Source: RealClearMarkets
For the G20, the Glass Is Half FullAs world leaders, finance ministers, and central bankers arrive in Toronto for the G20 meeting on June 26-27, it is important for them to avoid complacency and identify the necessary global financial reforms to avert another economic crisis. This group of rich and emerging countries can find lessons to coordinate policies - both good and bad - from an unlikely place: sovereign wealth funds.The verdict is still out if the G20, facing singular national interests, can effectively translate principles into more concrete policies and develop a financial architecture that defends a dynamic global economy. If anything, the financial crisis demonstrated that good governance, accountability, and transparency are not some lofty ideals, but have a monetary value - trillions of dollars. The G20 needs to take the lead in finding a solution.
Inspiration about alternative arrangements for meaningful global governance might come from an investor class that in recent years has a made a remarkably noisy entry into global economic affairs. Only two years ago, sovereign wealth funds (SWFs) were hugely exposed to critics - particularly in Europe and the United States - where they were perceived as opaque, politically motivated government agencies that challenged the very foundations of the global capitalist system.
Responding to these allegations, an unusual crowd of 26 SWFs from Norway, Abu Dhabi, Kuwait, Singapore, China, Russia, and other industrialized and emerging economies banded together in 2008 and developed a voluntary code of principles. The "Santiago Principles" committed SWFs to uniform governance, accountability, and transparency standards. And with their adoption, the world's leading SWFs have managed to become more transparent and accountable and as such provide the G20 with valuable lessons when designing new mechanisms for global governance.
Today, these SWFs marshal considerable financial resources, representing around US$2.3 trillion. This is double the size of the global hedge fund industry and roughly equal to the size of global private equity funds. They have made progress in implementing the principles, even though they were a radical deviation from their traditional approach at times.
By submitting to the principles, the SWFs voluntarily ceded their autonomy and made a conscious decision to limit the reach of their so-called sovereignty. The willingness of SWFs to supply higher levels of transparency and predictability has been part of the bargain with recipient countries to maintain open cross-border investment rules and regulations.
While there is no enforcement mechanism for SWFs and no institutionalized authority that can sanction non-compliance, the principles have developed an incentive structure for some of the most powerful players in international finance to voluntarily move forward with the good governance and transparency agenda. They provide a best practice benchmark, and an implicit peer review mechanism helps to prevent the more responsibility oriented funds from falling behind industry leaders.
But the story is not all positive. A closer look at the implementation process reveals that overall, the compliance level of SWFs to the Santiago Principles is just over 50 percent. A number of funds do not provide adequate financial information, including strategic asset allocation, benchmarks, and financial performance. Some also have difficulty clarifying the relationship between their operational management and political leadership.
Still, the glass is half full, rather than half empty.
The G20 in Toronto and in Seoul later this year will undoubtedly be concerned by the necessity to respond to the consequences of the sovereign debt crisis. It will examine mechanisms for closer macroeconomic coordination and hopefully introduce reforms for financial regulation and international financial institutions. As the G20 moves from crisis management to crisis prevention, the group needs to have a closer look at the work of sovereign wealth funds as a unique example of global governance.
Clearly, the G20 still has far to go in terms of reforming the global financial system and calming the lingering economic turmoil. Thankfully, the experience of sovereign wealth funds provides a useful outline for what's possible.