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The New Economics of Sovereign Wealth Funds


The New Economics of Sovereign Wealth Funds is a one-stop guide to the macroeconomic environment within which sovereign wealth funds operate. The book provides a thorough guide to sovereign wealth funds, covering the drivers of the industry, how it operates and grows, the interest from and in Western markets and the pivotal role that sovereign wealth funds play in the world economy.

The activity of sovereign wealth funds has often ignited a political reaction and a protectionist backlash. By going beyond discussions based on misconceptions to analyse state capitalism, this book evaluates the role played by sovereign wealth funds within the dynamics that are reshaping the economic and financial geography in the 21st century.

The book argues that the emergence of sovereign wealth funds represents a major element of the secular shift of power from mature Western economies to vibrant emerging markets. It offers an all-encompassing perspective, from a rigorous analysis of the economic and financial drivers of their growth to an accurate description of how these institutions invest for the long-term in global capital markets in the global economy.

Identifying the drivers of the growth of sovereign wealth funds, the book discusses commodity prices, macroeconomic imbalances and current account surpluses. The book goes on to analyse sovereign wealth funds in the wider global macroeconomic context and examines their capital allocation across regions, asset classes and currencies. The final chapters identify the challenges of sovereign wealth funds in the new regulatory framework and explore how they are increasingly investing in emerging markets. Finally the book provides an overview on how the Western world is reacting to the growing role of state-controlled investment vehicles and the initiatives by international institutions to find a common ground.

Written by two celebrated practitioners working in the industry, The New Economics of Sovereign Wealth Funds presents insights from officials in charge of investing a large pool of assets in global capital markets and includes a preface from John A. Fraser, Chairman & CEO of UBS Global Asset Management.

MASSIMILIANO CASTELLI, PhD, is Head of Global Strategy in the department advising central banks and Sovereign Wealth Funds at UBS Global Asset Management. In this role, he analyzes the market trends affecting the investment behaviour of sovereign institutions and works closely with investment specialists in providing investment advice and developing tailored investment solutions for this client segment. Since the political debate surrounding SWFs has appeared on the international policy agenda, he established himself as a global thought leader on the macroeconomic, financial and political trends in sovereign wealth management. He has often been called in by leading institutions and think tanks as an expert on global economic and financial matters, he regularly writes articles and essays on these topics and is often invited as a speaker at international conferences.

In his fifteen year long international professional career, he has been Head of governmental affairs for UBS in Europe, Middle East and Africa, Senior Economist for the Middle East region at UBS and an economic consultant advising governments and corporates in emerging markets on behalf of international institutions. He holds a PhD in Economics from the University of Rome where he lectured and an MSc in Economics from the University of London.

FABIO SCACCIAVILLANI, a PhD in Economics from the University of Chicago, is the Chief Economist and member of the Investment Committee of the Oman Investment Fund, which manages the Omani government’s oil revenues for the benefit of future generations. In this role, he develops economic forecasts, conducts analyses on global trends, evaluates asset class returns, and contributes to strategic decision-making. He is one of the world’s leading experts on the activity of Sovereign Wealth Funds, their influence on financial markets, and their investment strategies. He has written extensively on the political sensitivities that SWFs stirred in Western countries and the emergence of a multipolar world.

In his distinguished career he served as Director of Macroeconomics and Statistics at the Dubai International Financial Centre, Executive Director at Goldman Sachs, Senior Economist and Adviser at the European Central Bank and worked in several departments of the International Monetary Fund. He has an extensive scholarly publication record and is frequently interviewed and quoted on international media.

Foreword xi

List of Tables and Figures xiii

List of Abbreviations xv

Acknowledgements xvii

Introduction 1

A few stylized facts 2

SWFs under the spotlight 4

Defining SWFs 9

Misplaced fears 10

The plan of the book 13

1 The Macroeconomic Dynamics Behind SWFs 17

1.1 Persistent current account surpluses translate into accumulation of foreign assets 18

1.2 Absorption constraints: the rationale for establishing SWFs and FWFs 21

1.3 The management of natural resources windfall 24

1.4 Commodities demand and the super‑cycle theory 29

1.5 SWFs as alternative to an income tax system: what if Norway becomes like Saudi Arabia? 33

2 Size and Growth of SWFs Assets 37

2.1 Size and clusters of SWFs 38

2.2 Drivers of SWFs asset growth 43

2.3 The optimal level of foreign exchange reserves 45

2.4 Future growth in FX reserves: commodity- versus noncommodity-exporting countries 47

2.5 Size of SWFs by 2016 49

Appendix: How big could SWFs be by 2016? 54

3 SWFs as Investors in Global Markets 71

3.1 Clustering SWFs by objectives and investment profiles 74

3.2 SWFs as strategic investors in domestic and global markets 83

3.3 Geographical and sector distribution of SWF strategic investments: the 2007-2008 surge of investments in Western financials 86

3.4 Investment performance of SWFs and the impact of the financial crisis 94

3.5 Explicit and implicit liabilities of SWFs 97

3.6 Long-term investments: SWFs as the ultimate risk bearers 99

4 Risk Management for SWFs 105

4.1 The crisis in retrospect 108

4.2 The complex qualitative nature of risk: uncertainty, chaos, black swans and fat tails 111

4.3 Banking regulation, herd behaviour and contagion 113

4.4 The evolution of the regulatory framework 118

4.5 Sketches of risk management for SWFs 121

4.6 An unconventional dimension of risk management: shareholders vs stakeholders 129

5 SWFs in the Geopolitics of the Twenty-first Century 131

5.1 The shift to the East of the global economy: the New Silk Route 137

5.2 The law of unintended consequences? China’s influence through financial muscle 141

5.3 SWFs investing in the less developed economies: Africa as the last investment frontier 145

5.4 The new financial geography: the emerging multipolar financial architecture 147

5.5 The dominance of the US$ in global financial markets: SWFs as US$ diversifiers 149

5.6 SWFs and the new regulatory environment for financial institutions: the upcoming ‘war for capital’ 152

6 The Politics of SWFs Engagement 155

6.1 National responses to the growing role of SWFs 156

6.2 International response to the growing role of SWFs 159

6.3 SWFs’ response to international pressure 161

6.4 Santiago Principles: rationale, implementation and reality 163

6.5 A digression on public versus private role in the economy 168

7 Wrapping Up 173

7.1 Towards a multipolar world 175

7.2 Governments’ activism in economic and financial affairs 176

7.3 Barbarian at the gates or welcome partners? 177

7.4 The end of the savings gluts and the coming era of capital scarcity 179

7.5 Towards a multicurrency regime 180

7.6 A proposal to allay fears over transparency 185

7.7 The new responsibilities on the global scene 186

Bibliography 189

Index 199