Saturday, March 01, 2014

Part 17 Russian SWFs--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 three Russian SWFs--the National Welfare Fund, the Reserve Fund, and the Russian Direct Investment Fund.

Russia exemplifies a trend that we have seen developing over the last decade--the move toward special purpose SWFs.  Following the lead of Singapore, Saudi Arabia, The UAE, Norway and others, the Russians have split their sovereign investing into three "pots"-- -the National Welfare Fund (RNWF), the Reserve Fund (RRF), and the Russian Direct Investment Fund (RDIF).  All three are managed through the Russian Ministry of Finance. The first is operated as a pension fund.  The second serves, and the third, its newest fund, is operated as a development fund in partnership with other SWFs and international investment entities (public and private).

 While Russia is a member of the International Forum of Sovereign Wealth Funds, and thus in principal, obliged to operate its funds within the guidelines of the Santiago Principles, it, like many other SWF operators, tales these as guidelines from deviation is possible to the extent that such deviation does not produce adverse effects.  And adverse effects is measured by the SWF's ability to engage in market transactions abroad and, increasingly, with its SWF partners.  Thus, for example, at the time of the creation of the RRS and the RNWF, "A deputy finance minister, Dmitry V. Pankin, offered assurances in an interview Thursday that the new fund would serve purely economic goals. “What are they worried about, foreign investment coming to their country?” Mr. Pankin said of critics in Western countries. “They should not worry, they should hope.”" (Andrew E. Kramer, Russia Creates a $32 Billion Sovereign Wealth Fund, The New York Times, Feb. 1, 2008). 

Indeed, almost from the first host state have been leary of Russian motives--suspecting that the economic motivaiton of fund investment, while valid enough, also masked an aggresive projection of national power abroad for the advancement of Russian political goals.  The Europeans were especially sensitive to this.
Russian investing has already encountered criticism in European Union countries. The state-owned natural gas monopoly Gazprom is buying gas pipelines and storage facilities in Europe; officials there have suggested that the company was operating from foreign policy motives rather than economic ones when it shut off gas to Ukraine in 2006 after the election of a pro-Western government. Gazprom said it was a purely commercial matter. Andrew E. Kramer, Russia Creates a $32 Billion Sovereign Wealth Fund, The New York Times, Feb. 1, 2008).
There is irony here, of course, since one of their own, the Norwegian SWF had for year engaged in this sort of national power projection into Europe.  But perhaps because those projections were not adverse to general European interests they were treated as less threatening. The difficulty is compounded by Russia's international reputation, one that makes markets based interventions both suspect and more difficult (and thus more costly to Russia). 
When it comes to global benchmarks for the country's investment and business climate, Russia's ratings have improved—but they're still closer to the bottom than to the top. Transparency International ranks Russia 133 out of 176 in its corruption index (see graphic below). The Heritage Foundation lists it 144 out of 184 in its ranking of economic freedom. The World Bank says Russia is 92 out of 189 in ease of doing business. Watchdog organization Freedom House describes Russia's status as "Not Free." (, The $10 billion man out to change Russia's image,  CNBC Dec. 11, 2013).
Two of the funds, the RNWF and the RRF, were created in 2008 when Russia decided to split its Stabilization Fund into two functional parts.  Both serve fundamentally to as a means of managing wealth from Russia's petroleum exploitation. The RNWF was organized as a futures fund and the RRF was organized as a stabilization fund.
One of the new funds, now called the Reserve Fund, will retain the initial purpose of insuring the Russian budget against a steep fall in oil prices. It will hold $125 billion and be maintained at a size roughly 10 percent of Russia’s gross domestic product, as it is now.

The other, the Fund for National Well-Being, with $32 billion, is intended to buoy the pension system as the Russian population ages and the share of those working shrinks. Under a law passed last spring, the new fund can be invested in foreign stocks and bonds. Andrew E. Kramer, Russia Creates a $32 Billion Sovereign Wealth Fund, The New York Times, Feb. 1, 2008).
The RNWF was established to guarantee Russia's public pension scheme, and especially to help balance the budget of the Pension Fund for the Russian Federation (RNWF Mission). It is managed through the Russian Ministry of Finance.  "Management of NWF assets is executed by the Ministry of Finance of the Russian Federation in accordance with procedure and terms established by the Government of the Russian Federation. Bank of Russia may act as operational manager. In case specialized financial entities are engaged to exercise particular functions related to management of NWF assets then the Government establishes terms of such engagement and requirements to such entities."  (RNWF, Investment Management).  Its investment strategy is formally conservative and conventional.  may invest in listed foreign currencies and a variety of financial instruments including Russian and foreign equities subject to certain qualitative restrictions (Ibid). It's recent purchases of foreign currency has had effects on the value of the ruble and might be used for exchange rate management. (e.g., , Ruble Weakens on Bets of Currency Sale for Russian Wealth Fund, Bloomberg News, Dec,. 2013; and Russia postpones plan to replenish sovereign fund via forex purchases, Reuters, Feb. 4, 2014 (""When the central bank every day is taming volatility, we certainly will not harm the central bank," Deputy Finance Minister Alexei Moiseev told journalists.")). Transparency of fund operations and governance is substantially limited.

