By — Saahil Ayyaril Ali
Abstract
A Sovereign Wealth Fund (SWF) is a government-owned and controlled fund designed to achieve various macroeconomic and developmental objectives. The primary aim of these funds, which encompass all investment-related activities, is to diversify and boost a state’s financial returns through various investment initiatives. This piece aims to explore these funds by explaining the mechanism and rationale, followed by an in-depth analysis of their implementation in foreign policy prescriptions and the widening gap in accountability and transparency measures. This leads to the final argumentthat SWFs are often susceptible to being used as tools of political leverage, often leading to mismanagement and excessive corruption.
The Motivation and Use of Sovereign Wealth Funds
Sovereign Wealth Funds (SWFs) serve as multi-purpose investment tools, formed by a state’s profits from the sale of natural resources, trade surpluses, additional tax revenues and proceeds from the sale of state-run enterprises, among many others. The funds serve the purpose of maintaining long-term economic development goals, portfolio diversificationand making varied and calculated investments in private markets.
SWFs primarily begin due to excess surplus in funds, primarily through the sale of commodities. This pattern has often emerged amongst major oil-exporting states such as those in the Middle East, as during the late 1900s, many governments sought to diversify their economies and shift further away from the oil trade as a means to counteract the effect of oilprice changes on their government budgets. Furthermore, the over-reliance on non-renewable resources for wealth has been observed as unsustainable for future generations, and it has naturally led states to evolve to earn more returns on excess reserves through their SWFs. SWFs typically branch out into five main types: stabilization, savings, development, pension andreserve; all of which amalgamate to provide economic stability and boost confidence. These funds are often operatedby commodity-rich states such as those in the Persian Gulf and Southeast Asia- with states like the UAE and Norway forming their SWFs through excess revenue from hydrocarbons and states like Singapore and China forming their funds through abundant trade surpluses from their technological advancements.
Globally, an approximate total of $16.5 trillion is safeguarded within SWFs, with most accumulating in Asia and North America. This vast pool of wealth is responsible for macroeconomic stabilization, internal development, infrastructure reform and sustainable financing, leading to greater developmental implications. The sheer importance of these funds has made them highly susceptible to political coercion and corruption, as several states utilize them as tools in bilateral diplomacy and various political figures act unilaterally on their own behalf, largely leading to mismanagement and excessive corruption.
SWFs: A Breeding Ground for Corruption
The recency of the SWF as a developmental mechanism has resulted in the loosening of many restrictions to expand wealth; however, the very policies in place to manage these SWFs have subsequently deterred efforts to curb corruption or political leverage of these funds. This becomes a complication, as it becomes a question of the management of public funds, contributed both directly and indirectly by the taxpayer. Funds are established as a result of parliamentary or congressional action, with supervision being under the ambit of finance ministers. This form of supervision has typically been met with minimal legal regulation, as SWF management is given the freedom of investment with minimal auditing. The ambiguity regarding SWFs- the separation of ownership and oversight and the obligations of disclosure-has allowed for the mismanagement of these public assets- a systemic exploitation.
One highly pertinent, documented case is the scandal of 1Malaysia Development Berhad (1MDB)- the Malaysian SWF. The scheme was initiated in 2009 by former Malaysian Prime Minister Najib Razak, evolving from the Terengganu Investment Authority (TIA), with the goal of further developing the economy, specifically within the energy sector, and attracting foreign investment for infrastructural reform. Upon further investigation of the misappropriation of the funds, it was discovered that upwards of $4 billion was embezzled across six years, from 2009 to 2015. According to reports, senior officials in charge of the fund’s management had allegedly utilized it as a personal discretionary budget, spending it on luxury real estate, artwork and even film productions, with an even greater chunk found to have been funneled to Najib Razak himself, eventually leading to his conviction on corruption charges. This remains one of many
relevant cases that showcases the lack of transparency. With SWFs’ discrete management, public funds become jeopardized and continue to be abused and depleted. It becomes a testament to the adverse impact institutional weakness can have on these funds, as the unprecedented unilateral authority granted to the actors overseeing these SWFs often leads to the misappropriation of the funds, as suggested by the case of 1MDB.
