The politics of sovereign wealth: global financial markets enter a new era.

• Author: Badian, Laura

Sovereign wealth funds and government-owned companies have been receiving increased attention in the media due to a number of significant recent acquisitions. With trillions of dollars of cash at their disposal, these entities are also receiving increased attention from regulators, both in the United States and abroad. While it is too early to predict what the future regulatory landscape might look like, sovereign wealth funds and government-owned enterprises should not wait to find out. They need to closely monitor developments in both the United States and elsewhere, particularly Europe, and become involved in the discussions.

While state-owned sovereign wealth funds have existed at least since the 1950s, their total size worldwide has increased dramatically over the past ten to fifteen years. Today these funds control an estimated $2.5 trillion, more than all of the world's hedge funds combined. By some estimates, total assets in sovereign wealth funds could reach $12 trillion by 2015. (1) Their growth is being fueled by high commodity prices, particularly for oil, and high levels of foreign exchange reserves resulting from trade surpluses. Whereas in the past many sovereigns invested their currency reserves in conservative investments such as U.S. government securities, they now seek greater returns and are willing to invest in riskier assets to achieve them. At the same time, government-controlled enterprises are playing an increasingly important role in capital markets, driven by the semi-privatization of government enterprises in areas such as banking, oil and gas, infrastructure, transportation, and real estate. Eight of the twenty largest publicly traded companies worldwide are majority state-owned. (2)

The United States, France, and Germany are each considering regulating sovereign wealth funds, while Canada is launching a review of its foreign-investment and ownership rules. France and Germany have called for a joint European response. At a meeting of finance ministers and central bank chiefs in October, the G7 called for greater transparency of sovereign wealth funds, but stopped short of proposing reforms to limit their activities. While some nations demanded a tougher approach, currently there does not appear to be a consensus view because these funds also contribute to world economic growth and, in some cases, market stability. However, following strong pressure from the United States and France, the G7 called on the International Monetary Fund, the World Bank, and the Organization for Economic Cooperation and Development to draft a new code of conduct for sovereign wealth funds, which is expected to include provisions on institutional structure, risk management, transparency, and accountability. While it may be possible to get some agreement on best practices through these efforts, it is not certain that an unenforceable code of corporate conduct will forestall future regulation.

Some commentators suggest making the activities of sovereigns an issue in global trade, subject to negotiation between countries that have funds and countries where the funds invest. Violations of the accord could be enforced by prohibitions on future investment. Jeffrey Garten, professor of international trade at Yale University, argues that the United States and the European Union must coordinate their policies; otherwise, investment funds could play one country against another. But trade negotiations could be difficult. Investor countries could bring up divisive issues, such as whether private hedge funds should also be bound by the provisions of any deal that requires disclosure by funds of financial information.

Alternatively, individual countries or regions could pass their own regulations. There is a danger, as Christopher Cox, chairman of the U.S. Securities and Exchange Commission, has warned, that the rise of sovereign wealth funds could provoke a new round of protectionism, in which...