Sovereign Wealth Funds: Background and Policy Issues for Congress
Prepared for Members and Committees of Congress
Sovereign wealth funds (SWFs) are investment funds owned and managed by national
governments. Such funds currently manage between $1.9 and $2.9 trillion and are expected to
grow to over $10 trillion by 2015. This is due to the rapid growth of commodity prices and large
trade surpluses in several emerging market economies. Beginning in 2007, interest in SWFs
increased as Asian and Middle Eastern SWFs, fueled by surging foreign exchange reserves,
invested large sums of capital in U.S. and other Western companies.
Policy makers in the United States have raised two broad policy concerns about SWFs: (1) their
lack of transparency and (2) their possible misuse for political or other non-commercial goals.
Hearings have been held by several congressional committees including the House Financial
Services Committee and the Senate Foreign Relations and Senate Banking Committees.
SWFs pose a complex challenge for policy makers. On one hand, SWFs are long-term investment
vehicles looking beyond quarterly results and therefore serve as stable funding sources during
financial turbulence. On the other hand, however, there are operational concerns stemming from
government control (i.e., lack of transparency and possible non-commercial investment goals).
Without transparency, it is difficult to attain a clear picture of SWF investment activity. A lack of
SWF transparency can also obscure governance and risk-management problems within SWFs.
Many are also concerned that countries will use SWFs to support what one analyst has called
“state capitalism,” using government-controlled assets to secure stakes around the world in
strategic areas such as telecommunications, energy and mineral resources, and financial services,
among other sectors.
In response to these concerns, many analysts and policy makers are evaluating the operations of
existing SWFs and are looking to the international financial institutions such as the International
Monetary Fund, World Bank, and the Organization for Economic Cooperation and Development
to establish guidelines for SWF operations. All of these institutions are currently developing
proposals that will be deliberated during 2008. This report will be updated as events warrant.
Introduc tion ..................................................................................................................................... 1
Backgr ound ..................................................................................................................................... 2
What Are Sovereign Wealth Funds (SWFs)?............................................................................2
What Countries Operate SWFs?...............................................................................................4
The Size of SWFs......................................................................................................................5
Policy Issues for Congress...............................................................................................................7
Transparency and Governance-Related Concerns.....................................................................9
Non-Commercial Investment Motives....................................................................................10
U.S. Taxation of SWFs.............................................................................................................11
Existing legislation on foreign investment..............................................................................12
Banking ........................................................................................................................ ..... 12
Securi ti es ..................................................................................................................... ...... 13
The Global Response to SWFs......................................................................................................13
The Santiago Principles...........................................................................................................15
OECD Standards for Investment in Member Countries..........................................................17
Figure 1. Segments of the Global Capital Market, USD Trillion, 2007..........................................5
Figure 2. Global Reserve Growth and SWFs..................................................................................7
Figure 3. Standard Chartered Ranking of SWFs, by Investment Approach and
Tr ansparency ................................................................................................................................ 9
Table 1. Large Sovereign Wealth Funds..........................................................................................6
Author Contact Information..........................................................................................................17
Sovereign Wealth Funds (SWFs) are investment funds owned and managed by national
governments. Originally created in the 1950s by oil and resource-producing countries to help
stabilize their economies against fluctuating commodity prices, and to provide a source of wealth
for future generations, they have proliferated considerably in recent years. Although their lack of
transparency makes estimating SWF investment levels difficult, it is estimated that they currently 1
manage between $1.9 and $2.9 trillion. Estimates of their growth over the next several years 2
vary, with the consensus hovering around Morgan Stanley’s projection of $10 trillion by 2015.
Early estimates were higher, but it appears that the global financial crisis has led SWF growth to
slow due to losses by SWFs on the value of their existing portfolios, lower commodity prices, and
the likelihood that some developing countries will tap into their SWF resources for domestic
SWFs can be funded through a variety of means, including profits from the sale of commodities
(such as oil) or a current account surplus. SWFs can be established to serve several different
objectives. These may include diversifying national assets, stabilizing the domestic economy
against volatile commodity prices, saving for future generations, getting a better return on
investment than traditional foreign exchange reserves, and promoting political or strategic
The dramatic recent increase in SWF activity has raised concerns about this relatively
unexamined class of international investors. This report provides background on SWFs, including
what countries operate SWFs and the size of the SWF market, and discusses two broad areas of
concern to Members of Congress and the international financial community:
• governance and transparency-related issues, and
• possible non-commercial investment goals, including the potential use of
government-controlled investment vehicles to attain global strategic and political
Some U.S. policy makers stress that their concerns about SWFs are not meant to undermine the
U.S. commitment to open investment. They maintain that the United States is one of the most
open economies in the world and note that foreign investment in the United States provides many
benefits, including lower interest rates, increased employment, productivity, and access to capital
for American enterprise. Indeed, for countries such as the United States, which have both a high
national budget deficit and historically low levels of public savings, foreign investment has been 3
1 All figures are in U.S. dollars.
2 Stephen Jen, “SWFs’ Growth Tempered: US$10 Trillion by 2015,” Morgan Stanley Research Global, October 30,
3 For more information on foreign investment in the U.S. economy, see CRS Report RS21857, Foreign Direct
Investment in the United States: An Economic Analysis, by James K. Jackson.
