## _022908

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### SWFs: definition, objectives, and types
- Sovereign Wealth Funds (SWFs) are government-owned investment funds, commonly funded by the transfer of foreign exchange assets that are invested long term, overseas.
- Five types distinguished by main objective:
  - Stabilization funds.
  - Savings funds for future generations.
  - Reserve investment corporations.
  - Development funds.
  - Contingent pension reserve funds.
- Objectives may be multiple, overlapping, or change over time; objective differences imply different investment horizons and risk/return trade-offs (e.g., stabilization funds emphasize liquidity and shorter-term horizons; savings funds emphasize low liquidity needs and longer horizons).

### Size, current estimates, and projections
- Global and comparative figures:
  - International reserves (including gold): about US$7 trillion.
  - Additional assets in SWFs: US$2 to 3 trillion.
  - SWFs exceed the size of hedge funds (US$1.7 trillion).
  - Total global financial assets estimated at US$190 trillion.
- Projections and external estimates:
  - Fund projections indicate foreign assets under management of SWFs could reach US$6–10 trillion by 2013.
  - Morgan Stanley projects SWFs’ assets could exceed official reserves by 2011.
  - Standard Chartered projects SWFs’ assets to reach US$13.4 trillion over the next decade.
- Selected market estimates (Table 1, as of February 2008; figures in billions of U.S. dollars; lower/upper ranges shown):
  - Abu Dhabi Investment Authority: 250 875
  - Government Pension Fund-Global (Norway): 380 380
  - China Investment Corporation: 200 200
  - Singapore Government Investment Corp.: 100 330
  - Temasek Holdings (Singapore): 108 108
  - Total (aggregated lower and upper estimates): 2,093 2,968

### Investment strategies, management, and behavior
- Heterogeneous strategies reflecting objectives:
  - Some SWFs invest solely in publicly-listed financial assets (bonds, equities); others invest across major asset classes including alternative investments.
  - Some invest relative to market indices and impose caps on maximum holdings in individual companies; others aim to maximize absolute returns over longer horizons and may acquire larger stakes.
- Typical behavior and operational arrangements:
  - Generally described as passive and long-term investors; often vote by proxy and ask external managers to vote on their behalf.
  - Use of social responsibility or ethical guidelines by some SWFs to rule out specific industries.
  - Most SWFs actively use external managers; some have developed substantial in-house capacity (examples cited: Norway, Abu Dhabi, and Singapore).
  - Use of leverage is generally thought to be low, although some funds have used leverage.
- Specific operational note:
  - Some SWFs taking larger stakes have relinquished voting rights as a condition for private transactions (example cited: China Investment Corporation’s near 10 percent stake in Blackstone Group, May 2007).

### Transparency, governance, and best-practice agenda
- Current disclosure and governance gaps:
  - No uniform public disclosure across SWFs; institutional arrangements and accountability mechanisms often not publicly disclosed.
  - Some SWFs (Canada and Norway) are highlighted as leading in disclosure; Kuwait Investment Authority disclosed total assets in 2007.
- Rationale for best practices:
  - Best practices would strengthen domestic policy frameworks, improve transparency and accountability, and ease concerns of recipient countries and markets.
- Proposed focus areas for best practices:
  - Governance, institutional arrangements, and transparency.
  - Clear legal framework specifying roles, objectives, and responsibilities.
  - Clear allocation of responsibilities and coordination with macroeconomic policy.
  - A clearly specified risk management framework.
  - Regular and timely publication of accurate and comprehensive data on size, sources and uses of funds, operations, and, where significant, quarterly reporting of asset composition by type and class.
  - Annual independent external audits published in a timely fashion.
- Working definition proposed by Fund staff:
  - "SWFs are special purpose public investment funds, or arrangements. These funds are owned or controlled by the government, and hold, manage, or administer assets primarily for medium- to long-term macroeconomic and financial objectives.*"
- Included in scope (in principle): (i) fiscal stabilization funds; (ii) saving funds; (iii) reserve investment corporations; (iv) development funds; and (v) pension reserve funds (those without explicit pension liabilities).
- Excluded inter alia: (a) government-employee pension funds; (b) social security funds; (c) government lending funds; and (d) government-owned banks.

### Macrofinancial effects, market impact, and risks
- Portfolio composition and risk:
  - SWF portfolios typically more diversified than traditional reserves, with considerable equity stakes and wider geographic dispersion.
  - Norway’s GPF invested some 40 percent of holdings in equities (and the balance in fixed income) and aims for an allocation of 60 percent in equities by 2010.
  - A few SWFs have made alternative investments in hedge funds, private equity, and real estate.
  - Estimated that 22 percent of investments from the Gulf are in Asia, the Middle East, and North Africa (McKinsey Global Institute).
- SWFs’ role in recent financial turmoil:
  - Recent SWF capital injections into large banks totaled over US$35 billion.
  - Prominent participations cited: GIC and ADIA in Citigroup; Temasek, KIC, and KIA in Merrill Lynch; CIC in Morgan Stanley; GIC in UBS.
  - Such injections are likely to facilitate capital replenishment for systemically important banks and help contain credit-market impacts, though resilience under other macro shocks is uncertain.
- Potential stabilizing effects:
  - As long-term, mainly unleveraged investors, SWFs can sit out downturns, go against trends, and enhance market depth and breadth.
- Potential sources of volatility and concerns:
  - Large and sometimes unclear positions could cause market disturbance—actual or rumored transactions may affect relative valuations and induce herding, especially in shallower markets.
  - Risk that SWFs pursuing riskier strategies involving leverage could amplify cycles.
  - SWF involvement in the financial sector may complicate central bank crisis management and coordination.
- Effects on asset prices, capital flows, and global imbalances (selected quantitative assessments):
  - Foreign official investors are estimated to have kept 10-year U.S. Treasury nominal yields 100 bps lower than otherwise (Warnock and Warnock, NBER Working Paper 12560, October 2006).
  - Morgan Stanley estimates that over the next decade bond yields may rise by 30–40 basis points, while the equity risk premium falls by 50–70 basis points.
- Simulation results (Annex I, stylized exercise; assumptions preserved):
  - Assumed transfer of between 25 percent (lower bound) and 50 percent (upper bound) of newly available foreign currency inflows to SWFs.
  - United States effects from simulated diversification:
    - Estimated inflows into the United States could decline by ¼–½ percent of U.S. GDP per year on average depending on stylized asset allocation strategy.
    - Simulations (GIMF5 model) point to a 10–20 bp increase in U.S. real interest rates.
    - Simulations point to a 2–5 percent depreciation of the U.S. dollar.
    - U.S. current account deficit could improve by ¼–½ percentage point of GDP.
  - Rest of world effects:
    - Higher capital inflows to other regions would lead to lower real interest rates, more appreciated currencies (in real effective terms), and boosted domestic demand.
    - Inflation in Asia would increase as a result of continued reliance on a currency peg to the dollar.
  - Model caveats:
    - Model does not suggest disorderly depreciation of the U.S. dollar or disorderly unwinding of global imbalances.
    - Model does not take into account possible second round effects as other investors react to SWF behavior changes.

