Tuesday, March 31, 2009

Sovereign Wealth Funds as Regulatory Chameleons: Views From a Georgetown University Law School Symposium

On March 30, 2009, the Georgetown Journal of International Law (GJIL) held an important symposium, entitled Sovereign Wealth Funds, focused on legal issues related to sovereign wealth funds at the Georgetown University Law Center. Ahmed Mousa and Kevin Goldstein of the GSIL and the GJIL staff are to be congratulated on putting together an excellent program.

The daylong program featured a group of speakers who provided powerful insights on the nature and direction of these vehicles. The Symposium Agenda and program included:

10:15 A.M. Welcome
Ahmed S. Mousa
Editor in Chief GJIL

10:30 Country Studies: SWF Form and Function
David Marchick (Moderator)
Managing Director, Global Gov't & Regulatory Affairs
The Carlyle Group

Norwegian SWFs
Professor Larry Catá Backer
Pennsylvania State University

Singapore SWFs
Professor Yvonne C.L. Lee
National University of Singapore

Russian Federation SWFs
Arina V. Popova
Cravath, Swaine & Moore LLP

Chinese SWFs
Dr. Brad W. Setser
Fellow for Geoeconomics
Council on Foreign Relations

12:00 Luncheon Remarks
Dean T. Alexander Alienikoff
Georgetown University Law Center

1:00 Can SWFs Further Development of Human Rights?
Professor Rumu Sarkar (Moderator)
Africa Center for Strategic Studies

Professor Patrick Keenan
University of Illinois College of Law

Professor Christiana Ochoa
Indiana University School of Law--Bloomington

2:00 U.S. Law and Sovereign Wealth
Professor Donald Langevoort (Moderator)

Professor Paul Rose
Ohio State University

Anne W. Salladin
Senior Counsel (International Affairs)
U.S. Dept. of the Treasury

Joel Slawotsky
Interdisciplinary Center, Herzliya, Israel

3:00 Governing SWFs: Strategies to Achieve Accountability
Professor William W. Bratton (Moderator)

Wouter Bossu
Senior Counsel, International Monetary Fund

Professor Anna Gelpern
Rutgers School of Law--Newark

Amb. Alan P. Larson
Senior International Policy Advisor
Covington & Burling LLP

Dr. Edwin M. Truman
Senior Fellow
Peterson Institute for International Economics

4:30 Closing
Kevin B. Goldstein
Symposium Editor GJIL

One of the great insights of the presentations, and a theme that ran throughout the program, was the nature of sovereign wealth funds as regulatory chameleons. Sovereign wealth funds appear as both formally public entities and functionally private entities. They sit aside a legal regulatory universe that tended to more strictly separate, through the imposition of distinct legal regimes, private form state operations. That once small place within which private actors assumed sovereign characteristics and public actors assumed the role of private participants in markets, especially markets outside their own regulatory territory, has now widened to the point where it serves as a terrain of it own autonomous regulation. The problem is, of course, that this regulatory universe for creatures that do not conform to traditional behavior and legal role expectations does not yet exist. And so political, economic and academic elites spend much time either trying to squeeze these entities into traditional legal and policy categories, or to expand these categories just enough to marginally contain at least some portion of the operation of these entities. And, for the moment, the result is a welcome window dressing and a substantive failure to produce effective, predictable and consistent regulatory frameworks--both for private actors operating in the sovereign field and for sovereign entities seeking the benefits (and obligations) of market participation. And indeed, to speak of sovereign wealth funds without also considering the regulatory activities of private actors in these markets, suggests a fatal omission, or at least one will continue to hobble the discussion about sovereign wealth fund regulation.

The first panel was particularly interesting for exploring two issues. The first was the importance of understanding the diversity of form and operation of sovereign wealth funds. The second was the equally important issue of perspective in analysis. Working through the operations, investment philosophies organization and objectives of the Russian, Singapore, Norwegian and Chinese funds suggested that easy categorization is a fool's errand. The funds ranged from socially responsible (Norway) to almost purely commercial by traditional standards. (Singapore) The funds also ranged from aggressively moving into foreign equity investments (Norway, Singapore) to serving as a vehicle for internal economic development (Russia). to traditional sovereign investment in debt instruments of other sovereigns (China) Their effects ranged from issues of private governance through shareholder activism in the service of state policy (Norway) to a space within which internal power struggles over control of domestic and foreign economic activity play out (China). The reaction of funds and fund governance to the current economic slowdown also suggested regulatory challenges, from the use of fund investment strategies to mask protectionist efforts by fund owners, to the validity of characterizing these entities as sovereign wealth funds if their principle task becomes to aid in internal economic development.