The rising profile of SWFs is a direct consequence of the massive accumulation of global foreign
reserve assets over the past decade. While reserve accumulation has occurred in many emerging
market economies, it has been especially sharp among oil producers and Asian countries that have
large trade-surpluses with the United States and other developed countries. In these countries,
reserves have swelled to levels far in excess of the amount needed for balance of payments
support, thus presenting an opportunity for foreign exchange reserve managers to maximize
Foreign exchange reserves are traditionally invested in low-risk assets such as U.S. Treasury bills,
but their recent growth has seen an increasing shift of excess reserves to higher-risk, higher-return
investments. In contrast to traditional foreign exchange reserves, SWFs invest in a much broader
array of assets, including stocks, bonds, fixed assets, commodities, derivatives, and alternative
investments such as real estate and hedge funds. Like private hedge funds and government 4
pension funds, SWFs often rely on outside expertise and professional fund managers.
Two key forces drove congressional interest in SWFs during the 110th Congress: (1) the
introduction of new funds and (2) major acquisitions by existing SWFs following large losses by
Western financial institutions from the U.S. sub-prime mortgage crisis. Many point to the
September 29, 2007, launch of the new China Investment Corporation, Ltd. (CIC), with $200 5
billion of capital as a catalyst of the initial Western interest in SWFs.
While SWFs represent a small percentage of all investment classes globally, their rapid and
projected growth could increase demand for riskier assets, including equities and bonds. Deutsche
Bank estimates that future SWF asset allocation could lead to a gross capital inflow of over $1
trillion into global equity markets and $1.5 trillion into global debt markets over the coming five 6
years. Merrill Lynch, using more aggressive assumptions, estimates that $3.1 to $6 trillion is 7
likely to be invested in riskier assets by SWFs in the next five years. While SWF investments
peaked during the financial crisis in 2007-8, with many foreign SWFs taking large stakes in
Western financial institutions, it appears that the pace of investments has tailed off.
While the term “Sovereign Wealth Fund” was coined only recently, SWFs have a more than 50-8
year history, with the first fund established by Kuwait in 1953. There is no universally agreed
upon definition of SWFs. The U.S. Treasury Department narrowly defines SWFs as “a
4 Stephen Jen, “Economics: How Much Assets Could SWFs Farm Out?” Morgan Stanley Global Research, January 10,
5 See CRS Report RL34337, China’s Sovereign Wealth Fund, by Michael F. Martin.
6 Steffen Kern, “Sovereign Wealth Funds - State Investments on the Rise,” Deutsche Bank Research, September 10,
7 Alex Patelis, “The Overflowing Bathtub, the running tap and SWFs,” Merrill Lynch Economic Analysis, October 6,
8 For the first use of the term Sovereign Wealth Fund, see Andrew Rozanov, “Who Holds the Wealth of Nations,” State
Street Global Advisors, August 2005, at http://www.ssga.com/library/esps/
government investment vehicle which is funded by foreign exchange assets, and which manages
those assets separately from the official reserves of the monetary authorities (the Central Bank 9
and reserve-related functions of the Finance Ministry).” The U.S. Treasury Department’s
definition is meant primarily to distinguish SWF investment from official reserves managed by a
country’s central bank. Because the primary goals of official foreign reserves are liquidity and
security, the investment horizon for these for reserves is short.
Some observers provide a more detailed definition of SWFs. Stephen Jen, a currency analyst at
Morgan Stanley, expands on the Treasury definition to provide a broader understanding of SWFs
and how they differ from official foreign reserves and other government-sponsored funds.
According to Jen, there are five key traits of SWFs. They are (1) sovereign government entities
with (2) high foreign currency exposures, (3) no explicit liabilities (such as a national state 10
pension fund), (4) high-risk tolerances, and (5) long investment horizons.
The IMF divides SWFs into several categories based on their stated goals. In practice, however,
many SWFs combine elements of the following three categories. The three primary types of
SWFs, according to the IMF, are as follows:
(1) Stabilization funds—Volatile international market prices are a primary concern for resource-
and commodity-intensive economies. Some commodities face price fluctuations of an average of
capital inflows and stabilize fiscal revenues. Because stabilization funds serve a more
immediate function than long-term savings funds, they tend to be more conservative in their 12
investment decisions, focusing on fixed income rather than equity investments. Examples
include Russia’s Stabilization Fund of the Russian Federation and Kazakhstan’s National Oil
(2) Savings funds—Savings funds are intended to share wealth across generations. For countries
rich in natural resources, savings funds convert non-renewable natural resources into a diversified
portfolio of international financial assets to provide for future generations or other long-term
objectives. According to the IMF, while newer oil funds predominantly focus on stabilization
objectives, the recent increase in oil prices has allowed SWFs to emphasize savings objectives.
Because savings funds have longer investment horizons than pure stabilization funds, they invest
in a broader range of assets, including bonds and equities, as well as other forms of alternative
investments, such as real estate, private equity, hedge funds, and commodities. Examples include
the Abu Dhabi Investment Authority, Kuwait Investment Authority, Singapore’s Government
Investment Corporation, and the China Investment Corporation.
9 “Report to Congress on International Economic and Exchange Rate Policies,” Department of the Treasury, December
2007, at http://www.treas.gov/offices/international-affairs/economic-exchange-rates/.