### Simulated stylized portfolios and currency compositions (Annex I, Table 1)
- Stylized portfolios (percent allocation):
  - COFER (stylized reserves portfolio): Bonds 100.0
  - Norway-like portfolio: Bonds 40.0; Equities 60.0
  - Diversified portfolio: Bonds 23.0; Equities 55.0; Real estate 7.0; Hedge funds 7.5; Private equity 7.5
- Currency composition (percent):
  - COFER: U.S. dollar 59.0; Euro 29.7; Pound 5.8; Yen 3.0; Other 2.4
  - Norway: U.S. dollar 31.8; Euro 35.0; Pound 13.6; Yen 6.9; Other 12.7
  - Diversified portfolio: U.S. dollar 38.0; Euro 13.9; Pound 13.9; Yen 10.2; Other 24.0

### Corporate governance, recipient-country concerns, and regulatory responses
- Recipient-country concerns and regulatory levers:
  - Concerns include potential noncommercial investment practices, political motives, and perceived government guarantees that could lead to restrictive measures or targeted regulations.
  - Regulatory tools discussed:
    - Securities reporting thresholds (e.g., 5 percent in the United States, 10 percent in the EU).
    - Foreign investment vetting on public order and national security grounds (e.g., CFIUS in the United States); EU has no EU-level vetting agency.
    - Prudential rules for investments in supervised financial institutions, suitability tests for acquisitions above thresholds (e.g., 10 percent).
    - Scrutiny under anti-monopoly and takeover regulations.
- Proposed measures to allay concerns (examples, with noted trade-offs):
  - A standard covering objectives and investment strategy, governance, accountability, and transparency.
  - Investing at arm’s length solely through intermediary asset managers.
  - Upper limits on ownership and/or voting rights of SWFs in foreign firms.
  - Publishing a voting list on a regular basis.
  - A “negative list” of strategic and sensitive areas where SWFs should not invest.
- Caution: Some proposals may unduly inhibit SWF operations and impede efficient capital flows.

### IMF work program, surveillance role, and operational implications
- Recent IMF actions:
  - Organized a Roundtable of Sovereign Asset and Reserve Managers in November 2007.
  - Intensified analysis of SWFs in staff work and in the GFSR.
  - Set up an interdepartmental working group on SWFs chaired by FDMD.
- Mandate and scope for Fund involvement:
  - SWFs’ macroeconomic and financial stability implications fall within the Fund’s surveillance mandate.
  - The Fund should continue assessments of SWFs’ impact on members’ economic management and vulnerabilities, with evenhanded coverage across home and recipient countries.
  - Limits to Fund jurisdiction: members retain the right to regulate international capital movements; the Fund does not set market integrity rules or determine national security interests, though market-integrity and national-security issues affecting economic stability fall under surveillance.
- Surveillance, technical assistance, and statistics:
  - Bilateral surveillance (Article IV consultations) should ensure SWFs are captured in assessments of domestic and external stability, fiscal and monetary policy, and asset-liability management.
  - Multilateral surveillance (GFSR, WEO) to analyze macrofinancial linkages and likely capital flow directions and asset-price effects.
  - Technical assistance on SWF structure, integration into fiscal policy, reserve management, balance-sheet risks, governance, and transparency.
  - Statistics: SWF flows and positions should be captured in national accounts, fiscal statistics, monetary and financial statistics, and external accounts (BoP and IIP). A voluntary data item on SWFs in the IIP has been agreed for the draft BPM; draft BPM6 includes guidance on special purpose government funds.
  - Encourage increased participation in COFER, CPIS, and the Coordinated Direct Investment Survey (first at year end-2009).
- Data gaps and recommended reporting:
  - Significant gaps: some members do not include SWFs in BoP and IIP positions or do not compile an IIP; functional breakdowns often unavailable.
  - Adequate coverage would require quarterly reporting (with a quarterly lag for aggregate balance sheets) and possibly aspects of asset composition.
  - Data on returns and income could be useful; issues to be discussed with statistical committees.

### Resource implications, timetable, and next steps
- Resource cost estimate for program to develop best practices:
  - Resources amounting to two staff years (US$0.7 million) are expected to be required over the next fiscal year.
- Selected staff-calculated line items (as presented):
  - FY2008FY2009Total
  - Number of missions71522
    - Survey tabulation303
    - Coordination369
    - Roundtables112
    - Outreach088
  - Days/mission                                                                  118...
    - Survey tabulation 1/120...
    - Coordination 1/1212...
    - Roundtables 2/7.57.5...
    - Outreach 3/05...
  - Field time (in days)80119199
    - Survey tabulation36036
    - Coordination3672108
    - Roundtables8715
    - Outreach04040
  - Other costs (in days) 4/60260320
  - Total resource costs (days)140379519
  - Total resource costs (years)0.51.52.0
  - Total  resource costs (US$) 5/110,939330,037440,977
    - Mission travel (US$) 6/84,000184,500268,500
    - Total Costs (US$) 194,939514,537709,477
- Proposed approach and timetable (if Directors agree):
  - Convene an international Working Group of SWFs and a Roundtable of SWFs in April to begin technical discussions and drafting work.
  - Prepare a draft of SWF principles and practices by August 2008.
  - Circulate draft for wider consultation over the following two months.
  - Send a revised set of principles and practices to the Board for discussion ahead of the 2008 Annual Meetings.
- Consultation and coordination partners to include multilateral development banks, selected academics, market participants, international accounting and auditing bodies, legal practitioners, and the World Bank.

### Annex I — portfolio diversification key findings (summary)
- General observations:
  - SWFs typically have medium- to long-term investment horizons, making abrupt portfolio shifts less likely.
  - Even a benign shift toward greater portfolio diversification by sovereigns would affect absolute and relative asset prices, flow of funds, and evolution of global imbalances.
- Gravity model findings (selected):
  - Gravity model reinforces that geographic diversification may increase when shifting from reserve holdings to SWF assets; the United States and other advanced economies likely to receive lower inflows if assets are held by SWFs rather than as reserves.
  - Estimated betas from gravity model:
    - Equity: b_dist=-.7649499; b_contig=.6357502; b_comlang=.4907374
    - Debt: b_dist=-.8023374; b_contig=.1403246; b_comlang=.2249871
    - FDI: b_dist=-1.286229; b_contig=.6324757; b_comlang=.5407307
  - Gravity model comparisons (selected):
    - Norway (Actual portfolio as of September 2007): Asia and Pacific 25; Europe and Central Asia 60; Latin America/Caribbean 10; Africa and Middle East 0; North America 35
    - Gravity model predictions for Norway: Asia and Pacific 8; Europe and Central Asia 64; Latin America/Caribbean 12; Africa and Middle East 2; North America 26
    - Temasek (Actual portfolio as of March 2007, excludes Singaporean assets): Asia 65; OECD 13; Other 22
    - Gravity model predictions for Temasek: Asia 46; OECD 51; Other 3

*Source: IMF staff document excerpt (Sovereign Wealth Funds—A Work Agenda, Sections I–VII and Annexes).*

### 1.   SWFs and Investment Strategies ....................................................................................

