Download THEME: THE CHANGING ECONOMIC LANDSCAPE WITHIN EAC

THEME: THE CHANGING ECONOMIC LANDSCAPE WITHIN EAC:
OPPORTUNITIES AND CHALLENGES FOR EAST AFRICAN COMMUNITY
TOPIC: SOVEREIGN WEALTH FUND: SAVING FOR THE FUTURE
GENERATION
PRESENTATION OUTLINE BY:
PROF. PLO – LUMUMBA,
LL.D, CPS (K), MKIM
DIRECTOR, KENYA SCHOOL OF LAW
PRESENTATION AT THE INAUGURAL EAST AFRICAN CONGRESS OF
ACCOUNTANTS ON 3RD MARCH, 2016 IN ARUSHA, TANZANIA (1400 TO 1500
HOURS)
___________________________________________________________________________
3RD MARCH, 2016
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BRIEF PROFILE OF THE SPEAKER
Prof. PLO – Lumumba is the Director and Chief Executive Officer of the Kenya School of Law.
He is a Professor of Public Law and Founding Dean, Kabarak University School of Law. He has
lectured law at the University of Nairobi, the United States International University (Africa), Widener
University USA (Nairobi Summer School).
He is an Advocate of the High Courts of Kenya and Tanzania. He holds Bachelor of Laws and Master
of Laws degrees from the University of Nairobi and a LL.D from the University of Ghent, Belgium.
He is a Certified Public Secretary CPS (K) and a Member of the Kenya Institute of Management
(MKIM). He has been trained on Humans Rights at the Institute of Advanced Legal Studies University
of London in England, Humanitarian Law at the Raoul Wallenberg Institute of the University of Lund
in Sweden and on International Humanitarian Law in Geneva, Switzerland.
He is a renowned legal practitioner. He has written several books including: Criminal Procedure in Kenya,
An outline of Judicial Review in Kenya, Kenya’s long search for a Constitution: The Postponed Promise and
Judicial Review and Administrative Law. He has published numerous articles in refereed journals and
several book chapters. He has co-authored ‘The Constitution of Kenya 2010 An introductory commentary’
with Dr. Luis Franceschi. He has also co-authored several books on Ethics. His non-legal books
include; Swearing by Kenya, A Call for Political Hygiene in Kenya Politics and From Raw Deal to Real Deal.
He is a former Secretary of the Constitution of Kenya Review Commission and former Director of
the defunct Kenya Anti-Corruption Commission, (KACC). He is Founding Trustee of the African
Institute for Leaders and Leadership (AILL) and founding Chairman of the Association of the
Citizens Against Corruption (ACAC).
He has been named and recognized by the International Commission of Jurists (Kenya Section) and
the Law Society of Kenya for his exemplary contribution to the legal profession. He was recognized
by the Kenya-USA Association for the Martin Luther King Jnr., Leadership Award in 1996 and was
the recipient of the 2008 Martin Luther King Africa Salute to Greatness Award by the Martin Luther
King Jr. Africa Foundation. He has also been included in the Marquis Who’s Who in the World and
is the Distinguished Mwalimu Julius Nyerere Lecturer for 2014.
He has been designated the Kwame Nkurumah Memorial Lecturer for September 2016 at the Cape
Coast University in Ghana.
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SOVEREIGN WEALTH FUND: SAVING FOR THE FUTURE GENERATION
1. Introduction
A sovereign wealth fund (SWF) is a state owned investment fund, often financed by foreignexchange assets, which invests globally1 in real and financial assets such as stocks, bonds, real estate,
precious metals, or in alternative investments such as private equity fund or hedge funds. They are
typically created when governments have budgetary surpluses and little or no international debt.2 Most
SWFs are funded by revenues from commodity exports or from foreign-exchange reserves held by
the central bank.
Some sovereign wealth funds may be held by a central bank, which accumulates the funds in the
course of its management of a nation's banking system; this type of fund is usually of major economic
and fiscal importance. Other sovereign wealth funds are simply the state savings that are invested by
various entities for the purposes of investment return, and that may not have a significant role in fiscal
management.
Although there exists no commonly accepted definition of SWFs, three elements can be identified
that are common to such funds: First, SWFs are state-owned. Second, SWFs have no or only very
limited explicit liabilities and, third, SWFs are managed separately from official foreign exchange
reserves.