10 Stephen Jen, “Currencies: The Definition of a Sovereign Wealth Fund,” Morgan Stanley Research, October 25,
11 Currency sterilization is a form of monetary action in which a country’s central bank attempts to insulate itself from
the foreign exchange market to counteract the effects of a changing monetary base by selling or buying the domestic
currency in the foreign exchange market to stabilize the value of the domestic currency. For more information, see
Jang-Yung Lee, “Sterilizing Capital Inflows,” International Monetary Fund, 199, at http://www.imf.org/external/pubs/
12 Rachel Ziemba, “Responses to Sovereign Wealth Funds: Are ‘Draconian’ Measures on the Way?,” RGE Monitor,
(3) Reserve investment corporations—Reserve investment corporations are funds established to
reduce the opportunity cost of holding excess foreign reserves or to pursue investment policies
with higher returns. Reserve investment corporations adapt more aggressive investment
strategies, including taking direct equity stakes. These funds typically seek higher returns than
other SWFs and use leverage (i.e., debt) in their investments. Historically, theses vehicles tend to 13
be more secretive than other SWFs that are primarily portfolio investors. Examples of such 14
funds are Singapore’s Temasek, Qatar’s Investment Authority, and Abu Dhabi’s Mubadala.
Among funds, there are substantial differences in risk-return profiles, investment horizons, asset 15
allocation, eligible instruments, risk tolerances, and constraints. Because each fund is different
and has varying goals and objectives, it is difficult to generalize about the investment strategies of
SWFs as a class. For example, an oil-exporting economy may initially establish a SWF for
stabilization purposes. However, if the assets under management by the SWF grow to exceed the
levels needed for stabilization, the country may either change the priorities and investment
strategy of the fund or establish a separate fund with a more aggressive investment approach.
Thus, several countries have multiple sovereign wealth funds. For example, the United Arab
Emirates’s primary fund, the Abu Dhabi Investment Authority (ADIA), was established in 1974
to invest surplus cash in assets that provide steady gains and returns over a long time-horizon
using a portfolio investment strategy. In 2002, the United Arab Emirates established Mubadala
Development to pursue direct investment projects targeted at higher returns.
The first SWF was established by Kuwait in 1953 as a means to help stabilize the economy from 16
fluctuating oil prices. In 1956 the Gilbert Islands (now Kiribati) established the Revenue
Equalization Reserve Fund to manage profits from phosphate mining. Following Kuwait and
Kiribati, the next major SWFs were created in the 1970s in the wake of the oil shock. The most
recent wave began in the 1990s with the Norway Government Pension Fund-Global in 1990 and
continues to this day. In the last five years, funds have been established by China, Iran, Russia,
Qatar, and the United Arab Emirates.
As noted previously, the recent growth of SWFs is a consequence of rapid growth in emerging
market reserves driven by (1) the impact of rising oil prices for Middle Eastern economies and (2)
large trade surpluses, net foreign direct investment flows, and high savings rates among Asian
economies. Reserve accumulation has been especially sharp in the case of China, where there has
been extensive intervention in the foreign exchange markets to limit the yuan’s appreciation 17
against the dollar.
13 Similar entities to SWFs that raise many of the same concerns are state-backed companies engaged in foreign
acquisitions. For example, in 2005 an attempt by the China National Offshore Oil Cooperation (CNOOC) to purchase
the U.S. energy company Unocal raised substantial congressional concerns and was eventually abandoned. For more
information on the CNOOC case, see CRS Report RL33093, China and the CNOOC Bid for Unocal: Issues for
Congress, by Dick K. Nanto et al.
14 “Global Financial Stability Report: September 2007,” International Monetary Fund, September 2007.
15 For more information on the challenges of establishing a SWF, see Andrew Rozanov, “Sovereign Wealth Funds:
Defining Liabilities,” State Street Global Advisors, May 2007.
16 The first Kuwaiti SWF was called the Kuwait Investment Board. It was later acquired by a separate fund, the Kuwait
Investment Authority, which was founded in 1960.
17 CRS Report RL32165, China’s Currency: Economic Issues and Options for U.S. Trade Policy, by Wayne M.
Analysts estimate that foreign assets held by sovereign nations currently exceed $5 trillion and are, as the
growing U.S. current account imbalance would indicate, increasing at a significantly more rapid rate in emerging
market countries with high savings rates than in the industrialized countries.
It is difficult to accurately measure the amount of assets under management by SWFs because
many funds do not disclose much information about their operations and assets. The funds
believed to be the largest do not disclose their size, investment strategies, or current holdings.
Estimates for the size of the largest fund, the United Arab Emirates’ ADIA, for example, range
widely between $500 and $900 billion. Reportedly, ADIA has achieved a 20% rate of return for 18
many years and rarely considers deals less than $100 million.
Official and private sector analysts estimate that there is between $1.9 and $2.9 trillion under
management by SWFs. This is significantly smaller than other investment classes (Figure 1).
Figure 1. Segments of the Global Capital Market, USD Trillion, 2007
Source: Norges Bank
However, analysts expect that if oil prices remain, and there no immediate correction of current
global imbalances, SWFs will grow rapidly over the next few years. Morgan Stanley estimates
that if foreign reserves continue to increase at a current pace, they could grow to $12 trillion by 19
2015. Several factors could weaken these growth projections, including a cyclical economic
downturn, a reduction in oil prices, or a weakening of competitiveness in Asian exporting
economies. On the contrary, given the rapid increase in emerging market foreign exchange
Morrison and Marc Labonte.
18 Henny Sender, Live at Apollo (Management): Plan to Cash In, Limit Scrutiny, Wall Street Journal, July 17, 2007.
19 Stephen Jen, “Currencies: How Big Can Sovereign Wealth Funds Be by 2015,” Morgan Stanley Global Research,
May 3, 2007.
reserves, if countries decide to increase transfers from official reserves to SWFs, projected figures
could be substantially higher. SWFs financed by oil and gas exports are estimated to account for
around two thirds of SWFs by amount invested. Asian funds financed by current account 20
surpluses make up the rest. Table 1 provides a list of the largest funds. Figure 2 combines
global foreign reserve growth with recent growth of Asian and oil SWFs.