### 1.   SWFs and Investment Strategies

### Introduction
- Sovereign Wealth Funds (SWFs) are government-owned investment funds, set up for a variety of macroeconomic purposes and commonly funded by the transfer of foreign exchange assets that are invested long term, overseas.
- Drivers of recent rapid growth: high oil prices, financial globalization, and sustained, large global imbalances.
- Rising number and size of SWFs has increased their prominence in international capital markets and drawn attention to their macroeconomic and financial linkages.

### Objectives and Types of SWFs
- Five types distinguished by main objective:
  - Stabilization funds: primary objective to insulate the budget and the economy against commodity (usually oil) price swings.
  - Savings funds for future generations: convert nonrenewable assets into a more diversified portfolio and mitigate Dutch disease.
  - Reserve investment corporations: assets often still counted as reserve assets, established to increase the return on reserves.
  - Development funds: fund socio-economic projects or promote industrial policies to raise potential output growth.
  - Contingent pension reserve funds: provide for contingent unspecified pension liabilities on the government’s balance sheet (from sources other than individual pension contributions).
- Objectives may be multiple, overlapping, or change over time; objectives imply different investment horizons and risk/return trade-offs (e.g., stabilization funds emphasize liquidity and shorter-term horizons; savings funds emphasize low liquidity needs and longer horizons).

### Size, Current Estimates, and Projections
- Estimates and comparisons:
  - International reserves (including gold): about US$7 trillion.
  - Additional assets in SWFs: US$2 to 3 trillion.
  - SWFs exceed the size of hedge funds (US$1.7 trillion), though hedge funds tend to be heavily leveraged.
  - Total global financial assets estimated at US$190 trillion.
- Projections and outlook:
  - Fund projections indicate foreign assets under management of SWFs could reach US$6–10 trillion by 2013.
  - External commentary and projections cited:
    - Morgan Stanley projects SWFs’ assets could exceed official reserves by 2011.
    - Standard Chartered projects SWFs’ assets to reach US$13.4 trillion over the next decade.
- Selected market estimates from Table 1 (Based on Latest Available Information, As of February 2008; figures in billions of U.S. dollars; lower/upper ranges shown):
  - Abu Dhabi Investment Authority: 250 875
  - Government Pension Fund-Global (Norway): 380 380
  - China Investment Corporation: 200 200
  - Singapore Government Investment Corp.: 100 330
  - Temasek Holdings (Singapore): 108 108
  - Total (Table 1, aggregated lower and upper estimates): 2,093 2,968

### Transparency, Governance, and Integration with Domestic Policy
- Disclosure and reporting:
  - No uniform public disclosure of assets, strategies, and governance across SWFs; some funds reveal little.
  - Institutional arrangements (withdrawal and accumulation rules, investment management, reporting channels) are often not publicly disclosed.
  - Internal and external accountability arrangements are sometimes unclear.
  - Some SWFs (examples provided) are increasing disclosure: Canada and Norway highlighted as leading in disclosure; Kuwait Investment Authority disclosed total assets in 2007.
- Integration with domestic policy:
  - It is sometimes difficult to establish how SWFs are integrated into domestic policy frameworks and macroeconomic data sets.
  - Example of integration: Singapore’s SWFs are integrated in the fiscal framework through a constitutional rule that allows a transfer to the budget of up to 50 percent of dividends and interest earned (in practice significantly less than this upper bound).

### Investment Strategies and Management (Box 1)
- Heterogeneous strategies reflecting different objectives:
  - Some SWFs invest solely in publicly-listed financial assets (bonds, equities); others invest across major asset classes including alternative investments.
  - Some invest relative to market indices and impose caps on maximum holdings in individual companies to ensure diversification.
  - Others aiming to maximize absolute returns over longer horizons may shift between asset classes and acquire larger stakes in specific companies.
- Evidence on behavior:
  - SWFs are generally described as passive and long-term investors with no desire to impact company decisions by actively using their voting rights (often vote by proxy and ask external managers to vote on their behalf).
  - Use of social responsibility or ethical guidelines by some SWFs to rule out specific industries (e.g., tobacco, military).
- Management and implementation:
  - Most SWFs actively use external managers to match index returns or to create active risk-adjusted return.
  - Public sector investment managers have significant experience in fixed-income markets but often limited capacity for other asset classes; reliance on external managers is common.
  - Some SWFs have developed substantial in-house capacity and operate as professional investment managers (examples cited: Norway, Abu Dhabi, and Singapore).
  - Use of leverage is generally thought to be low for SWFs, although some funds have used leverage.
- Specific operational note:
  - Some SWFs taking larger stakes in companies have explicitly relinquished their voting rights as a condition for private transactions (example cited: China Investment Corporation’s near 10 percent stake in Blackstone Group, May 2007).

### Issues Raised by SWF Growth
- Concerns from official and private commentators:
  - Transparency of SWFs (size, investment strategies).
  - Potential political objectives influencing SWF investments.
  - Expanded role of governments in international markets and industries.
  - Effects on recipient countries with shallow markets.
  - Risk of protectionist restrictions on SWF investments.
  - SWFs’ vulnerability to changes in regulatory climate and the costliness of operational adjustments.

### IMF Fund Staff Work and Proposed Agenda
- Recent Fund actions:
  - Organized a first Roundtable of Sovereign Asset and Reserve Managers in November 2007 to facilitate dialogue on best practices; participants welcomed the dialogue.
  - Intensified analysis of SWFs, drawing out macroeconomic and financial linkages and including assessments in the Global Financial Stability Report (GFSR).
  - Stepped up contacts with financial market participants and coordinated work with the OECD; liaised with the World Bank and others.
  - Fund Management set up an interdepartmental working group on SWFs, chaired by the FDMD, to consider policy, operational, and technical aspects relevant for Fund surveillance.
- Objectives of the paper:
  - Improve the Fund’s surveillance over SWF operations given their importance for domestic policy and effects on international financial markets.
  - Discuss issues surrounding development of a set of voluntary best practices to improve institutional arrangements, organizational structures and risk management, and information dissemination practices.
- Areas signaled for future work (paper organization):
  - Section II: what is known about SWFs.
  - Section III: issues they raise.
  - Section IV: operational implications for the Fund.
  - Section V: identifying best practices.
  - Section VI: estimates of resource costs.
  - Section VII: possible next steps and questions for the Board.

