporate governance by listed companies.

An individual may hold up to 25 corporate directorships. All public and private company directors are required to attend classes on corporate rules and regulations. Legislation also regulates equity buybacks, mandates book entry of all securities transfers, and requires that all owners of securities accounts be identified. A Central Depository System CDS for stocks and bonds established in makes physical possession of certificates unnecessary. Short selling of stocks is prohibited.

Although privately owned banks are competitive with state-owned banks, the state-owned banks dominate the market. According to the World Bank, total banking sector lending for was Bank Negara prohibits hostile takeovers of banks, but the Securities Commission has established non-discriminatory rules and disclosure requirements for hostile takeovers of publicly traded companies. In December , the central bank, began implementing new foreign exchange management requirements.

Under the policy, exporters are required to convert 75 percent of their export earnings into Malaysian ringgit. The goal of this policy was to deepen the market for the currency, with the goal of reducing exchange rate volatility. The policy remains in place, with the Central Bank giving case-by-case exceptions. All domestic trade in goods and services must be transacted in ringgit only, with no optional settlement in foreign currency. The Central Bank has demonstrated little flexibility with respect to the ratio of earnings that exporters hold in ringgit.

Post is unaware of any instances where the requirement for exporters to hold their earnings in ringgit has impeded their ability to remit profits to headquarters. Malaysia imposes few investment remittances rules on resident companies. Incorporated and individual U. Tax advisory firms and consultancies have not flagged payments as a significant concern among U.

Foreign exchange administration policies place no foreign currency asset limits on firms that have no ringgit-denominated debt. Companies that fund their purchases of foreign exchange assets with either onshore or offshore foreign exchange holdings, whether or not such companies have ringgit-denominated debt, face no limits in making remittances. However, a company with ringgit-denominated debt will need approval from the Central Bank for conversions of RM50 million or more into foreign exchange assets in a calendar year.

The Malaysian Government established government-linked investment companies GLICs as vehicles to harness revenue from commodity-based industries and promote growth in strategic development areas. Khazanah is the largest of the GLICs, and the company holds equity in a range of domestic firms as well as investments outside Malaysia. Khazanah was incorporated in under the Companies Act of as a public limited company with a charter to promote growth in strategic industries and national initiatives.

Khazanah also recorded a pre-tax loss of RM6. The sectors comprising its major holdings include telecommunications and media, airports, banking, real estate, health care, and the national energy utility.

State-owned enterprises which in Malaysia are called government-linked companies GLCs , play a very significant role in the Malaysian economy. Such enterprises have been used to spearhead infrastructure and industrial projects. A analysis by the University of Malaya estimated that the government owns approximately 42 percent of the value of firms listed on the Bursa Malaysia through its seven Government-Linked Investment Corporations GLICs , including a majority stake in a number of companies.

Only a minority portion of stock is available for trading for some of the largest publicly listed local companies. As part of its Government Linked Companies GLC Transformation Program, the Malaysian Government embarked on a two-pronged strategy to reduce its shares across a range of companies and to make those companies more competitive through improved corporate governance.

The Transformation Program pushes for more independent and professionalized board membership, but the OECD noted in that in practice shareholder oversight is lax an government officials exert influence over corporate boards. Among the notable divestments of recent years, Khazanah offloaded its stake in the national car company Proton to DRB-Hicom Bhd in In , Khazanah divested its holdings in telecommunications services giant Time Engineering Bhd.

In April , Khazanah sold 1. GLCs with publicly traded shares must produce audited financial statements every year. The SOEs that do not offer publicly traded shares are required to submit annual reports to the Companies Commission. The requirement for publicly reporting the financial standing and scope of activities of SOEs has increased their transparency.

Moreover, many SOEs prioritize operations that maximize their earnings. The close relationships SOEs have with senior government officials, however, blur the line between strictly commercial activity pursued for its own sake and activity that has been directed to advance a policy interest. The government also holds a golden share in 32 companies from key industries such as aerospace, marine technology, energy industries and ports. However, a comprehensive list of the more than GLCs that are controlled by these seven investment companies is not readily available.

With formal and informal ties between board members and government, Malaysian SOEs GLCs may have access to capital and financial protection from bankruptcy as well as reduced pressure to deliver profits to government shareholders. The legal framework establishing GLCs under Malaysian law specifically seeks economic opportunity for Bumiputera entrepreneurs. In several key sectors, including transportation, agriculture, utilities, financial services, manufacturing, and construction, Government Linked Corporations GLCs continue to dominate the market.

However, the Malaysian Government remains publicly committed to the continued, eventual privatization, though it has not set a timeline for the process and faces substantial political pressure to preserve the roles of the GLCs. The Malaysian Government established the Public-Private Partnership Unit UKAS in to provide guidance and administrative support to businesses interested in privatization projects as well as large-scale government procurement projects. UKAS oversees transactions ranging from contracts and concessions to sales and transfers of ownership from the public sector to the private sector.

The privatization process is formally subject to public bidding. The development of RBC programs in Malaysia has transformed from a government-led initiative into a concept embraced by the private sector. Through the efforts of the Bursa Malaysia and other governmental bodies, awareness of corporate responsibility now exists across wide swathes of the private sector in Malaysia.

In , the Malaysian government began to take a more holistic approach to RBC, using it as a way to facilitate change in Malaysian society. That year the government launched the 1Malaysia Training Plan SL1M , an employment incentive program that allows businesses to double the permitted tax deduction for expenses incurred in hiring and training graduates from rural areas and low-income families.

Additionally, BCSDM has laid out its own Vision plan, which aims to facilitate an improvement in global living standards through the implementation of a series of environmentally responsible steps. These companies are screened in accordance with transparent and defined ESG criteria, and the index provides an avenue for investors to make ESG-focused investments and increase ESG exposure in their investment portfolios, thereby putting indirect pressure on companies to behave more responsibly.

As part of their new responsibilities, PLCs were required to disclose sustainability statements in their annual reports, incorporating ESG issues related to their respective businesses. In Bursa Malaysia launched a 2nd edition of the Sustainability Reporting Guidelines, which include recommendations for PLCs regarding how to integrate sustainability into their businesses, and how to conduct more extensive reporting on material Economic, Environmental, and Social EES risks and opportunities.

Various governmental entities have enacted measures to encourage RBC. In the wake of the Companies Act , The Companies Commission of Malaysia similarly sought to push RBC, by developing a best practices circular that promotes adherence to international sustainability reporting standards.

The push toward effectuating RBC by the government has not only involved human rights, but has also addressed environmental concerns. In September , U. Irrespective of the internal steps that the Malaysian government may have taken to codify protection of workers, CBP provided feedback to WRP to adjust its manufacturing and labor practices to ensure they are compliant with U. In the state of Johor in March , a lorry dumped a mixture of toxic chemicals into the Kim Kim River, causing the hospitalization of almost 3, individuals.

The overwhelming majority of those hospitalized did not get sick after the initial dumping, but rather days later aided by strong winds. The authorities did not immediately remove the chemicals from the river due to the costliness of the procedure, leading to a political backlash. The state government took straightforward legal steps against the responsible parties, and completed its investigation in a thorough and impartial manner.

The Johor government charged the driver of the lorry under the Environmental Quality Act , and charged the owners of the factory responsible for the dumping pursuant to the Environment Quality Regulations Scheduled Wastes and Environmental Quality Regulations Clean Air Regulations The Malaysian Securities Commission leads issues regarding corporate governance and shareholder protection.

This -document includes principles on board leadership and effectiveness, audit and risk management, integrity in corporate reporting, and meaningful relationships with stakeholders. The CG Monitor evaluates issues ranging from executive compensation standards to the quality of disclosures made by PLCs. The SC also issues policy papers on a range of related issues, including rules on takeovers, mergers, and acquisitions, with an eye on protecting shareholders.

Bursa Malaysia is similarly interested in ensuring shareholder protection, and has a dedicated chapter in its Listing Requirements to corporate governance. This chapter lays out in detail the requirements for listed companies concerning board composition, rights of directors, and auditing practices. Promotion of RBC in Malaysia has been increasing due to pressure from institutional investors and government-linked investment funds. The MCII includes six principles of effective stewardship by institutional investors, as well as guidance to facilitate implementation.

Furthermore, the MCII encourages institutional investors to invest responsibly by taking stock of the RBC and corporate governance standards of the company. The interest in RBC and good governance has taken hold not only in industry, but in governmental funds as well. As signatories, they are required to carry out PRI principles, including taking ESG into consideration during the due diligence phase before making a potential investment, and ensuring that ESG best practices are met in companies in which they invest.