Table 1. Large Sovereign Wealth Funds
Date Size Source of
Country Name Est. ($ billions) Funds
Abu Dhabi Investment Authority and 1976 500-875 Oil
Corporation United Arab
Mubadala Development Company 2002 10 Oil Emirates
Isithmar 2003 4 Oil
Norway Government Pension Fund—Global 1990 329 Oil
Government of Singapore Investment 1981 100-330 Other
Temasek Holding 1974 108 Other
Kuwait Kuwait Investment Authority 1960 213 Oil
Russia Stabilization Fund of the Russian Federation 2004 141 Oil
China China Investment Corporation 2007 200 Other
Qatar Qatar Investment Authority 2005 50 Oil
Australia Future Fund 2006 49 Other
Algeria Revenue Regulation Fund 2000 43 Oil
United States Alaska Permanent Fund 1976 40 Oil
Brunei Brunei Investment Agency 1983 30 Oil
Korea Korea Investment Corporation 2005 20 Other
Kazakhstan National Oil Fund 2000 19 Oil, Gas
Malaysia Khazanah Nasional 1993 18 Other
Venezuela National Development Fund 2005 15 Oil
Macroeconomic Stabilization Fund 1998 1 Oil
Canada Alberta Heritage Savings Trust Fund 1976 15 Oil
Chile Economic and Social Stabilization Fund 2006 10 Other
New Zealand Superannuation Fund 2001 10 Other
Iran Oil Stabilization Fund 2000 9 Oil
Source: Peterson Institute for International Economics
20 Stephen Jen, “How Big Could Sovereign Wealth Funds Be by 2015,” Morgan Stanley Perspectives, May 3, 2007.
Figure 2. Global Reserve Growth and SWFs
(USD Billion, rolling 4th quarter sums)
Source: RGE Monitor
The magnitude of financial impact combined with the lack of transparency and possibly political
investment motivations of non-commercial entities has sparked concern among some analysts and
Members of Congress about the rapidly growing wealth of emerging market countries and how
this wealth is being invested in the United States. Hearings on SWFs have been held in several
congressional committees including the Senate Banking Committee, Senate Foreign Relations
Committee, House Financial Services, House Foreign Affairs Committee, and the Joint Economic 21
Committee. In addition to hearings, Senator Richard Shelby (AL) has requested a study from 22
the Government Accountability Office (GAO) to ensure that SWFs are “effectively monitored.
21 Congressional hearings on SWFs include:
1. Senate Committee on Banking, Housing, and Urban Affairs hearing, “Sovereign Wealth Fund Acquisitions and
Other Foreign Government Investments in the U.S.: Assessing the Economic and National Security Implications,”
November 14, 2007;
2. Joint Economic Committee hearing, “Do Sovereign Wealth Funds Make the U.S. Economy Stronger or Pose
National Security Risks?,” February 13, 2008;
3. House Financial Services Subcommittee on Domestic and International Monetary Policy, Trade and Technology,
and the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises hearing, “Foreign
Government Investment in the U.S. Economy and Financial Sector,” March 5, 2008;
4. Senate Banking Committee hearing, “Turmoil in U.S. Credit Markets: Examining the U.S. Regulatory Framework
for Assessing Sovereign Investments,” March 24, 2008;
5. House Foreign Affairs Committee hearing, “The Rise of Sovereign Wealth Funds: Impacts on U.S. Foreign Policy
and Economic Interests,” May 21, 2008; and
In his opening remarks at the first congressional SWF hearing, before the Senate Banking
Committee on November 13, 2007, Senator Evan Bayh (IN) neatly summarized the two primary
concerns about SWF activity in the United States and the challenge they present:
A lack of transparency that characterizes many sovereign wealth funds undermines the
theory of efficient markets at the heart of our economic system. In addition, unlike private
investors, pension funds and mutual funds, government owned-entities may have interests
that will take precedence over profit maximization. Just as the United States has geopolitical
interests in addition to financial ones, so do other countries. Just as we value some things
more than money, so do they. Why should we assume that other nations are driven purely by 23
financial interests when we are not?
The political challenges facing U.S. leaders are aptly summarized by Senator Charles Schumer
Right now, the U.S. finds itself in a difficult position. Some of our financial institutions have
made mistakes and need capital. So we’re short of capital because of the credit crunch, and
in the longer run because of our own habits. We import more than we export; we consume
more than we save. The best choice would be that financial institutions could raise capital
within the U.S. But we don’t have that choice. So they raise capital from where it exists, and
sovereign wealth funds are the most available form of capital right now. Or [financial
institutions] can dramatically shrink, and we can lose thousands and thousands of jobs. The
choice is a simple one, and the issue with sovereign wealth funds can be defined in a single
sentence: Because they are government-owned, noneconomic factors may influence their 24
decision-making and the pressure they put on companies that they own a piece of.
