Part 9: Australia Future Fund--Reimaging the State in the Global Sphere: An Inventory of Sovereign Wealth Funds as Regulator and Participant in Global Markets

(Pix (C) Larry Catá Backer 2014)

This Blog Essay site devotes every February to a series of integrated but short essays on a single theme. For 2014 this site introduces a new theme:  Reimaging the State in the Global Sphere: An Inventory of Sovereign Wealth Fund as Regulator and Participant in Global Markets.

There have been a number of studies that have sought to provide an overarching structure for understanding SWFs. The easiest way to to this is to find the largest and most influential funds and then extrapolate universal behaviors or characteristics from them.  This is a useful enterprise, it may erase substantial nuance that itself might provide the basis for a deeper understanding of SWFs within globalization and in the context of a state system in which not all states are created equal.  In this sense, while the large SWFs are better known, they do not define the entire field of emerging SWF activity. This study provides a brief critical inventory of the emerging communities of sovereign wealth funds. Each post will consider a different and less well known SWF.  Taken together, these brief studies might suggest the character and nature of the emerging universe of SWFs, and their possible rationalization.

This Post considers the Australia Future Fund.

The Australia Future Fund (ASWF) was established through the Future Fund Act of 2006 (FFA) In simplified outline (FFA Pt I, ¶4) "This Act sets up the Future Fund. The Future Fund Board of Guardians (FFA Pt IV §§ 33-72) is responsible for deciding how to invest the Future Fund. Investments of the Future Fund will consist of financial assets. The Board is bound by a Future Fund Investment Mandate given to it by the responsible Ministers. The Future Fund Management Agency is responsible for assisting and advising the Board." The ASWF is constructed to conform to the premises of the Santiago Principles and Australia is a member of the International Forum of Sovereign Wealth Funds.  "Through participation in the International Forum of Sovereign Wealth Funds, the Board supports the Santiago Principles, which establish a framework for governance, accountability and transparency for Sovereign Wealth Funds. The Board fully implements the Santiago Principles and its review of how the Principles are applied is provided in its annual report." (Australia Future Fund, Governance).  The Act presumes to extend itself quite broadly "This Act extends to acts, omissions, matters and things outside Australia (unless the contrary intention appears)." (FFA Pt. I ¶ 9). To the extent it means to govern the behavior of ASWF investment abroad it might make sense, to the extent it means top discipline actors outside the jurisdiction of Australia, the effect of this provision is likley less comprehensive.

The principle object of the ASWF is to "strengthen the Commonwealth’s long‑term financial position by establishing the Future Fund. The Future Fund will make provision for unfunded superannuation liabilities that will become payable during a period when an ageing population is likely to place significant pressure on the Commonwealth’s finances." (FFA Pt. I, ¶ 3).  Like other conventional future funds, it is meant to act like a national pension plan fund, that is to draw current assets away from current spending, and to attempt to increase the value of those segregated funds to a degree sufficient to meet the projected social welfare needs of the state at a time when its own population becomes more enfeebled. t "Investment of the Future Fund is the responsibility of the Future Fund Board of Guardians with the support of the Future Fund Management Agency. The Board and Agency also invest the assets of the Building Australia Fund, the Education Investment Fund and the Health and Hospitals Fund which were established by the Nation-building Funds Act 2008."  (Australia Future Fund, homepage).

The Future Fund consists of a Future Fund Special Account, along with the investments made with those funds. (FFA Pt. II, § 11). "The Future Fund Board of Guardians is responsible for deciding how to invest the Future Fund. Investments of the Future Fund will consist of financial assets. Investments of the Future Fund will be held in the name of the Board. The Board is bound by a Future Fund Investment Mandate given to it by the responsible Ministers." (Ibid., § 14). Contributions to the fund  have been made from government funds.  Unlike resource management funds, these contributions are not tied to the management of natural resources, most of which, in Australia, are exploited by private enterprises and subject to much looser regulation and policy initiatives.