Post is not aware of any governmental interference in the efforts of regulators, business associations, and investors to improve responsible business practices amongst Malaysian corporations. There is no systematic requirement for public officials to disclose their assets and the Whistleblower Protection Act does not provide protection for those who disclose allegations to the media.

The former Pakatan Harapan government prioritized anti-corruption efforts in its campaign manifesto. The government subsequently charged former Prime Minister Najib with 42 counts of money laundering, criminal breach of trust, and abuse of power for his alleged involvement in the 1MDB corruption scandal. It remains to be seen how robustly this plan will be implemented. There have been no significant incidents of political violence since the national elections.

The May 9, national election led to the first transition of power between coalitions since independence and was peaceful. The Pakatan Harapan administration collapsed on February 24, and was replaced by the Perikatan Nasional coalition led by Muhyiddin Yassin.

In April , the Peaceful Assembly Act took effect, which outlaws street protests and places other significant restrictions on public assemblies. Over a several week period, protestors picketed at several McDonalds restaurants, at times taunting and harassing employees. Periodically, Malaysian groups will organize modest protests against U. To date, these have remained peaceful and localized, with a strong police presence.

Likewise, several non-governmental organizations have organized mass rallies in major cities in peninsular and East Malaysia related to domestic policies that have been peaceful. Malaysia has an acute shortage of highly qualified professionals, scientists, and academics.

Labor relations in Malaysia are generally non-confrontational. Some labor disputes are settled through negotiation or arbitration by an industrial court. Although national unions are currently proscribed due to sovereignty issues within Malaysia, there are a number of territorial federations of unions the three territories being Peninsular Malaysia, Sabah and Sarawak.

The government has prevented some trade unions, such as those in the electronics and textile sectors, from forming territorial federations. Instead of allowing a federation for all of Peninsular Malaysia, the electronics sector is limited to forming four regional federations of unions, while the textile sector is limited to state-based federations of unions, for those states which have a textile industry. Proposed changes to the Trade Unions Act should address this issue and allow unions to form.

No systematic welfare programs or government unemployment benefits exist; however, the Employee Provident Fund, which employers and employees are required to contribute to, provides retirement benefits for workers in the private sector.

Civil servants receive pensions upon retirement. The regulation of employment in Malaysia, specifically as it affects the hiring and redundancy of workers, remains a notable impediment to employing workers in Malaysia. The high cost of terminating employees, even in cases of wrongdoing, is a source of complaint for domestic and foreign employers. The former prime minister formed an Independent Committee on Foreign Workers to study foreign worker policies.

The Committee submitted 40 recommendations for streamlining the hiring of foreign workers and protecting employees from debt bondage and forced labor conditions. It is unclear whether or how the new government will act on these recommendations. Senior officials across the Malaysian interagency have taken this listing seriously and have been working with the private sector and civil society to address concerns relating to the recruitment, hiring, and management of foreign workers in all sectors of the Malaysian economy, including palm oil and electronics.

Malaysia has a limited investment guarantee agreement with the United States under the U. Skip to content State Department Home. Anti-Corruption and Transparency. Arms Control and Nonproliferation. Climate and Environment. Combating Drugs and Crime. Countering Terrorism. Cyber Issues. Economic Prosperity and Trade Policy. Global Health. Global Women's Issues. Human Rights Abuses in Xinjiang.

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In some cases the investments were likely critically important to stabilizing the capital conditions at the invested institution; however, it would be premature to regard SWF commitments as fundamentally altering market sentiments in a fragile market environment. Note: Cumulative abnormal returns on share prices within 30 days prior to and after SWF investments in those banks.

Drawing on budgetary revenues or official reserves, SWFs are state-funded investment vehicles, open to the charge that their activities stand in contrast to the concept of a free-market economy with minimum state intervention and that they distort market activities because their funds are not refinanced under market conditions or do not originate from market activity.

With states having provided support to the financial sector in industrial economies in response to the financial crisis, and the critical importance of that support for restoring well-functioning markets, this argument has receded to the background in the current debate. The practical impact of foreign state investments on enterprises, however, remains subject to scientific scrutiny, suggesting that a negative impact on the long-run performance of enterprises with shares owned by SWFs cannot be excluded.

Although SWFs emphasize their commercial objectives, much of the public debate in recipient countries has centered on the concern that foreign investors with non-financial motivations could seek control of companies and assets. Such control, it was conjectured, could pose a threat to national security and public order, especially in the defense industry, public and private infrastructure, high technology, and financial markets, but also with respect to access to natural resources worldwide.

This issue was seriously considered in many recipient countries, even though it is certainly not specific to SWFs. In fact, states have a number of means and institutions at their disposal through which investments can be pursued. These include public pension funds, development banks, state-owned enterprises, and other public entities. Of these institutions, SWFs are the least suspicious with regard to political investment objectives, given their commitment as long-term-oriented financial investors, mainly seeking small minority stakes.

Many of the SWFs also have proven and long-standing track records as reliable partners of the companies in which they have invested. Although no significant cases of security issues involving SWFs have been observed in practice, 11 the political concerns have remained the single most critical issue in political and public perception. Finally, critics of foreign state fund investments have argued that SWFs—especially if domiciled in emerging economies—may not be able to live up to corporate governance requirements as established in many traditional industrial economies.

As these concerns were increasingly articulated, governments in many countries 13 were quick to review their domestic rules governing incoming investments. In the end, legislative or regulatory initiatives were limited, with concrete changes in market-entry conditions in Australia, Germany, the Russian Federation, and the United States, while the European Union has announced that it will explore the need for EU-wide policy adjustments.

The outcomes vary considerably, from the establishment or refinement of reasonable review mechanisms for inward investments to the establishment or heightening of outright protectionist barriers to entry of foreign capital. Australia has maintained a foreign investment screening process since , as introduced by the Foreign Acquisitions and Takeovers Act. The process is designed to ensure that foreign investment in Australia is consistent with the national interest.

The process requires that significant foreign investment proposals be notified to the government and examined by the Foreign Investment Review Board FIRB , which advises the Treasurer, who can reject proposals deemed contrary to the national interest or can impose conditions. The FIRB examines whether foreign investments might have adverse implications for national security, economic development, or government policies.

In , the government issued additional principles applicable to foreign state investors, including the operational independence of investors from the government, clear commercial objectives, the adherence to adequate and transparent regulation and supervision, and the economic impact of foreign state investments on Australian business. Even though none of these principles establishes qualitatively new criteria, the intervention clearly set the tone for investment policies at a time when the Australian public was particularly concerned about the entry of foreign state investors in the areas of natural resources, commodities, ownership and exploration rights, and processing.

Unlike the policy measures in the United States and Germany discussed below , the Australian approach explicitly includes broader economic and societal interests in its review criteria, and does not confine itself to questions of national security in a strict sense. The law envisages the establishment of a review process, under the auspices of the Federal Ministry of Economics, for foreign investments originating outside the EU or the European Free Trade Association and leading to a stake in a listed or unlisted German company of more than 25 percent of its capital.

The law largely resembles the basic functioning of the Committee on Foreign Investments in the United States review process, but with its high trigger value, a generally lean review process, and its transparent structure, the German investment law is one of the less restrictive in an international comparison. In the final analysis, the quality of the new law can only be judged by the way it is applied in practice.

Optimally, the process would and should be invoked in as few cases as possible, and certainly only in circumstances where a material threat to public order or security can be detected Deutsche Bank, ; Kern, In , the Russian Federation introduced a federal law on foreign investments in companies having strategic importance for state security and defense, 16 establishing a process of approval of foreign investments in strategic sectors in the Russian Federation.

The process features the specification of 42 strategic sectors in which foreign investments are outlawed or can be prohibited by the government. Furthermore, it sets threshold values for foreign shares in Russian companies triggering the review process and establishes notification requirements and sanctions. The law marked a substantial tightening of conditions for foreign investments in the Russian Federation, especially in the strategic sectors identified by the new rules.

In addition, investments in areas outside the realm of the strategic sectors ring-fenced by the new laws are regulated by a number of existing general or sectoral rules, which are tight by international standards. Existing rules were strengthened in and to extend the range of transactions open to CFIUS review and to broaden the definition of the review criteria of national security to encompass transactions involving critical infrastructure, energy assets, and critical technologies.

Further implementing regulations substantially lowered the trigger value for setting off the CFIUS process and increased the reporting requirements for the companies involved. The Foreign Investment and National Security Act reform clearly sharpened CFIUS as a policy instrument, raising the complexity of the review and making it one of the most demanding foreign investment processes among the industrial economies—not least for sovereign investors.

With the entry into force of the Lisbon Treaty, the EU has assumed exclusive competence on foreign direct investment policy as part of its common commercial policy. In the long term, this new competence may substantially change the framework conditions of foreign investment flows into the EU.