*Sovereign Wealth Funds—A Work Agenda, Sections I–II.*

### 13.      SWF portfolios typically involve more diversified asset allocations than traditional

### _022908 - 13.      SWF portfolios typically involve more diversified asset allocations than traditional

### Portfolio composition and risk profile
- SWF portfolios typically involve more diversified asset allocations than traditional reserves holdings, with considerable stakes in equities and a wider geographical dispersion.
- Norway’s GPF currently invests some 40 percent of holdings in equities (and the balance in fixed income) and aims for an allocation of 60 percent in equities by 2010.
- SWF portfolio composition resembles that of larger public sector pension funds (example: Canadian Caisse de Dépôt et Placement du Québec; Dutch Algemeen Burgerlijk Pensioenfonds).
- SWFs are estimated to hold relatively large shares in emerging markets, which tend to be more volatile but generate higher returns in the long run.
- A few SWFs have made alternative investments including in hedge funds, private equity, and real estate.
- It is estimated that 22 percent of investments from the Gulf are in Asia, the Middle East, and North Africa (McKinsey Global Institute).

### SWFs’ role during financial turmoil
- In the recent financial turmoil, SWFs demonstrated potential stabilizing influence on markets.
- Recent announcements of substantial injections of capital into several large banks by SWFs from East Asia and the Middle East totaled over US$35 billion.
- Prominent investments cited include participations by GIC (Singapore) and ADIA (UAE) in Citigroup; Temasek (Singapore), KIC (Korea), and KIA (Kuwait) in Merrill Lynch; CIC (China) in Morgan Stanley; and GIC (Singapore) in UBS.
- These injections are likely to facilitate replenishment of capital bases of systemically important banks, help contain the impact on credit markets of large bank losses, and safeguard the continuation of bank lending.
- Caution: in other circumstances SWFs could pose risks and it is difficult to assess whether SWF positions would remain steady and resilient in the face of other major macroeconomic shocks.

### Macroeconomic impact in home and host countries
- SWFs’ assets and returns can significantly affect public finances, monetary conditions, the balance of payments, and balance-sheet linkages; they may also affect public sector wealth and private sector behavior.
- Four policy angles are highlighted: fiscal policy, monetary policy, balance sheet implications, and external stability.

Fiscal policy
- SWFs can facilitate fiscal stabilization and/or saving fiscal resources for long-term purposes (e.g., preparing for population aging or intergenerational transfers).
- SWFs can introduce more professional investment and risk management frameworks and enhance transparency and accountability in management of government financial assets.
- Poorly managed SWFs may pose fiscal risks: oil funds with rigid operational rules and authority to spend independently, or those involved in quasi-fiscal activities (including on-lending), have led to budget fragmentation and negative implications for efficiency and transparency when control and monitoring mechanisms are weak.
- SWFs can potentially generate losses; fiscal authorities have a direct stake in ensuring adequate risk profiles and sound management.
- SWFs need to be taken into account in public sector solvency and debt sustainability assessments.

Monetary policy
- SWF investment decisions (domestic vs. abroad) involve currency transactions and can affect the exchange rate.
- Discretionary shifts from foreign into domestic assets would pose difficulties for monetary authorities’ sterilization operations.
- SWF investments in domestic assets add to domestic demand, can cause local asset price bubbles, and may complicate monetary policy by injecting liquidity.

Public-sector balance sheets
- Stabilization funds (short- to medium-term objectives) are normally more conservative with shorter investment horizons and low risk-return profiles.
- Long-term objective SWFs typically aim at higher returns and have higher risk profiles.
- SWFs with objectives to hedge country-specific risks may hold assets with negative correlation to the country’s major exports.
- SWFs with explicit (or implicit) liabilities must consider portfolio mismatches and risks to balance-sheet soundness; leveraging SWFs by borrowing domestically to accumulate foreign assets would substantially add to fiscal risks.
- Clarifying and limiting objectives of an SWF and effective coordination with government and monetary authorities are important.

External stability
- For countries with SWFs, the SWF is a key part of assessing external stability and the evolution of the net external asset position relative to the underlying current account.
  - For commodity exporters, it may be appropriate to run transitory current account surpluses while resources are extracted and draw down assets after depletion; transitory price shocks and resource depletion must be considered.
  - For other countries with SWFs where accumulation of net foreign assets may relate to exchange rate policies, assessment of external stability is likely less affected by commodity price swings; reserve adequacy must be considered.
- For countries receiving SWF inflows, flows affect the capital and financial account and relative prices; character and motive of inflows matter for policy response.
- Challenges in managing these capital flows are small for large advanced economies but may be acute for small open economies or economies with nascent capital markets.

### Implications for global financial stability and markets
- SWFs can play a stabilizing role: as long-term, mainly unleveraged investors, they can sit out downturns or go against trends; they may pursue gradual reallocations to limit adverse price effects; their investments can enhance market depth and breadth; diversifying the global investor base may contribute to greater market efficiency and lower volatility.
- Currently, SWFs are generally not regarded as highly leveraged and there is little evidence of sudden shifts in portfolio allocations.

Potential sources of volatility
- Large and often unclear positions in financial markets mean SWFs could cause market disturbance; actual or rumored transactions may affect relative valuations and result in herding behavior, adding volatility—especially in shallower markets.
- If SWFs pursue riskier strategies involving leverage and margin requirements, they may amplify cycles.
- SWF involvement in the financial sector may complicate central bank crisis management and coordination during turmoil.

Effects on asset prices, capital flows, and global imbalances
- Shift from reserve assets to SWFs could affect absolute and relative asset prices, flow of funds between countries, and evolution of global imbalances.
- By investing in more diversified and riskier assets than traditional reserve holdings, SWFs may:
  - Diversify away from low-risk, short-term instruments (e.g., U.S. Treasury bills) into longer-term equity stakes, affecting interest rates and equity prices.
  - If SWFs diversify away from dollar holdings and invest more in line with global equity indices, a decline in capital inflows into the United States may cause an increase in real interest rate differentials and a dollar depreciation.
- At present, dollar effects appear partly offset by announced large injections of capital into the U.S. banking sector.
- In the rest of the world, higher capital inflows would lead to lower real interest rates, more appreciated currencies (in real effective terms), and higher domestic demand.
- Estimates and projections are subject to uncertainties over shifts in asset allocation and reactions of other investors; separate research supports likely directions of effects.

Selected quantitative assessments and estimates
- Foreign official investors are estimated to have kept 10-year U.S. Treasury nominal yields 100 bps lower than otherwise. (“International Capital Flows and U.S. Interest Rates,” NBER Working Paper 12560, Francis E. Warnock and Veronica C. Warnock, October 2006.)
- Morgan Stanley estimates that over the next decade bond yields may rise by 30–40 basis points, while the equity risk premium falls by 50–70 basis points (Morgan Stanley: “Economics and Currencies—Sovereign Wealth Funds and Bond and Equity Prices,” May 2007).