Given these concerns, Congressional attention on SWFs has focused on two broad areas, namely
(1) the lack of SWF transparency and (2) the potential use of SWF capital for strategic or political
(i.e., non-commercial) purposes. These concerns as applied to specific SWFs are mapped in
Figure 3. The X axis illustrates fund transparency, or levels of disclosure. The Y axis measures
the active, or strategic, nature of their stated (or perceived) investment philosophy. For example,
the funds of Norway, Alaska, and Alberta, Canada, are conventionally invested in a wide range of
investments and are highly transparent. Malaysia’s SWF and Singapore’s Temasek, while also
highly transparent, pursue a more strategic approach to their investments, targeting various
industries that are of interest to their respective governments. The funds in the upper-left quadrant
are of most concern to Western policy makers. These are the funds that disclose the least
information about their funds and are the most strategic in their investment philosophy. A third
issue that has sparked some congressional interest is how the United States taxes gains on
investments in the United States made by SWFs.
6. Senate Foreign Relations Committee hearing, “Sovereign Wealth Funds: Foreign Policy Consequences in an Era of
New Money,” June 11, 2008.
22 Christopher S. Rugaber, “Agency Investigates Sovereign Funds,” Associated Press, January 11, 2008. Available at
23 Senate Banking, Housing and Urban Affairs Committee Hearing on Foreign Government Investment in the United
States, November 14, 2007.
24 Maria Bartiromo, “Chuck Schumer on the Rise of Sovereign Wealth Funds,” BusinessWeek, March 6, 2008.
Figure 3. Standard Chartered Ranking of SWFs,
by Investment Approach and Transparency
Source: Standard Chartered and Oxford Analytica
Given the recent and projected growth of SWFs, many analysts stress the need for increased
transparency of SWF activity. There are no supra-national regulations or disclosure requirements
for the size of SWFs, their investment strategies, or their current holdings. Unlike privately
owned, nationally regulated funds, SWFs are not required to provide information to stock-holders
and stake-holders. “In terms of disclosure on fund performance, investment strategy, or even
basic philosophy, many [SWFs] rank below the most secretive hedge fund,” according to Gary
Kleiman, a senior partner at Kleiman International Consultants, an emerging financial markets 25
consulting group. Of the existing national funds, only Norway’s fund is universally considered
to be transparent and publically accountable.
Minimal SWF transparency masks SWF investment activity and can obscure governance and
risk-management problems within the funds. This can have distressing consequences for policy
makers. First, without insight into SWF activity, it is difficult to assess systemic risks or to
determine whether SWFs are in fact pursuing strategic, non-commercial investment strategies
(see next section). Second, limited disclosure makes it difficult to assess the management and
governance of the funds and therefore difficult to identify mismanagement or corruption by fund
mangers. Conflating this problem, many of these SWFs are established in countries that currently
lack the underpinnings for good SWF governance or SWF oversight. This is of concern to policy
makers, because sizable failures due to poor management, particularly if concentrated within
certain sectors, could affect national or global markets.
25 Tony Tassell and Joanna Chung, “The $2,500 Question,” Financial Times, May 25, 2007.
Some analysts have tried to empirically measure the lack of SWF transparency. The Peterson
Institute of International Economics (IIE) has tabulated a SWF scorecard, that among other 26
variables, looks at transparency and accountability. For its transparency and accountability
figure, IIE scored several questions, including the following:
• Do regular reports on the investments by the SWF include the size of the fund?
Information on the returns it earns?
• Do reports provide information on the types of investments? Information on the
geographic location of investments? Information on the specific investments, for
example, which instruments, countries, and companies? Information on the
currency composition of investments?
• Is the SWF subjected to a regular audit? Is the audit published? Is the audit
Consistent with Figure 2 above, the IIE found that the largest funds (i.e., those owned by the
United Arab Emirates, Qatar, Kuwait, and China) scored very low on the transparency and
While the ostensible goal of SWF investment is long-term value creation, government control
could mean that a SWF may be motivated by non-commercial considerations in its investment
decisions. Felix Rohatyn, a prominent investment banker and former U.S. official, has noted that
for many funds, political and commercial objectives are closely intertwined. According to Mr. 27
Rohatyn, “they are making investments that they probably think are O.K. but not spectacular.”
However, for these funds, “there has to be a political objective over and above the rate of 28
Many U.S. policy makers are concerned that countries will use SWFs to support what one analyst
has called “state capitalism,” using government-controlled assets to secure strategic stakes around
the world in areas such as telecommunications, energy resources, and financial services, among 29
other sectors. Recent deals in the energy and finance sector suggest that securing access to
natural resources and developing domestic financial markets appear to be the two primary SWF 30
26 Edwin M. Truman, “Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the United
States: Assessing the Economic and National Security Implications,” Testimony before the Committee on Banking,
Housing, and Urban Affairs United States Senate, November 14, 2007. Testimony is available at http://iie.com/
27 Andrew Ross Sorkin, “What Money Can Buy: Influence,” The New York Times, January 22, 2008, at
29 Gerald Lyons, “State Capitalism: The Rise of Sovereign Wealth Funds,” Standard Chartered, October 15, 2007.
Document is available from the author.
30 Richard Portes, “Sovereign Wealth Funds,” VOXEU, October 17, 2007, at http://www.voxeu.org/index.php?q=node/
636. See also Huw Van Stenis, “Banks & Financials: Sovereign Wealth Funds—building stakes in financials,” Morgan
Stanley Research Europe, September 24, 2007.
A report by Citigroup notes that “some sovereign wealth funds invest purely to achieve financial 31
returns and portfolio diversification while others have a broader economic or social agenda.”