Foreign investment policy until used to be an exclusive prerogative of the member states, leading to a total of almost 1, bilateral investment agreements, which account today for almost half of the investment agreements currently in force around the world. In response to these new EU-level powers, the EU Commission has decided to explore the feasibility of developing an international investment policy for the EU.

In a first Communication, the Commission announced that it intends to enable the EU to enlarge, and better define and protect, the competitive space that is available to all EU investors, building on the body and substance of the bilateral arrangements that already exist.

In the long term, the Commission is planning to achieve a situation where investors from the EU and from third countries will not need to rely on bilateral investment treaties entered into by the member state for an effective protection of its investments. In the interim, the Commission has issued a Proposal for a Regulation establishing transitional arrangements for existing bilateral investment agreements between the member states and third countries.

The act is aimed at maintaining the status quo by authorizing the continued existence and application of bilateral agreements between the member states and third countries, and avoiding the erosion of rights and benefits available to investors and investments under international investment agreements.

The transfer of exclusive powers in investment policy to the EU represents an historic opportunity for the EU to greatly simplify and encourage investments across the Union. In the end, the EU can only succeed in completing the single market if it manages to establish a joint EU-level investment policy. With the transitional act and its Communication, the Commission has laid the basis for the conceptual debate that will be important to arrive at such a single policy.

Rules to govern foreign investments have remained a national prerogative. In practice, most economies worldwide impose substantial regulatory barriers in the form of direct and indirect hurdles on foreign investment. This discourages important investments, or—if they are undertaken notwithstanding—substantially raises the cost, especially considering that the barriers differ widely from country to country, with no general patterns. From an international perspective, no global agreements exist that provide national governments with guidelines, let alone binding rules, to encourage the liberalization of investment regimes or at least their standardization.

In addition, a growing number of international and bilateral agreements, although useful for facilitating cross-border capital flows, further fragment the operational environment for international investments. As of end, almost 5, international investment agreements IIAs , including almost 2, bilateral investment treaties, more than 2, double taxation treaties, and more than free trade agreements, were in place Kern, The severity of investment barriers has been measured across various categories of direct and indirect hurdles as well as sectors.

The EU and its member states are, on average, the most open and liberal economies in the world, with the Netherlands, Portugal, Romania, Slovenia, Belgium, Spain, and Germany leading the field. Japan, the United States, and other industrial and emerging economies follow. China, the Russian Federation, and India, in contrast, are among the most restrictive countries Kalinova, Palerm, and Thomsen, Paradoxically, a comparison of the degree of restrictiveness on foreign direct investment to the volumes of sovereign assets at issue suggests that it is, in particular, countries with extensive state-owned funds at their disposal that currently maintain the strictest regimes for preventing foreign investments from entering their domestic markets.

With protectionist reflexes against foreign state investors in potential recipient countries looming, the finance ministers of the Group of Seven 19 asked the OECD to examine possibilities to provide principles for foreign investment policies.

These principles and the detailed guidance the OECD provides are important yardsticks for national investment policies. The extent to which this guidance will lead to more open and harmonized investment regimes is a different question, critically hinging on four factors OECD, :. The GAPP are designed as a voluntary framework that is subject to home-country laws, regulations, requirements, and obligations.

They provide guidance for appropriate governance and accountability arrangements, 20 as well as guide the conduct of appropriate investment practices on the part of SWFs. With regard to transparency, the GAPP seek to improve knowledge of investment strategies, including details on the intended use of voting rights, risk management, and the use of financial leverage. Regarding governance, the GAPP aim at better information about organizational structures and processes, most importantly featuring a commitment to a separation of SWF asset management from government Kern, Despite the breadth of the GAPP and their voluntary nature, their adoption in signaled a remarkable achievement on the part of the IMF and the members of the IWG, especially considering the political challenges along the way.

Reaching agreement on the GAPP marks an important step. Their success in practice will depend on three critical questions:. Similarly, the efforts by a number of SWFs to enhance their public reporting in the wake of the adoption of the Santiago Principles can be seen as progress in the spirit of the principles.

These first steps, it is hoped, will inspire more far-reaching efforts at meeting requirements and expectations set by the Santiago process. SWFs and their investments are one facet of a new phase of globalization that will lead to ownership of assets globally and a new quality of the participation of emerging markets in the global economy.

Because many emerging markets have made tremendous economic progress in recent years and are becoming wealthier, private individuals and public institutions in these economies are increasingly engaging in international investments. This engagement has boosted capital flows from the emerging economies to the traditional industrial economies and resulted in greater and more active participation in global capital markets. Both are positive and highly welcome developments, considering that—owing to the economic realities in earlier phases of globalization—capital had traditionally flowed from industrial countries into emerging markets.

The growing international investments by emerging markets are likely to help them achieve a more established role in world finance commensurate with their increasing importance in the global economy. Foreseeable economic developments of this kind, and their growing magnitudes, call for early and coordinated policy approaches.

If SWFs can be regarded as harbingers of the escalating international involvement of emerging markets in global economics and finance, their case illustrates that intensification of the dialogue increases the chances of achieving mutually acceptable policy outcomes. Ultimately, stronger participation of the emerging markets in international economic and financial policymaking and diplomacy will be needed.

Their participation will be an important element for reaching joint rules in globalized capital markets. Clark Gordon and Ashby H. Gilson Ronald J. Greene Edward F. Reprinted as Appendix 1 to this volume. Jackson James K. Miracky W.

Bortolotti eds. Monk Ashby H. Truman Edwin M. The potential benefits of SWFs to their home economies are described in Kern, A discussion of the sovereign investments relative to other uses of government revenues is provided in Blackburn, Figures on SWF investments presented in this chapter are based on completed and reported equity transactions by state-sponsored investment vehicles. The total volume of investments flows, including nonreported equity transactions and investments in other asset classes, is substantially higher.

On the relative economic importance of SWFs, see also Balding, For a review of sovereign investment strategies, see, for example, Bernstein, Lerner, and Schoar, ; and Chhaochharia and Laeven, The long-term ratio of asset sales to investments is likely to be altered by the pickup in asset sales in the wake of the crisis, albeit only temporarily. Further evidence on the portfolio composition of SWFs has been provided by Balding, ; Fernandes, ; and Fisher, Evidence on the role of third-party asset managers has been presented by Clark and Monk, An overview of the political issues discussed in the context of the SWFs can be found in Greene, ; and Rose, Evidence on a negative impact has been provided by Bortolotti, A competing view has been presented by Fernandes, For a review of associated issues, see Backer, ; Gilson and Milhaupt, ; and Monk, For details, see Australia, Treasurer of the Commonwealth, Also Kern, For details on the U.

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Some authors view transparency as a means to achieve other results, while others argue in favour of transparency as an objective in itself. Transparency and accountability could become powerful tools in the hands of regulators tasked with maintaining financial stability and eradicating market imperfections. In the case of SWFs, such funds should be actively encouraged to increase transparency, as this can alleviate potential concerns of recipient countries and create a more open environment for SWFs.

Conversely, as things currently stand, SWFs should not be obliged to implement higher transparency standards than those required for their competitors which is usually taken as the standard required for the maintenance of financial stability. Therefore, as long as no particular considerations apply to SWFs, then their mere government-owned status should not be enough to ground theoretical and unclear concerns about national security and political interference.

At the same time, if a level playing field is established in the regulation of all financial actors, SWFs would not be permitted to resist calls for transparency on the basis that they are being unfairly discriminated against. Based on the rationale and the objectives of regulation discussed above, this article below develops various theoretical regulatory models that have been suggested in the past and may be applied to regulate the behaviour of SWFs.

Having analyzed the theoretical framework of the rationale for regulating SWFs, the article now moves on to examine regulatory structures that have been proposed in the past in the context of SWFs. In recent years, and since SWFs have attracted a level of attention, various regulatory models for SWFs have been proposed.

A categorization of the models most commonly offered in the relevant literature follows. For example, one suggestion proposes a ceiling on the amount of shares SWFs can acquire in domestic companies, or that it be conditional on state approval for share ownership to exceed a certain percentage.

Supporters propose imposing charges on SWFs such as additional taxes or restricting voting rights until they rectify the costs they impose on target countries, or until they transfer their assets to private actors. The third kind of regulatory proposal suggests imposing reporting requirements on SWFs. Garten suggested a requirement of reciprocity, where the ability of a country to buy foreign assets was conditional on it granting similar access to foreign Western funds.

In his view, the underlying premise is that SWFs are essentially political entities and should be treated as such. Investment caps soon became a popular idea among European countries. The Press Notes determine which sectors require the prior approval of the Foreign Investment Promotion Board before foreigners may directly invest in them and which do not require approval.

