Regulating Sovereign Wealth Funds: A Double-Edged Sword

The present credit crisis in the United States has resulted in some sovereign wealth funds picking up stakes in U.S. companies. Sovereign wealth funds are investment funds owned by national governments. These funds are generally well armed with cash but very secretive. There is no uniformity among the sovereign wealth funds that are investing in the United States. Their disclosure standards vary widely. While certain funds publish their portfolio holdings regularly, certain funds refuse to disclose even the assets they manage.

More than 20 countries have set up sovereign wealth funds while a dozen more have expressed interest in establishing them. More than half of these assets are in the hands of countries that export a significant amount of oil and gas. The total value of debt and equity securities denominated in U.S. dollars is expected to be more than $50 trillion.

The secretive nature of these sovereign wealth funds has now given rise to fears that their investments have ulterior political motives. With more than $200 billion in bad debts, these investments are at the moment welcomed by many. Due to their rapid growth, there is now an increasing demand for regulating the investment by sovereign funds.

The Abu Dhabi International Authority recently invested $7.6 billion for a 4.9% stake in Citigroup which was reeling under the effects of bad loans to the housing sector. This investment provided a lifeline to the world’s biggest financial services group.

The key question is: Is a sovereign wealth fund different from an ordinary market participant? Sovereign wealth funds are owned by national governments. Governments can explicitly use their financial holdings in order to maximize ulterior goals. If a government has huge holdings of U.S. government bonds in their reverse portfolio, it can trigger a crisis in the U.S. bond market by dumping those bonds. The prospect of a foreign government owning a large fraction of our government bonds is less benign than it used to be.

The need for such investment in the U.S. is much more than the need for the sovereign wealth funds to invest their money. The main fear is that these funds are politically motivated and foreign governments, including some not very friendly ones, may gain access to U.S. technology.

It will not be an easy take to regulate wealth sovereign funds. If one country does not want sovereign funds, there are others who will welcome them. Many sovereign wealth funds may just turn their backs on countries that try to regulate them.

Attempts to regulate sovereign wealth funds may be seen as protectionism and chill the climate for foreign investment in the U.S. as the global economy slows down. Instead the U.S. government must take steps to ensure that the sovereign wealth funds remain a positive influence.

Sovereign wealth funds are not going away, and it will be increasingly necessary to work to integrate these funds as smoothly as possible into the financial system.

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