The issue of the regulatory effect of substantive investment was also raised along with the general issue of governance--does a state project power through investment as effectively as through traditional means and does not change the nature of regulatory responses in host states? Does it make a difference that private funds may act to project behavior changing policy power through their own investments as well? If both private socially conscious funds and state policy driven funds invest to maximize returns within the context of a set of ethical or policy parameters are they both exercising governance or commercial power and should the regulatory responses to the activities of both be the same?

Lastly, the importance of regulatory perspective became clear. Americans tend to worry about sovereign wealth funds when they appear to be deployed by states who are of interest to the Americans because of their size and military/political/economic power. Thus, sovereign wealth fund regulation became an issue when the Chinese and the Russians began to develop a taste for the instrument, but appeared of less concern when used as a vehicle for the investment of dynastic wealth from Middle East states or to manage state wealth of small commercial centers (though important in their own right) like, for example, Singapore. Yet, the operational context in which funds operate are as much And it is not clear that substantive standards useful in the interplay among the great military powers are responsive to the use of these funds by others. Consistent substantive regulation is thus unlikely in the near future, and larger states may be unnecessarily blind to the importance of the small commercial states in the development of practices and operations of these funds within global private markets (as well, of course, as the importance of these states and their funds for the evolution of global markets themselves). They also miss the important difference between sovereign wealth funds as a vehicle for extraterritorial projections of state power in financial markets and state owned enterprises, a distinction considered in more detail in later panels.

The issue of the utility of sovereign wealth funds in the ongoing project to develop and implement human rights standards in commercial and economic activity usefully highlighted another aspect of the regulatory complex that are sovereign wealth funds--their inextricable relationship to the regulation of private actors operating in host states and the search for a set of harmonized substantive standards. Certainly, the Norwegian fund's operations seek to move in that direction. They have sought to ground their shareholder activism as investors on the substantive standards of the Organization for Economic Cooperation and Development's Guidelines for Multinational Enterprises, and the Principles of Corporate Governance. But the Norwegian efforts are state centered, and its approach might be viewed as idiosyncratic. Professors Keenan and Ochoa would reorient the regulatory debate focus--moving away from a focus on the internal construction and governance of sovereign wealth funds and their relationship to financial markets an to a consideration of the possibility of using sovereign wealth funds as an aid to development for the developing world.

Sovereign wealth funds as tools of development requires the construction of a supra national institutional structure, an international organization as middleman for the creation of markets in development financing using the financial strength of sovereign wealth funds. This international institution, a "Multilateral Sovereign Investment Agency" would be constructed as an autonomous agency that acts as a conduit for investment of sovereign wealth fund assets. The object is to avoid some of the problems of the Norwegian social conscious investment problem--seeking to influence corporate governance behaviors and ethical conduct as a minority shareholder in entities operating in territories where public governance is weak, or in systems in which local banks and corporate governance systems are in effective. The Multilateral sovereign Investment Agency circumvents these problems, and the endemic corruption in certain states by taking controlling positions in entities. The targets would be the small to medium sized local firms that might serve as the backbone to the creation of viable middle classes in developing states, who in turn would serve as a guardian of governance cultures freed of the worst sorts of corruption. The proposal is intriguing on many levels. It provides an alternative to the International Monetary Fund framework. It segregates sovereign investment in ways that make more global regulation unnecessary, and it harnesses the sovereign element of the investment in the object of regulation. This is sovereign investment for sovereign purposes--private power for public purposes. The proposal raises additional interesting issues: how does the program distinguish between macro and micro corruption issues, that is between systemic corruption within the polity and corruption within organizations in which the agency invests. Moreover, if the agency takes majority or controlling positions in firms, is it or ought it to be subject directly to the systems of global corporate governance soft law as a mandatory matter. Can or ought a sovereign wealth fund to be accountable as complicit in the criminal or other unlawful activities of companies in which it has taken a controlling interest? Related to that issue is whether the agency becomes subject to liability under those soft law guidelines where an entity in which it invests violates domestic home or host state law or the behavior guidelines of soft law. Lastly, there is the issue of the regulation of the relationship of the home/host state and the agency. Where the host state, for example, is hostile, the problems of investment and governance might be considerable.