Additionally, the Press Notes establish the maximum percentage of a company that can be owned by a foreign investor based on the sector in which that company operates. Incentive-type regulation is softer than the regulation-type discussed above. It is designed to offer incentives to SWFs operating in various countries which encourage them either to rectify the various costs they impose on the system or to transfer the exercise of voting rights attached to company shares to third parties.

While superficially appealing, analysis reveals that the underlying purpose of such proposals is to incentivize SWFs to suspend investment activities altogether. The first incentive-type regulation is the one restricting the voting rights of shares held by SWFs, a historic protectionist measure against foreign corporate control. Under the charter, only resident shareholders could vote and only American citizens could become directors.

This provision prevented foreign control of the Bank, even though 70 per cent of its shares by were foreign owned. Gilson and Milhaupt developed this idea in relation to SWFs. By removing voting rights, sovereigns will refrain from exercising influence over management and those who have purely financial motives will continue to invest. Gilson and Milhaupt accept that their model may lead to unsuccessful results if applied in an under-inclusive or an over-inclusive manner.

In the first case under-inclusion , the model will lack effectiveness if it is not applied to other manipulative transactions, such as requiring strategic concessions before an SWF injects more capital into a portfolio company problem of reciprocity ; or if it does not cover state investment entities other than SWFs which may also be used to advance political goals, such as government-controlled companies.

In the second case over-inclusion , the measure may apply to foreign public entities other than SWFs, such as state pension funds, and could risk being imposed by foreign governments on US state pension funds, such as the CalPERS. The authors accept this cost, but believe it is not a large one, mainly because the role played by US state pension funds in the effort to improve corporate governance standards has not been central. Calculating when an exemption should be warranted would be complex since SWFs have varying degrees of independence from government influence.

In other cases it may be futile to attempt to link an SWF action to its respective government. Even if this hurdle is overcome, most governments now adopt a more restrictive approach towards sovereign immunity, which immunizes foreign states from suits in connection with sovereign acts, but does not equally cover commercial acts. The jurisdictional immunities of the state were addressed again in February in the case of Germany v Italy Greece intervening before the International Court of Justice.

The Court noted that it was not called upon in these proceedings to consider the question of how international law treats the issue of state immunity for non-sovereign activities, especially private and commercial activities acta jure gestionis to which, under many laws, immunity does not apply. Fleischer develops a theory of taxing sovereign wealth as a complementary instrument to other regulations.

He performs a cost—benefit analysis CBA of the operation of SWFs and concludes that the negative externalities outweigh the positive ones. Following representations made to the US Joint Committee on Taxation, Funk argues the US tax exemption in reality is unlikely to impact on the structure of an investment by an SWF, given the usual nature of such investments.

However, as discussed below, both systems contain the basic elements of all incentivizing schemes but fail to provide clear guideline by which SWFs could continue to operate in financial markets and, simultaneously, retain their voting rights or avoid tax charges.

This type of regulation advocates forcing SWFs, through legislation, to produce reports with specific information, thus aligning themselves with the regulated part of the industry, such as mutual funds, banks, and insurance companies. In this respect, she recalls the provisions introduced in in the Italian Financial Consolidated Act in order to increase transparency, and thus market discipline, in relationships between Italian listed companies and foreign companies having their registered office in a country whose legal system does not ensure transparency.

In order to prevent jurisdiction shopping by SWFs, where state investors would select as targets the jurisdictions that are more favourable to them, reporting requirements could be implemented on a global basis. Since the beginning of the debate on SWFs, the idea of self-regulation has not received wide support in the literature. Most commentators seemed unaccepting that, left to themselves, SWFs would produce a reliable regulatory framework to address the perceived costs raised by the activity of SWFs.

The categorization above of the most commonly proposed regulatory models has offered a platform of analysis on the basis of the real issues that surround SWFs, namely their benefits and concerns about them. The analysis below focuses on the theoretical aspects of the above models, but also aspects pertaining to the implementation and the costs of each system.

The basic problem identified in the above-mentioned proposals is that they appear to be overshooting the mark. Nearly all of these proposals are based on the misguided premise that regulation is necessary to preserve national security and other interests, while the available evidence on SWFs shows that such intervention is unnecessary. Moreover, imposing additional burdens against foreign funds simply on the basis of state ownership appears discriminatory and ignores the fact that state-owned actors can behave like model investors in global markets.

Finally, some of the measures contemplated are too severe on those SWFs that have already implemented high transparency standards, such as the Norwegian and Australian funds, and may even discourage others from making similar progress. These difficulties are discussed in detail below. The first ground for criticizing the above models is that, with the exception of the self-regulatory model, they cannot avoid being labelled as overtly protectionist.

In practice, any measure that aims at screening FDI on national security or any other grounds even those justified involves some degree of protectionism. However, the above models appear to go beyond what is necessary to guarantee specific national interests. As explained above, most of the concerns about SWFs, which prompted the above regulatory models, are either theoretical, exaggerated, or completely unfounded and thus do not need addressing with hard-line legislative measures.

In fact, the available evidence on SWFs shows that they do not pose realistic national security threats. Moreover, it has been advocated in this article that nothing in the structure, size, or behavior of SWFs poses particular financial stability risks, that is, different to those posed by other market actors, such as hedge funds and private equity firms. In other words, while acknowledging that SWFs could have an impact on financial stability and, thus, should be subjected to the same standards of prudential regulation as other actors, there is nothing specific about SWFs that should warrant special regulations.

If anything, the behaviour of SWFs, given their risk aversion, passive behaviour and long-term outlooks as well as their injections of liquidity during the crisis, show they are a factor of stability in international financial markets. If, for example, the government of North Korea was in a position to lay its hands on vital defence-related technology by buying British Aerospace, say, that would, indeed, be a worrisome development.

There is little SWFs can do to remove those restrictions or avoid taxation, other than abandon the market altogether. Finally, the issue of discrimination equally arises in relation to the command and control regulatory proposals, specifically those by Truman, Garten, and Mezzacapo, advocating mandatory reporting requirements which put sovereign investors at a serious competitive disadvantage.

The second part of this analysis focuses on implementation of the above proposals. It is shown that many of them involve important, if not insurmountable, difficulties, and as such do not represent a reliable solution to the concerns about SWFs. The implementation of the first category of proposals, namely, restricting the investments of SWFs, is prevented by the problem as to how to identify an investor or a fund that should be subjected to such restrictions.

This is a controversial and multifaceted issue. Furthermore, some host country corporations and pension funds may be as averse to such limitations on the SWFs as the SWFs themselves. First, restricting SWFs either by imposing investment caps or excluding various sectors from their ambit would run into difficulties if applied in the EU. According to the rulings of the Court, FDI may be screened, or hindered, only so far as it is necessary in order to protect a fundamental national interest, such as national security or the provision of a universal service water, electricity, etc.

As such, EU Courts would strike them down. In carrying out such an enterprise, each Member State would be bound by its own interests and beliefs and by its own special circumstances, making it difficult to identify those sectors or sub-sectors of a strategic value to every Member State. A similar, if not more difficult, task would involve identifying those funds that should be subject to reporting requirements.

First, a number of high-profile SWFs would refuse to be characterized as such. To ensure a level playing field among all countries concerned, a global list of SWFs could be agreed multilaterally, possibly within the context of the WTO, as suggested by Mattoo and Subramanian. All in all, the models suggested by Truman, Garten, and Mezzacapo appear extremely time-consuming and ultimately unworkable. Tax authorities are hardly the appropriate bodies to protect national security and set foreign policy.

The final part of the analysis discusses the potential costs of each system. Here, the consequences between various policy options deriving from the Great Tradeoff as described by Cohen between market openness and national security, become more obvious. The costs associated with each system may differ greatly, but they also depend on the special circumstances of each country. For example, during the Dubai Ports case, the argument was used that such a deal might facilitate the smuggling of terrorists into the USA from the Middle East.

This fact must be considered when assessing the costs and benefits of a model, when applied in different countries. If the USA is a far more popular destination for foreign capital than other recipient countries, it may be more willing to sacrifice a small part of this in order to maintain national security safeguards.

In contrast, FDI in Greece, Portugal, Spain, and Ireland might have a higher value during the debt crises currently facing these countries, and thus the cost of hindering foreign capital might be higher for them than for Switzerland or Estonia. A regulator that does not use a CBA to formulate new policy or to check on the impact of specific measures runs the risk of delivering an output that may reflect the given objectives but may lead to unintended inefficiency, since not all relevant factors will be considered.