### Corporate governance, investment behavior, and risk of financial protectionism
- Good corporate governance of SWFs is key for domestic stakeholders: clarity on authority relationships, rights of shareholders, role of stakeholders, disclosure and transparency, board composition and responsibilities, and internal risk management.
- Internal risks to address include operational risks (especially high in new organizations and developing countries with capacity shortages) and reputational risks when high-profile investments incur temporary losses.
- Oversight for outsourced functions (external fund management, custodians, fund administration) is critical to prevent misstatements or misappropriations.
- Concerns among recipients of SWF investments:
  - Objectives and possible noncommercial investment practices, including political motives or targeting strategic areas, which could fuel resistance and lead to targeted regulations or restrictions on foreign investments and takeovers.
  - Perception that SWFs could gain unfair advantage if financial commitments are guaranteed by government or perceived to be so.
  - Risk of regulatory arbitrage, with SWF investments directed to host countries with the lightest restrictions.
- Corporate governance effects:
  - Concern that SWFs may exert too great an influence over strategic direction of firms.
  - Opposing view: SWFs may be too passive, abstaining from using voting rights and weakening oversight.
- Proposals and suggested standards to allay concerns (examples mentioned; costs and trade-offs noted):
  - A standard covering objectives and investment strategy, governance, accountability, and transparency.
  - Invest at arm’s length solely through intermediary asset managers (as in some endowment funds); critics note guidance to asset managers by SWFs may still present conflicts.
  - Upper limits on ownership and/or voting rights of SWFs in foreign firms (limits set below thresholds for a controlling minority).
  - Publish a voting list on a regular basis.
  - A “negative list” of strategic and sensitive areas where SWFs should not invest.
- Caution: some proposals may unduly inhibit SWF operations and impede efficient flow of capital.

*Source: IMF chapter/section content as provided.*

### 30.      Eliminating all the concerns about SWFs is likely to be difficult, but if left entirely

### 30.      Eliminating all the concerns about SWFs is likely to be difficult, but if left entirely

### Transparency and the Availability of Statistics
- Absence of SWF data can hinder economic analysis and mislead policymakers, market participants, and commentators (¶31).
- SWF flows and positions should be captured in:
  - national accounts;
  - fiscal statistics (public finance statistics);
  - monetary and financial statistics;
  - external accounts, including the balance of payments (BoP) and international investment position (IIP) (¶31).
- Rationale for inclusion:
  - SWFs can significantly affect generation and distribution of income, consumption behavior, and accumulation activities (¶31).
  - Net assets of SWFs, whether held directly or indirectly, should be encompassed in the government’s net worth (¶31).
  - SWFs are often a significant part of an economy’s external wealth and affect monetary policy formulation and financial analysis (¶31).
- Current gaps and ongoing work:
  - Significant gaps exist: some members do not include SWFs in BoP and IIP positions or do not compile an IIP; functional breakdowns often unavailable; gaps in the Coordinated Portfolio Investment Survey (¶32).
  - A voluntary data item on SWFs in the international investment position has been agreed for the draft Balance of Payments Manual (¶32).
  - The draft sixth edition of the Balance of Payments and International Investment Position Manual (BPM6) includes guidance on special purpose government funds, usually known as SWFs, in relation to reserves (footnote 20).

### Operational Implications for the Fund — Mandate and Scope
- Mandate fit:
  - SWFs’ macroeconomic and financial stability implications fall within the Fund’s surveillance mandate and ensuring the effective functioning of the international monetary system (¶33).
  - The Fund should continue assessments of SWFs’ impact on members’ economic management and vulnerabilities, with evenhanded coverage across home and recipient countries (¶33).
  - From a multilateral perspective, SWFs may affect international financial stability via global liquidity conditions, asset prices, and capital flows (¶33).
- Advice and technical assistance:
  - SWF issues are relevant to the Fund’s technical assistance on monetary, fiscal, and balance sheet risk management (¶34).
  - The Fund has provided advice on SWF structure, integration into fiscal policy (fiscal ROSCs), and reserve management (¶34).
- Limits to Fund jurisdiction:
  - Members retain the right to regulate international capital movements under the Fund’s Articles; capital controls related to SWF operations that do not restrict current international transactions or unduly delay transfers would fall outside Fund jurisdiction (¶35; footnote 21).
  - The Fund is not positioned to regulate financial markets, set market integrity rules, or determine members’ national security interests (¶35).
  - Where market integrity or national security issues impact domestic/external economic stability or international financial stability, they fall under the Fund’s surveillance authority (¶35; footnote 22).
  - Domestic market regulators (e.g., SEC, Autorité des Marchés Financiers) and IOSCO handle market integrity; national safeguard procedures (e.g., CFIUS) handle national security (¶35).

### Regulation of SWF Activities by Recipient Countries (Box 2)
- Securities regulation and corporate governance:
  - Reporting thresholds: acquisitions above certain thresholds trigger reporting—5 percent in the United States, 10 percent in the EU.
  - Corporate governance rules of invested companies could be applied to address perceived noncommercial influence; company by-laws may require notification below regulatory thresholds (Box 2).
  - Legal principles on fiduciary responsibility and avoidance of conflicts of interest apply where SWFs acquire influence over directors (Box 2).
  - Market integrity rules (insider trading, market manipulation) may apply similarly to SWFs, though enforcement may be complicated by sovereign immunity (Box 2).
- Foreign investment vetting:
  - Countries may impose limits under foreign investment regimes and reserve the right to oppose foreign investments on public order and national security grounds; special agencies (e.g., CFIUS) review such transactions (Box 2).
  - EU: no EU-level vetting agency; individual member states may restrict capital inflows on “public policy or public security” grounds (Box 2, footnote).
- Financial institution regulation:
  - Investments in supervised financial institutions may be subject to prudential rules; acquisitions above thresholds (e.g., 10 percent) may require prior approval via a “suitability test” (Box 2).
- Regulation of strategic sectors:
  - Sectors deemed strategic or socially important (e.g., energy, media, telecommunications) often face special laws that may apply to SWFs (Box 2).
- Anti-monopoly agencies:
  - SWF investments may be scrutinized under anti-monopoly or takeover regulations on market structure grounds (Box 2).
- Examples and precedents:
  - Reported investment by a China SWF subsidiary of under 1 percent in Australian banks illustrates reporting application (Box 2, footnote 1).
  - U.K. Monopoly and Mergers Commission review: Kuwaiti SWF acquisition of 20 percent of BP led to a decision that constrained BP’s competitiveness; resulting reduction of holding to 9.9 percent over 12 months (Box 2, footnote 4).

### The Work of the OECD (Box 3)
- OECD instruments relevant to capital movements and investment:
  - Codes of Liberalization: Code of Liberalization of Capital Movements and Code of Liberalization of Current Invisible Operations impose legally binding rules on progressive, nondiscriminatory liberalization (Box 3).
  - Declaration and Decisions on International Investment and Multinational Enterprises: political agreement with binding decisions; comprises National Treatment instrument, Guidelines for Multinational Enterprises, an instrument on incentives/disincentives, and an instrument on conflicting requirements (Box 3).
  - All 30 OECD member countries and eight nonmember countries have subscribed to the Declaration (Box 3).
- OECD recent work on national security and investment:
  - “Freedom of Investment, National Security and ‘Strategic’ Industries” project launched early 2006, endorsed by G-8 Communiqué of June 2007.
  - Project seeks to clarify national security and strategic industries concepts; progress report expected in the spring of 2008; update to be completed in 2009 (Box 3).
- Corporate governance of state-owned enterprises:
  - Working Group examining relevance of OECD guidelines for State-Owned Enterprises to SWFs and potential extension; no decision to draft new SWF-specific guidelines at this stage (Box 3).

