Sovereign wealth funds in nondemocratic countries: financing entrenchment or change?

• Author: Behrendt, Sven
• Position: Inside the Authoritarian State - Report

The rising prominence of sovereign wealth funds--investment funds that are owned or controlled by national governments--has stirred debate about their potential use as tools to pursue global political interests rather than economic or financial ends. Recent sanctions levied on the Libyan Investment Authority, formerly operated by the government of Muammar al-Qaddafi, underscore this question. This article argues that the governance, accountability and transparency arrangements of sovereign wealth funds reflect the quality of political institutions within the countries that own them. In contrast to funds based in democratic states, those managed by authoritarian governments are distinguished by a lack of public oversight and are instead tightly controlled by the prevailing political leadership. The link between political leadership and fund management in many authoritarian countries allows governments more flexibility in using financial assets to pursue immediate political agendas.

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As the unrest in Libya escalated in February 2011, the United Nations Security Council voted unanimously to adopt Resolution 1970. This measure--along with Resolution 1973, which closely followed it in March--condemned the Libyan government's use of force against civilians and imposed a number of international sanctions on the country, (1) In an attempt to drain financial resources from the government of Muammar al-Qaddafi, the Council requested that UN member states freeze all funds, financial assets and economic resources controlled by institutions and individuals affiliated with the regime." One of these institutions was a sovereign wealth fund (SWF) named the Libyan Investment Authority (LIA). Established by the Qaddafi government in 2006 to manage state-owned financial assets, it was mandated to build a well-diversified investment portfolio that would create a sustainable source of revenue, reduce the economy's dependence on oil and act as a savings fund for the future. (3) Since its establishment, Qaddafi and his family retained tight control over the fund, and Qaddafi's son Saif al-Islam

directed much of its investment activity. (4) The precise volume of assets controlled by the LIA remained unclear until May 2011, when Global Witness, a British nongovernmental organization, obtained LIA internal documents estimating the sum to be around $64 billion. (5)

By imposing sanctions on the LIA, the Security Council made clear its recognition of the fund's political influence. Security Council Resolution 1973 identified the LIA as "a potential source of funding for [Qaddafi's] regime" and thus ultimately capable of influencing the outcome of the civil war. This marked the first time that an SWF was specifically targeted by international sanctions. The shift in the international perception of SWFs and their role in political unrest became an unforeseen repercussion of the Libyan conflict.

The rise of SWFs during the past decade ignited intense debate about their impact on international affairs. The funds, defined as "government-controlled pools of assets designed to engage primarily in foreign investment," have recently emerged as important actors on the global financial and diplomatic stage. (6) Because SWFs are directed by governments, they represent potential instruments for states to exercise soft power in support of foreign policy objectives. They are thus recognized as capable of influencing outcomes in times of mounting geopolitical rivalry. To some observers, the growing prominence of SWFs indicates that the global financial system is becoming increasingly "neo-Westphalian" in character--i.e., dominated by the political interests of nation-states pursued by their governments. (7)

Academic analysis adds another dimension to this debate by assessing the interplay between SWF characteristics and domestic politics. A recent comparative analysis of global SWF assets has found that approximately 72 percent of assets under management of SWFs is controlled by authoritarian governments or hybrid regimes, while only 28 percent is controlled by democratic governments. (8) Roughly 30 percent of assets under management globally is controlled by autocracies in the Middle East and 17 percent by the Chinese government. Evidence also suggests that the varying performance of SWFs on indicators related to accountability, transparency and good governance is tightly correlated with the varying strength of the political climate within owner countries. (9)

The events around the LIA, unfolding against the background of mounting international interest in SWFs, raised additional questions about the political role of SWFs in nondemocratic states. Do authoritarian countries have common characteristics in the way they govern their SWFs? Are SWFs a financial buffer for authoritarian regimes against destabilizing shocks? Given the liberal nature of the global financial system, can SWFs promote good governance and accountability?

SOVEREIGN WEALTH FUNDS: A BRIEF OVERVIEW

The exact definition of the term "sovereign wealth fund" remains amorphous as it encompasses two very different concepts: political sovereignty and financial wealth. This conceptual vagueness defines the ongoing conversation about the role of SWFs in international affairs. A distinguishing feature that sets SWFs apart from other investment tools is that their principal beneficiaries are citizens of the owner countries. SWFs invest for the benefit of Emiratis, Norwegians and Russians and discriminate against noncitizens. As such, SWFs represent an antithesis to the principles of nondiscriminatory, liberal global finance.

SWFs entered the global stage not by design but by default, "as an externally imposed category in search of a definition." (10) Until 2005, SWFs were not even identified as a distinct category from other financial market actors. This changed when Andrew Rozanov coined the term "sovereign wealth fund," leading to the recognition of SWFs as a coherent, growing and potentially menacing investor group. (11) The new definition also provided the impetus for SWFs to develop a sense of their common nature, which became a foundation for the establishment of a representative body for the group, the International Working Group of Sovereign Wealth Funds, in 2008. One year later, this organization became the International Forum of Sovereign Wealth Funds, an assembly of twenty-six funds from twenty-three countries with accumulated assets of roughly $2.5 trillion. (12)

This article assesses a number of SWFs belonging to the International Forum. Their financial base is supplied by state transfers derived from a number of sources: balance-of-payments surpluses, official foreign currency operations, privatization proceeds, fiscal surpluses and receipts from commodity exports. (13) Another unifying feature of SWFs is their role as financial risk-management instruments. Though countries establish SWFs with different objectives in mind, the funds are commonly used to buffer national economies against economic and financial shocks. Savings funds protect against the risk of erosion of national resource wealth; stabilization funds ameliorate the risks of inherently volatile commodity markets; pension reserve funds mitigate future demographic pressures; and reserve investment corporations safeguard national wealth against global financial market downturns.

SWFs can also serve to assert political influence inside and outside the state. Ashby Monk, coauthor of the forthcoming book Sovereign Wealth Funds, argues that states use SWFs as tools to gain ground in international finance and to cushion the transformative forces of global capitalism. (14) Establishing and operating an SWF allows states to reclaim a degree of authority over financial markets, not only as regulators but also as active players.

As a result of the Asian crisis, when foreign lenders caused a credit crunch and sent regional currencies into a tailspin by withdrawing their money from the weakened Asian economies, many Asian governments developed policies to build up large reserves--instruments, if not guarantees, against capital-flow volatility. (15) This sentiment was expressed by Lee Kuan Yew, former prime minister...