Sovereign wealth funds can be characterized as maximizing long-term return, with foreign exchange
reserves serving short-term "currency stabilization", and liquidity management. Many central banks in
recent years possess reserves massively in excess of needs for liquidity or foreign exchange
management. Moreover, it is widely believed most have diversified hugely into assets other than shortterm, highly liquid monetary ones, though almost no data is publicly available to back up this assertion.
Some central banks have even begun buying equities, or derivatives of differing ilk (even if fairly safe
ones, like overnight interest rate swaps).
1
Caroline Wedmore, IF Volunteer, Funding The Future, ‘How Sovereign Wealth Funds benefit future generations’.
(November 2013)
2
Ibid
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2. History
The term "sovereign wealth fund" was first used in 2005 by Andrew Rozanov in an article entitled,
"Who holds the wealth of nations?" in the Central Banking Journal.3 The previous edition of the journal
described the shift from traditional reserve management to sovereign wealth management;
subsequently the term gained widespread use as the spending power of global officialdom has rocketed
upward.
Some of them have grabbed attention making bad investments in several Wall Street financial firms
such as Citigroup, Morgan Stanley, and Merrill Lynch. These firms needed a cash infusion due to
losses resulting from mismanagement and the subprime mortgage crisis.
SWFs invest in a variety of asset classes such as stocks, bonds, real estate, private equity and hedge
funds. Many sovereign funds are directly investing in institutional real estate. According to the
Sovereign Wealth Fund Institute's transaction database around US$9.26 billion in direct sovereign
wealth fund transactions were recorded in institutional real estate for the last half of 2012.4 In the first
half of 2014, global sovereign wealth fund direct deals amounted to $50.02 bil according to the SWFI.5
3.
Early SWFs
Sovereign wealth funds have existed for more than a century, but since 2000, the number of sovereign
wealth funds has increased dramatically. The first SWFs were non-Federal U.S. state funds established
in the mid-19th century to fund specific public services.6 The U.S. state of Texas was thus the first to
establish such a scheme, to fund public education. The Permanent School Fund (PSF) was created in
1854 to benefit primary and secondary schools, with the Permanent University Fund (PUF) following
in 1876 to benefit universities. The PUF was endowed with public lands, the ownership of which the
state retained by terms of the 1845 annexation treaty between the Republic of Texas and the United
States. While the PSF was first funded by an appropriation from the state legislature, it also received
public lands at the same time that the PUF was created. The first SWF established for a sovereign
3
"Who holds the wealth of nations?" (PDF). Central Banking Journal (May 2005, Volume 15, Number 4). Archived from the original
(PDF) on 2008-05-29.
4
"Sovereign Funds Embrace Direct Real Asset Deals." SWF Institute. August 1, 2013.
5
Dunkley, Dan. "Sovereign-Wealth Funds Pump Near Record Amount of Cash in Deals". Wall Street Journal.
6
M. Nicolas J. Firzli and Joshua Franzel: ‘Non-Federal Sovereign Wealth Funds in the United States and Canada’, Revue
Analyse Financière, Q3 2014
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state is the Kuwait Investment Authority, a commodity SWF created in 1953 from oil revenues before
Kuwait gained independence from the United Kingdom. According to many estimates, Kuwait's fund
is now worth approximately US$600 billion.
Other early registered SWFs is the Revenue Equalization Reserve Fund of Kiribati. Created in 1956,
when the British administration of the Gilbert Islands in Micronesia put a levy on the export of
phosphates used in fertilizer, the fund has since then grown to $520 million.7
4. Nature and Purpose
SWFs are typically created when governments have budgetary surpluses and have little or no
international debt. It is not always possible or desirable to hold this excess liquidity as money or to
channel it into immediate consumption. This is especially the case when a nation depends on raw
material exports like oil, copper or diamonds. In such countries, the main reason for creating a SWF
is because of the properties of resource revenue: high volatility of resource prices, unpredictability of
extraction, and exhaustibility of resources.
There are two types of funds: saving funds and stabilization funds. Stabilization SWFs are created to
reduce the volatility of government revenues, to counter the boom-bust cycles' adverse effect on
government spending and the national economy. Savings SWFs build up savings for future
generations. One such fund is the Government Pension Fund of Norway. It is believed that SWFs in
resource-rich countries can help avoid resource curse, but the literature on this question is
controversial. Governments may be able to spend the money immediately, but risk causing the
economy to overheat, e.g., in Hugo Chávez's Venezuela or Shah-era Iran. In such circumstances,
saving the money to spend during a period of low inflation is often desirable.
