The Sovereign Wealth Fund was conceived by a person named Andrew Rozanov (August 2005, p.6). Sovereign Wealth Funds (SWFs) are not only diversified but also have a long history.
The diversification of SWFs is reflected in geography, capital source, size, age and investment strategies. The first SWF was established in 1953 called Kuwait Investment Authority and the first industry association was founded in 2007, which is International Working Group (IWG) (Aldo & Emil, 2011, p.6). That is to say, IWG is quite important for SWFs. According to Aldo & Emil (2011), they argued that the definition of SWFs includes Government Pension Fund of Norway, the Chinese Investment Corporation and Kiribati’s Revenue Equalization Reserve Fund. In the view of Ian Bremmer (2010, p.7), he defined SWFs as “state-managed pools of excess cash that can be invested strategically”. At the same time, there is also an understanding of SWFs in the Santiago Principles.
SWFs are accumulated through the distribution of specific taxes and budget allocation, the balance of payments surpluses, etc. (Santiago Principles, 2011, p.21).
In another aspect, ownership, investments and purpose and objectives constitute three critical factors for SWFs (Santiago Principles, 2011, p.21). Ownership is reflected in SWFs by government control and allocation. The key investment strategy of SWFs is that they are owned by a number of sovereign governments for long-term foreign financial investment. Thus, the purpose and objective of SWFs are to use the government’s funds to achieve the original financial goals and reduce the debt, and to undertake certain investment risks. According to investment and capital (Aldo & Emil, 2011, p.8), SWFs can be divided into four categories: saving and pension reserve funds, stabilization funds, economic development funds and reserve investment corporations.
Saving and pension reserve funds were set up to better preserve capital for future generations. The scale of these funds is usually large and old and are mainly concentrated in the developed market. Besides, the risk of inflation can easily affect saving and pension reserve funds, so it is the key to maintain and increase the value. Stabilization funds found in the last 20 years and these funds are established by the government and central bank in order to effectively reduce the impact of commodity price fluctuations or inflation. That is, the main purpose of stabilization funds is to stabilize the countries’ fiscal expenditure, especially in the period of the recession. Economic development funds are to promote economic diversification under the condition of abundant national resources. Direct investment has become the first choice for these funds, but still some of them focus on the domestic economy (Aldo & Emil, 2011, p.
9). Reserve investment corporations are to reduce the flow of foreign currencies, and better to manage the risk of currencies and use the risky investment to achieve high returns. For example, Chinese Investment Corporation is ones of the largest sovereign wealth funds in the world.There is nothing to be afraid of SWFs because they are growing and strengthening.
SWFs have the financial strength of a large pension fund, which is reflected in the flexibility of venture capital. In addition, SWF industry is more concentrated than other industries of the same kind. Through the large number of foreign exchange funds that some central banks have to support SWFs assets, which can be developed organically through the current investments’ appreciation (Aldo & Emil, 2011, p.9). There are also some benefits that can be shown not to be afraid of SWFs.
Firstly, SWFs not only bring benefits to their own countries but also enhance their competitiveness of natural resources and exports in the world, so as to get rid of the single national economy. SWFs transfer some consumable natural assets into some permanent income financial assets through the liquidity of the resource exportation (Aldo & Emil, 2011, p.9). Secondly, stabilization funds help to prevent domestic monetary losses from domestic shocks, thereby promoting the growth of the financial economy and strengthening national security against foreign attacks.
Thirdly, large institutional investors reflected by SWFs can help improve the return of the capital market, while reducing transaction costs make large investors can also benefit from it, have more investment opportunities, and help reduce risk (Aldo & Emil, 2011, p.10). SWFs can stabilize the impact of the financial crisis on the market and keep investment in a period of undervaluation.
Furthermore, SWFs have played an important role in the survival of many financial systems in the financial crisis. Finally, the removal of capital restrictions can bring some benefits. Funds owned by SWFs are conducive to large-scale, high-risk investment, and their available capital which is much more than the source of the traditional emerging markets (Aldo & Emil, 2011, p.
11). In a world, SWFs benefits outweigh the disadvantages, so do not have to be afraid of them.SWFs need to be regulated due to the emergence of some problems. The most common criticism of SWFs is their poor management or poor allocation of capital. This problem is the one that needs to be corrected the most. The key to solving this problem is to adjust.
In other words, not only the supervision of the regulator, but also the internal needs to be strengthened. This can reduce the damage caused by the financial crisis and minimize its losses. SWFs are in charge of financial bubbles.
If there is no regulation, the financial bubbles are breaking out quickly and they have a wide range of impact. The emergence of financial bubbles can cause a stock market crash, a large number of debt crises and harm the global financial system to make its stable system damaged. In order to avoid this kind of harm, financial institutions should better control investment, not excessive investment and pursuit of economic growth blindly.
The system of financial institutions would be threatened without regulation. Private financial companies have to deal with regulations that can not only limit their size but also control their exposures to risky assets (Aldo & Emil, 2011, p.12). When debt financing occurs, the introduction of market discipline can better improve and govern companies and consolidate risk management. Political incentives can cause confusion in some financial institutions or damage to reputation. The government should strengthen the political risk of overseas investing and make clear the moral standards of some investments to make the financial system more perfect.
The political motives of SWFs have been blamed for the lack of transparency and SWFs’ investments may affect the market. For countries with SWFs, profits and international capital flows can bring adverse changes. OCED and IMF should work together with SWFs to establish a set of governance and transparency guidelines for the fund, so that SWFs can operate and regulate better and improve the ability of risk management. The financial protectionism can put SWFs at risk. That is to say, SWFs are controlled by the government, and threaten their own economic security if they do not comply with market rules.
The government should curb the financial protectionism effectively and better regulate SWFs.General speaking, SWFs are the controversial issue.The supervision of SWFs should let the state make their decisions and rely onbilateral agreements or it can create across-border investment regulatory agency. The World Trade Organization wouldbe a good example (Aldo & Emil, 2011, p.14).I learned that SWFsare the most important institutional investors in the world.
Firstly, they havemade important contributions to global economic security and financialstability. Secondly, duringthe period of the financial crisis, the SWFs help reduce the financialinstitutions’ risk and maintain the stability of the global financial market. Finally,the SWFs will become an important part of financial markets. They will promotethe growth of economic transactions, accelerate and adjust the global assetallocation pattern, and slow down the price fluctuation of the market.