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Temptation and the Virtues of Long-Term Commitment: The Governance of Sovereign Wealth Fund Investment

Published online by Cambridge University Press:  07 October 2010

Gordon L. CLARK  and
Eric R.W. KNIGHT
Gordon L. CLARK*
Affiliation:
Oxford University Centre for the Environment, United [email protected] and [email protected]
Eric R.W. KNIGHT*
Affiliation:
Oxford University Centre for the Environment, United [email protected] and [email protected]
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Abstract

In this article we look at the governance of SWFs from the perspective of the competing political interests embedded in the sponsor—the domestic political claims on funds and the principles and practice of governance used to discipline those interests in favour of a long-term perspective that emphasizes the conservation of wealth and the intergenerational transfer of benefits. Using the case-study of the Australian SWF known as the Future Fund, we argue that SWFs can be used as legal instruments to promote the interests of future generations. In this way, it puts into action the principle of intergenerational equity which has been hereto notoriously difficult to substantively apply in international law. By invoking the intergenerational principle, we argue that the Australian government not only responded to the legal challenges of implementing intergenerational equity but also contributed to its currency as a customary norm.

Type
Symposium: Sovereign Wealth Funds
Information
Asian Journal of International Law , Volume 1 , Issue 2 , 14 June 2011 , pp. 321 - 348
Copyright
Copyright © Asian Journal of International Law 2010

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References

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47. Australian Bureau of Statistics, “International Trade in Goods and Services” at Cat. no. 5368.0, Table 2, Goods and Services, online: Australian Government 〈http://www.abs.gov.au/〉 (in Australian Dollars (millions)). Converted from monthly to annual (data for 2008 includes January–November)); and the Hon. Wayne Swan MP, Treasurer of the Commonwealth of Australia and the Hon. Lindsay Tanner MP, Minister for Finance and Deregulation, Treasury of Australia, “Final Budget Outcome 2007–08” (2008), at 88, Appendix B: Historical Fiscal Data, online: Budget Office 〈http://www.budget.gov.au/〉 (in Australian Dollars (millions). Underlying cash balance is equal to receipts less payments less Future Fund earnings).

48. Treasurer Costello established the Wallis inquiry into financial regulation when the Liberal Party assumed office in 1996. The report of the inquiry sought to modernize regulation, recognizing the significance of new forms of communication, the growing role of intermediation, and the growth of different types of financial institutions. See generally Commonwealth of Australia, Financial System Inquiry: Final Report (Canberra ACT: Australian Government, 1997)Google Scholar. It took seriously the functional model of finance developed by Merton and his colleagues. See generally MERTON, Robert, “Operation and Regulation in Financial Intermediation: A Functional Perspective” in Peter ENGLUND, ed., Operation and Regulation of Financial Markets (Stockholm: Ekonomiska Rdet, 1993), 17Google Scholar; MERTON, Robert, “Financial Innovation and the Management and Regulation of Financial Institutions” (1995) 19 Journal of Banking and Finance 461CrossRefGoogle Scholar; see also MERTON, Robert and BODIE, Zvi, “The Design of Financial Systems: Towards a Synthesis of Function and Structure” (2005) 3 Journal of Investment Management 1Google Scholar.

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60. Ibid., at 48. This remains a significant point of contention, with some commentators arguing that infrastructure investment that boosts labour productivity has a more beneficial effect for the whole economy than a finance sector that invests assets through capital markets. There is considerable academic debate about this issue. See KING, Robert and LEVINE, Ross, “Finance and Growth: Schumpeter Might Be Right” (1993) 108 Quarterly Journal of Economics 717CrossRefGoogle Scholar; KING, Robert and LEVINE, Ross, “Finance, Entrepreneurship and Growth: Theory and Evidence” (1993) 32 Journal of Monetary Economics 513CrossRefGoogle Scholar.

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62. In theory, it is clear that institutions are better governed if they have unambiguous mandates or objective functions. See generally CLARK, Gordon L. and URWIN, Roger, “Best-Practice Investment Management” (2008) 9 Journal of Asset Management 2Google Scholar [Clark and Urwin, “Best-Practice”] (developing this point with respect to best-practice pension fund governance and underlining the relevance of the argument that defined benefit and defined contribution pension plans serve very different interests over distinctly different time horizons).

63. Hansard, 7 February 2006. When the government came to sell the third tranche of Telstra shares, the National Party negotiated the establishment of another endowment fund whose income would be invested in rural telecommunications infrastructure. That fund was abolished with the support of the Liberal Party when the Labor opposition assumed government. I am indebted to Nick Howarth for pointing this out.

64. Future Fund Act 2006 (Cth), Part 1, Section 3 [Future Fund]. Note that a number of other funds have been established by the incoming Labor government since the Future Fund, administered through the guardians and managed by the Future Fund. See e.g., Nation-building Funds Act 2008 (Cth), Chapter 1, Section 3.

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66. See generally ROE, Mark J., “Legal Origins, Politics and Stock Markets” (2006) 120 Harvard Law Review 460Google Scholar.

67. See generally TRUMAN, Edwin M., “A Blueprint for Sovereign Wealth Fund Best Practices” (Peterson Institute for International Economics, Policy Brief 08-3, April 2008), online: Peterson Institute 〈http://www.iie.com/publications/pb/pb08-3.pdf〉Google Scholar.

68. In fact, close scrutiny of Truman’s scoring suggests that the zero values attributed to four elements of transparency and accountability were mistaken given the recent establishment of the fund and the constitution of its long-term mandate. If that were the case, the FF would have scored the same as the CPPib and the New Zealand Superannuation Fund.