Such an agenda could be benign; many countries have expressed their interest in using
investments in foreign financial institutions to acquire knowledge and technology to help build
their own domestic financial institutions. On the other hand, many are concerned that countries
may use their SWFs to gain access to other countries’ natural resource industries or other
politically sensitive sectors. Such concern is not limited to Western countries. In January 2006,
one of Singapore’s SWFs, Temasek, purchased from the family of then-Prime Minister Thaksin
Shinawatra a controlling stake in the Thai telecom company Shin Corporation, which included
taking control of space satellites used by the Thai military. This purchase sparked a political crisis
in Thailand, which eventually led to the ousting of Thaksin’s government.
Members have begun raising concerns about U.S. tax policy regarding investments in the United
States by foreign SWFs, specifically a long-standing exemption from U.S. income tax that applies
to certain passive investments made by SWFs and other investments made by foreign sovereigns.
Under Section 892 of the U.S. Internal Revenue code, foreign governments are exempted from
income tax on certain passive investments in the United States. Thus, a foreign government’s
income from investments in the United States in stocks, bonds, and other domestic securities,
financial instruments held in the execution of governmental fiscal or monetary policy, and interest
on deposits in U.S. banks are exempt from US tax. Section 892 also carves an exception for
income derived from a commercial activity by a foreign government, or a foreign-controlled
commercial entity. The gains on passive investment, however, is not considered by the U.S.
Internal Revenue Service (IRS) as a commercial activity.
In March 2008, Senators Max Baucus and Chuck Grassley, chairman and ranking member of the
Senate Committee on Finance requested that the Joint Committee on Taxation (JTC), a
nonpartisan House-Senate committee of the U.S. Congress, undertake a study to “analyze the
history, current rules, and policy underpinnings of the U.S. tax rules applicable to U.S. investment 32
by foreign governments, including investments made by Sovereign Wealth Funds.” The JTC’s
final report found that treatment as a foreign sovereign imparts limited but significant advantages
to foreign governments over foreign private investors. According to the JTC’s final report,
In practice, some of the most important statutory U.S. income tax advantages that a foreign
sovereign investor enjoys over a foreign private investor are: exemption from U.S.
withholding tax on all U.S. source dividends paid by noncontrolled corporations; exemption
from U.S. withholding tax on interest paid by a corporation where the foreign sovereign
owns at least 10% (so the general “portfolio interest” exemption is not available) but less
than 50% (so the payor is not “controlled” by the foreign sovereign) of the payor; and 33
exemption from U.S. tax on certain gains from real estate transactions.
31 The World Economic Forum ranks the United States first in its 2007 competitiveness report. The Global
Competitiveness Report 2007-2008, World Economic Forum, at http://www.gcr.weforum.org/.
32 “Baucus, Grassley Seek JCT Analysis of U.S. Taxation of Sovereign Wealth Funds,” United States Senate
Committee on Finance, March 13, 2008.
33 Joint Committee on Taxation, Economic and U.S. Income Tax Issues Raised by Sovereign Wealth Fund Investment
in the United States (JCX-49-08), June 17, 2008.
Some analysts propose revising the U.S. tax code to tax SWFs the same as foreign private
investors are. Victor Fleischer, a law professor at the University of Illinois, has proposed that the
baseline tax rate on any SWF investment in the United States could be raised to equal the flat
According to Prof. Fleischer, “This approach would raise significant amounts of tax revenue, and
it would give the U.S. a new policy lever to achieve nontax objectives, such as encouraging 34
SWFs to comply with best practices of transparency, disclosure, and accountability.” To date, no
legislation has been introduced that would move to remove the tax exemption granted foreign
Congress has broad powers regulating foreign investment in the United States. While there is no
express constitutional provision permitting the regulation of foreign investment in the United
States, justification for congressional legislation regulating foreign investment includes federal
powers over immigration and naturalisation, the federal power to regulate interstate and foreign 35
commerce, and the power to provide for the national defense. Of course there are already some
restrictions on foreign investment in the United States, but existing legislation is transaction-
specific and not entity-specific. Thus, there is no legislation that specifically regulates sovereign
wealth funds as a unique class of investors. However, certain sectors of the American economy,
such as the financial sector, telecommunications, energy, among others, have statuary limitations
on the types and amounts of investments in which non-American individuals and entities can
participate. In addition, the United States has legislation that allows the president to block any
investment which may impact national security.
The relevant statute regarding investments by sovereign wealth funds in the American banking
sector is the Bank Holding Company Act, which regulates a “bank holding company” – that is,
any company that controls an American bank, meaning any bank chartered by the federal or state
government to do business in the United States. It is important to distinguish between bank
holding companies from foreign banks, which are chartered in their home countries, but do
business in the United States.
The Bank Holding Company Act defines “control” of a bank or bank holding company as
follows: the acquisition of a 25% share or more of any class of voting securities; controlling the
election of a majority of the directors or trustees; or having been determined by the Federal
Reserve to be exercising a controlling interest over the management or policies of the entity. The
law presumes that “any company which owns, controls, or has power to vote less than 5% of any
class of voting securities of a given bank or [bank holding] company does not have control over
that bank or company.”
34 Victor Fleischer, “Taxing Sovereign Wealth Funds,” The Conglomerate, March 4, 2008. Available at
http://www.theconglomerate.org/2008/03/taxing-sovereig.html. See also Victor Fleischer, “A Theory of Taxing
Sovereign Wealth,” University of Illinois Law & Economics Research Paper Series, LE08-030, available at
35 . See CRS Report RL33103, Foreign Investment in the United States: Major Federal Statutory Restrictions, by
Michael V. Seitzinger.