The case of transparency introduces an interesting paradox. The largest funds, predominantly owned and operated by authoritarian governments, not only maintain SWFs for developmental reasons, but for political reasons as well. These states maintain the incentive to remain secretive about the public funds’ holdings to protect their political motivations.However, these very funds engage in investment activities in MNCs and banks located within Western democracies,entities which would remain sceptical due to the lack of transparency, in which regulators would expect a certain transparency baseline within the SWFs’ governance structure before engaging with them. Research further supports this claim, with empirical scoring systems finding that SWFs maintain greater governance when under the purview of, and originating from, democracies, with democracy scoring higher in areas of accountability and transparency.
Internationally, the Santiago Principles have operated as a recommendatory institution which lays the groundwork and scope for future attempts at binding accountability measures. Upon the realization of the need for transparency, under the guidance of the IMF, 26 SWFs met to discuss and draft the 24 guiding principles which would construct a basic legal framework, governance standards and suggested practices. However, compliance evaluations have revealed that SWFs still lack the transparency the principles necessitate, with considerable discrepancies hidden beneath the overallcompliance rate, and with the voluntary self-assessment framework rendering compliance difficult to enforce. This has naturally led to the perception that the Santiago Principles are not a binding authority, but rather a recommendatory foundation which would potentially lead to much-needed international legal accountability.
SWFs as Tools of Foreign and Investment Diplomacy
In recent decades, governments have employed SWFs as legitimate foreign policy tools, which dictate the flow of international investment. We have seen instances of such a phenomenon through states in the GCC, which utilize their funds to maintain stability in times of crisis but also use them for security policy signalling, manoeuvring funds forforeign investments, building strategic, investment-based partnerships, financially supporting allies and absorbinggeopolitical anomalies. Given the perception of SWFs as solely financial agents, states often use them for political motivations whilst maintaining plausible deniability.
This feature can be seen in the manner in which bilateral deals are concluded between investment funds: direct investment into important foreign companies, deals regarding infrastructure closed as part of the overall economicpartnership and mutual investment sectors
that are binding, determined interests of both investor and host countries. Larger, more holistic SWFs often hold implicit advantages over other states, as these funds often engage in investments with other countries. This would incentivizecountries receiving these investments to maintain friendlier relations with those states under which the fund operates, in an effort to regulate its capital inflows. However, analysis would suggest SWFs are not tools of deliberate geopolitical strategy, but maintain another implication: SWFs refine geopolitical structures. Only a select few states hold the majority proportion of SWF wealth, and the differences in forms of government make it difficult for states on the receiving end of the investment to commercially regulate them without being subject to political backlash from the state with the SWF. This supports the argument that SWFs often operate as indirect tools of coercion, and their growth often implicitly redefines international economic power balances.
Conclusion
SWFs are a duality, with effective uses in economic policy but also in political leverage and diplomacy. While these funds stabilize revenue flows and widen the scope for intergenerational saving, the lack of accountability and the differing impacts of SWF management due to the variability of governance structures lead to uncertainty and exploitation, assuggested by the case of the 1MDB scandal. With initial efforts, such as that of the Santiago Principles, attempting to curbthe impact of a lack of monitoring, there still remains a gap in governance and self-regulation, which has largely gone unattended. This gives us the understanding that whilst SWFs are crucial for economic diversification and future development, the failure in transparency and their implicit coercive nature calls for a discussion on its impacts andnecessity within the geoeconomic order.
About the Author
Saahil Ali is a 2nd year Economics student at the Jindal School of Government and Public Policy with a minor in International Relations. His primary research interests lie in political economy, geoeconomics and trade policy, international law, and democratic governance. His goal is to continue his pursuit in policy research in these domains.
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