Turning to the regulation of sovereign wealth funds in host states brought the issue of private /public parity and difference to the surface. On the one hand, the traditional sovereign character of the investment represented by sovereign wealth funds and other mechanisms for investing public wealth has produced a regime in which such investments are subject to certain tax benefits unavailable to similar investments by private vehicles. On the other hand, to the extent that sovereign wealth funds are engaged in active investment strategies in equity markets it is not clear that the tax benefits grounded on the sovereign character of the investment ought to apply. Moreover, there appears to be little connection between the commercial activities regimes of sovereign immunity and the tax distinctions grounded in sovereign investment. Yet perhaps there ought to be some congruence between the two. Yet that is unlikely to happen under the current American regulatory universe in which those questions never seem to be considered by the same regulators at the same time. Equally interesting was the related issue of limitations on foreign investment. In this context at least, the United States appears to make no distinction between public and private foreign investors, or the form or source of the investment. Instead the focus is on the relationship between the foreign investor and the object of investment as it touches on issues of national security. Yet even the elaborate structure of such regulation appears to mask a political reality in which the ability to excite the public (or better put, the political classes, elected or not) appears to be more important than many other factors). Not that the functionaries in charge of the system do not do their jobs--apparently they might be the only ones who do, but the process within which their work is done appears touched with political considerations in substantial and interesting ways.

Lastly there were insightful suggestions in the way in which sovereign wealth fund governance is conceptualized. While the common theorizing looks at sovereign wealth funds as individual, autonomous and discrete units--the way in which separate corporate actors are understood to be legally distinct from other natural or legal persons--there was a suggestion that under some circumstances it might be more useful to consider sovereign wealth funds as aggregations. The issues raised are potentially important--dealing with sovereign wealth funds that decide to invest in concert, or against the interests of particular states or sovereign wealth fund competitors, regulatory approaches to special purpose "super" funds that are funded and controlled, in turn, by other sovereign wealth funds, and the regulation of private investment vehicles that serve as a front for public investors.

The last panel of the day served both to sum up and to point to the frontiers of governance issues. The panelists emphasized the disconnect between sovereign wealth funds as a political or rhetorical notion animating host state politics and sovereign wealth funds as a legally definable object of regulation. They reminded the audience that much of the storm over sovereign wealth funds in the United States, from the Dubai Ports World to the Chinese state efforts to take a position in Unocal did not involve sovereign wealth funds, but instead involved state owned enterprises. The relationship between sovereign wealth funds and state owned enterprises, of course, is at the frontiers of regulatory theory. See, e.g., Larry Catá Backer, State Owned Enterprises and Sovereign Investment in Foreign Economic Entities, Law at the End of the Day, Jan. 28, 2009. If the focus is on the traditional objectives of funds--to invest excess wealth in the assets of other states, then the investment activities of state owned enterprises does fit easily into the sovereign wealth fund universe. On the other hand, if the focus is on effect, the projection of market participatory investment power from one state into the other, the form of that investment (fun or enterprise) ought not to count for much. Yet the two vehicles are substantially distinct in organization, orientation, objectives and the like. Yet, as a matter of political rhetoric, their conflation comes easy in the United States, though their regulatory conflation does not--even in the United States.

Lastly, the panel considered issues of accountability. Again,ambiguity and complexity make easy theorizing impossible. In the corporate context, of course, accountability starts (and sometimes ends) with the shareholder. If that were the case with sovereign wealth funds, then the funds ought to develop mechanics of accountability to the sovereigns that fund them and in whose names investments are made and held. Yet accountability in the sovereign wealth context also implies accountability to host states. Here the regulatory rhetoric comes close to mimicking that of the great corporate soft law efforts, for example from the OECD and the United Nations Global Compact. In essence, a broadened accountability universe might suggest the incorporation of a stakeholder model for sovereign wealth funds, in which obligations to host states, to the entities in which such investments are made and perhaps even to the integrity of the markets in which (or through which) activity is undertaken, become sources of legal obligation. Lastly, of course, there are notions of accountability to the ultimate holders of sovereign wealth funds--the people of each state. This is an issue that tends to be overlooked. Equally opaque, from a regulatory perspective, are accountability issues in the process through which sovereign wealth funds determine policy. While in some states a corporate or closed (bureaucratic or administrative) model is followed that permits little effective input from other actors, in other fund administration models, civil society actors might play a more direct role in investment policy or in accountability frameworks. The role of such actors as stakeholders in the context of corporate (and multinational enterprise) regulation has become an important issue; it is likely to become one in the context of sovereign wealth fund regulation as well.