Other reasons for creating SWFs may be economic, or strategic, such as war chests for uncertain
times. For example, the Kuwait Investment Authority during the Gulf War managed excess reserves
above the level needed for currency reserves (although many central banks do that now). The
Government of Singapore Investment Corporation and Temasek Holdings are partially the expression
of a desire to bolster Singapore's standing as an international financial centre. The Korea Investment
7
"The world's most expensive club". The Economist. 2007-05-24.
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Corporation has since been similarly managed. Sovereign wealth funds invest in all types of companies
and assets, including startups like Xiaomi and renewable energy companies like Bloom Energy.8
5. Concerns about SWFs
The growth of sovereign wealth funds is attracting close attention because:
a.
As this asset pool continues to expand in size and importance, so does its potential impact on
various asset markets.
b.
Some countries worry that foreign investment by SWFs raises national security concerns
because the purpose of the investment might be to secure control of strategically important
industries for political rather than financial gain.
c.
Former U.S. Secretary of the Treasury Lawrence Summers has argued that the U.S. could
potentially lose control of assets to wealthier foreign funds whose emergence “shake[s] [the]
capitalist logic”9 These concerns have led the European Union (EU) to reconsider whether to
allow its members to use "golden shares" to block certain foreign acquisitions.10 This strategy
has largely been excluded as a viable option by the EU, for fear it would give rise to a
resurgence in international protectionism. In the United States, these concerns are addressed
by the Exon–Florio Amendment to the Omnibus Trade and Competitiveness Act of 1988,
Pub. L. No. 100-418, § 5021, 102 Stat. 1107, 1426 (codified as amended at 50 U.S.C. app. §
2170 (2000)), as administered by the Committee on Foreign Investment in the United States
(CFIUS).
d.
Their inadequate transparency is a concern for investors and regulators: for example, size and
source of funds, investment goals, internal checks and balances, disclosure of relationships,
and holdings in private equity funds. Many of these concerns have been addressed by the IMF
and its Santiago Principles, which set out common standards regarding transparency,
independence, and governance.11
e.
SWFs are not nearly as homogeneous as central banks or public pension funds.
8
"Sovereign-Wealth Funds Went Full Steam Ahead Direct Investing in 2014". Wall Street Journal. 2015-01-06.
9
M. Nicolas J. Firzli and Joshua Franzel: ‘Non-Federal Sovereign Wealth Funds in the United States and Canada’, Revue
Analyse Financière, Q3 2014
10
"Sovereign Wealth Funds: The New Hedge Fund?". The New York Times. 2007-08-01.
11
Sovereign Wealth Funds: Generally Accepted Principles and Practices (Santiago Principles), International Working
Group of Sovereign Wealth Funds, October 2008
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The governments of SWF's commit to follow certain rules:
i.
Accumulation rule (what portion of revenue can be spent/saved)
ii.
Withdraw rule (when the Government can withdraw from the fund)
iii.
Investment (where revenue can be invested in foreign or domestic assets)
6. The Importance of SWFs for Intergenerational Equity
Usually, these funds are set up with one or more of the following objectives:12
a. To insulate the budget and economy from extreme volatility in revenues,
b. To help monetary authorities manage excess liquidity,
c. To develop domestic infrastructure,
d. To build up savings for future generations.
The importance of SWFs for intergenerational equity is at once clear. Not only do they build up vital
savings for future generations but they also act in the present to stabilize potentially unpredictable
economies in resource rich countries by diversifying their sources of income.
As such, SWFs are often broadly divided into two types:
i.
Stabilization funds, created to counteract the adverse effect of “boomdbust” market cycles
on government spending and the national economy.
ii.
Saving funds, created with a view to building up savings for future generations.
For countries rich in a specific raw material, SWFs can be especially useful: they help to protect the
economy against the high volatility of resource prices and the unpredictability of extraction.
Resource rich countries can reduce their dependence on a single commodity by investing the returns
in a greater range of industries. In doing so, they can create a more complex infrastructure and a
greater number of jobs on a national scale.
Moreover, SWFs in resource-rich countries can help to negotiate the unavoidable issue that resources
are constantly being depleted and, one day, will be exhausted completely.
