By Linda Du · On March 30, 2017
In September 2016, Congress passed the Justice Against Sponsors of Terror Act (JASTA) that would allow families of the victims of 9/11 to sue the government of Saudi Arabia for its involvement in the terrorist operation. Fearing that this bill would jeopardize one of the United States’ only alliances in the region, President Obama vetoed the bill, only to have Congress override his veto and sign the bill into law five days later.
To say that the United States’ relationship with Saudi Arabia is complex is an understatement. Saudi Arabia, often at the centre of human rights violations, has always been an onerous ally to the United States. The country played an excruciatingly demanding role during the negotiation of the Iran Nuclear Deal and has often enacted policies that have contributed to inciting Islamic extremists from the region. Nevertheless, Saudi Arabia is an important oil trading partner to the US and an ally in the fight against terrorism. The ramifications of JASTA could undermine the countries’ bilateral relations. Indeed, Saudi Arabia has already threatened to withdraw billions of dollars in America-based assets to negotiate against court action in response to JASTA. This incident brings attention to the influence of sovereign wealth funds, their investment opportunities, and their ability to create volatility in foreign financial systems based on geopolitical incentives.
The growth experienced by commodities-exporting countries and emerging-market economies has resulted in large pools of foreign exchange reserves. Although these reserves have existed since the 1950s, recent economic developments have illuminated the impact of these reserves on international financial stability, labeling these reserves as a new class of investment vehicles known as sovereign wealth funds (SWFs). SWFs are managed by governments and are meant to be a tool for investing a country’s commodities revenues in good economic times therefore hedging against times when commodities revenues are low. Rather than investing large amounts of foreign revenues domestically, which increases inflation and concentrates risk, SWFs invest capital abroad in the international bond and equity markets which minimizes risk through diversification.
SWFs, like other investment funds, employ a myriad of investment strategies. For example, the Norwegian and Kuwaiti SWFs employ a more traditional investment strategy by holding small investments in many foreign assets including publicly traded companies, mutual funds, government bonds, hedge funds, and private equity funds. On the other hand, Singapore’s Temasek Fund and Dubai International Capital are more critical SWFs because they often take substantial positions in foreign companies that lead to majority control or ownership. Moreover, against the current backdrop of the slower growth economy and low-rates, many SWFs have begun adopting strategies that focus less on conservative debt instruments and more on higher-yield alternative investments. Inevitably, their closeness to geopolitical and international relations policies has given rise to concern surrounding the kind of impacts more active SWFs may have on the entire international financial system.
Given the large size of some of these SWFs, their investment activities can disrupt markets. In 2006, the Government Pension Fund of Norway began suddenly short selling all of Iceland’s financial institutions, sparking mass market panic and a period of financial instability. SWFs can also have significant impacts on sovereignty. In many cases, funds that take significant positions or ownership in foreign companies contribute to undermining the economic independence of small countries . This problem is exacerbated further by the limited disclosure and transparency regarding SWF operations, which ultimately raises concerns over national security. Whereas hedge funds and private equity funds focus solely on maximizing investment returns, SWFs often simultaneously act as political entities in pursuit of geopolitical interests. As JASTA illustrates, nations can leverage the importance of their SWFs in the international global markets to exert influence over the United States’ foreign policy. Problematically, SWFs can also assume investment positions in sectors like natural resources or advanced technologies, ultimately moving closer towards meeting their own political and strategic objectives. Due to this inherent risk, increased regulatory action on sovereign wealth funds is justified.
While existing financial regulatory policies –such as antitrust, antifraud, and other corporate legislation- already inhibit SWFs from obtaining controlling power in sensitive or strategic sectors, there are still significant loopholes that have the ability to jeopardize domestic interests. For example, in the United States, SWFs are subject to the same regulations of the Securities Exchange Act as private equity and hedge funds but are not subject to more detailed disclosure than other funds at the same investment level . If SWFs were found to be exercising political interests, they would be under the jurisdiction of US courts in connection to their investment activities. Moreover, the Committee on Foreign Investment in the United States reviews foreign investments in domestic companies and gives more attention to large positions.
Globally, SWFs provide a tremendous amount of positive impact by investing in capital-scarce companies and special situations –especially when other funds cannot. In the 2008 financial crisis, SWFs provided significant capital injection into U.S. financial institutions, ultimately ensuring their solvency. SWF capital injection in selected US financial institutions are demonstrated below.
As Brexit and other various ultranationalist movements in places like Hungary and Poland illusrate, rising anti-globalization sentiment has gained momentum. The wall-builders of anti-globalization sentiment appeal to the fear of a more chaotic, hostile world, even though globalization has clearly improved the lives of people overall. While caution is necessary, we cannot let this sentiment overpower the fact that SWFs have the capacity to be partners in funding globally beneficial projects in infrastructure, healthcare, and education in capital-scare countries such as Mongolia and Angola .