### Fund Surveillance — Bilateral and Multilateral, Technical Assistance, and Statistics
- Bilateral surveillance (Article IV consultations):
  - For members with established or newly forming SWFs, the Fund should ensure SWFs are fully captured in assessments of domestic and external stability, fiscal and monetary policy, and asset-liability management (¶37).
  - Surveillance should highlight tensions between SWF activities and coordination of monetary and fiscal policy, spillovers to other economies, and implications for external stability (¶37).
- Multilateral surveillance:
  - The GFSR has begun analyzing SWFs’ growing market impact; prior WEO and GFSR work examined oil export revenues’ impact on global imbalances (¶38).
  - The Fund is stepping up multilateral surveillance to analyze macrofinancial linkages and SWF implications (¶38).
  - Further work may consider likely capital flow directions, effects on asset prices, and impacts on specific markets or institutions (e.g., U.S. banking sector) (¶38).
- Technical assistance and advice:
  - Fund advice covers balance sheet risks, reserve management, public finances, financial stability, governance structure, and transparency arrangements of SWFs; relevant for established SWFs and countries setting up new SWFs (¶39).
- Statistics and data collection:
  - The Fund should continue working with countries to improve data provision consistent with existing requirements, promoting full coverage of SWFs in BoP, IIP, public finance statistics, and national accounts (¶40).
  - Adequate coverage in national accounts and public finance statistics would require quarterly reporting (with a quarterly lag for aggregate balance sheets) and possibly aspects of asset composition (¶40).
  - Increased participation is encouraged in: COFER (Currency Composition of Foreign Exchange Reserves initiative — voluntary and confidential), CPIS, and the Coordinated Direct Investment Survey to be conducted for the first time at year end-2009 (¶40).
  - Data on returns and income could be useful; issues to be discussed with statistical committees, including the IMF Committee on Balance of Payments Statistics (¶40).

### Identifying Best Practices (beginning of Section V)
- Purpose:
  - A set of best practices for SWFs with broad agreement would help strengthen domestic policy frameworks, benefit international financial markets, and ease raised concerns (¶41).
- Role of the Fund:
  - The Fund is well placed to coordinate work on best practices, drawing on past operational guidance in fiscal transparency (ROSC) and reserve management (¶41).
  - An inclusive, collaborative approach involving relevant members and SWFs themselves would be pursued (¶41).
- Next steps:
  - The section that follows reviews existing guidelines applicable to SWFs and proposes a tentative roadmap for best practices (¶41).

*Source: IMF chapter/section titled “Eliminating all the concerns about SWFs is likely to be difficult, but if left entirely” (paragraphs 30–41, Boxes 2–3).*

### 42.      There is already a range of existing Fund guidance for fiscal, monetary, and

### _022908 - 42.      There is already a range of existing Fund guidance for fiscal, monetary, and

### Existing Fund guidance and applicability
- The Fund has a range of existing guidance for fiscal, monetary, and financial transparency and for reserve management that are widely applied, offering well-established internationally-accepted guidance on governance, transparency, accountability issues, and risk management frameworks.
- Relevant Fund standards include: The Code on Good Practices on Fiscal Transparency, Special Data Dissemination Standards, General Data Dissemination System, and the Code on Good Practices on Transparency in Monetary and Financial Policies. These are supported by the Guide on Resource Revenue Transparency and the Manual on Fiscal Transparency.23
- The Guidelines for Foreign Exchange Reserve Management (GFERM)24 are also relevant to the issues discussed.

### Key elements of Fund guidance highlighted
- Fiscal transparency guidelines emphasize:
  - Clarity in the legal structure specifying roles, objectives, and responsibilities.
  - Coordination of policy objectives and operations, information flows, and assurances of integrity.
- Reserve management guidelines emphasize:
  - Clarity of roles, responsibilities, and objectives of financial agencies responsible for reserve management.
  - An open process for reserve management operations and public availability of information on foreign exchange reserves, accountability and assurances of integrity by reserve management agencies, and the existence of a sound institutional and risk management framework.

### Relevance of guidance to Sovereign Wealth Funds (SWFs)
- Several components of Fund guidance are relevant to SWFs. Common themes of particular relevance include:
  - A clear legal framework that specifies the institutional structure within which a sovereign entity (and its subsidiaries) operates and ensures that its objectives, role, scope, and responsibilities are clearly laid out.
  - Clear and publicly disclosed allocation of responsibilities and its relationships with counterparties (for reserve management entities).
  - Mechanisms to ensure that the sovereign entity operates in a manner consistent with the pursuit of overall government policy objectives.
  - A clearly specified risk management framework.25
  - Regular and timely publication of accurate and comprehensive data on the size of sovereign entities, their sources and uses of funds, and their operations. Where financial asset holdings are significant, balances should be reported quarterly on the composition of assets and liabilities, including by type and class.26
  - Annual independent external audits of the entity’s financial statements that should be published in a timely fashion.
  - Clear provisions to ensure the integrity of operations and of all published information.

### Best practices: scope, rationale, and process
- Rationale for Fund coordination:
  - Given its wide membership, mandate, and experience, the Fund is well placed to coordinate work on a set of best practices, to be adopted by SWFs on a voluntary basis.
  - Best practices would draw on existing practices of SWFs and build, where appropriate, on relevant existing guidelines, including those of the Fund and the OECD, and be prepared with input from SWFs, the OECD, the World Bank, other multilateral development banks, and others.
- Focus areas proposed for best practices:
  - Governance, institutional arrangements, and transparency.
  - Clear governance structures to foster accountability and a disciplined and stable investment policy which reduces fiscal risk and promotes financial stability.
  - Transparency to contribute to efficient allocation of resources by ensuring markets and the public have information to identify risks and better assess SWF behavior.
  - A blueprint to set out needed information, create a level playing field, and reduce scope for different degrees of transparency between SWFs, thereby reducing uncertainty and possibly volatility in markets.
- Benefits of best practices:
  - Allow countries to benefit from the experience of other countries and provide a benchmark for evaluating arrangements for SWFs.
  - Help strengthen domestic policy frameworks and institutions for countries with or planning SWFs, ensuring SWFs further country interests and safeguard against potential mismanagement and abuse.
  - Enhance public understanding of SWF operations and improve transparency and accountability of SWF-type arrangements, making investment processes and objectives more open and comprehensible to the public, markets, and recipient countries.

