Appendix 2: Sovereign Wealth Funds …

                                   Appendix 2: Sovereign Wealth Funds

Global cross-border assets of the official sector continue to rise at a rapid pace. The IMF
projects that sovereigns will continue to accumulate foreign assets at a rate of $800-900 billion
per year.1 Cross-border assets of the official sector include about $6 trillion in foreign exchange
reserve holdings and approximately $1.9-2.9 trillion in sovereign wealth fund (SWF) holdings.

Of course, absolute size alone is an          Selected Sovereign Wealth Funds
insufficient metric to assess the                                                                                               Estimated            Source of
relative importance of official               Country               Name of Fund                                               Assets1 ($bn)            Funds
reserves and SWFs in the                      UAE                   Abu Dhabi Investment Authority                               250-875    2
                                                                                                                                                     oil and gas
international financial system.               Norway                Government Pension Fund - Global                               397               oil and gas
Below are four different relative             Saudi Arabia          Saudi Arabia Monetary Agency                                   2503             oil and gas
metrics: private pools of capital; net        Kuwait                Kuwait Investment Authority                                     213             oil and gas
new issuance of traditional reserve           China                 China Investment Corporation                                    200           non-commodity
assets; existing stocks of traditional        Singapore             Government Investment Corporation                              >100           non-commodity
reserve assets; and existing stocks           Russia                Stabilization Fund                                              144             oil and gas
of other financial assets.                    South Korea           Korea Investment Corporation                                    20            non-commodity
                                              1                                           2                                3
                                                  National data unless otherwise noted.       Range of market estimates        Non-reserve foreign assets.
Private Pools of Capital
To get a better perspective of the relative importance of SWFs, it is useful to consider how they
measure up against private pools of global capital. Total SWF assets of $1.9-2.9 trillion may be
small relative to the roughly $62 trillion managed by private institutional investors. But SWF
assets are currently larger than the total assets under management by either hedge funds or
private equity funds (estimated at $1.5 trillion and $700 billion, respectively), and are set to grow
at a much faster pace. Some private analysts project that aggregate SWF assets could grow to
$7-8 trillion by 2012 and to $12-15 trillion by 2015.

"Forced Diversification" of Official Flows
Global official reserve accumulation
is running far ahead of new net                                                                      Net Issuance
                                         $ billions
issuance of traditional reserve assets.
In 2007, assuming an annualized rate 1400              UK Treasury
                                                                                                                                                                1400
                                         1200          Euro Area Gov                                                                                            1200
of global reserves growth of 27                        U.S. Agency
                                         1000          U.S. Treasury                                                                                            1000
percent (based on actual reserve          800          Reserve Grow th                                                                                          800
growth in Q2), new reserves               600                                                                                                                   600
accumulation would be $1.3 trillion       400                                                                                                                   400
and net new issuance $603 billion. So 200                                                                                                                       200
even if emerging market central banks        0                                                                                                                  0
purchased all new net issuance of        -200                                                                                                                   -200
traditional reserve assets in 2007, they -400                                                                                                                   -400
would still need to find somewhere to              2000       2001     2002                           2003         2004   2005          2006          2007

invest roughly $742 billion.




1
    Annex 1.2. Sovereign Wealth Funds, IMF Global Financial Stability Report, September 2007.
Reserves Size Relative to Stocks of Traditional Reserve Assets
This $742 billion could also be invested not just in new issuance but also in existing stocks of
traditional reserve assets through secondary debt markets. Official reserves amounted to nearly
40 percent of the outstanding stock of U.S. Treasuries, Agencies, and Euro-area and UK
government securities in 2006. For U.S. Treasuries and Agencies specifically, Treasury
International Capital reporting system data show that on June 30, 2006, foreign official holdings
constituted 37 percent of marketable long-term Treasury and 8 percent of long-term Agency
securities.

Reserves and SWF Size Relative to Stocks of Other Financial Assets
Other mainstream financial asset classes are       $trillions
                                                     80                                                             80
absorbing most of the remaining reserve and
SWF assets that diversify away from traditional      70                 US                                          70

assets. Reserves and SWFs are still small            60                 EU                                          60
                                                                        Japan
relative to global financial assets, estimated by    50                 Other                                       50
the IMF to be $190 trillion in 2006. Of that,
                                                     40                                                             40
$120 trillion is stocks and bonds. $96 trillion is
                                                     30                                                             30
in U.S., EU or Japanese markets. Private
analysts believe that currently only a relatively    20                                                             20

small share of assets is allocated to alternative    10                                                             10
asset classes such as private equity, real estate,    0                                                             0
or commodities.                                              Reserves Public          Private   Stocks    Bank
                                                                  + SWFs    Bonds     Bonds               Assets
                                                                               Source: Treasury estimates and IMF
Policy Issues
SWFs represent a large and rapidly growing stock of government-controlled assets, invested
more aggressively than traditional reserves, with implications for the international financial
system.