Summary of Transfers

Date	Source of Funds	Amount ($ billion)
5 May 2006	Initial Seed Capital	$18.0
22 January 2007	2005-06 Budget Surplus and first instalment of Telstra 3 sale proceeds	$18.639
16 February 2007	The remainder of the 2005-06 Budget Surplus	$3.638
28 February 2007	2,104,657,933 Telstra shares	$8.966 (value at time of transfer)
22 June 2007	Telstra 3 sale proceeds (prepayments of the second instalment received in the period February to April 2007)	$0.151
28 June 2007	21,894,459 Telstra shares	$0.102 (value at time of transfer)
24 August 2007	2006-07 Budget Surplus	$7.0
25 June 2008	Telstra 3 sale proceeds (second instalment receipts)	$3.9
21 November 2008	35,361,956 Telstra shares	$0.141 (value at time of transfer)
Total Transfers		$60.537 (value at time of transfer)

The Future Fund has reported its list of the Future Fund's top 100 listed equity holdings is available here. The ASWF, as of 31 December 2013, invested about 10% of its funds in Australian equities.  Substantially larger stakes were held in foreign equities from developed states (almost 25%) and developing states (about 9%).  Almost 8% of the Fund was held in what is described as "private equity", and the rest includes cash and natural resource holdings. (Future Fund, Portfolio update at 31 December 2013, 3 February 2014).  "Our private equity strategy is predicated on our view that private equity fulfils two functions within the Fund’s investment portfolio. The first is to invest in high ‘alpha’ opportunities, where we believe we can earn a significant premium over similar but more
liquid equity investments. Most of these  investments would fall in the buyout or secondaries categories. The second function is to expose the Fund to investment themes that it cannot readily gain exposure to through other more liquid investments." (Future Fund Annual Report 2012-2013 (Sept., 2013) p. 25).  The rationale for natural resource investment can be found Ibid., pp. 28-30.  The great majority of investment is made in the United States (36%) and Australia (31%).  (Future Fund Annual Report 2012-2013 (Sept., 2013) p. 34). The United Kingdom (7%), Japan (2%) and the rest of Europe (9%) make up the bulf of the rest (Ibid).

The principle objective of investment is to make money (Ibid., Part III § 15; Cf Santiago Principles 19). "The Board has interpreted the requirement to achieve a return of at least CPI +4.5% per annum over the long term as meaning over rolling 10 year periods." (Future Fund Annual Report 2012-2013 (Sept., 2013), p. 14).  Investing, as in most other funds, is directed through policy determined by the appropriate government minister. Those directions, the Future Fund Investment Mandate (FFA § 18(3)) are both constrained and open-ended: "the responsible Ministers must have regard to: (a) maximising the return earned on the Fund over the long term, consistent with international best practice for institutional investment; and (b) such other matters as the responsible Ministers consider relevant." (FFA § 18(2)). Thus, though FFA § 18(10) requires that the Future Find Investment Mandate "must seek to maximise the return earned on the Fund over the long term, consistent with international best practice for institutional investment;" that requirement may itself be disregarded by other provisions f the Mandate (Ibid., § 18(7)), subject to the limitation in FFA § 18A that the Mandate not require investment in a specific (particular) instrument or entity). 

The Ministerial Future Funds Investment Mandate provides:

5. Benchmark return. The Board is to adopt an average return of at least the Consumer Price Index (CPI) + 4.5 to + 5.5 per cent per annum over the long term as the benchmark return on the Fund. During the initial transition period, as the Board develops a long-term strategic asset allocation, a return lower than the benchmark return is expected. In targeting the benchmark return, the Board must determine an acceptable but not excessive level of risk for the Fund measured in terms such as the probability of losses in a particular year.

6. Limits for holdings of listed companies. The Board must establish a limit for holdings on any listed company in order to prevent a breach of the statutory limits imposed by sections 21 and 22 of the Act.