12
Andrew Rozanov, ‘Who holds the wealth of Nations?’, SSGA, 2005.
http://web.archive.org/web/20080529122341/http://www.ssga.com/library/esps/Who_Holds_Wealth
_of_Nations_Andrew_Rozanov_8.15.05REVCCRI1145995576.pdf
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Sage investment, via the creation of a SWF, can halt the valid criticism that the current generation is
giddily consuming their national resources at the expense of the prosperity and financial well being of
the next. With the aid of sovereign wealth enterprises, countries are able to transform oil receipts into
other, more sustainable forms of wealth, rather than carelessly consuming them. 13 By creating a
broader base for economic growth, they act now to prepare themselves for a post-commodity era in
the future.
7. The Intergenerational Objective
All SWFs share the goal of efficiently and effectively managing their country's official financial wealth.
The recent proliferation of SWFs is probably due, in large part, to the current price of oil, which has
recently reached near unprecedented levels. 14 However, many of these more recent SWFs are
motivated by more than a desire to manage successfully the huge revenues derived from natural
resources. They are also driven to establish SWFs on account of intergenerational concerns. If we look
to the rhetoric and to the ideals with which these organizations present themselves to their nation and
to the world, we may note a growing trend to voice concerns about their impact on future
generations.15
The Papua New Guinea Sovereign Wealth Fund claims the ultimate goal of protecting the economy
and to aid the long term economic and social development aims of the country by safeguarding
resource revenues.16
Russia’s National Welfare Fund, created in 2008 with 32Bn, had risen to 85.21Bn by August 2012.17
Its mission statement claims that the NWF is dedicated to supporting the pension system of the
Russian Federation to guarantee the long term sound functioning of the system. The fund looks to
13
S
Kern,
‘How
to
spend
it:
Commodity
and
no
commodity
sovereign
http://www.oecd.org/dataoecd/62/33/41212577.pdf
14
Supra Note 1
15
Ibid
16
‘Organic Law on the Sovereign Wealth Fund’, PNG National Gazette, 2 November 2011.
http://www.treasury.gov.pg/html/media_releases/files/2011/national.gazette_organic.law.on.swf.pdf
17
‘Aggregate amount of the Fund’, Ministry of Finance of the Russian Federation
http://www1.minfin.ru/en/nationalwealthfund/statistics/amount/index.php?id4=5830
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wealth’,
2008.
“co-finance” the voluntary pension savings of Russian citizens and to balance the budget of the
Pension Fund of the Russian Federation.18
The SWF looks essential when one considers the ticking time-bomb that is the Russian Pension
system. Like many post-industrial countries, Russia and its ageing population have seen the vital need
to create a fund to help them deal with future social obligations. Russia’s SWF aims to subsidise the
long-term fiscal liabilities and responsibilities of the pension system, a problem which many countries
without SWFs share but are unable to confront successfully.19
The Pension Reserve Fund (PRF) of Chile had an initial contribution of US 604.5 million and now
boasts an estimated worth of US 4.4 billion. This fund receives an annual contribution of between
0.2% and 0.5% of GDP.20
It was set up in response to Chile’s new demographic pressures which are characterised by an increase
in life expectancy and the growth of its elderly population21
Sovereign wealth funds facilitate a transfer of wealth from one generation to the next and
institutionalise a fiscally responsible mentality.
Tanzania’s SWF, although still in the planning stages, also claims an intergenerational objective.
Former President Kikwete planned to use the fund to finance development projects in the future.22
With natural gas revenues worth up to 3Bn a year (as estimated by the World Bank), he hoped to
speed up the development of infrastructure, science and technology which would see the country
transformed into a middle upper income economy by 2040. The existence of a successful SWF would
play a key part in advancing the National Development Vision 2025,"which looks to the economic,
social, political and cultural progress of Tanzania.23
‘Mission
18
of
the
Fund’,
Ministry
of
Finance
of
the
http://www1.minfin.ru/en/nationalwealthfund/mission/
19
Supra Note 1.
20
‘Pension Reserve Fund’, Chilean Ministry of Finance.
http://www.hacienda.cl/english/sovereigndwealthdfunds/pensiondreservedfund.html
21
ibid
22
Fumbuka Ng'wanakilala, ‘Tanzania plans sovereign wealth fund for gas finds’, August 2012.
http://in.reuters.com/article/2012/08/02/tanzaniadgasdfunddidINL6E8J21PZ20120802
23
ibid
Page9of12
Russian
Federation.