Conversely, the indirect costs that may arise from strict regulation of FDI warrant more attention and analysis. At the present time there are sufficient indications of the trade-off that ensues if governments give way to protectionist calls and adopt legislation restricting SWFs.

Bloomberg and Schumer have cited the example of the US Sarbanes—Oxley Act —shortly after its passing, there were signs of investment shifts towards Europe and Asia. It thus becomes apparent that each of the above regulatory models perhaps with the exception of self-regulation discussed below imposes significant costs on the system, the extent of which depends on the nature of each model and its degree of protectionism. These costs can ultimately defeat the very rationale for adopting each of the above models, which is to rectify other indirect costs associated with SWFs, such as political leverage and investor uncertainty.

This finding should inform the next part of the analysis. However, at the same time, it creates an excessively hostile economic environment for SWFs and is almost certainly the most effective way of driving their investments overseas. Such a system, however, is still far from optimal because of the uncertainty it creates with regard to the sectors open to investment. Such a model has serious drawbacks when considering its implementation, which may lead to additional costs in the form of the loss of investment activity.

Gilson and Milhaupt, who suggest removing the voting rights of state investors, themselves admit the risk of over-inclusion, namely the expectation that governments whose SWFs and pension funds have their voting rights suspended will impose similar suspensions on the equity holdings of comparable US government entities. Sovereign shareholders, in their few instances of activism have on many occasions benefited companies by raising takeover premiums and opposing hostile takeovers.

As SWFs would abstain from purchasing such stock, and would arguably favour stocks from other countries or investments in government bonds or real estate, the subsequent drop in demand for shares would also be reflected in their price. Although this reduction could be small even minuscule , no company management would choose to incur it simply to prevent sovereign shareholders from voting in company meetings. Fleischer suggests that the transactions carried out by SWFs impose certain costs on the recipient countries, which, however, are not reflected in the actual price of the transaction.

The above analysis indicates that most types of hard regulatory interventions to regulate SWFs have serious setbacks as much from a theoretical perspective, as from the point of view of implementation and costs. The present section discusses the alternative model of supranational self-regulation favoured by the IMF.

A proposal prioritizing international over national action is founded upon the belief that a set of commonly accepted shared values is of chief importance for the effectiveness and legitimacy of such a governance structure. Binding sovereign investors together, with the additional involvement of an international institution, is a more effective way of enhancing the legitimacy of regulatory intervention than unilateral action.

Compared to the national regulatory options discussed above, supranational responses to SWFs present a number of advantages. First, supranational bodies are perhaps more immune to short-term political considerations such as a possible momentary suspicion towards foreign investments. Secondly, the objectivity of a supranational effort, removed from national political considerations, could also appeal more easily to SWFs and include them in the rule-making process, thus equating this process to that of self-regulation.

The heterogeneity of various national investment review standards could impose undue costs of compliance on SWFs and hence affect the efficient flow of capital. This regulatory framework is typically implemented through the means of a Code of Conduct CoC. A CoC is defined by the International Federation of Accountants as a set of: principles, values, standards, or rules of behavior that guide the decisions, procedures and systems of an organization in a way that a contributes to the welfare of its key stakeholders, and b respects the rights of all constituents affected by its operations.

CoCs, as policy tools, are usually entered into on a voluntary basis, meaning that the negotiating members were not compelled to participate by a central decision maker. Rather, a central body provided its members with an opportunity to negotiate and agree on a set of rules. This method of setting international standards is common, given that the drafting of command-based tools is, in most cases, unrealistic beyond the national level.

GAPP consists of 24 practices and principles, focusing on three key areas. These are intended to be implemented by SWFs and include: i legal framework, objectives, and coordination with macroeconomic policies; ii institutional framework and governance structure; and iii investment and risk management framework where SWF managers were encouraged to disclose more information.

The object of SWFs should not be to project state power. It is suggested by Backer that such deviation from the suggested model might open that fund to special regulation. GAPP reaffirmed the distinction between private and public funds. This view of GAPP suggests, however, that the attainment of macroeconomic objectives is limited to economic ones and does not extend to political goals. Moreover, a number of principles encouraged the separation between the entity and the sovereign.

This is supported through the establishment of clear objectives for the fund, the division of roles and responsibilities, and provisions on independence and the maximization of risk-adjusted financial returns. CoCs still present a significant weakness in terms of the absence of any formal enforcement mechanism. No SWF is under any obligation to implement or observe any of these principles, not even those funds that took part in the preparatory work of the IWG.

This concern, although a valid one, should not be overstated. Enforcement, just like standard-setting, differs significantly depending on whether it is made at the national or supranational level. At the supranational level, both the drafting of command-based tools and the enforcement of the agreed rules are, in most cases, unrealistic or at least unworkable.

International commitments, even when drafted as binding rules, are left to Member States to implement domestically. It is observed that, following the financial crisis, SWFs have demonstrated an increased appetite for joint ventures and foreign investment activities in cooperation with local funds.

For the time being, the available evidence on compliance with GAPP shows mixed results: while overall compliance is still lacking, many encouraging signs can already be observed. Source: Behrendt n 6. This, however, does not constitute in any way a reason to abandon the entire effort. It is natural to expect institutional change to be slow, especially when it happens on a voluntary basis and it takes place in countries with varying traditions of governance and administration.

It is, thus, supported that the option of self-regulation at the international level avoids the majority of the problems identified in the hard-law national regulatory proposals discussed above. It is proportional to the issues relevant to SWFs and preserves the investment-friendly environment that is necessary in a global post-crisis recovery scenario such as the current one.

Therefore, it offers a better theoretical framework upon which to base the regulation of SWFs. The purpose of this analysis is to provide a rationale for regulating SWFs rather than a full regulatory framework. However, some brief discussion and thoughts on the form of this self-regulatory body is warranted, to be of benefit to the conclusion. The current annual meetings of the IFSWF are by invitation only and, aside from press briefings, there is no detailed account of their meetings.

The lack of transparency is displayed openly with a members-only log-in to their website required to view any detailed accounts. A sensible means of organizing a self-regulating SWF body would be to assign responsibility for such organization to a secretariat. The secretariat would arrange an annual forum, which would be for SWFs to exchange ideas and discuss their progress in implementing GAPP.

Ideally, membership should be open to all state-owned investment funds regardless of their investment objectives, thus drawing as much participation as possible including pension funds, development banks, and similar organizations. The IMF would be a suitable and convenient platform to be used as secretariat. Otherwise, it may be possible for the WTO to play an administrative role such as a secretariat, since as the article has highlighted, it would be impracticable for the WTO to undertake a regulatory role.

The advantage of the WTO is that it provides equal participation among members, as opposed to the IMF or the World Bank which may be viewed as Western-controlled bodies since by political agreement they are always headed by Westerners and the voting power of their Western members carry more weight. However, they should specifically not be empowered to impose additional disciplinary measures since this would defeat the voluntary nature of the scheme.

Furthermore, it would be impracticable, create divisions among SWFs, and consequently risk damaging the project as a whole. It is equally important that GAPP is constructed in a broad way so as to provide SWFs with sufficient flexibility in their manner of implementation as long as the spirit of the code is complied with.

This article has demonstrated that regulatory responses to SWFs need to take into account the reality and the actual characteristics of sovereign investors. Otherwise, they run the risk of becoming overtly protectionist and imposing unwanted costs on the global financial system.

It is true that where SWFs are involved there is no consensus on how they should be dealt with from a regulatory perspective. At the same time, a trade-off can be said to exist in the option of adopting hard regulation, which is a loss of efficiencies.

At the same time, a trade-off can be said to exist in the option of adopting hard regulation. This could erase efficiency benefits, and consequently would means the actual negative costs of SWFs are not significant enough to justify hard regulatory intervention. Nevertheless, a limited form of regulation may be warranted simply to ease protectionist pressures and maintain consumer and corporate confidence in the market for SWF investments.

While other risks, such as the undue political leverage of countries managing huge SWFs, may be real, they cannot be tackled by a simple regulatory instrument. Increasing transparency might have a positive impact, but SWFs should be allowed to remain opaque to the extent that their immediate competitors are allowed to. These models are either excessively protectionist and discriminatory and are not justified by the real facts regarding SWFs or they are too costly and unworkable.

Alternatively, a supranational regulatory framework that would involve the participation of such funds, such as GAPP, appears to eliminate many of the direct costs identified. As a result, it creates a more investment-friendly global environment and assures the continued operation of those benign investors. SWF Institute n 6. Nevertheless, a modest tendency in favour of in-house asset management can be discerned.