7. Telstra Corporation; The Board must not acquire a direct equity holding of voting shares in Telstra Corporation Limited except as a result of a transfer of financial assets by the responsible Ministers under clause 6 of Schedule 1 of the Act or a gift of financial assets under clause 7 of Schedule 1 of the Act.

8. Board must consider impacts from its investment strategy. In undertaking its investment activities, the Board must act in a way that:

(a) minimises the potential to effect any abnormal change in the volatility or efficient operation of Australian financial markets; and
(b) is unlikely to cause any diminution of the Australian Government’s reputation in Australian and international financial markets.

9. Corporate Governance. The Board must have regard to international best practice for institutional investment in determining its approach to corporate governance principles, including in relation to its voting policy. (Future Fund Investment Mandate Directions 2006 - F2006L01388, Part 2).

This mandate provides a curious mixture of sovereign policy (limiting for example, investment in Australia's largest telecommunications and media company, Telstra, economic objectives, and to a limited extent, active shareholding in the service of reforming corporate governance of firms in which the ASWF takes an interest. Yet note that the Australian government transferred a 17% stake in Telstra in 2007 to the ASWF.  (Sovereign Wealth Fund Institute Australia; see also  Explanation of the transfer of Telstra shares to the Future Fund PDF version).  There are echoes here of the Norwegian model, one in which the principal objective--money making--is mediated by state political agendas including reforming corporate governance.  (Cf., Backer, Larry Catá, Sovereign Investing and Markets-Based Transnational Rule of Law Building: The Norwegian Sovereign Wealth Fund in Global Markets American University International Law Review 29 no. 1 (2013): 1-122 (December 2013).). There is more than a subtle echo of Norwegian style politically targeted sovereign investing with respect to corporate governance and CSR concerns.

The Board believes that the effective management of material financial and reputational risks and opportunities related to environmental, social and governance (ESG) issues will, over the long term, support its requirement to maximise returns earned on the Funds

The Board builds this perspective into its own investment decision-making, including the management of ownership rights, and into its process for selecting the external investment managers responsible for individual investment decisions.

Furthermore, the Board, consistent with its obligations under the Future Fund Act 2006 has regard to international best practice for institutional investment in determining its approach to corporate governance (including in relation to its voting policy).

The Board’s policy on Ownership Rights and ESG Risk Management is included in its Statement of Investment Policies and provides the framework for the Board's approach and details of its principles for the exercise of voting rights. (Future Fund, Ownership rights and ESG risk management).

The ASWF exercises a milder form of active shareholding but on the Norwegian model.  It does not act as aggressively on the management of its investment universe,.  The core of its active shareholding is centered on using its shareholder voting power, and the use of its shareholder power to engage with management to seek changes in company behaviors that accord with the ASWF's governance and behavior paradigms . 

The exercise of ownership rights is a key means by which to encourage owner-orientated governance in investee entities. This reflects the Board’s view that good governance (how an organisation is structured, operated and controlled and how it manages environmental, social and regulatory risks and opportunities) protects and creates investment value.
Since September 2009 voting rights in publicly listed Australian companies have been managed directly by the Fund and exercised by the Agency on behalf of the Board. In exercising these voting rights the Agency applies the Board’s voting principles, as outlined in its Statement of Investment Policies, while also drawing on the insight of relevant investment managers and research providers.

. . . . 

In 2012/13 the Future Fund’s international listed equities managers were eligible to exercise proxy votes in respect of 36,129 resolutions at 3,358 shareholder meetings. Those votes were exercised in 99% of cases at the resolution level and 99% of cases at the ballot (meeting) level. (Future Fund Annual Report 2012-2013 (Sept., 2013) p. 38).

The Future Fund Annual Report 2012-2013 ( p. 37-40). provides a discussion both of the parameters within which the ASWF seeks to engage with enterprises in which it has invested, and listed the policies it has sought to further by that engagement.

