International framework needed to govern sovereign wealth funds, says Carnegie Endowment
Source: BI-ME , Author: Justin Smith
Posted: Thu October 16, 2008 12:00 am

INTERNATIONAL. The financial interdependence that sovereign wealth funds (SWFs) created between the West and the Arab world could help stabilise multilateral relations and promote economic development and political stability in the Middle East, concludes a new paper from the Carnegie Middle East Center, based in Beirut.

Sven Behrendt studies the rise of Arab SWFs, assesses their investment strategy, and evaluates the policies of Arab investors and Western nations. He also analyses the political implications of policy initiatives, such as the International Working Group of Sovereign Wealth Funds convened by the IMF, which agreed to new voluntary principles and investment practices in Washington last Saturday.

The report titled 'When Money Talks: Arab Sovereign Wealth Funds in the Global Public Policy Discourse', says an international framework between investing and recipients nations is needed and should reflect the changing nature of the global market. A fragmented system of national policies is inefficient and in no one’s interest.

Among the other conclusions, it says Arab investment managers need to adjust their strategies and take broader responsibility for the stability of the global financial markets. They can no longer play the role of quiet investors.

Arab public opinion, media, and civil society should take an interest in their countries’ SWFs and demand a more transparent accounting of how the funds are being invested.

Western governments should acknowledge the increased bargaining power of the Gulf countries and reach out in a constructive manner. They must also avoid policy decisions based on misplaced fear of foreign domination and populist sentiments.

The rise of SWFs in the past years appears to have taken most, if not all, stakeholders in the global financial system by surprise. Western policy makers and the general public were surprised by the emergence of financial powerhouses from the Arab world, Russia, and China. Arab investors were surprised by the antagonistic reception they received in the United States and Europe. International regulators were surprised by the precariousness of the consensus on which the international financial architecture is based.

More than one year into the discussion about the new role of SWFs and the future of the international financial architecture, the principal actors have begun to weigh policy options. The analysis in this paper suggests a number of issues for them to keep in mind.

In the report Behrendt cautions: “It is vital that the International Working Group’s work acquires a high degree of political legitimacy, anticipating the tremendous growth of SWFs in the mid-term future, further straining any new financial markets regime. Otherwise states will revert to national legislation in regard to regulating SWFs. The outcomes of these policy processes risk becoming a function of the domestic discourse between pragmatists and populists in the Western countries.”

The paper argues that, rather than the absolute size of these funds, it is their rapid shift from the periphery to the centre of global financial markets and the speed by which they have joined the ranks of other significant investor classes that have moved them into the global public space. Arab sovereign wealth fund managers have become increasingly sophisticated as global investors, managing complex international portfolios. Some of them make strategic investments in industries that their governments perceive to be particularly relevant for the development and diversification of their national economies.

The rise of SWFs has been accompanied by a heated public debate regarding the threats that such funds could pose to Western economic, corporate, and eventually political interests. However, these debates, which began in late Spring 2007, have failed to develop substantial concepts to suggest how SWFs could constructively be integrated into the global fi nancial architecture.

In response to public pressure, regulators on the international and national levels began to develop policies to provide new frameworks in which foreign investors, such as SWFs, could operate. The most important international initiative in this regard has been the International Working Group of Sovereign Wealth Funds convened by the International Monetary Fund (IMF), which sought to develop a voluntary code of conduct. However, this initiative has not prevented national regulators from developing their own policies with regard to foreign, sovereign investment. Rather, its results will compete with the outcomes of policy processes pursued on national and other supranational levels.

This complex political situation is posing new challenges for Arab investment managers. Given the SWFs’ rapid transition from peripheral to central global investors, strategies that served them well in the past will have to be adjusted in light of their new position and exposure. They need to develop the capacity to manage more effectively the political challenges that are bound to confront them in the future.

Their newfound central position also needs to translate into taking broader responsibilities for the stability of global financial markets. For the time being, Arab investors have largely benefited from Western markets that are open and fairly transparent. They made a financial contribution to maintain some degree of market stability in late 2007 and early 2008. Now, they need to go a step further by making an active contribution to the development of the norms and principles that will provide long-term stability to global fi nancial markets. They need to play a key role in the construction of an institutional framework that will provide overall guidance to market participants.

