Wealth is the name of the game

THEY have been around for quite some time. Armed with a large cache of foreign exchange surplus the hunters have been poaching in many a sovereign territory whipping up controversies.

They are the much-maligned Sovereign Wealth Funds (SWFs), who now control about $2-3 trillion in assets globally.

Although SWFs have not so far plunged the world into any form of crisis, unfortunately, there's a lot we don't know about them. Very few of them publish information about their assets, liabilities, or investment strategies.

Partly because of this, whenever SWFs bought into a Western institution, a lot of heat was generated.

Some US politicians protested when China's recently launched State Foreign Exchange Investment Corp bought non-controlling shares in private-equity giant Blackstone, and also cringed at government-owned Dubai Borse's acquisition of a stake in the Nasdaq stock market.

Nevertheless, SWFs have kept growing and Merrill Lynch, in a recent research paper, says they're proliferating, with the potential to surge to about $7.9 trillion by 2011.

Morgan Stanley estimates that the funds could swell to $12 trillion by 2015.

All countries have foreign exchange reserves. When a country, by running a current account surplus, accumulates more reserves than it feels it needs for immediate purposes, it can create a sovereign fund to manage those extra resources.

Sovereign funds have existed at least since the 1950s, but their total size worldwide has increased dramatically over the past 10 to15 years. In 1990, sovereign funds probably held, at most, $500 billion.

Currently, more than 20 countries have these funds, and half a dozen more have expressed an interest in establishing one. Still, the holdings remain quite concentrated, with the top five funds accounting for about 70 per cent of total assets.

Over half of these assets are in the hands of countries that export significant amounts of oil and gas.

The Abu Dhabi Investment Authority, which manages surplus revenues of the world's sixth-largest oil exporter, has at least $500 billion in assets, Washington-based Peterson Institute for International Economics estimated in a report in August.

According to most estimates it is the world's largest sovereign fund.

The Qatar Investment Authority manages about $50 billion in assets and the Kuwait Investment Authority had about $213 billion on March 31.

Net foreign assets of the Saudi Arabian Monetary Agency, the central bank of the world's largest oil exporter, were worth about $251 billion at the end of July.

Currently, SWFs are causing heartburn for politicians and policy-makers and leading to calls for the funds and their government masters to clarify their practices and intentions.

The concerns were echoed by the finance ministers from the Group of Seven (G7) industrialised nations when they sat down with representatives of some of the biggest funds to urge them to increase transparency and adopt a set of best practices.

US Federal Reserve chairman Ben Bernanke says he endorses the G7 idea to craft a code of conduct for sovereign wealth funds to help ensure their investments are economic and not politically motivated.

The G7 wants the International Monetary Fund (IMF) to develop guidelines for the funds as a set of best practices would help tamp down the potential for a protectionist backlash in countries where the funds invest.

Best practices would provide multilateral guidance to new funds on how to make sound decisions on how to structure themselves, mitigate any potential systemic risk, and help demonstrate to critics that SWFs can be constructive, responsible participants in the international financial system.

Part of the nervousness surrounding the sovereign funds in the developed world stems from the potential for a political backlash against foreign-government ownership of major companies.

The IMF has encouraged countries with wealth funds to voluntarily disclose investment information to allay concerns.

Western countries have raised concerns that these funds lack foresight and could destabilise global markets.

They want rules in place to protect politically sensitive companies from take-over approaches.

Some wealth fund owners have said they were being unfairly singled out. Russian Finance Minister Alexei Kudrin says sovereign wealth funds should be subject to the general rules of the free movement of capital and his country would object to any special restrictions.

However, it cannot be discounted that the Gulf funds need to reform. In the competition for Western assets, greater transparency will prove a competitive advantage. Concerns raised recently in the US Congress and by policy-makers in Europe echo anxieties voiced about private equity firms and hedge funds.

The US insists that no one wants to deter sovereign funds from investing their billions in assets in the West, but governments, businesses and the public feel threatened by a lack of transparency.

David McCormick, the US Treasury official in charge of international affairs, visited Dubai recently to try to make progress on the sovereign wealth fund issue.

The US does not want to be seen to deter Gulf investors, but, according to Dubai officials, McCormick made clear that the political environment requires greater transparency.

Dubai committed itself to working with the US on a code of practice for its investment funds.

The establishment of best practices for SWFs would ensure that citizens know what is being done with their nation's wealth.