"Such contact is fundamental to establishing a climate of long-term asset stewardship, with active oversight from investors and accountability of management to the provider of capital.Engagement is also used as a complement to voting activities to improve our analysis and the signalling power of the votes cast. In addition, maintaining open, constructive relationships with investee entities improves fundamental investors’ understanding of the quality of management and the long-term drivers of value, including ESG risks and opportunities."(Ibid., 37).

The Annual Report (2012-2013) provides examples.  Among the most significant is an example of engagement with U.S. companies through which the ASWF has sought to incorporate within the governance behaviors of the U.S. form, in its supply chain operations, the U.N. Guiding Principles for Business and Human Rights.  (Future Fund Annual Report 2012-2013 ( p. 38) Examples of direct engagement by the Agency in 2012/13). "Software United States, Meeting between major US IT hard- and software provider and a group of international asset owners and managers. The focus of the discussion was the company’s journey in managing human rights considerations both internally and in terms of supply chain, using the Ruggie/UN Guiding Principles on Business and Human Rights framework. Specific points examined: Key human rights risks, Human rights impact assessments, Board and management responsibility for these issues, The potential not just to avoid negative human rights impacts,but potentially to effect positive outcomes." (Ibid).

Under direction of the responsible ministers, and consistent with the Future Fund Investment Mandate, the Board of Guardians "must formulate written policies to be complied with by it in relation to the following matters in connection with the Fund: (a) the investment strategy for the Fund; (b) benchmarks and standards for assessing the performance of the Fund; (c) risk management for the Fund; (d) a matter relating to international best practice for institutional investment; (e) a matter specified in the regulations." (FFA § 24). Special provision is made for investment in derivatives (Ibid., § 25) but may engage in securities lending arrangements (Ibid, § 26). Like virtually all other SWFs, the ASWF may engage outside investment managers (Ibid., § 28).  "The Future Fund Board of Guardians is responsible for deciding how to invest the Future Fund.  The Board consists of a Chair and 6 other members. An asset held by the Board is held for and on behalf of the Commonwealth.  Board members must act in good faith." (Ibid., Pt. IV, § 33).  The Fund Management Agency is responsible for assisting and advising the Board. (Ibid., Pt. V, § 73).  It functions like a Secretariat (Ibid., § 75).

The Board of Guardians is responsible for a number of related Funds:

The Building Australia Fund was established by the Nation-building Funds Act 2008. The object of the fund is to enhance the Commonwealth's ability to make payments in relation to the creation or development of transport, communications, energy and water infrastructure and in relation to eligible national broadband matters.

The Future Fund Board of Guardians is responsible for deciding how to invest the assets of the fund. Payments from the fund are determined by government, with advice from Infrastructure Australia, in accordance with the legislation.
Education Investment Fund

The Education Investment Fund was established by the Nation-building Funds Act 2008. The object of the fund is to enhance the Commonwealth's ability to make payments in relation to the creation or development of higher education infrastructure , research infrastructure, vocational education and training infrastructure, eligible education infrastructure and to make transitional Higher Education Endowment Fund payments. The Higher Education Endowment Fund was discontinued in December 2008 and its assets transfered into the Education Investment Fund.

The Future Fund Board of Guardians is responsible for deciding how to invest the assets of the fund. Payments from the fund are determined by government, with advice from the Education Investment Fund Advisory Board, in accordance with the legislation.
Health and Hospitals Fund

The Health and Hospitals Fund was established by the Nation-building Funds Act 2008. The object of the fund is to enhance the Commonwealth's ability to make payments in relation to the creation or development of health infrastructure.

The Future Fund Board of Guardians is responsible for deciding how to invest the assets of the fund. Payments from the fund are determined by government, with advice from the Health and Hospitals Fund Advisory Board, in accordance with the legislation. (Future Funds, About the Funds)

The ASWF position paper on long term investing is worth considering as representative of SWF positions on investment horizons.