Indeed, they have a profound stake in contributing to a new global framework that is robust enough to outbalance national legislation. Policies that would result in the fragmentation of the global investment space for SWFs are not in their interest.

The West, broadly speaking, will have to come to the realisation that the global economic power equation is shifting. SWFs are not a passing phenomenon but a new, powerful, and lasting feature of international fi nancial relations. Learning how to navigate a new investor landscape and how to negotiate with new investor classes eye to eye will become essential for Western economic diplomacy in its quest to secure access to capital from the Arab world and other emerging economies now and in the future.

Rather than focusing on defending Western assets from foreign investors, the West should acknowledge the foreign investors’ new role and reach out to Arab SWFs in a constructive manner. The West should also consider the geopolitical consequences of tighter financial relations with the Arab world. Financial interdependence might help stabilize political ties between Western recipient economies and Arab investors. Arab strategic investments in Western assets can help diversify Arab economies and support the economic and social development agenda, thereby contributing to overall political stability in the broader
Middle East.

Finally, the West needs to prevent a populist agenda based on fear of foreign domination from determining its future policies with regard to Arab SWFs and those of other emerging economies.

There is room for speculation over whether the efforts of the International Working Group of Sovereign Wealth Funds, facilitated by the IMF, will acquire the necessary degree of legitimacy to shield financial markets from political intervention by national regulators. If, as financial analysts suggest, SWF assets
increase from the current US$3 trillion to US$12 trillion in the coming years, financial markets and the explicit and implicit norms and principles that govern them will be under even greater strain than today.

International regulators need to take into account these profound transformations in global financial markets. A code of conduct that is tactically designed to help avoid controversy and to maintain business as usual will be insufficient. Any agreement between investing and recipient economies needs to be based on an understanding that fragmentation of the global financial markets is in nobody’s interest. Investing and recipient economies therefore need to work toward an agreement that proves to be resilient in the long run.

Beyond tactical considerations, it would be useful for the key parties and stakeholders to engage in a sustained and inclusive dialogue to address the broader strategic context that will shape the global investment landscape in the years to come. This dialogue could help establish the basis for a new arrangement, one that enjoys the high degree of legitimacy necessary to provide long-term stability, as well as predictability, in global fi nancial markets.

Looking ahead, given the numerous policy processes under way on the national and international levels, intense competition can be expected among different policy approaches to the challenges that SWFs present. The outcome of the International Working Group’s deliberations will be particularly important because most countries that have SWFs are involved in the process.

Furthermore, it is vital that the group’s work results in a robust framework that anticipates the tremendous growth of SWFs in the mid-term future, further straining any new financial markets regime.

Should the International Working Group fail to present a resilient framework for the global financial architecture, states will revert to national legislation in regard to regulating SWFs. The outcome of these policy processes will largely be a function of the domestic discourse between pragmatists and populists
in the Western countries.

Note: Sven Behrendt  is a visiting scholar at the Carnegie Middle East Center. He is an expert in global policy issues, international negotiations, corporate strategy, and diplomacy. Prior to his appointment at Carnegie, he served in various management positions at the World Economic Forum and the Bertelsmann Group on Policy Research. He is a regular commentator on television and in the press on corporate strategy and globalisation.

The Carnegie Middle East Center is a public policy research centre based in Beirut, Lebanon, established by the Carnegie Endowment for International Peace in 2006. The Middle East Center is concerned with the challenges facing political and economic development and reform in the Arab Middle East and aims to better inform the process of political change in the region and deepen understanding of the complex issues that affect it. The Center brings together senior researchers from the region, as well as collaborating with Carnegie scholars in Washington, Moscow, and Beijing and a wide variety of research centres in the Middle East and Europe, to work on in-depth, policy-relevant, empirical research relating to critical matters facing the countries and peoples of the region. This distinctive approach provides policy makers, practitioners, and activists in all countries with analysis and recommendations that are deeply informed by knowledge and views from the region, enhancing the prospects for effectively addressing key challenges.

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