Dealing with new actors in the financial markets, such as sovereign wealth funds

13th Conference of Finance Ministers of the Nordic and Baltic Sea Countries, 17/18 April 2008, Hamburg, Germany.

SLIDE 1

Let me first thank our host for arranging and preparing this meeting, allowing us to discuss topics of relevance and mutual interest.

Last year, many would have mistaken the abbreviation SWF for Single White Female. Not so anymore. The debate on Sovereign Wealth Funds has spread like a whirlwind, dominating the arena of broad politics as well as that of economic policymakers.

SLIDE 2

As time has passed, my sense is that the debate has become slightly more informed. Irrational fears in countries receiving investments from such funds have given way to a more nuanced understanding of what are the key issues. And over time, I have noted that several of these funds have shown an increased willingness to address some of the concerns that have been raised in recipient countries.

We have to bear in mind that an open investment climate is in everybody’s interest, and misguided regulation and protectionism is detrimental to us all. I think it is important that we continue to communicate this simple, but important, message to our constituents. The Communication on Sovereign Wealth Funds by the European Commission, and the statement on the same by the European Council in March, are positive contributions in this process.

With increased knowledge and a willingness to reach mutually beneficial solutions, I am optimistic that we can find a model that satisfies investors and recipient countries alike.

Norway strongly endorses the multilateral track in this issue. The OECD’s work on highlighting best practice regulation and the benefits of a free and open investment climate is important. And I think the cooperative effort, led by the IMF, to design a voluntary set of best practice guidelines for sovereign wealth funds may prove useful to both such funds as well as the recipient countries in reaching a common understanding.

SLIDE 3

When I have this opportunity to comment on the SWF issue, there are several interesting aspects that deserve to be raised.

First, I would like to remind us of the old truth that “to reach a good solution, we need a good understanding of the problem”.

So, what are the problems that are being talked about? If we peel away universal fears about globalization, foreign investment and change generally, which are important topics in their own right, I sense two important concerns that are raised: (a) will state-owned investment vehicles stick to the market “rules” of only applying commercial considerations to the investment decisions, and (b) can these sovereign wealth funds give rise to financial market instability due to their size and varying degree of transparency?

SLIDE 4

If we today ask financial market practitioners, be it investors, middlemen, borrowers or regulators, I think most would rank sovereign wealth funds fairly low on their list of key concerns. We have witnessed a credit and banking crisis exploding in slow motion before our eyes. This has taken place in what are – presumably – the best regulated financial markets in the world. And while we still need to spend some time to reach a clear understanding on what caused this mess – perhaps a mix of zealous financial innovation, weak corporate governance mechanisms, inadequate or inappropriate regulation, easy monetary policy and herd behaviour by investors – I doubt that sovereign wealth funds deserve a large portion of the blame.

Instead, many see them as part of the solution. With deep pockets, a long investment horizon and a strong risk bearing capacity, sovereign wealth funds may provide much needed diversity in the market place and contribute to better functioning financial markets.

So while such funds in principle can give rise to financial market instability, due to their size and varying degree of transparency, I suspect there are other sources of market instability that we need to worry more about. To my knowledge, sovereign wealth funds have not been accredited with causing major market turmoil.

And as far as I am aware, there is little evidence that such funds have been investing by other aims than maximizing the financial return. However, this concern of not only pursuing financial objectives, but also taking into account objectives of industrial policy, foreign policy or security policy, is a concern that is perhaps relevant for other state owned investment vehicles than sovereign wealth funds.

The definition of sovereign wealth funds can be broad or narrow, depending on whether it includes only such funds that are integrated into the macroeconomic policy framework of a country – typically receiving foreign exchange inflow from either natural resources or currency interventions. But one can also argue that central bank reserves represent sovereign wealth, as well as public pension funds, and not to forget state owned enterprises. And I believe it is the latter, state owned enterprises, which often has been lurking at the back of people’s minds when they have voiced their skepticism to sovereign wealth funds.

This is not to say that the debate on sovereign wealth funds misses the point. If people are concerned about such funds, we need to address those concerns. But I also believe we need to keep in mind the broader context. And in that broader context, it is not altogether obvious that the label “sovereign wealth fund” is the key to understanding the main challenges we are facing in our economies and financial markets.