Despite the obvious attractions of establishing a SWF, a dilemma immediately arises for countries
considering the creation of a SWF: whether to look to the future or to plough their funds straight back
into current infrastructure projects.24
The media maelstrom that envelops Australia’s Future Fund highlights the fierce debate that
surrounds the decision to spend or to save.
Guy Fowler, head of investment banking at UBS Australasia, urges Australians to capitalise on the
current favourable market conditions. He argues that when their resources are inevitably depleted,
they will have nothing to show for it.25
Rather than squandering their significant mineral wealth they should – he claims – invest wisely now
in order to provide for future generations.26
By contrast, Peter Costello, Future Fund guardian and former treasurer, in opposition, claims that the
creation of a new SWF, or heavy further investment into their existing SWF, would be inappropriate
since Australia is currently struggling with a budget deficit of 40 billion with an aggregate deficit of
120 billion. Costello argues that the reduction of this should be the country’s primary concern.27
Even when not dealing with a deficit, in the short-sighted world of politics the temptation is to spend
rather than to save. In circumstances where the government is short of money, there is always an
additional temptation to raid the resources of future generations.
An efficient balance between current domestic spending and investing in foreign assets for the future
is politically difficult to sustain, as there will always be competing demands for current consumption
at home. This is especially true in times of economic turbulence.
Nigeria has approached this dilemma uniquely, attempting to hedge its bets by acknowledging the
benefits of both spending and saving.28 The National Executive Council decided upon a 1 billion
24
Supra Note 1
25
Jemima Whyte, ‘Sovereign Wealth Funds:$just$a$fad?’,$Financial"Review,$April$2012.$
http://afr.com/p/markets/capital/sovereign_wealth_funds_just_fad_w2ZRbNEL37znJG8F8QofcN$
26
Ibid
27
Supra Note 1.
28
Ade Ogidan, ‘Sovereign Wealth Fund: The beginning of fiscal prudence?’ The"Guardian" Nigeria, June
2012.
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Sovereign Wealth Fund (SWF) at the end of June 2012 which was split into three different funds: an
infrastructure fund, a stabilisation fund and a future generations fund.
The Future Generations Fund was to be used to build an intergenerational savings base by investing
in longer-term assets that generate returns to accumulate wealth for future generations of Nigerians.29
8. Conclusion
The Future Fund has a long-term investment horizon, which provides it with a number of advantages,
including the ability to take on greater levels of market risk; the ability to accept capital being lockedup in illiquid assets or structures; and the ability to be counter-cyclical, patient and opportunistic.
Sovereign wealth funds have been investing governments’ foreign assets for decades. However, it is
only in recent times that such funds have emerged as managers of large “excess reserves” and other
foreign assets.30
A transfer of sizeable amounts of traditional foreign exchange reserves to these investment vehicles
may have an impact on the global financial landscape since such funds are likely to pursue an
investment strategy that differs considerably from that of central banks.
Whether a change in the global financial structure will have a significant impact on financial stability
will depend critically on the motives underlying the investment decisions of such funds. In fact, SWFs
may contribute to a widening of the long-term investor base for risky assets such as stocks, corporate
bonds, emerging market assets, private equity and real estate. In this regard, such funds could exert a
stabilising effect on financial markets, in particular as SWFs are typically not leveraged.31
In addition, SWFs may contribute to a more efficient sharing and diversification of risk at the global
level.
On the other hand, other investment motives (e.g. when SWF acquisitions are driven by political
considerations) could potentially lead to excessive risk-taking and a distortion of asset prices. For
29
Supra Note 27.
30
Roland Beck and Michael Fidora, The Impact Of Sovereign Wealth Funds On Global Financial Markets, Occasional
Paper Series No91 / July 2008 (http://www.ecb.europa.eu or from the Social Science Research Network
electronic library at http://ssrn.com/abstract_id= 1144482)
31
ibid
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instance, some observers have expressed a concern that certain SWFs may be prone to an abrupt
selling of assets, thereby contributing to market volatility.32
Other observers have warned that some SWFs may acquire stakes in companies of sensitive industries,
and possibly bail out or support local firms for non-economic reasons. However, there is so far no
firm evidence of such investment patterns which would also negatively impact market integrity.
On balance, several potential channels through which the emergence of SWFs as large global players
may affect the global financial system can be identified. In this respect, it is of particular importance
that SWFs be sufficiently transparent on their size, asset allocation and investment motives so as to
assuage concerns about potentially distorting the effects of SWFs and to reduce uncertainty in financial
markets.
32
Ibid
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