In this piece, Professor Hisham Farag and Professor Santosh Koirala, University of Birmingham, and Professor Biwesh Neupane, University of Strathclyde, discuss the opportunities and challenges the creation of a Sovereign Wealth Fund could bring for the UK in relation to its sustainable development goals.
Sovereign Wealth Fund: Navigating the Dichotomy of Good and Evil
Context
The post-COVID global politico-economic situation has increased the risk of governments losing focus on climate change adaptation and Environmental, Social, and Corporate Governance (ESG) strategies. The world is currently experiencing significant economic and geopolitical tensions, due to a combination of factors including regime shift to high interest rates, the climate crisis, the Russian invasion of Ukraine, and tension in the Middle East to name a few.
Since the introduction of the United Nations Principles for Responsible Investment (PRI) in 2006, the number of signatories has increased dramatically, from 734 in 2010 to 3038 in 2020, and the total assets under management has grown from $21 trillion in 2010 to $103 trillion in 2020. With increasing concerns about climate change there have been ever increasing studies that argue climate change will have economic impact that leads to a major shift in business and investment strategies, resulting in unprecedented reallocation of capital and distributive consequences. A recent study by Boston Consulting Group estimates the capital gap of around USD 18 trillion between current commitments and the actual investments that would be needed for align the net zero goals in 2030. Sea level rise and flooding risk are obvious examples that have clear economic impact e.g. the impact of Hurricane Sandy in 2012 on property prices in New York City. The long-run impact of climate risk has been investigated; a study finds that by the year 2100- around 13.1 million Americans will be impacted if the sea level rise by 1.8 meter; another study estimates that about 1.9 million houses worth of $882 billion, mainly in Florida, will be at risk of flooding if sea level rises by six feet. A recent study finds that houses exposed to rising sea levels are sold on average 7% less than unexposed properties. There is also a heightened risk that nations like the UK, in their fight against inflation internally and responding to emerging geopolitical tensions externally may be caught in traps of short-termism to the point of going against their strategic vision of net zero and climate adaptation.
As the UK government is exploring its options to have its own Sovereign Wealth Fund, recent media and financial presses have extensively covered the increasing concern around sub-optimal and the often-myopic horizon of this class of investors when performing their fiduciary duties in the face of political pressures. Emerged as an important institutional investor class with sheer size and influence, the value of assets under management of Sovereign Wealth Funds, which stood at USD 6.07 trillion in 2012, grew to a whopping USD 11.16 trillion in 2023 as reported by SWF Global.
As the investment world celebrates the success of the Norwegian model for responsible investment, targeting sustainable economic growth through a long-term, fiduciary-focused state, the Sovereign Wealth Fund, as an institutional investor, faces criticism for potential lopsidedness in state-agency issues due to conflicting political and fiduciary objectives that the fund’s trustees may pursue. Some of these criticisms do have bite. For instance, four executives at Barclays Bank of UK were charged with fraud by the Serious Fraud Office (SFO) over the financial assistance it received from Qatar Holdings LLC (a whole subsidiary of Qatar Investment Authority, one of the largest SWF) during the financial crisis of 2008. The trial centres on undisclosed payments made to Qatar, stemming from Barclays’ efforts to secure over 11 billion pounds from the Gulf state and additional investors to avert a state bailout amidst the turbulence of the global credit crisis (Ridley, 2019). Later in 2020, the former Barclays executives were acquitted of conspiracy to commit fraud. On 5th Dec 2023, shares in Barclays fell by more than 4% after the Qatar Investment Authority, the bank’s second-largest shareholder, revealed that it is to halve its stake in the lender with plans to raise £644m through the sale. QIA’s move to drastically reduce its backing for Barclays is a significant blow to the bank, especially given its recent announcement of an overhaul geared toward enhancing performance.