SLIDE 5

I am pleased to note that very few people have any problems with how we invest the Norwegian sovereign fund – the Government Pension Fund – Global. The Fund is large – around 250 billion Euros – and is still growing rapidly on the back of high petroleum revenues. This is a fund to help us manage our petroleum wealth well, avoiding the dreaded “resource curse” that afflicts so many countries rich in natural resources. The fund is also a tool to set aside enough savings to meet the large financial obligations associated with our public pension system. The Fund is an integral part of the government budget framework, where all surplus financial savings are invested abroad, and with a high degree of transparency surrounding all aspects of the fund.

I can assure everyone that there is no reason to be concerned about the Fund’s investment activities. Without going into details about the Fund’s purpose and organization, I would like to highlight the five factors that I believe are key to us having avoided skepticism from recipient countries when we invest:

• There is an explicit aim to maximize financial returns. We have no hidden political or strategic agenda.
• The Fund is a financial investor with non-strategic holdings. The average ownership share is less than 1 per cent, and there will be a ceiling set at 10 per cent to underscore the Fund’s role as a financial investor.
• There are clear lines of responsibility between political authorities and the operational management. The individual investment decisions are not politicized.
• We have a high degree of transparency in all aspects of the Fund’s purpose and operation.
• The Fund’s Ethical Guidelines are transparent and predictable, and are based on internationally recognized standards, such as the UN Global Compact, OECD Principles of Corporate Governance and the OECD Guidelines for Multinational Enterprises. The Ethical Guidelines recognize the objective of sound financial return, along with the obligation to respect fundamental rights of those that are affected by the companies in which the Fund invests.

SLIDE 6

I believe transparency is perhaps the key to reach a common understanding in this debate on sovereign wealth funds. Transparency is important for several reasons. It builds trust – both on the international scene, in the financial market place, and domestically.

Let me point out that the reason we are being very transparent is not primarily to please the international community. Instead, it is a precondition in our domestic political scene to be open about all aspect of the management of the Fund. It would impossible for a finance minister in Norway to get support for putting aside large amounts of money – such as 15 per cent of GDP –  without giving the stakeholders the reason for doing so, as well as giving them insight in how the money is managed.

And, I would like to add, transparency provides an important disciplinary mechanism – it provides a channel for us to get input from others whether we are managing the assets according to the high standards we have set ourselves.

Transparency is an abstract concept, and there is perhaps a need to better define the concept and which elements of disclosure that will be necessary to best serve well-functioning markets. It may in this regard prove useful to distinguish between three different areas of transparency.

• Governance structure: Who are the ultimate owners of a fund, who makes investment decisions, what are the arrangements for audit, supervision and control?
• Investment objectives: What is the purpose of the fund, the time horizon for investments, the liabilities, the rules governing allocations to and withdrawals from a fund?
• Investment strategy and implementation: What is the size of the fund, the asset composition, risk limits and returns?

Transparency about governance structure and investment objectives would be helpful steps to alleviate concerns about sovereign wealth fund investments. Transparency on investment strategy and implementation would probably need to reflect the characteristics of the investor.

Claims for increased transparency have to be balanced against legitimate business interests of investors. Whilst the Norwegian fund is characterized by a high degree of transparency, there are certain aspects in the management that, based on pure business considerations, are not made public. There are risks associated with deploying considerable amounts of capital into the financial markets. The disclosure of the exact timing and procedure of fund allocations in advance of the relevant actions could have adverse pricing effects in the markets. There is a need to strike a balance – also for us – between the need for transparency and on the other hand to use business sense and not be put at a disadvantage in the market.

Let me finally add that transparency also has to run both ways. If recipient countries set up screening processes to address legitimate national security concerns, there must be transparency with respect to how such screening decisions are made, by whom and under which criteria. Lack of transparency in this area can lead to suspicions of financial protectionism, introduce an element of uncertainty to the investment process, reduce investor confidence, and may ultimately reduce the relative attractiveness of non-transparent recipient countries.

I believe I have now taken enough of your time, and look forward to your comments and a fruitful discussion. Thank you.