69. The Clark-Urwin governance scoring system was conceived to be a diagnostic tool for evaluating the form and functions of investment institutions, including SWFs, pension funds, and endowments. It has developed from our work on global best practice, and the nature of institutional innovation in the context of the global financial crisis. See Clark, and Urwin, , “Best-Practice”, supra note 62Google Scholar; Clark, and Urwin, , “Innovative Models”, supra note 10Google Scholar.

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72. Future Fund, Statement of Investment Policies (Melbourne: Australian Government, 2008)Google Scholar; but see Future Fund, Statement of Investment Policies (Melbourne: Australian Government, 2009)Google Scholar, online: Future Fund 〈http://www.futurefund.gov.au/investment/investment_policies〉 (revising and reissuing the investment policies in April 2009).

73. See generally CLARK, Gordon L., “Expertise and Representation in Financial Institutions: UK Legislation on Pension Fund Governance and US Regulation of the Mutual Fund Industry” (2007) 2 Twenty-First Century Society: Journal of the Academy of Social Sciences 1CrossRefGoogle Scholar.

74. See generally CLARK, Gordon L. and URWIN, Roger, “Making Pension Boards Work: The Critical Role of Leadership” (2008) 1 Rotman Journal of International Pension Management 38Google Scholar [Clark and Urwin, “Making Pension Boards Work”].

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78. Future Fund, supra note 64 at Section 38.

79. Notice that Board members are also required to “discharge his or her duties with the degree of care and diligence that a reasonable person would exercise”. Future Fund, supra note 64 at Section 56. Elsewhere in the Act, the Board is required to formulate “written policies” pertaining to the investment strategy of the fund in a manner consistent with “international best practice for institutional investment”. Future Fund, supra note 64 at Section 24.

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81. See generally Clark, and Urwin, , “Making Pension Boards Work”, supra note 74Google Scholar.

82. See generally BAUER, Rob, HOEVENAARS, Roy, and STEENKAMP, Tom, “Asset Liability Management” in Gordon L. CLARK, Alicia MUNNELL, and Michael ORSZAG, eds., The Oxford Handbook of Pension and Retirement Income (Oxford: Oxford University Press, 2006), 441Google Scholar.

83. See e.g., Commonwealth of Australia, Parliamentary Debates, House of Representatives, 7 February 2006, E16-17 (exchange between Senator Stephens and an expert witness).

84. See generally CLARK, Gordon L., Pension Fund Capitalism (Oxford: Oxford University Press, 2000)Google Scholar; see also SHLEIFER, Andrei, “A Theory of Yardstick Competition” (1985) 16 RAND Journal of Economics 319CrossRefGoogle Scholar.

85. See generally Shiller, supra note 9.

86. See generally Future Fund, Annual Report 2007–08 (Canberra ACT: Australian Government, 2008)Google Scholar, online: Future Fund 〈http://www.futurefund.gov.au/annual_reports〉.

87. For a detailed analysis of the emerging third sector in venture capital and private equity product offerings—i.e. the clean tech (or climate change related) sector, see KNIGHT, Eric R.W., “The Economic Geography of Clean Tech Venture Capital”, Oxford University Centre for the Environment, Working Paper G10-06, 2010Google Scholar.

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91. The regard paid to social and environmental conditions more broadly in mainstream financial analysis by investment consultants, the advisers to institutions like pension funds and SWFs, is examined more closely in KNIGHT, Eric R.W. and DIXON, Adam, “The Role of Asset Consulting in Transforming Investment Decision-Making: The Integration of Environmental, Social and Governance Considerations into Corporate Valuation” in James P. HAWLEY, Shyam KAMATH, and Andrew T. WILLIAMS, eds., Institutional Investors, Risk/Return Tradeoffs and Corporate Governance Failures (Philadelphia: University of Pennsylvania Press, [2011 forthcoming])Google Scholar.

92. For early expositions of this argument in the legislative context, see NORTON, Bryan G., “Intergenerational Equity and Environmental Decisions: A Model Using Rawls’ ‘Veil of Ignorance’” (1989) 1 Ecological Economics 137CrossRefGoogle Scholar; see also BROWN WEISS, Edith, “The Planetary Trust: Conservation and Intergenerational Equity” (1984) 11 Ecology Law Quarterly 495Google Scholar [Brown Weiss, “Planetary Trust”].

93. Brown Weiss, “Planetary Trust”, ibid.

94. For a more detailed analysis of the relationship between intergenerational equity and fiduciary duty, see generally Woods, , “Intergenerational Justice”, supra note 30Google Scholar.

95. Compare the rationale of the Norwegian SWF formally known as Norges Bank Investment Management, which has a strong ethical mandate as well as a commitment to enhancing global standards of corporate governance. See generally CHESTERMAN, Simon, “The Turn to Ethics: Disinvestment from Multinational Corporations for Human Rights Violations—The Case of Norway's Sovereign Wealth Fund” (2008) 23 American University International Law Review 577Google Scholar. In the April 2009 Statement of Investment Policies, the Future Fund noted their responsibilities for promoting standards of corporate governance in Section 7—“Policy for management of ownership rights”. There may follow, in the near future, further communications about its social responsibilities, albeit framed in terms of risk management taking into account the “value” proposition that underpins any long-term investment strategy.

96. Another interpretation of this provision is that it means that the fund would not be a direct competitor to private infrastructure investors such as Macquarie Bank. Rather it will rely upon this growing sector of the Australian finance industry.

97. Weiss, Brown, “Future Generations”, supra note 13 at 206Google Scholar.