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October 13, 2009

Sovereign Wealth Funds Are Slow to Adopt Santiago Principles
    by Robert Kropp

Report from the Investor Responsibility Research Center Institute and RiskMetrics Group finds low levels of disclosure among the ten largest SWFs, and little evidence of ESG considerations. -- In October, 2008, the International Working Group of Sovereign Wealth Funds (IWG) published the Santiago Principles, a set of 24 voluntary principles designed to ensure transparent and sound governance structure, and compliance with applicable regulatory and disclosure requirements in the countries in which they invest, by sovereign wealth funds (SWFs).

SWFs are defined by the International Monetary Fund (IMF) as "special purpose investment funds or arrangements, owned by the general government." Their investment strategies include investing in foreign financial assets. The assets under management of SWFs currently exceed $2 trillion, and are estimated to grow to about $6-10 trillion within five years, according to the IMF.

One year later, a report by the Investor Responsibility Research Center Institute (IRRCi ) and RiskMetrics Group finds that "there has been little analysis of the actual influence of the SWFs on the companies in their portfolio and the related risks and opportunities for the investment community." The report, entitled An Analysis of Proxy Voting and Engagement Policies and Practices of the Sovereign Wealth Funds, is the first comprehensive analysis of the engagement and proxy voting practices of the ten largest SWFs, according to IRRCi.

"The goal of this report was to demystify the role of sovereign wealth funds in global capital markets," said Jon Lukomnik, program director for IRRCi. "There have been lots of received wisdom and very few facts about the role of SWFs. This is the first comprehensive report to provide benchmarking of the levels of transparency and opacity at the funds."

Foreign investment by SWFs has raised concerns in some quarters regarding issues of national security, and activities by some SWFs in the aftermath of the economic crisis may have exacerbated those concerns. Two such investments referenced in the IRRCi report were the acquisition by the China Investment Corporation (CIC) of a $5 billion stake in Morgan Stanley, and the $7.5 billion stake in Citigroup acquired by the Abu Dhabi Investment Authority (ADIA).

In May, 2009, the Government Accountability Office (GAO) addressed these foreign investments in US-based financial institutions by reporting, "if a company's stake exceeds 25% or the company would control the bank, the company must receive prior approval and become regulated by banking regulators and would be limited in the types of nonbanking activities in which it can also invest."

Lukomnik observed, "We found no instances of inappropriate engagement for one country's political ends to the detriment of other owners or investors. However, we found a general lack of disclosure around engagement and proxy voting policies."

According to Afshin Mehrpouya, a Senior Analyst at RiskMetrics and the primary author of the report, concurred with Lukomnik's observation, saying, "In all cases we found low levels of disclosure regarding proxy voting policies. Half have low levels of compliance with the Santiago Principles."

But Lukomnik said of the adherence of SWFs to the Santiago Principles, "This was a self-imposed code of conduct. Some sovereign wealth funds take disclosure and the Santiago Principles seriously. About half of the ten largest SWFs have achieved some level of meaningful disclosure."

According to the ICCRi report, fears that the investment activities could lead to excessive foreign political influence over corporations have been widely reported in the media, but are exaggerated. In fact, the report finds, "our estimate of the total international equity investments of the ten largest SWFs is about half of the figures generally reported in the media." The report estimates current foreign investments by SWFs to total less than $1 trillion.

Most SWFs practice active investment management strategies, the report found. Especially in cases where SWFs acquire large stakes in companies, "it is important that they clarify the principles underlying their engagement practices and, ideally, provide engagement records." One of the Santiago Principles states, "There should be clear and publicly disclosed policies, rules, procedures, or arrangements in relation to the SWF's general approach to funding, withdrawal, and spending operations." But the IRRCi report found that disclosure of engagement policy or performance data was rare among SWFs.

Also highlighted in the Santiago Principles was the area of governance, in which "a clear and effective division of roles and responsibilities in order to facilitate accountability and operational independence" should be an essential part of the governance framework. While the report did not find it unusual that government officials would be included on the boards of SWFs, given the fact that SWFs are owned by governments, it did find that independent boards and senior management could lead to improved investment strategies.

Of the ten SWFs analyzed in the report, only the Norwegian Government Pension Fund (GPFG) publishes any proxy voting records. But because of their size and active ownership practices, disclosure by SWFs of proxy voting activities "would provide other investors and corporate managers with adequate information to evaluate the funds' intents and actions."

Given the fact that most SWFs identify themselves as long-term investors, the responsible investment community would consider it to be of importance that these influential funds begin to adopt environmental, social, and governance (ESG) considerations into their investment strategies. However, the IRRCi report found little evidence of such activity. GPFG was found to be the only SWF with explicit ESG policies.

"Many SWFs are long-term investors who should have interest in the level of integration of ESG risk," Mehrpouya of RiskMetrics said. "But none of them showed strategic interest in these criteria. Many did practice negative screening according to national values."

In addition to CIC and GPFG, the SWFs analyzed by the report were Abu Dhabi Investment Authority (ADIA), Australian Government Future Fund (AGFF), Government of Singapore Investment Corporation (GIC), Kuwait Investment Authority (KIA); Libyan Investment Authority (LIA), Russian Reserve Fund and National Wealth Fund, Qatar Investment Authority (QIA), and Temasek Holdings (Temasek).

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