According to the IMF, ADIA has now established an in-house capacity and operates as highly professional investment managers and relies less on external managers than in its past, IMF n 21 8. What Lessons Can Be Learned? In certain cases it would, indeed, be futile to attempt to link an SWF action to its respective government. Treasury Regulation s 1. Reports , p. Finding for the defendant, the court determined that Hernandez had acted in his official capacity as a military commander so his actions were those of the Venezuelan government.

If the opposite applies, this may warrant subsidizing SWFs, ibid It is nevertheless a step in the right direction. Oxford University Press is a department of the University of Oxford. It furthers the University's objective of excellence in research, scholarship, and education by publishing worldwide. Sign In or Create an Account. Sign In. This has given way to widespread concern over the influence these funds have on the global economy. As such, it is important to understand exactly what sovereign wealth funds are and how they first came about.

A sovereign wealth fund is a state-owned pool of money that is invested in various financial assets. The money typically comes from a nation's budgetary surplus. When a nation has excess money, it uses a sovereign wealth fund as a way to funnel it into investments rather than simply keeping it in the central bank or channeling it back into the economy. The motives for establishing a sovereign wealth fund vary by country.

For example, the United Arab Emirates generates a large portion of its revenue from exporting oil and needs a way to protect the surplus reserves from oil-based risk; thus, it places a portion of that money in a sovereign wealth fund. The first funds originated in the s. Sovereign wealth funds came about as a solution for a country with a budgetary surplus. The first sovereign wealth fund was the Kuwait Investment Authority , established in to invest excess oil revenues.

Over the last few decades, the size and number of sovereign wealth funds have increased dramatically. Sovereign wealth funds can fall into two categories, commodity or non-commodity. The difference between the two categories is how the fund is financed. Commodity sovereign wealth funds are financed by exporting commodities. When the price of a commodity rises, nations that export that commodity will see greater surpluses.

Conversely, when an export-driven economy experiences a fall in the price of that commodity, a deficit is created that could hurt the economy. A sovereign wealth fund acts as a stabilizer to diversify the country's money by investing in other areas. Non-commodity funds are typically financed by an excess of foreign currency reserves from current account surpluses.

Sovereign wealth funds are traditionally passive , long-term investors. Few sovereign wealth funds reveal their full portfolios , but sovereign wealth funds invest in a wide range of asset classes including:. However, a growing number of funds are turning to alternative investments , such as hedge funds or private equity , which are not accessible to most retail investors.

The International Monetary Fund reports that sovereign wealth funds have a higher degree of risk than traditional investment portfolios, holding large stakes in the often-volatile emerging markets. Sovereign wealth funds use a variety of investment strategies :. Funds also differ in the level of control they assume when investing in companies:. Sovereign wealth funds represent a large and growing portion of the global economy. The size and potential impact that these funds could have on international trade have led to considerable opposition, and the criticism has mounted after controversial investments in the United States and Europe.

This fear could also lead to investment protectionism , potentially damaging the global economy by restricting valuable investment dollars. In the United States and Europe, many financial and political leaders have stressed the importance of monitoring and possibly regulating sovereign wealth funds. Many political leaders assert that sovereign wealth funds pose a threat to national security, and their lack of transparency has fueled this controversy. The United States addressed this concern by passing the Foreign Investment and National Security Act of , which established greater scrutiny when a foreign government or government-owned entity attempts to purchase a U.

Western powers have been guarded about allowing sovereign wealth funds to invest and have asked for improved transparency. However, as there is no substantive evidence that funds are operating under political or strategic motives, most countries have softened their position and even welcomed the investors. Kuwait Investment Authority. John Mikesell.

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The fourth component of the rationale for financial regulation is the need for consumer confidence which also has a positive externality. Generally this means that, because of regulation, consumers are confident their rights and interests are duly protected and, therefore, undertake more transactions and increase liquidity into the market. In the case of SWFs, regulation could ensure that parties on the other side of a transaction involving an SWF whether companies, a shareholder or entire countries will be protected from any abuse by such a fund.

Regulation could, based on this argument, reduce popular or business backlash to sensitive SWF investments. The fifth component is the potential for gridlock. This term describes the situation where all firms know how they should behave towards customers but, nevertheless, adopt hazardous strategies to secure short-term advantages since detecting such hazardous behaviour is only possible in the long-term.

The sixth rationale for regulation is the risk of moral hazard. This element has no relevance to SWFs. Llewellyn states consumer demand for regulation as the final component of the rationale. This applies to SWFs if the recipient companies and countries are considered to be the consumers. A graphic representation of this analysis is provided in Figure 1.

As seen from the discussion above, the majority of rationales used to justify the regulation of the wider banking and financial sector could also apply to SWFs. However, the underlying premises of these rationales are disputed by various commentators. When such risks are unsubstantial, then the rationale for regulating SWFs folds. Thus, the question is whether the above-mentioned market imperfections necessarily warrant the adoption of regulation or whether the market response to market imperfections can be cost-effectively replaced or improved by government.

Indeed, Mezzacapo argues that although markets do not necessarily provide first-best incentives to behave as efficiently as possible, sometimes they could provide strong incentives. Therefore, a clear incentive is created for SWFs themselves to build trust, but also more particularly, to devise rules, institutions, and behaviours, minimizing the costs flowing from the opacity of SWFs.

Thus, the question of whether it is transparency that must be targeted by regulatory proposals has been elevated to centre stage in the discussion. It must be pointed out in this respect that various US and EU regulations provide for a considerable and comprehensive mandatory disclosure regime when a major stake in a listed company is acquired. Opinions diverge as to the role of transparency in the debate about regulating SWFs.

Some authors view transparency as a means to achieve other results, while others argue in favour of transparency as an objective in itself. Transparency and accountability could become powerful tools in the hands of regulators tasked with maintaining financial stability and eradicating market imperfections. In the case of SWFs, such funds should be actively encouraged to increase transparency, as this can alleviate potential concerns of recipient countries and create a more open environment for SWFs.

Conversely, as things currently stand, SWFs should not be obliged to implement higher transparency standards than those required for their competitors which is usually taken as the standard required for the maintenance of financial stability. Therefore, as long as no particular considerations apply to SWFs, then their mere government-owned status should not be enough to ground theoretical and unclear concerns about national security and political interference.

At the same time, if a level playing field is established in the regulation of all financial actors, SWFs would not be permitted to resist calls for transparency on the basis that they are being unfairly discriminated against. Based on the rationale and the objectives of regulation discussed above, this article below develops various theoretical regulatory models that have been suggested in the past and may be applied to regulate the behaviour of SWFs. Having analyzed the theoretical framework of the rationale for regulating SWFs, the article now moves on to examine regulatory structures that have been proposed in the past in the context of SWFs.

In recent years, and since SWFs have attracted a level of attention, various regulatory models for SWFs have been proposed. A categorization of the models most commonly offered in the relevant literature follows.

For example, one suggestion proposes a ceiling on the amount of shares SWFs can acquire in domestic companies, or that it be conditional on state approval for share ownership to exceed a certain percentage. Supporters propose imposing charges on SWFs such as additional taxes or restricting voting rights until they rectify the costs they impose on target countries, or until they transfer their assets to private actors. The third kind of regulatory proposal suggests imposing reporting requirements on SWFs.

Garten suggested a requirement of reciprocity, where the ability of a country to buy foreign assets was conditional on it granting similar access to foreign Western funds. In his view, the underlying premise is that SWFs are essentially political entities and should be treated as such.

Investment caps soon became a popular idea among European countries. The Press Notes determine which sectors require the prior approval of the Foreign Investment Promotion Board before foreigners may directly invest in them and which do not require approval. Additionally, the Press Notes establish the maximum percentage of a company that can be owned by a foreign investor based on the sector in which that company operates.

Incentive-type regulation is softer than the regulation-type discussed above. It is designed to offer incentives to SWFs operating in various countries which encourage them either to rectify the various costs they impose on the system or to transfer the exercise of voting rights attached to company shares to third parties.

While superficially appealing, analysis reveals that the underlying purpose of such proposals is to incentivize SWFs to suspend investment activities altogether. The first incentive-type regulation is the one restricting the voting rights of shares held by SWFs, a historic protectionist measure against foreign corporate control. Under the charter, only resident shareholders could vote and only American citizens could become directors. This provision prevented foreign control of the Bank, even though 70 per cent of its shares by were foreign owned.

Gilson and Milhaupt developed this idea in relation to SWFs. By removing voting rights, sovereigns will refrain from exercising influence over management and those who have purely financial motives will continue to invest. Gilson and Milhaupt accept that their model may lead to unsuccessful results if applied in an under-inclusive or an over-inclusive manner.