Long term investing
We believe there are three main comparative advantages to being a long-term investor:

i. the ability to take on greater levels of market risk, on the assumption that a long-term investor is able to tolerate the shorter-term losses that come with the greater market risk exposure. The greater market risk ought to (albeit in practice it need not necessarily) be rewarded with higher long-term returns;
ii. the ability to accept capital being locked-up in assets or structures that are impossible and/or costly to sell out of within a short period of time. Such investments ought to (again, albeit in practice they need not necessarily) attract a premium return to compensate for this loss of liquidity; and
iii. the ability to be counter-cyclical, patient and opportunistic. The investor can use its long-term nature to reduce risk when prospective returns are unattractive and wait for more compelling opportunities to buy (or sell). At times of market stress when other investors are selling, the long-term investor is able to step in and provide liquidity to the markets in return for outsized forward-looking expected returns.

The balance between these three advantages is controllable. Many investors emphasise the first, by holding high and relatively fixed levels of equity exposure. Some funds are increasingly supplementing this by seeking to exploit the second advantage, by growing their private markets portfolios (such as property and infrastructure). The use of the third advantage is lower, often limited to a modest rebalancing strategy around the fixed strategic asset allocation.
Essentially having a high exposure to market risk (the first advantage) removes the ability to play meaningfully to the patient opportunistic capital approach, because there is no spare capital to invest in times of distress because it is already invested.
The Future Fund seeks to benefit from all three advantages:
i. we have a meaningful exposure to riskier assets, given the expected (but not guaranteed) higher long-term rewards for this risk;
ii. we search hard for opportunities to extract strong excess returns for locking our capital away in less liquid investments; and
iii. we seek to manage the portfolio risk dynamically to reflect substantial changes in conditions. While the portfolio strategy is under regular review and will be adjusted as the relative attractiveness of different sectors changes, meaningful changes to the Fund’s risk profile are only expected upon substantial changes in external conditions. One aim of this dynamic approach is to have capital ready to deploy into areas of market weakness. (Will Hetherton, Head of Public Affairs, Future Fund Position Paper, Long Term Investing,  October 2013).

The ASWF has been quote transparent about  the strategic use of financial vehicles to avoid taxation in host states.  While the ASWF declares its opposition to tax evasion, its investment maximization objection appears to compel it to act strategically to minimize its tax obligation within host states.

The Future Fund is exempt from income tax in Australia. The Future Fund is, however, potentially subject to foreign tax on income from overseas investments, subject to any exemptions that may be available on sovereign immunity grounds.
The Future Fund may use collective investment vehicles and/or subsidiaries which invest through low or nil tax jurisdictions. 

 . . . . .
What is a “subsidiary” of the Future Fund is defined by reference to financial reporting standards and is generally any entity controlled by the Future Fund. In practice the Future Fund’s subsidiaries are entities owned 100% by the Future Fund.
There are a number of reasons why the Future Fund may invest via a subsidiary established in a nil tax jurisdiction:
Tax Neutral Intermediary Vehicle / Familiar Legal Jurisdiction. . . .
 Protect Against Loss of US Sovereign Immunity Entitlements. As an investor on behalf of the Australian Government, the Future Fund is exempt from US tax on certain categories of income pursuant to Section 892 of the US Internal Revenue Code. This exemption may be lost if Future Fund is taken to derive any income (even $1) from “commercial activities” undertaken anywhere in the world. To mitigate this risk, the Future Fund may invest into a CIV via a subsidiary that is classified as a corporation for US tax purposes.
 Accounting Consolidation. Where the Future Fund’s CIV fund stake would otherwise exceed 50% but be less than 100%, the Future Fund may invest via its own (100% owned) parallel fund. This is to avoid consolidating the CIV fund into the Future Fund’s balance sheet (as a controlled entity) and recognising outside equity interests in the Future Fund controlled entity assets for financial reporting purposes.
 Concessional Fee Arrangements. The Future Fund may also invest via a Future Fund 100% owned parallel fund where it has secured concessional manager fee arrangements not available to other fund investors.
 Administrative (Fund of Funds). The Future Fund may engage a manager to invest in a large number of CIV funds (30 – 60) on our behalf. For administrative reasons it is generally simpler to hold these fund interests in an “aggregator” / “separate account” vehicle owned 100% by the Future Fund and managed by the manager, with the manager producing consolidated investment and financial reporting for that vehicle and deducting fees, than for the individual funds to be held directly by the Future Fund. (Will Hetherton, Head of Public Affairs, Australia Future Fund, POSITION PAPER, Subsidiaries, collective investment vehicles and taxation arrangements, Oct. 2013)