### Governance and operational independence
- Governance challenge:
  - Ensure that investment decisions are autonomous. Governance arrangements should provide for SWFs’ independence in their investment decisions, in both operational/functional and political senses.
  - Governance structures should allow for different legal forms of SWFs, adequate coordination with macroeconomic policies, and clear lines of accountability.27
- Legal-structure considerations:
  - Different legal structures (e.g., pools of assets administered by government or central bank vs. separate legal entities established under constitutive law or as private corporations) have a bearing on institutional arrangements and governance.27

### Transparency: types and trade-offs
- Transparency serves diverse audiences: the general public, markets, counterparties, recipient countries, and regulators.
- Three broad categories of transparency:
  - (i) objectives;
  - (ii) organizational structure and institutional arrangements; and
  - (iii) investment portfolio (size, composition, returns, risk indicators).
- Investment-portfolio transparency likely to generate considerable discussion; a balance is required between market sensitivity of data and the minimum needed to verify stated objectives.
- Formulation of best practices should be collaborative, involving SWFs:
  - Modeled after the drafting of IMF guidelines for Foreign Exchange Reserve Management.
  - An agreed first step: survey of SWFs on practices in areas including legal/regulatory framework; roles, responsibilities, and objectives; funding and withdrawal rules, fiscal treatment, and noninvestment functions; governance structure; accountability; investment policy; risk management practices; inclusion of SWFs in existing economic statistics; and public information services adopted by SWFs.
  - The Survey is under way and will provide a basis for assessing current structures and practices (although not all elements need inclusion in best practices). Staff will then work with members to develop best practices, building on current SWF practices and existing Fund guidelines.

### Definition and coverage of institutions for best practices
- Working definition proposed by Fund staff:
  - "SWFs are special purpose public investment funds, or arrangements. These funds are owned or controlled by the government, and hold, manage, or administer assets primarily for medium- to long-term macroeconomic and financial objectives.* The funds are commonly established out of official foreign currency operations, the proceeds of privatizations, fiscal surpluses, and/or receipts resulting from commodity exports. These funds employ a set of investment strategies which include investments in foreign financial assets."
- Included, in principle:
  - (i) fiscal stabilization funds; (ii) saving funds; (iii) reserve investment corporations; (iv) development funds; and (v) pension reserve funds (those without explicit pension liabilities).
- Excluded inter alia:
  - (a) government-employee pension funds; (b) social security funds; (c) government lending funds; and (d) government-owned banks.
- Rationale for focusing on SWFs rather than broader vehicle sets:
  - SWFs are government-owned and thus subject to higher standards of accountability for investment decisions and are within macroeconomic management, with potential for noncommercial motives.
  - Pension funds have well-identified liabilities, are covered by specific international guidelines, are included in macroeconomic datasets, and tend to be more closely regulated.
  - Hedge funds and private equity are privately owned, often highly leveraged, and raise a different set of issues (e.g., counterparty risk); these are being addressed by private-sector-led and regulatory initiatives.

### Resource costs for the program to develop best practices
- The program will entail resource costs. Resources amounting to two staff years (US$0.7 million) are expected to be required over the next fiscal year to cover additional costs.
- Table 3 (Staff calculations) — selected line items as presented:
  - FY2008FY2009Total
  - Number of missions71522
    - Survey tabulation303
    - Coordination369
    - Roundtables112
    - Outreach088
  - Days/mission                                                                  118...
    - Survey tabulation 1/120...
    - Coordination 1/1212...
    - Roundtables 2/7.57.5...
    - Outreach 3/05...
  - Field time (in days)80119199
    - Survey tabulation36036
    - Coordination3672108
    - Roundtables8715
    - Outreach04040
  - Other costs (in days) 4/60260320
  - Total resource costs (days)140379519
  - Total resource costs (years)0.51.52.0
  - Total  resource costs (US$) 5/110,939330,037440,977
    - Mission travel (US$) 6/84,000184,500268,500
    - Total Costs (US$)
  194,939514,537709,477
- Footnotes summarized as presented:
  - 1/ Three IMF staff will participate per mission (4 day visits on average).
  - 2/ Three IMF staff will participate per mission (2.5 day visits on average).
  - 3/ Two IMF staff will participate per mission (2.5 day visits on average).
  - 4/ One external consultant in FY2008 and one staff year in FY2009 for technical advice.
  - 5/ Based on standard costs for A9-15 staff and that of a short-term expert.
  - 6/ Based on an average of 11 and 8 staff-days per mission in FY2008 and FY2009, respectively, and cost inflation of 2.5 percent in FY2009.

*Source: IMF staff calculations.*

### 55.      If Directors agree, staff would begin to work with members and SWFs to facilitate

### _022908 - 55.      If Directors agree, staff would begin to work with members and SWFs to facilitate

### Proposed approach and timetable
- Staff intention: draw principles for the establishment and operation of SWFs and identify best practices currently used by them; not to develop a prescriptive code but a point of reference to inform the Fund’s policy advice.
- Initial steps:
  - Convene an international Working Group of SWFs.
  - Convene a Roundtable of SWFs in April to begin technical discussions and drafting work.
  - Establish subgroups after initial SWF discussions to undertake technical drafting work.
- Draft timeline:
  - A draft of the SWF principles and practices could be prepared by August 2008.
  - Draft to be circulated for wider consultation over the following two months.
  - Revised set of principles and practices to be sent to the Board for discussion ahead of the 2008 Annual Meetings.

### Consultations and coordination
- Staff will confer with others outside the Fund and coordinate with the OECD as appropriate.
- Consultation participants to include:
  - Multilateral development banks
  - Selected academics
  - Market participants
  - International accounting and auditing bodies
  - Legal practitioners
  - World Bank (to provide technical inputs)
- Data/statistics action: it is important to set out how the economic statistics on SWFs need to be improved.

### Questions posed to Directors
- Do Directors agree with the approach proposed?
- Specific points for Director input:
  - Has staff identified all aspects of SWFs that are relevant for the Fund’s work?
  - Do Directors share staff’s assessment of the operational implications for bilateral and multilateral surveillance?
  - Do Directors agree with the working definition of SWFs?
  - Do Directors agree with the direction and thrust of the work on best practices?
  - Are there any additional elements that Directors feel should be included in best practices?
  - Do Directors have views on the types of transparency that should be included in best practices and what elements should be outside the scope of a set of best practices?
  - Do Directors have any comments on process or timetable?