SWFs have the potential to promote financial stability. They are, in principle, long term, stable
investors that provide significant capital to the system. They are typically not highly leveraged
and cannot be forced by capital requirements or investor withdrawals to liquidate positions
rapidly. SWFs, as public sector entities, should have an interest in and a responsibility for
financial market stability. Foreign direct investment by SWFs can contribute to economic
growth in recipient countries.

SWFs also raise two sets of potential concerns:

On the investment side, SWFs could provoke investment protectionism, which could have
negative consequences for the global economy. Transactions involving SWF investment may
raise legitimate national security concerns. SWFs may also raise a number of non-national
security issues related to a larger role of foreign governments in markets. For example, through
inefficient allocation of capital, perceived unfair competition with private firms, or the pursuit of
broader strategic rather than strictly economic return-oriented investments, SWFs could
potentially distort markets.

On the financial markets side, SWFs may also raise concerns related to financial stability. They
can represent large, concentrated, and often non-transparent positions in certain markets and
asset classes. Actual shifts in their asset allocations could cause market volatility. In fact, even


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perceived shifts or rumors can cause volatility as the market reacts to what it perceives SWFs to
be doing.

Policy Response
The Department of the Treasury, in coordination with other U.S. government agencies, is
working to shape an appropriate international policy response to financial market and investment
issues raised by SWFs.

First, as the chair of the Committee on Foreign Investment in the United States (CFIUS),
Treasury is implementing the new Foreign Investment and National Security Act of 2007
(FINSA), which has introduced several reforms to the CFIUS process. CFIUS reviews certain
foreign direct investments, including from SWFs. CFIUS reviewed its first SWF investment
soon after beginning reviews under the 1988 Exon-Florio amendment to the Defense Production
Act. CFIUS's focus has always been limited to transactions that raise genuine national security
issues, and FINSA maintains that focus. The U.S. investment security framework, as improved
by FINSA, helps protect national security while maintaining the longstanding U.S. commitment
to open investment policies. Treasury is actively engaging countries where protectionist
sentiment is on the rise to help them avoid reactionary policies.

Second, Treasury has proposed that the international community collaborate on a multilateral
framework for best practices. The International Monetary Fund, with support from the World
Bank, should develop best practices for SWFs, building on existing best practices for foreign
exchange reserve management. These would provide guidance to new funds on how to structure
themselves, reduce any potential systemic risk, and help demonstrate to critics that SWFs can be
responsible, constructive participants in the international financial system.

Third, the Organization for Economic Cooperation and Development (OECD) should identify
best practices for countries that receive foreign government-controlled investment, based on its
extensive work on promoting open investment regimes. These should have a focus on
proportionality, predictability and accountability, and should be guided by the well-established
principles embraced by OECD and its members for the treatment of foreign investment. It is
important to address the growing importance of SWFs, on both sides of the investment equation.

The Treasury has already achieved meaningful progress along these lines. On October 19,
Secretary Paulson hosted a G-7 outreach dinner with Finance Ministers and heads of SWFs from
eight countries (China, Korea, Kuwait, Norway, Russia, Saudi Arabia, Singapore, and the United
Arab Emirates) to build support for a set of best practices for SWFs. On October 20, the
International Monetary and Financial Committee (IMFC) ­ a ministerial level advisory
committee to the IMF ­ issued a statement calling on the IMF to begin a dialogue to identify best
practices for SWFs. On November 15-16, the IMF hosted a roundtable meeting for sovereign
asset and reserve managers. In response to the IMFC statement, the IMF added a special session
on policy and operational issues relating to SWFs for official sector delegates. This marks the
beginning of an important process in the IMF. IMF Managing Director Dominique Strauss-Kahn
opened the roundtable meeting and underlined that some form of agreement on best practices for
the operations of SWFs could help maintain an open global financial system.2 A separate

2
 IMF Convenes First Annual Roundtable of Sovereign Asset and Reserve Managers, IMF Press Release, November
16, 2007. http://www.imf.org/external/np/sec/pr/2007/pr07267.htm

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dialogue is well underway in the OECD on investment policy issues with regard to SWFs,
building on the discussions on Freedom of Investment, National Security, and "Strategic"
Industries.

Fourth, Treasury has taken a number of steps internally and within the U.S. Government to
enhance our understanding of SWFs. Treasury has created a working group on SWFs that draws
on the expertise of Treasury's offices of International Affairs and Domestic Finance. Treasury's
new market room is ensuring vigilant, ongoing monitoring of SWF trends and transactions.
Through the President's Working Group on Financial Markets, chaired by Secretary Paulson, we
continue to discuss and review SWFs. We also have initiated bilateral outreach to ensure an
ongoing and candid dialogue with countries with significant SWFs and their management.

The Treasury Department will continue its work on SWFs through bilateral and multilateral
efforts to ensure the United States shapes an appropriate international response to this issue,
addresses legitimate areas of concern, and ensures that the United States remains welcoming of
foreign investment. Treasury will also continue to keep Congress closely informed, both through
formal testimony such as that of Under Secretary McCormick3 on November 14 to the Senate
Committee on Banking, Housing, and Urban Affairs and staff briefings.




3
    http://www.treas.gov/press/releases/hp681.htm

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