“We believe that this document will in both home and recipient countries improve the understanding of the objectives, structures, and governance arrangements of SWFs; enhance the understanding of SWFs as economically and financially oriented entities; and help maintain an open and stable investment climate. Through the implementation of the Santiago Principles, we seek to ensure that the international investment environment will remain open and our capital can continue to be put to use when it is most needed.”
—Hamad Al Hurr Al Suwaidi, International Working Group of Sovereign Wealth Funds Co-Chair and Undersecretary of the Abu Dhabi Department of Finance, October 11, 2008.1
The first modern sovereign wealth funds (“SWFs”)2 were formed in the 1950s, and their importance within their home countries and the global financial system has grown steadily since then. Market estimates suggest that SWF assets under management currently total between US$2 and US$3 trillion, and these assets are projected to grow to between US$7 and US$11 trillion by 2013. The investment activity of SWFs has accelerated in the last several years, and their involvement in high-profile transactions across diverse asset classes has resulted in attention and scrutiny of their activities that did not exist before. Many recipient countries have expressed concerns that SWFs’ investments may be politically-motivated, raising questions of national security and transparency.
These concerns and recognition of the growing role of SWFs in the global economy led to the establishment of the International Working Group of Sovereign Wealth Funds (the “IWG”) at a meeting of countries with SWFs on April 30 – May 1, 2008, in Washington, DC. The goal of the IWG was to identify and draft a common set of voluntary principles that would promote a clearer understanding of the institutional framework, governance and investment activities of SWFs, as well as support an open and stable investment climate globally.3 On October 11, 2008, the IWG presented principles that it believes SWFs should follow with respect their governance and investment activities. The IWG intends that these “generally accepted principles and practices” (the “GAPP”) for SWFs, also known as the “Santiago Principles,” be applied by each SWF in a manner that reflects the different institutional, constitutional and legal environments in which they exist. While the GAPP may serve as a minimum standard for those SWFs that have well-established practices, adoption of some or all of the guidance provided by the GAPP will likely require a transition period for those SWFs with shorter histories. The IWG has agreed to explore establishing a standing group of SWFs to keep the GAPP under review and to enable implementation of the GAPP.
Underlying the twenty-four voluntary principles and supporting commentary that comprise the GAPP are three key themes: (i) public disclosure; (ii) sound governance and (iii) investment and risk management. We discuss each of these themes in more detail below.
The Santiago Principles need to be assessed by each SWF in light of its unique circumstances. As a result, while there is no single set of “action items” or steps that can or should be applied universally to SWFs and their implementation of the GAPP, we have listed in Appendix A a summary of recommended actions that arise out of the possible implementation of different aspects of the GAPP. Our firm’s representation of many SWFs and sensitivity to the issues they face in their home countries and recipient countries, as well as the challenges of competing and managing diverse, complicated transactions, make White & Case uniquely well-suited to provide advice regarding appropriate implementation of the Santiago Principles.
I. Public Disclosure
“It’s all about trust,” said Mr. Al Suwaidi. “It’s about collectively doing everything in our power to ensure that trust lies in the heart of everything we do.”4
This quote illustrates a key theme prevalent throughout the GAPP: a call for increased public disclosure by SWFs. Recipient countries have expressed concern that SWF investments could affect national security, or that SWF investments could be based on noncommercial motives or undesirable macroeconomic policies. Regardless of whether such concerns have any basis, the risk of a protectionist response from recipient countries is real. Fear or uncertainty regarding SWF operations by recipient countries could limit SWFs’ investment opportunities, increase their investment risks and result in retaliatory measures. These potential negative ramifications would undermine the efficient flow of global capital and, at a time when the international financial and monetary system is already fragile, further diminish economic stability.
The IWG hopes that compliance with GAPP-recommended public disclosures regarding SWF financial information (such as asset allocation, benchmarks, rates of return, etc.), governance structure, operational controls, investment policies and accountability, will encourage the free flow of cross-border capital and improve understanding of SWFs as economically driven entities in home and recipient countries. It is hoped that this understanding will reduce protectionist tendencies and contribute to an open and stable investment climate.
Please refer to Appendix B for a summary of the individual items of information that SWFs are recommended to disclose publicly under the GAPP.
II. Sound Governance
Alongside the call for greater public disclosure, the Santiago Principles also emphasize the need for sound governance of SWFs. The GAPP provide that SWFs’ activities should be underpinned by a well-framed governance framework set out in either the legislation governing the SWF or in its charter, constitutive documents or management agreement.
The IWG believes that an appropriate governance structure separates the functions of the owner(s), the governing body(ies) and management, thereby promoting independent management and enabling the SWF to pursue investment decisions and operations based on economic and financial considerations free of political influence. The IWG believes that the role of the government should be to determine the broad policy objectives of the SWF, but not to interfere with particular investment decisions. Desirable governance structures also typically articulate clear roles, responsibilities and interrelationships between the different bodies responsible for the SWF’s administration and management, with the goal of facilitating operational independence for investment decisions.
The GAPP state that the accountability procedures for a SWF’s operations should be clearly defined in the relevant legislation, charter, constitutive documents or management agreement. Such accountability procedures help ensure that actions of the owner(s), the governing body(ies) and the operational management, as applicable, are consistent with their respective defined responsibilities. In addition, appropriate evaluation methods permit more effective monitoring by owner(s) and governing body(ies) of the performance of SWF investment managers in achieving their stated objectives.
III. Investment and Risk Management
The IWG also encourages SWFs to establish clear and consistent investment and risk management frameworks. In order to harmonize the investment decisions that SWFs make within their approved investment objectives and strategies, the GAPP provide that SWF’s investment policies should: (i) define objectives, risk tolerance and investment strategy (as set by the owner(s) or the governing body(ies)); (ii) be based on sound portfolio management principles; (iii) guide the SWF’s financial risk exposures and the possible use of leverage and (iv) address the use, authority, and monitoring of external institutions for investment management. Further, in keeping with its recurring themes of transparency and politically-free investment decisions, the GAPP call for public disclosure of a SWF’s investment policy and investment decisions to show a commitment to a disciplined investment plan and provide a benchmark to judge compliance and success.
The GAPP also provide that SWFs should establish a publicly disclosed risk management framework that identifies, assesses and manages the risks of its operations. The IWG believes that a well-defined and implemented risk management framework will enable SWFs to: (i) protect their assets; (ii) operate within the tolerance levels set forth in the investment policy; (iii) preserve financial stability and (iv) maintain a stable investment environment. Moreover, with reliable information and regular reporting, the SWFs should be able to effectively monitor and manage relevant risks within acceptable levels. The adoption of a clear investment policy is a vital part of risk management, enabling a SWF to match its strategy with its appetite for risk. For example, stabilization funds are more likely to invest conservatively and have shorter investment horizons. Conversely, savings funds often have longer investment horizons and may invest in more risky asset classes.
IV. Looking Forward
The Santiago Principles were developed due to concern about a lack of information and openness expressed by home countries of SWFs, recipient countries and the wider international financial community. The IWG has attempted to address these concerns by adopting the GAPP, which address the broad themes of: (i) public disclosure; (ii) sound governance and (iii) investment and risk management. The IWG acknowledges that this initial framework has limitations and will require a transition period, further discussion and review and, of course, voluntary compliance by SWFs.