### Annex I — Portfolio diversification by SWFs: key findings
- General observations:
  - SWFs typically have medium- to long-term investment horizons, making abrupt portfolio shifts less likely.
  - Even a benign shift toward greater portfolio diversification of reserve assets by sovereigns would affect absolute and relative asset prices, flow of funds between countries, and evolution of global imbalances.
  - Analysis limited by lack of transparency about asset allocations of several large SWFs.
- Scenario assumptions for illustrative portfolio analysis:
  - Countries that have recently established SWFs (or announced intention) will channel a portion of prospective reserve accumulation to SWFs.
  - Assumed transfer of between 25 percent (lower bound) and 50 percent (upper bound) of newly available foreign currency inflows to their SWFs to be invested in foreign assets.
  - Exercise focuses on new sovereign investments; existing reserve stock assumed unchanged.
- Implications of diversification (summary of simulated results):
  - Pattern of global capital flows: industrial countries face lower capital inflows; emerging market countries attract substantially larger inflows.
  - Reserve assets (predominantly dollar-denominated, generally held as U.S. Treasury bills) versus SWF portfolios (more diversified and riskier) implies lower inflows into government bond markets and implications for interest rates.
  - United States effects:
    - Estimated inflows into the United States could decline by ¼–½ percent of U.S. GDP per year on average depending on stylized asset allocation strategy.
    - Simulations (GIMF5 model) point to a 10–20 bp increase in U.S. real interest rates.
    - Simulations point to a 2–5 percent depreciation of the U.S. dollar.
    - U.S. current account deficit could improve by ¼–½ percentage point of GDP.
  - Rest of world effects:
    - Higher capital inflows to other regions would lead to lower real interest rates, more appreciated currencies (in real effective terms), and boosted domestic demand.
    - Inflation in Asia would increase as a result of continued reliance on a currency peg to the dollar.
  - Model caveats:
    - Model does not suggest disorderly depreciation of the U.S. dollar or disorderly unwinding of global imbalances.
    - Model does not take into account possible second round effects as other investors react to SWF behavior changes.
    - Without adjustment by surplus countries, the model predicts that current account deficits will appear in other regions—most notably Europe.

### Stylized portfolios and quantitative inputs
- Stylized portfolios used (Annex 1, Table 1):
  - COFER (stylized reserves portfolio): Bonds 100.0
  - Norway-like portfolio: Bonds 40.0; Equities 60.0 (current Norway investments are 40 percent equity and 60 percent bonds; parliament approved change to 60 percent equity and 40 percent fixed income)
  - Diversified portfolio: Bonds 23.0; Equities 55.0; Real estate 7.0; Hedge funds 7.5; Private equity 7.5
- Currency composition (Annex 1, Table 1):
  - COFER: U.S. dollar 59.0; Euro 29.7; Pound 5.8; Yen 3.0; Other 2.4
  - Norway: U.S. dollar 31.8; Euro 35.0; Pound 13.6; Yen 6.9; Other 12.7
  - Diversified portfolio: U.S. dollar 38.0; Euro 13.9; Pound 13.9; Yen 10.2; Other 24.0

### Simulation methodology (Annex I, Section B)
- Main assumptions:
  - Analysis pertains only to newly available foreign exchange flows; existing stocks assumed unchanged.
  - All new flows into SWFs are assumed invested abroad.
  - New flows calculated as sum of each country’s current account balance and net private capital flows, based on WEO projections for 2008–13.
  - For countries setting up SWFs where projections do not distinguish between reserve accumulation and asset accumulation in SWFs, assume 25–50 percent of all new funds flow to the SWF (25 percent lower bound, 50 percent upper bound).
- Simulation steps:
  - Calibrate three portfolios (stylized reserves, Norway-like, more diversified).
  - Simulate how future flows into SWFs would be allocated by currency and into government bonds under each portfolio.
  - Compute differences in capital flows between each SWF portfolio and the reserve portfolio to interpret potential changes in the pattern of capital flows.

### Gravity model exercise (Annex I, Section C) — purpose and results
- Purpose: assess geographic distribution of SWF assets in absence of reliable data on assets under management and asset allocation for several large SWFs; exercise applied to Norway and Temasek.
- Main finding: gravity model reinforces that geographic diversification of sovereign asset holdings may increase when shifting from reserve holdings to SWF assets; United States and other advanced economies likely to receive lower inflows if assets are held by SWFs rather than as reserves.
- Gravity model data sources:
  - Equity and debt holdings from the IMF’s Coordinated Portfolio Investment Survey (CPIS)
  - Bank loans from the BIS
  - FDI from the OECD
  - Trade from the IMF’s Direction of Trade Statistics
  - Capital controls data constructed from the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions
- Gravity model estimation specification:
  - log(Holding_ij) = b_dist*log(dist_ij) + b_border*border_ij + b_comlang*comlang_ij + X_ijb + u_i + u_j + e_ij
- Estimated betas from gravity model:
  - Equity: b_dist=-.7649499; b_contig=.6357502; b_comlang=.4907374
  - Debt: b_dist=-.8023374; b_contig=.1403246; b_comlang=.2249871
  - FDI: b_dist=-1.286229; b_contig=.6324757; b_comlang=.5407307
- Gravity model versus actual allocations (Annex 1, Table 2; selected numbers):
  - Norway (Actual portfolio as of September 2007): Asia and Pacific 25; Europe and Central Asia 60; Latin America/Caribbean 10; Africa and Middle East 0; North America 35
  - Gravity model predictions for Norway: Asia and Pacific 8; Europe and Central Asia 64; Latin America/Caribbean 12; Africa and Middle East 2; North America 26
  - Temasek (Actual portfolio as of March 2007, excludes Singaporean assets): Asia 65; OECD 13; Other 22
  - Gravity model predictions for Temasek: Asia 46; OECD 51; Other 3
- Interpretation: model predicts Norway’s pattern reasonably well; poorer fit for Temasek, which invests heavily in Asia.

### Definitions of SWFs (Annex II — selected)
- OECD (November 2007): “Government-owned investment vehicles that are funded by foreign exchange assets.”
- Investopedia (December 2007): “Pools of money derived from a country’s reserves, which are set aside for investment purposes to benefit the country’s economy and citizens. The funding for SWFs comes from central bank reserves that accumulate as a result of budget and trade surpluses, and even from revenue generated from the exports of natural resources.”
- Edwin M. Truman (November 2007): “Separate pools of international assets owned and managed by governments to achieve a variety of economic and financial objectives. They sometimes hold domestic assets as well.”
- Deutsche Bank (September 2007): “Sovereign wealth funds—or state investment funds—are financial vehicles owned by states which hold, manage, or administer public funds and invest them in a wider range of assets of various kinds. Their funds are mainly derived from excess liquidity in the public sector stemming from government fiscal surpluses or from official reserves at central banks.”
- U.S. Treasury (June 2007): “There is no single universally accepted definition of an SWF. [In this paper,] the term “SWF” means a government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from the official reserves of the monetary authorities.”
- BPM6 (March draft): “Some governments create special-purpose government funds, usually called sovereign wealth funds, to hold assets of the economy for long-term objectives. The funds to be invested commonly arise from commodity sales, the proceeds of privatizations, and/or the accumulation of foreign financial assets by the authorities.”
- McKinsey Global Institute (October 2007): “Sovereign wealth funds are usually funded by the nation’s central bank reserves and have the objective of maximizing financial returns within certain risk boundaries.”
- Morgan Stanley (October 2007): “An SWF needs to have five ingredients: sovereign; high foreign currency exposure; no explicit liabilities; high-risk tolerance; and long-term investment horizon.”

*Source: IMF staff document excerpt.*

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