In the first case under-inclusion , the model will lack effectiveness if it is not applied to other manipulative transactions, such as requiring strategic concessions before an SWF injects more capital into a portfolio company problem of reciprocity ; or if it does not cover state investment entities other than SWFs which may also be used to advance political goals, such as government-controlled companies.

In the second case over-inclusion , the measure may apply to foreign public entities other than SWFs, such as state pension funds, and could risk being imposed by foreign governments on US state pension funds, such as the CalPERS. The authors accept this cost, but believe it is not a large one, mainly because the role played by US state pension funds in the effort to improve corporate governance standards has not been central.

Calculating when an exemption should be warranted would be complex since SWFs have varying degrees of independence from government influence. In other cases it may be futile to attempt to link an SWF action to its respective government. Even if this hurdle is overcome, most governments now adopt a more restrictive approach towards sovereign immunity, which immunizes foreign states from suits in connection with sovereign acts, but does not equally cover commercial acts.

The jurisdictional immunities of the state were addressed again in February in the case of Germany v Italy Greece intervening before the International Court of Justice. The Court noted that it was not called upon in these proceedings to consider the question of how international law treats the issue of state immunity for non-sovereign activities, especially private and commercial activities acta jure gestionis to which, under many laws, immunity does not apply.

Fleischer develops a theory of taxing sovereign wealth as a complementary instrument to other regulations. He performs a cost—benefit analysis CBA of the operation of SWFs and concludes that the negative externalities outweigh the positive ones. Following representations made to the US Joint Committee on Taxation, Funk argues the US tax exemption in reality is unlikely to impact on the structure of an investment by an SWF, given the usual nature of such investments.

However, as discussed below, both systems contain the basic elements of all incentivizing schemes but fail to provide clear guideline by which SWFs could continue to operate in financial markets and, simultaneously, retain their voting rights or avoid tax charges.

This type of regulation advocates forcing SWFs, through legislation, to produce reports with specific information, thus aligning themselves with the regulated part of the industry, such as mutual funds, banks, and insurance companies. In this respect, she recalls the provisions introduced in in the Italian Financial Consolidated Act in order to increase transparency, and thus market discipline, in relationships between Italian listed companies and foreign companies having their registered office in a country whose legal system does not ensure transparency.

In order to prevent jurisdiction shopping by SWFs, where state investors would select as targets the jurisdictions that are more favourable to them, reporting requirements could be implemented on a global basis. Since the beginning of the debate on SWFs, the idea of self-regulation has not received wide support in the literature.

Most commentators seemed unaccepting that, left to themselves, SWFs would produce a reliable regulatory framework to address the perceived costs raised by the activity of SWFs. The categorization above of the most commonly proposed regulatory models has offered a platform of analysis on the basis of the real issues that surround SWFs, namely their benefits and concerns about them.

The analysis below focuses on the theoretical aspects of the above models, but also aspects pertaining to the implementation and the costs of each system. The basic problem identified in the above-mentioned proposals is that they appear to be overshooting the mark. Nearly all of these proposals are based on the misguided premise that regulation is necessary to preserve national security and other interests, while the available evidence on SWFs shows that such intervention is unnecessary.

Moreover, imposing additional burdens against foreign funds simply on the basis of state ownership appears discriminatory and ignores the fact that state-owned actors can behave like model investors in global markets. Finally, some of the measures contemplated are too severe on those SWFs that have already implemented high transparency standards, such as the Norwegian and Australian funds, and may even discourage others from making similar progress.

These difficulties are discussed in detail below. The first ground for criticizing the above models is that, with the exception of the self-regulatory model, they cannot avoid being labelled as overtly protectionist. In practice, any measure that aims at screening FDI on national security or any other grounds even those justified involves some degree of protectionism. However, the above models appear to go beyond what is necessary to guarantee specific national interests.

As explained above, most of the concerns about SWFs, which prompted the above regulatory models, are either theoretical, exaggerated, or completely unfounded and thus do not need addressing with hard-line legislative measures. In fact, the available evidence on SWFs shows that they do not pose realistic national security threats. Moreover, it has been advocated in this article that nothing in the structure, size, or behavior of SWFs poses particular financial stability risks, that is, different to those posed by other market actors, such as hedge funds and private equity firms.

In other words, while acknowledging that SWFs could have an impact on financial stability and, thus, should be subjected to the same standards of prudential regulation as other actors, there is nothing specific about SWFs that should warrant special regulations. If anything, the behaviour of SWFs, given their risk aversion, passive behaviour and long-term outlooks as well as their injections of liquidity during the crisis, show they are a factor of stability in international financial markets.

If, for example, the government of North Korea was in a position to lay its hands on vital defence-related technology by buying British Aerospace, say, that would, indeed, be a worrisome development. There is little SWFs can do to remove those restrictions or avoid taxation, other than abandon the market altogether. Finally, the issue of discrimination equally arises in relation to the command and control regulatory proposals, specifically those by Truman, Garten, and Mezzacapo, advocating mandatory reporting requirements which put sovereign investors at a serious competitive disadvantage.

The second part of this analysis focuses on implementation of the above proposals. It is shown that many of them involve important, if not insurmountable, difficulties, and as such do not represent a reliable solution to the concerns about SWFs. The implementation of the first category of proposals, namely, restricting the investments of SWFs, is prevented by the problem as to how to identify an investor or a fund that should be subjected to such restrictions.

This is a controversial and multifaceted issue. Furthermore, some host country corporations and pension funds may be as averse to such limitations on the SWFs as the SWFs themselves. First, restricting SWFs either by imposing investment caps or excluding various sectors from their ambit would run into difficulties if applied in the EU.

According to the rulings of the Court, FDI may be screened, or hindered, only so far as it is necessary in order to protect a fundamental national interest, such as national security or the provision of a universal service water, electricity, etc.

As such, EU Courts would strike them down. In carrying out such an enterprise, each Member State would be bound by its own interests and beliefs and by its own special circumstances, making it difficult to identify those sectors or sub-sectors of a strategic value to every Member State. A similar, if not more difficult, task would involve identifying those funds that should be subject to reporting requirements.

First, a number of high-profile SWFs would refuse to be characterized as such. To ensure a level playing field among all countries concerned, a global list of SWFs could be agreed multilaterally, possibly within the context of the WTO, as suggested by Mattoo and Subramanian. All in all, the models suggested by Truman, Garten, and Mezzacapo appear extremely time-consuming and ultimately unworkable. Tax authorities are hardly the appropriate bodies to protect national security and set foreign policy.

The final part of the analysis discusses the potential costs of each system. Here, the consequences between various policy options deriving from the Great Tradeoff as described by Cohen between market openness and national security, become more obvious. The costs associated with each system may differ greatly, but they also depend on the special circumstances of each country.

For example, during the Dubai Ports case, the argument was used that such a deal might facilitate the smuggling of terrorists into the USA from the Middle East. This fact must be considered when assessing the costs and benefits of a model, when applied in different countries.

If the USA is a far more popular destination for foreign capital than other recipient countries, it may be more willing to sacrifice a small part of this in order to maintain national security safeguards. In contrast, FDI in Greece, Portugal, Spain, and Ireland might have a higher value during the debt crises currently facing these countries, and thus the cost of hindering foreign capital might be higher for them than for Switzerland or Estonia.

A regulator that does not use a CBA to formulate new policy or to check on the impact of specific measures runs the risk of delivering an output that may reflect the given objectives but may lead to unintended inefficiency, since not all relevant factors will be considered. Conversely, the indirect costs that may arise from strict regulation of FDI warrant more attention and analysis.

At the present time there are sufficient indications of the trade-off that ensues if governments give way to protectionist calls and adopt legislation restricting SWFs. Bloomberg and Schumer have cited the example of the US Sarbanes—Oxley Act —shortly after its passing, there were signs of investment shifts towards Europe and Asia.

It thus becomes apparent that each of the above regulatory models perhaps with the exception of self-regulation discussed below imposes significant costs on the system, the extent of which depends on the nature of each model and its degree of protectionism. These costs can ultimately defeat the very rationale for adopting each of the above models, which is to rectify other indirect costs associated with SWFs, such as political leverage and investor uncertainty.

This finding should inform the next part of the analysis. However, at the same time, it creates an excessively hostile economic environment for SWFs and is almost certainly the most effective way of driving their investments overseas. Such a system, however, is still far from optimal because of the uncertainty it creates with regard to the sectors open to investment. Such a model has serious drawbacks when considering its implementation, which may lead to additional costs in the form of the loss of investment activity.

Gilson and Milhaupt, who suggest removing the voting rights of state investors, themselves admit the risk of over-inclusion, namely the expectation that governments whose SWFs and pension funds have their voting rights suspended will impose similar suspensions on the equity holdings of comparable US government entities. Sovereign shareholders, in their few instances of activism have on many occasions benefited companies by raising takeover premiums and opposing hostile takeovers.