 The line between tax minimization and avoidance is small and likely that line is crossed at different points whether the home ort host state is doing the measuring.

Like other small funds with an internally driven and disciplinary objective, it is managed as part of a network of multiple funds that are meant to coordinate spending activity.   Within this structure, of course, the state is able to remove temptation from the electorate, through its legislators, to assert their sovereign authority of governance. 

The statutory governance arrangements for the Future Fund and Nation-building Funds are set out primarily in the Future Fund Act 2006 and the Nation-building Funds Act 2008. This core legislation sets out the roles and responsibilities of the Government and of the Future Fund Board of Guardians (Board) and the Future Fund Managemnent Agency (Agency). The Financial Managamenent and Accountablity Act 1997, together with other Commonwealth guidelines, procedures and orders, establishes arrangements for delegations and authorities, spending and the budget accounting of costs, liabilities, income and expenses.

The legislation provides the Government, through the Treasurer and the Minister for Finance and Deregulation, with oversight of the Funds subject to arrangements that establish the independence of the Board. The Government's role includes the appointment of Board members and the establishment of Investment Mandates for each of the Funds. Details of the Board's current members are available here.

The legal framework retains beneficial ownership of the assets of each Fund in the Commonwealth. It also clearly states the purpose of each Fund and makes clear that contributions to the Funds are discretionary.

The Board is responsible for investing the assets of the Funds in accordance with the legislation and Investment Mandates. To assist it in this role, the Board receives recommendations and advice from the Agency which is also responsible for implementing investment decisions.

The Board operates independently from Government. This independence is emphasised in a number of ways, including:
--the expenses of the Funds are met from the assets of the Funds themselves rather than from appropriations through Parliament;
--the Board must be consulted on draft investment directions which must be consistent with the requirements of the legislation. Any submissions the Board makes on a draft direction must be tabled in Parliament. The Investment Mandates for each of the Funds clearly define the risk and return requirements and timeframe for investment activity and the legislation imposes very few limitations on asset allocation, selection of markets and portfolio design on the Board;
--Board members must be drawn from outside Government and must meet the legislated requirements of having substantial expertise and professional credibility in investing or managing financial assets or in corporate governance.

The Board is not involved in advising on macroeconomic management or policy formulation and implementation and so is focused solely on the pursuit of its investment objectives in a commercial manner. (Australia Future Fund, Governance)

That "dead hand" form, of legislation through fund segregation is one of the more substantial characteristics that tends to mark many futures and development funds.  Its anti-democratic character has yet to be explored,.  But the effect is clear--to take discretion from the apparatus of elected power and to place it within a matrix of technical and regulatory constraints.  This technicity and control feature increasingly marks governance not just through SWFs but throughout the establishment of power. 

The Future Fund's Annual Reports may be accessed here:

Annual Report 2012-13 (PDF) | Annual Report 2012-13 (Interactive)
Annual Report 2011-12 (PDF) | Annual Report 2011-12 (Interactive)
Annual Report 2010-11
Annual Report 2009-10
Annual Report 2008-09
Annual Report 2007-08
Annual Report 2006-07
Annual Report 2005-06