Foreign companies are subject to the Bank Holding Company Act unless: they are organised as a
banking holding company under foreign law and are principally engaged in the banking business
outside the United States; they control less than 5% of the outstanding shares of an class of voting
stock; the Federal Reserve determines that an exemption would “not be substantially at variance
with the purposes of the [Bank Holding Company Act] and would be in the public interest.”
Added as part of the Foreign Corrupt Practices Act of 1977, the Domestic and Foreign Investment
Improved Disclosure Act of 1977 requires that any entity acquiring 5% or more of the equity
securities of a company registered with the Securities Exchange Commission must disclose
certain specified information including their citizenship and residence. According to one legal
expert, “The 5% threshold … explains the levels of investment of sovereign wealth funds, which
have been and will almost certainly continue to be in amounts below the 5% level.
American law also provides statutory authority for the Committee on Foreign Investment in the
United States (CFIUS), a multi-Cabinet member board led by the Secretary of the Treasury, to
review certain foreign investment and determine whether such investment raises a national
security threat to the United States and then make a recommendation to the president whether or 36
not to prohibit the transaction. By law, CFIUS can review “covered transactions,” which
includes any merger, acquisition, or takeover by any foreign person, which could result in foreign
control of any person engaged in interstate commerce in the United States.
The statutory limitation on “mergers, acquisitions, and/or takeovers” appears to lead to the
conclusion that CFIUS is not legally required to review the types of transactions that sovereign
wealth funds have invested in to date. However, if sovereign wealth funds were to begin
assuming ownership stakes of American companies in critical sectors, there may be a larger role
for CFIUS in reviewing their transactions in the future.
At the G7 Finance Ministers meeting in October 2007, ministers discussed SWFs for the first
time, noting that they are “increasingly important participants in the international financial system
and that our economies can benefit from openness to SWF investment flows.” The final G7
communique for the meeting stated that the IMF, World Bank, and the OECD should explore best
practices for SWFs in key areas such as institutional structure, risk management, transparency, 37
and accountability. Secretary of the Treasury Henry Paulson further elaborated on this in his
remarks to the International Monetary and Finance Committee of the IMF:
36 For more information on CFIUS, see CRS Report RL33312, The Exon-Florio National Security Test for Foreign
Investment, by James K. Jackson; CRS Report RL33388, The Committee on Foreign Investment in the United States
(CFIUS), by James K. Jackson; and Edward M. Graham and David M. Marchick, U.S. National Security and Foreign
Direct Investment, Peterson Institute for International Economics, May 2006.
37 Statement of G-7 Finance Ministers and Central Bank Governors, October 19, 2007, at http://treas.gov/press/releases/
The United States believes a multilateral approach to SWFs that maintains open investment
policies is in the best interest of countries that have these funds, and countries in which they
invest. The IMF is uniquely positioned to identify best practices for SWFs, building on the
existing Guidelines for Foreign Exchange Reserve Management. Best practices would
provide multilateral guidance to new funds on how to make sound decisions on how to
structure themselves, mitigate any potential systemic risk, and help demonstrate to critics
that SWFs can be constructive, responsible participants in the international financial system.
Recipient countries of SWF investment also have a responsibility to maintain openness to
investment and should work through the OECD to develop best practices for inward 38
To address concerns related to the lack of SWF transparency, some have called for an
international body, such as the IMF, to establish guidelines and monitor countries’ compliance
with transparency efforts. Proponents maintain that increased transparency would limit the
potential negative impact of greater SWF investment by allowing financial markets to better
observe SWF activity and exercise any necessary market discipline. Edwin Truman, of the
Peterson Institute for International Economics, argued during November 2007 Senate Banking
Committee hearings on SWFs that
[t]he development of a set of best practices for sovereign wealth funds, and similar
understandings covering other cross-border government investments, offers the most
promising way to increase the accountability of these activities, which are likely to increase
in relative importance over the next decade. The associated increase in transparency, which
is a means to the end of greater accountability, would help to reduce the mysteries and
misunderstandings surrounding these governmental activities. At the same time, the 39
environment for them would become more stable and predictable.
During the October 20, 2007 G7 finance ministers meeting, U.S. Treasury Secretary Henry
Paulson hosted an outreach dinner with top SWF managers from around the world to begin the
process of negotiating increased levels of SWF transparency. There appears to be some positive
reception from leading SWFs. According to Dr. Tony Tan, Executive Director of Singapore’s
We believe there is a case for further disclosure on the part of sovereign wealth funds in the
interest of transparency. Such disclosure can include clarity on the relationship between the
funds and the respective governments, their investment objectives and general strategies, and
their internal governance and risk management practices.... Any guidelines on sovereign
wealth funds should encourage them to operate according to commercial principles with a
long-term orientation, free from political motivations. Singapore will participate in 40
formulating a set of principles and best practices for sovereign wealth funds.
38 Statement by Henry M. Paulson, Jr. Secretary of the U.S. Treasury before the International Monetary and Finance
Committee, International Monetary Fund, October 20, 2007, at http://www.imf.org/external/am/2007/imfc/statement/
39 Edwin M. Truman, “Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the United
States: Assessing the Economic and National Security Implications,” Testimony before the Committee on Banking,
Housing, and Urban Affairs United States Senate, November 14, 2007. Prepared testimony is available at
40 Cited in Huw van Steenis and Huberty Lam, “Sovereign Wealth Funds and Chinese Financials,” Morgan Stanley
Research, January 15, 2008.