Similarly, another most notable SWF scandal relates to the Malaysian State Fund named 1Malaysian Development Berhad (1MDB); It was uncovered that around £3.5 billion disappeared from 1MDB funds and found its way to several associates of the Ex-prime minister of Malaysia. Moreover, Goldman Sachs, which helped 1MDB raise around £5 billion pounds in a series of bond issues in 2012 and 2013, agreed to pay multi–billion pounds charges to several governments including the US, Malaysia, and Singapore for their role in the scandal (Reuters 2023; BBC, 2020). Allegedly, 1MDB was also involved in financial transactions with other large SWFs, including the UAE’s International Petroleum Investment Company, whose head was dismissed after the 1MDB scandal surfaced (Stone & Truman, 2016).
On the one hand, establishment of a Sovereign Wealth Fund could help the UK contribute positively to its Sustainable Development Goals by promoting relocation of capital into adaptation initiatives and sectors thus contributing to the country’s sustainable growth. Nevertheless, the potential that a Sovereign Wealth Fund could pursue state political goals in the guise of investment means there is the risk of corruption culminating in a vicious playing field of state expropriation and political opportunism.
Below is a series of national and international interventions which, if adopted, would build on existing expertise, and go some way to addressing concerns with Sovereign Wealth Funds as sustainable growth vehicles.
Policy Recommendations related to Sovereign Wealth Fund Management
A Sovereign Wealth Fund could pose a reputation risk to investee firms through undue intervention, appointments, and influence. Scandals involving SWFs could consequently affect these investee firms, undermining their reputational integrity. To address this, the government should implement policies ensuring that the appointment of trustees and fund monitors remains independent and based on meritocracy.
- Our empirical work highlights that individuals holding distinct societal positions play a crucial role when seated on corporate boards, contributing positively to the Environmental, Social, and Governance (ESG) performance not only of the firms they directly oversee but also those within the supply chain. We recommend that Sovereign Wealth Funds leverage trustees and board members with societal distinction to foster positive and sustainable outcomes in the assets managed by these funds.
- Our study shows that Sovereign Wealth Fund interferences trigger managerial short termism, investment myopia and deterioration of operational efficiency. Therefore, we advocate for more independent boards. The government should revise existing policies to advocate board independence and prevent political interference in the decisions of investee firms.
- We recommend that the government implements a policy wherein Sovereign Wealth Funds, while considering investments in cross-border firms, prioritise funds originating from countries with transparent practices, higher standards of national governance, and a predictable legal environment. This approach aims to mitigate potential reputational risks.
- A Sovereign Wealth Fund can mitigate potential reputational damage while investing in cross border firms by screening investee firms with formal and informal institutional proximity like similar dominant ideology and democratic belief and similar languages and cultural connectedness.
Policy Recommendations to the investee Firms
- We recommend that investee firms exposed to reputation risk of Sovereign Wealth Fund should carefully design contracts giving differential voting rights to lower the influence of such negative impacts.
- We recommend that investee firms establish closer bonds with Sovereign Wealth Funds that share proximal institutional factors, both formal (national governance) and informal (language and culture)
About the authors
Professor Hisham Farag is a Professor of Finance and Director of Research at Birmingham Business School. He is currently the Editor in Chief of Journal of Sustainable Finance and Investment. He is also the Founding Director of the Sustainable Financial Innovation Research Centre (SFIC). He specialises in sustainability, financial innovation, board diversity, corporate governance, ESG and comparative regulations.
Dr Santosh Koirala is an Associate Professor of Finance at Birmingham Business School and specialises on corporate governance, Emerging Market Finance and regulations. His research interest lies in corporate risk-taking, investment decisions and M&As with a focus on law and regulatory interventions. His current research interests include issues in Fintech, Financial Intermediation and Climate Finance.
Dr Biwesh Neupane of an Associate Professor of Finance at Strathclyde Business School and specialises in Corporate Finance. His research interests include international investments, emerging markets finance, corporate governance, sustainable finance, climate finance, trading behaviour, corporate bond markets and initial public offerings.
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