A week ago (14 March 2012), the Commonwealth Government appointed Mr David Gonski to replace Mr David Murray as chairman of the Future Fund effective from 3 April 2012.  Given Mr Gonski’s extremely successful business career in law, investment banking and as a board member of literally dozens of substantial corporations operating in Australia, allied with his significant contributions to civic society in the fields of health, education, the arts and philanthropy there are few, perhaps no, Australians better equipped to head the Future Fund.  Nevertheless, the merits of the selection process became a front page story for the nation’s broadsheet newspapers and a hot topic for television news affairs programmes as political salvoes were fired at each other by current and past figures from the major political parties. 

Former Federal Treasurer, founder of the Future Fund, current Future Fund Guardian and overlooked candidate to be its next chair, Mr Peter Costello, described the selection process as a “shemozzle”.  In Parliament the Opposition leader Tony Abbott accused the Labor Government of being incompetent in the selection process whereas Federal Treasurer Wayne Swan rebutted the criticism and stated that Mr Gonski was simply the best candidate in the view of not only the Government, but also the majority of the Australian business community. 

Hindsight is of course 20/20 and all concerned might wish the selection process had taken a different path, but it is literally water under the bridge now.  All Australians should wish well to Mr Gonski, Mr Costello and other Future Fund Guardians because after all the purpose of the Future Fund established by the Future Fund Act 2006 is to assist future Australian governments cover the nation’s public sector superannuation liabilities through investment returns on contributions to the Fund.

The purpose of this opinion piece and another one to appear soon on the CLMR website is not to deconstruct yet again the appointment process surrounding Mr Gonski, but to consider the role and likely impacts not only of the Future Fund, but also the increasing number of state capital mechanisms that are emerging around the world.  In particular, to leverage the recent media profile surrounding the Future Fund to promote debate about some of problems of definition surrounding Sovereign Wealth Funds (SWFs), State Owned Enterprises (SOEs) and other forms of State Capital Pools (SCPs), and similarly (in Part 2) the problems of measuring the impacts of such state capital mechanisms on national and international finance markets.

If we focus on SWFs, what are they, and which countries have them?  The jurisdictions that operate SWFs are extremely diverse, some are authoritarian one party states, others are sophisticated democracies, and they range from highly developed oil/gas exporters in Europe (e.g. Norway, Russia) to less developed ones in the former USSR and Middle East (e.g. Azerbaijan, Kazakhstan, Iran, Libya) to large and smaller manufacturing/trading entrepots in Asia (e.g. China, Korea Singapore), to broad-based commodity exporters (e.g. Chile), to smaller emerging economies (e.g. Gabon, Mauritania).

Although some SWFs have been in existence for more than fifty years with the Kuwait Investment Office (KIO) being established in London in 1953 as an asset manager for Kuwait’s Foreign Ministry, public recognition of the label SWF is quite recent and the term Sovereign Wealth Fund appears to have been introduced by Rozanov in an article on central banks in 2005. 

The category SWF is problematic in many ways because numerous types of actor have been collapsed into popular understandings of the term.  There are many grey areas, for example between central banks’ foreign reserves management and other types of investment vehicles.  Pension funds are not SWFs even though they may be government sponsored, but they do have a clear link to the beneficiaries via fiduciary duties.  Some SWFs are legal entities, (e.g. ADIA/ADIC – Abu Dhabi), others are corporations (e.g. Temasek - Singapore) and others are not legal persons (e.g. Norway Government Global Fund). 

All SWF countries are members of the IMF and the IMF (2008) sees SWFs as a heterogeneous group with five sub-categories based on their main objective: i) stabilization funds whose primary objective is to help insulate the economy from the effects of commodity (usually oil and also as well more recently gas) price swings; ii) savings funds for future generations and so mitigate the effects of Dutch disease; iii)  reserve investment corporations; iv) development funds; and v) contingent pension reserve funds which provide for unspecified pension liabilities on the government’s balance sheet.  The Future Fund probably best fits category v) although a good case could be made for it to fit in category ii) as well.

Given the broad array of potential SWFs defining them is not a straightforward task. The International Forum of Sovereign Wealth Funds (IFSWF), of which the Future Fund Board of Guardians is a member, was established by the International Working Group of Sovereign Wealth Funds (IWG) in Kuwait in April 2009 and it defines SWFs in this way: “special purpose investment funds or arrangements, owned by the general government.  Created by the general government for macroeconomic purposes, SWFs hold, manage or administer assets to achieve financial objectives, and employ a set of investment strategies which include investing in foreign financial assets.”

This definition is a wide church and the uncertainty about SWFs spills over into other forms of state-related capital and how they should be classified.  This murkiness about classification has helped create uncertainty not only about whether the Future Fund should be a more proactive investment actor in Australia especially in infrastructure, but also whether Australia should have more SWFs, and if so whether they should be federal and/or state based entities, (note that the US states of North Dakota, Texas and Wyoming have their own SWFs).  For example, in November 2011 Queensland Premier Anna Bligh announced that she wanted to channel royalties from that state’s liquefied natural gas industry to fund a sovereign wealth fund for education.  The looming state election in Queensland may well remove that particular decision from current Premier Bligh’s portfolio of responsibilities. 

Nevertheless, whatever political parties hold office in Australia at both federal and state level, they face the issue of how best to utilise the wealth generated by the ongoing “commodities boom” in the best interests of current and future generations of Australians.  It is a strong possibility that Australia, like jurisdictions such as Norway and Singapore will become a more active participant in investment markets at home and abroad.  If so, should it for example follow the Singapore model?  The proactive investment strategies of Temasek Holdings and the Government of Singapore Investment Corporation (GIC) have allowed Singapore not only to increase its national wealth but also to increase its impacts in Australia and elsewhere through their commercial investments.  If Australia does become a more proactive state capital investment actor whether through an enhanced role for the Future Fund, additional SWFs (federal and/or state based), or other investment mechanisms, then there needs to be more debate about how any such investment mechanisms should be structured and classified, so that evaluation and accountability processes are equitable and transparent.

For more detailed analysis of SWFs and their role in financial markets see: George Gilligan, Multi-lateral governance of financial markets – the case of sovereign wealth funds, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1866038