In November 2007, the IMF convened the first of a proposed annual roundtable of sovereign asset
and reserve managers. At the meeting, delegates from 28 countries discussed how best to address 41
the policy and operational issues faced by managers of growing reserves and sovereign assets.
The IMF’s work agenda on SWFs was approved at a meeting of the IMF Executive Board, which
includes representatives from both sovereign investors and recipients of sovereign wealth, on
March 21, 2008.
In September 2008, following four months of negotiations and several international meetings,
members of the newly formed International Working Group of Sovereign Wealth Funds agreed to 42
a voluntary code of conduct at meetings in Santiago, Chile. Although voluntary guidelines may
likely help policy makers better understand the motives and methods of existing and emerging
SWFs, it is unclear whether the voluntary guidelines will satisfy Western governments, which had
sought more restrictive rules requiring greater SWF transparency. Reportedly, the debate of how
much financial transparency SWFs should provide was one of the more contentious issues in the
working group. While some countries agreed that greater transparency would allay concerns that
SWFs may use their wealth for non-economic reasons and also reassure domestic constituents
that the national wealth is being appropriately invested, many countries insisted that SWFs be 43
allow to maintain a high degree of secrecy regarding their operations.
The chairman of the Australian Fund Board of Guardians, David Murray, chaired a subgroup of
the IWG responsible for drafting the Principles. The group met three times in Oslo, Singapore
and the final meeting in Singapore, where on September 2, 2008, the IWG agreed on a set of
voluntary principles, the Generally Accepted Principles and Practices for Sovereign Wealth Funds
(GAPP or Santiago Principles).
The Santiago Principles are comprised of 24 principles and additional sub-principles in three
broad categories: (1) legal framework, objectives, and macroeconomic linkages; (2) institutional
framework and governance; and (3) investment policies and risk management frameworks (see
box). While country endorsement and adherence to the Santiago Principles is voluntary and must
be ratified by authorities in each national country, by committing to financial objectives and
guidelines for increased transparency and disclosure of investments, the creation of the Santiago
Principles appears to be the beginning of the normalization of SWFs as global institutional
41 IMF Convenes First Annual Roundtable of Sovereign Asset and Reserve Managers, IMF press release No. 07/267,
November 16, 2007.
42 Member countries of the SWF IMF working group are: Australia, Azerbaijan, Bahrain, Botswana, Canada, Chile,
China, Equatorial Guinea, Iran, Ireland, South Korea, Kuwait, Libya, Mexico, New Zealand, Norway, Qatar, Russia,
Singapore, Timor-Leste, Trinidad & Tobago, the United Arab Emirates, and the United States. Oman, Saudi Arabia,
Vietnam, the OECD, and the World Bank, participate as permanent observers. The IMF helped to facilitate and
coordinate the work of the IWG by providing a secretariat for the IWG.
43 Krishna Gura, “Sovereign funds back code,” Financial Times, September 3, 2008.
Generally Accepted Principles and Practices (GAPP) on Sovereign Wealth Funds
A. Legal Framework, Objectives, and Coordination with Macroeconomic policies
1. Sound legal framework with a clear delineation of responsibilities between the SWF and other government bodies.
2, Clearly defined and publicly disclosed policy purpose
3. Coordination with domestic fiscal and monetary authorities
4. Clear and publically disclosed policies, rules, procedures, or arrangements regarding an SWF’s funding, withdrawal,,
and spending operations
5. Timely reporting of statistical data
B. Institutional Framework and Governance Structure
6. Sound governance framework to facilitate accountability and operational independence
7. SWF owner should set the objectives, appoint members of the governing bodies, and exercise oversight
8. Governing bodies should have a clear mandate and adequate authorities.
9. Independent operational management with clearly defined responsibilities
10. Clearly defined accountability framework
11. Annual report and financial statements should be prepared in accordance with recognized international or national
12. Operations and financial statements should be audited annually in accordance with recognized international or
national accounting standards.
13. Clearly defined professional and ethical standards
14. Third-party dealings regarding SWF management based on economic and financial grounds
15. Respecting and complying with all applicablehost country rules, laws, and regulations
16. Public disclosure of governance framework and objectives, as well as the manner in which the SWF’s management
is operationally independent
17. Public disclosure of financial information to demonstrate its economic and financial orientation
C. Investment and Risk Management Framework
18. Clear and consistent investment policy based on sound portfolio management principles
19. Investment decisions should aim to maximize risk adjusted financial returns or if investment decisions are subject
to other than economic or financial considerations, these should be clearly set out and publically disclosed
20. No seeking advantages of privileged information or government’s inappropriate influence
21. Exercising shareholder ownership rights in a manner consistent with its investment policy
22, Transparent and sound operational control and risk management systems
23. Accurate and consistent reporting of investments and investment performance
24. Regular review of GAPP implementation
While the IMF is working to establish guidelines for the management and operations of sovereign
wealth funds, the OECD has an ongoing work program to establish a set of best practices for 44
recipients of investments from SWFs. These guidelines would draw on the OECD’s extensive
work on the treatment of foreign investment in OECD economies. OECD work will also draw on
the OECD Guidelines for Corporate Governance of State Owned Enterprises (the SOE 45
Guidelines). The Guidelines are applicable to both SWFs and SOEs.
Martin A. Weiss
Analyst in International Trade and Finance
44 OECD Investment Newsletter, October 2007, Issue 5, at http://www.oecd.org/dataoecd/0/57/39534401.pdf.
45 The OECD Guidelines on Corporate Governance of State-Owned Enterprises is available at http://www.oecd.org/