As SWFs would abstain from purchasing such stock, and would arguably favour stocks from other countries or investments in government bonds or real estate, the subsequent drop in demand for shares would also be reflected in their price. Although this reduction could be small even minuscule , no company management would choose to incur it simply to prevent sovereign shareholders from voting in company meetings. Fleischer suggests that the transactions carried out by SWFs impose certain costs on the recipient countries, which, however, are not reflected in the actual price of the transaction.

The above analysis indicates that most types of hard regulatory interventions to regulate SWFs have serious setbacks as much from a theoretical perspective, as from the point of view of implementation and costs. The present section discusses the alternative model of supranational self-regulation favoured by the IMF. A proposal prioritizing international over national action is founded upon the belief that a set of commonly accepted shared values is of chief importance for the effectiveness and legitimacy of such a governance structure.

Binding sovereign investors together, with the additional involvement of an international institution, is a more effective way of enhancing the legitimacy of regulatory intervention than unilateral action. Compared to the national regulatory options discussed above, supranational responses to SWFs present a number of advantages.

First, supranational bodies are perhaps more immune to short-term political considerations such as a possible momentary suspicion towards foreign investments. Secondly, the objectivity of a supranational effort, removed from national political considerations, could also appeal more easily to SWFs and include them in the rule-making process, thus equating this process to that of self-regulation.

The heterogeneity of various national investment review standards could impose undue costs of compliance on SWFs and hence affect the efficient flow of capital. This regulatory framework is typically implemented through the means of a Code of Conduct CoC. A CoC is defined by the International Federation of Accountants as a set of: principles, values, standards, or rules of behavior that guide the decisions, procedures and systems of an organization in a way that a contributes to the welfare of its key stakeholders, and b respects the rights of all constituents affected by its operations.

CoCs, as policy tools, are usually entered into on a voluntary basis, meaning that the negotiating members were not compelled to participate by a central decision maker. Rather, a central body provided its members with an opportunity to negotiate and agree on a set of rules. This method of setting international standards is common, given that the drafting of command-based tools is, in most cases, unrealistic beyond the national level.

GAPP consists of 24 practices and principles, focusing on three key areas. These are intended to be implemented by SWFs and include: i legal framework, objectives, and coordination with macroeconomic policies; ii institutional framework and governance structure; and iii investment and risk management framework where SWF managers were encouraged to disclose more information. The object of SWFs should not be to project state power. It is suggested by Backer that such deviation from the suggested model might open that fund to special regulation.

GAPP reaffirmed the distinction between private and public funds. This view of GAPP suggests, however, that the attainment of macroeconomic objectives is limited to economic ones and does not extend to political goals. Moreover, a number of principles encouraged the separation between the entity and the sovereign. This is supported through the establishment of clear objectives for the fund, the division of roles and responsibilities, and provisions on independence and the maximization of risk-adjusted financial returns.

CoCs still present a significant weakness in terms of the absence of any formal enforcement mechanism. No SWF is under any obligation to implement or observe any of these principles, not even those funds that took part in the preparatory work of the IWG. This concern, although a valid one, should not be overstated. Enforcement, just like standard-setting, differs significantly depending on whether it is made at the national or supranational level. At the supranational level, both the drafting of command-based tools and the enforcement of the agreed rules are, in most cases, unrealistic or at least unworkable.

International commitments, even when drafted as binding rules, are left to Member States to implement domestically. It is observed that, following the financial crisis, SWFs have demonstrated an increased appetite for joint ventures and foreign investment activities in cooperation with local funds.

For the time being, the available evidence on compliance with GAPP shows mixed results: while overall compliance is still lacking, many encouraging signs can already be observed. Source: Behrendt n 6. This, however, does not constitute in any way a reason to abandon the entire effort.

It is natural to expect institutional change to be slow, especially when it happens on a voluntary basis and it takes place in countries with varying traditions of governance and administration. It is, thus, supported that the option of self-regulation at the international level avoids the majority of the problems identified in the hard-law national regulatory proposals discussed above.

It is proportional to the issues relevant to SWFs and preserves the investment-friendly environment that is necessary in a global post-crisis recovery scenario such as the current one. Therefore, it offers a better theoretical framework upon which to base the regulation of SWFs. The purpose of this analysis is to provide a rationale for regulating SWFs rather than a full regulatory framework. However, some brief discussion and thoughts on the form of this self-regulatory body is warranted, to be of benefit to the conclusion.

The current annual meetings of the IFSWF are by invitation only and, aside from press briefings, there is no detailed account of their meetings. The lack of transparency is displayed openly with a members-only log-in to their website required to view any detailed accounts. A sensible means of organizing a self-regulating SWF body would be to assign responsibility for such organization to a secretariat. The secretariat would arrange an annual forum, which would be for SWFs to exchange ideas and discuss their progress in implementing GAPP.

Ideally, membership should be open to all state-owned investment funds regardless of their investment objectives, thus drawing as much participation as possible including pension funds, development banks, and similar organizations.

The IMF would be a suitable and convenient platform to be used as secretariat. Otherwise, it may be possible for the WTO to play an administrative role such as a secretariat, since as the article has highlighted, it would be impracticable for the WTO to undertake a regulatory role. The advantage of the WTO is that it provides equal participation among members, as opposed to the IMF or the World Bank which may be viewed as Western-controlled bodies since by political agreement they are always headed by Westerners and the voting power of their Western members carry more weight.

However, they should specifically not be empowered to impose additional disciplinary measures since this would defeat the voluntary nature of the scheme. Furthermore, it would be impracticable, create divisions among SWFs, and consequently risk damaging the project as a whole. It is equally important that GAPP is constructed in a broad way so as to provide SWFs with sufficient flexibility in their manner of implementation as long as the spirit of the code is complied with.

This article has demonstrated that regulatory responses to SWFs need to take into account the reality and the actual characteristics of sovereign investors. Otherwise, they run the risk of becoming overtly protectionist and imposing unwanted costs on the global financial system.

It is true that where SWFs are involved there is no consensus on how they should be dealt with from a regulatory perspective. At the same time, a trade-off can be said to exist in the option of adopting hard regulation, which is a loss of efficiencies. At the same time, a trade-off can be said to exist in the option of adopting hard regulation. This could erase efficiency benefits, and consequently would means the actual negative costs of SWFs are not significant enough to justify hard regulatory intervention.

Sovereign wealth funds can fall into two categories, commodity or non-commodity. The difference between the two categories is how the fund is financed. Commodity sovereign wealth funds are financed by exporting commodities. When the price of a commodity rises, nations that export that commodity will see greater surpluses.

Conversely, when an export-driven economy experiences a fall in the price of that commodity, a deficit is created that could hurt the economy. A sovereign wealth fund acts as a stabilizer to diversify the country's money by investing in other areas. Non-commodity funds are typically financed by an excess of foreign currency reserves from current account surpluses.

Sovereign wealth funds are traditionally passive , long-term investors. Few sovereign wealth funds reveal their full portfolios , but sovereign wealth funds invest in a wide range of asset classes including:. However, a growing number of funds are turning to alternative investments , such as hedge funds or private equity , which are not accessible to most retail investors.

The International Monetary Fund reports that sovereign wealth funds have a higher degree of risk than traditional investment portfolios, holding large stakes in the often-volatile emerging markets. Sovereign wealth funds use a variety of investment strategies :. Funds also differ in the level of control they assume when investing in companies:. Sovereign wealth funds represent a large and growing portion of the global economy. The size and potential impact that these funds could have on international trade have led to considerable opposition, and the criticism has mounted after controversial investments in the United States and Europe.

This fear could also lead to investment protectionism , potentially damaging the global economy by restricting valuable investment dollars. In the United States and Europe, many financial and political leaders have stressed the importance of monitoring and possibly regulating sovereign wealth funds. Many political leaders assert that sovereign wealth funds pose a threat to national security, and their lack of transparency has fueled this controversy.

The United States addressed this concern by passing the Foreign Investment and National Security Act of , which established greater scrutiny when a foreign government or government-owned entity attempts to purchase a U. Western powers have been guarded about allowing sovereign wealth funds to invest and have asked for improved transparency. However, as there is no substantive evidence that funds are operating under political or strategic motives, most countries have softened their position and even welcomed the investors.

Kuwait Investment Authority. John Mikesell. Cengage Learning, Accessed May 22, Abu Dhabi Investment Authority. Singapore Government -- HistorySG. Norges Bank Investment Manager. Sovereign Wealth Fund Institute. International Monetary Fund. The Guardian. Monetary Policy. Your Money. Personal Finance.

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