The the chameleon quality of sovereign wealth fund regulation. Formally public, functionally private, direct projection of state power abroad, participant in global markets, consumers of invest, threat to the integrity of private markets, source of diminution of state sovereign power, contributor to global matrix of economic regulation. The next several years will see great advances in frameworks for regulation of these entities. The direction of that regulation is difficult to predict. But models in other areas, principally from the private transnational sector, ought not to be ignored in that regard.

I end with the abstract of the paper I presented at the conference. The full paper will be available soon.

Sovereign Wealth Funds, Private Global Governance, and Public Global Investment: The Example of the Norwegian Sovereign Wealth Funds.

Larry Catá Backer

Abstract: The character of global regulation has changed dramatically over the last decade. Today, multinational corporations sometimes assert substantial regulatory power across borders, and states sometimes enter markets as participants rather than as regulators—especially when they engage in economic activity outside their borders through sovereign wealth funds (SWFs). In both cases the current transnational ordering has settled on voluntary principles based approaches to regulation—for example the Santiago Principles for SWFs and the U.N.’s Global Compact for multinational corporations. Both of these trends collide in interesting ways when sovereign wealth funds seek to develop and impose a principles-based investment strategy founded on specific notions of good governance and corporate social responsibility. The Global Compact suggests regulatory responsibilities for private economic actors: the Santiago Principles suggests that private economic actors might conform to notions of an idealized private investor. This paper looks closely at one example of this rising phenomenon—the socially responsible sovereign wealth fund. It focuses on a close review of one of the most influential funds, the Norwegian Government Pension Fund—Global (Statens pensjonsfond - Utland) more commonly known as the Oljefondetalong, along with its domestic counterpart, the Statens pensjonsfond – Norge, (formerly the Folketrygdfondet). Together they are among the largest and most influential sovereign wealth funds (SWF) in the world, and the largest in Europe. It first describes conceptual and regulatory frameworks on which current policy discussions of sovereign wealth funds are undertaken. It then turns to the Norwegian funds, focusing on the history of the Norwegian fund, its legal structure and the development of its investment principles. It then looks to the way those principles were used in two distinct areas—the creation of incentives to produce changes in the behavior and culture of corporations and the response to the global financial crisis of 2008. Both efforts expose the great policy and regulatory issues of sovereign wealth funds, their relationship to the regulation of multinational corporations, and their character as public private vehicles of transnational governance. What are the roles of investment? Does the SWF act as a private or a public investor, for example with respect to issues from wealth maximization and obligation to shareholders-stakeholders? The Norwegian funds provide a particularly useful case study of the issues that are now at the center of re-conceptualizations of the relationships between state and corporation, between economic and political regulation, between national and transnational legal frameworks, and between public and private legal regimes. The article first describes conceptual and regulatory frameworks on which current policy discussions of sovereign wealth funds are undertaken. It then turns to the Norwegian funds themselves, focusing on the history of these funds, its legal structure and the development of its investment principles. It then looks to the way those principles were used in two distinct areas. The first is corporate social responsibility—the creation of incentives to produce changes in the behavior and culture of corporations, the exclusion of companies doing business in Israel and the exclusion of companies doing business in Burma. The second is the response of the Funds to the global financial crisis of 2008. The paper ends with a consideration of the regulatory implications.

The paper argues that sovereign wealth funds like that of Norway are strong examples of the character of these entities as regulatory chameleons. Current regulation is based on a formally public/functionally private model. The touchstone for the model is an "idealized private investor" that can be distinguished from others. The idealized private investor standard at the heart of sovereign wealth fund soft regulation does not work. But it also does not work for private investment funds from which they are in part derived. For that purpose, the Norwegian Fund is considered against private socially responsible funds--like the TIAA CREF Social Choice Fund. Sovereign wealth funds may mimic private investment as much because private funds engage in regulatory/sovereign investment strategies as because the public fund mimics wealth or benefit maximizing participatory private commercial activity. The Norwegian funds evidence this nicely and point to the need for a different regulatory framework.

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