The RRF inherited a substantial portion of the stabilization function of the older Russian Stabilization fund. It is funded through sales of both oil and natural gas (Sovereign Wealth Fund institute, Russia Reserve Fund). The RRF is managed by the Ministry of Finance and it constitutes a part of the assets of the Russian federal budget.  To that extent it may not be separable from the short term budgeting of the Russian Federation.  To speak of the autonomy of the RRF from the state is also not possible. It serves, instead, as a source of funds for the federal budget, and one with little by way of a disciplinary effect that is achieved by the funds of places like Ghana.  It is said to invest only in conservative inc¡vestments (Sovereign Wealth Fund Institute, Russia Reserve Fund). It is estimated to have about $87 billion (Bloomberg). 

The RDIF is structured as an international development fund.  The operations of RDIF is managed through a subsidiary of Russia's state development bank and its operations are said to be overseen by a Supervisory board (Sovereign Wealth Fund Institute, Russian Direct Investment Fund). What makes it distinctive if that it operates as a set of managed and overlapping joint ventures with other development oriented SWFs, international financial organizations and private finance entities.  Indeed, it is mandated to co-invest with an internal investor (Sovereign Wealth Fund Institute, Russian Direct Investment Fund).  This is a practice, made official with the structuring of the RDIF that has already become part of the functional operaiton of other funds, especially the RNWF (discussed below).
Kirill Dmitriev is on a one-man mission to change Russia's image in the eyes of world investors. The 38-year-old graduate of Harvard and Stanford runs Russia's newest sovereign wealth fund—the $10 billion Russian Direct Investment Fund.

Unlike most sovereign wealth funds, which invest outside their country of origin (including two other Russian wealth funds that control more than $80 billion in assets) the fund that Dmitriev manages directs money back into Russia—co-investing in the country with the sovereign wealth funds of China, Abu Dhabi, Korea, Italy, France and Japan. (, The $10 billion man out to change Russia's image,  CNBC Dec. 11, 2013).
The RDIF's most interesting development deals have been with China's SWF and also with that of Korea (see HERE).  Chris Wright, writing for Forbes, has provided a useful analysis that is essentially correct.  But because of the difficulty of transparency with these SWFs, a detailed analysis becomes more difficult. (Chris Wright,  Korea And Russia's Sovereign Wealth Funds To Build Private Equity Together,  Forbes, Nov. 14, 2013 ("As for the RDIF, that is a trickier institution to understand, lacking the KIC’s transparency. It was created in 2011, apparently with about $10 billion in assets, and it, too, has built similar deals with the China Investment Corporation prior to the Korea deal. An example of the sort of transaction the Russia-China platform has conducted is a co-investment, in two tranches so far, in Russian Forest Products. Forestry and infrastructure deals are also likely to appear in the new Russia-Korea platform.")).

But the operation of the Russian SWFs within functional silos appears to be an inexact science in Russia and there are overlaps in function and objectives.  
The Russian government will invest up to 450 billion rubles ($13.7 billion) in infrastructure projects from its sovereign wealth fund together with private capital, President Vladimir Putin said on Friday, in a move that could give a significant kickstart to the faltering Russian economy.  Up to half the money to be invested in the projects will come from the National Welfare Fund, Russia’s $87 billion sovereign wealth fund made up of windfall oil export revenues, he said. (Putin Pledges $14 Bln From Wealth Fund for Infrastructure, RIA Novosti, June 21, 2013).
Thus the futures (pension) Fund has been used like a development fund as well. Indeed, the object of these projects could only most charitably be characterized as motivated by their financial or economic return to investors, rather than to the Russian state, a hallmark of development funds. "The infrastructure projects should eventually return the money invested, Putin said." (Ibid).  Indeed, when combined with the strategic investor partner pattern that serves as the foundation of RDIF function, it suggests the use of RNWF as a sort of guarantor of  return on economically questionable projects as well as a means of using foreign partners' willingness to invest as a marker for the eventual economic viability of projects. " I know that investors’ interest in infrastructure projects is very significant, especially if government is ready to ensure risks are minimized and act as a co-investor,” he added. “We should not squander this, or trade it for non-existent programs, but direct it toward those projects which change the shape of the country, and open new perspectives for development,” Putin stressed."" (Ibid).

This fudging of functional divisions among the three SWFs is as much a result of divisions within Russia about the use and operation of these funds as it may be about necessity, goiven the performance of these funds and the sources of casgh available for short term projects high on the government's wish list. In the case of the use of the RNWF, this emerged most clearly during the course of debates initiated by a call in 2012 by Putin to use the NSWF assets for development projects (Douglas Busvine and Jason Bush, Russia may invest wealth fund in economy - Putin, Reuters April 11, 2012).
Putin's comments come amid disagreements within Russia's government over how to manage the country's oil revenues. Energy levies account for half of federal revenues, making the budget highly sensitive to the oil price.
. . . .

While only the Reserve Fund is officially designated to protect the budget against lower oil prices, the fund was heavily depleted, having fallen to 3 percent of gross domestic product from 10 percent in 2008, when global markets crashed.
The National Welfare Fund is officially designated to secure Russia's pension system, and plug a growing deficit in Russia's state pension fund. It is mostly invested abroad in low-risk government securities.

Those disagreemnst tend to pit long term future fund interests against more short term macro economic stability and development objectives.
The government has discussed the possibility of dipping into the National Welfare Fund before, a prospect that has met a mixed response from investors, according to Vladimir Savov, an analyst at Otkritie Bank in Moscow.

“On the one hand, investors like that there is this money sitting there [in the reserve fund] that will be a cushion against global turbulence and external shocks. On the other hand if there are these pressing needs to stimulate growth not by printing money or dipping into the budget maybe it’s not a bad idea,” he said. (Courtney Weaver, Russia to Dip Into Reserve Fund, Financial Times, April 22, 2013)

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