Promoting Responsible Investing: Rethinking International Frameworks for Sovereign Wealth Funds

By: Xenia Karametaxas |

Sovereign Wealth Funds (SWFs) are public investment vehicles owned and managed directly or indirectly by governments and set up to achieve a variety of macroeconomic objectives. SWFs typically seek to invest the funds from budget or trade surpluses deriving from national oil or mining revenues, for example. Although Kuwait established the first SWF in 1953 to invest excess oil revenues, the increased use of SWFs is a fairly new worldwide phenomenon. Indeed, their use has rapidly expanded over the past decade and SWFs control remarkable financial assets. In the aftermath of the 2007-2009 financial crisis, they played a major role in the bail-out of global banks such as UBS and Citigroup. With a combined total of over seven trillion dollars in assets as of 2014, SWFs have become key players in the international financial markets and in the global economy.

What Obligations Do SWFs Have to Invest Responsibly?

As institutional investors, SWFs have the fiduciary duty to act in the best long-term interests of their beneficiaries. Since the sovereign manages SWFs according to its territory’s objectives, the ultimate beneficiary is not a specific individual but rather the country’s present and future citizenry. In this context, therefore, socially responsible investment may enable a SWF to increase its financial profitability. Investing in companies with a positive ethical footprint has less negative impacts upon social, environmental and human rights factors. Companies that are involved in human rights violations or engage in severe environmental damage may get bad press coverage, become the target of campaigns by non-governmental organizations (NGOs), or even face lawsuits from employees, the community or other stakeholders. This has adverse business consequences, including lower share prices, high litigation costs, damaged corporate reputation, limited market access, and increased difficulties in recruiting the best employees. Conversely, a SWF that invests in companies with a positive ethical footprint may achieve better economic returns.

However, the fiduciary duties of SWFs towards their beneficiaries, the citizens, go beyond the economic maximization of returns on their investments.

First, SWFs operate as saving funds for future generations and consequently their management has the responsibility to respect and promote sustainable development and social justice through their investments in order to give future generations the opportunity to reap the rewards of the investment.

Second, the duty of SWFs to ensure responsible investment practices derives directly form the 1948 Universal Declaration of Human Rights (UDHR), under which “every individual and every organ of society” should respect and promote, to the extent of its capabilities, the rights set out in the UDHR. Thus, as societal actors under this agreement, investors have the obligation to respect and promote human rights.

Third, although SWFs do not formally become parties to international law treaties in the same way that states do and although such treaties do not impose obligations directly on corporations or investors, SWFs can use international treaties “as a moral compass for their responsible investment practices.” Moreover, as state organs, SWFs act as an extended arm of the state, which is often a formal treaty signatory with a clear mandate to protect human rights and the environment under these treaties.

Finally, as important capital providers and shareholders of large public companies, SWFs have the power to influence the behavior of the companies in which they invest. SWFs can be active owners through the exercise of shareholder rights at annual general meetings, by engaging in negotiations with the management of companies with poor corporate social responsibility records, or by putting pressure on such companies through disinvestment. Because SWFs have the ability to influence the management of large companies, they also have the responsibility to take action to correct negative consequences of the companies’ corporate activities.

SWFs’ Responsibilities Under International Normative Frameworks

The only international voluntary framework of investment and operational principles directed at SWFs are the Generally Agreed Practices and Principles (GAPP), commonly referred to as the Santiago Principles. Launched in 2008 by a working group composed of SWFs (the International Working Group of Sovereign Wealth Funds, or “IWG-SWF”) and the International Monetary Fund (IMF), the Santiago Principles aim to guarantee transparency, clarity, and equivalent treatment to SWFs and private funds. The underlying rationale behind the Santiago Principles is to avoid political interference exerted by or upon SWFs in recipient countries, and also to ease the concerns of recipient countries regarding SWFs’ investments.

Surprisingly, the Santiago Principles do not contain any provision addressing responsible investment practices in particular. Nevertheless, the Santiago Principles implicitly encourage responsible investment principles where avoidance of complicity in unethical conduct or social and environmental harm would protect the SWFs’ financial value. Moreover, responsible investment practices are inherently encouraged by the Santiago Principles’ requirement that SWFs identify, assess, and manage the risk of their operations. Thus, investing in a company that (allegedly) violates human rights or that causes environmental damage could risk the SWF’s reputation and bottom-line.

Of course, there are other existing regulatory frameworks that advocate for greater social responsibility that can also be applied to SWFs. The United Nations (UN) Principles for Responsible Investment, the UN Guiding Principles on Business and Human Rights, and the UN Global Compact all reflect the increasing relevance of environmental, social, and governance issues to investment practices of private and public actors. Nonetheless, given the corporate focus of these resources, they are unsuitable tools to apply to SWFs. Indeed, the small number of SWFs among the signatories of such codes reveals that SWFs may be unwilling or unable to meet the responsibilities outlined in these agreements.

Alternatively, given wide acceptance of the Santiago Principles and its focus on SWFs, the Santiago Principles would be a good starting point to reconcile the ethical and financial aspirations of SWFs. A first step towards greater implementation of responsible investment practices of SWFs should be provided by assessing the implementation of the Santiago Principles and encouraging the development of corporate responsibility provisions. In the long-term, the development of a code of conduct under the supervision of an international body such as the IMF, tailored to meet the specific needs of SWFs, should be considered.

SWFs as Promoters for Responsible Investment Practices

Because of their large size and potential market leverage, and due to their long-term investment horizons and their widespread public visibility, SWFs have the potential to catalyze change beyond their own portfolios.

With $ 863 billion in assets, the Norwegian SWF is not only the world’s largest SWF, but has also established itself as a leader and a model for responsible investment practices. Indeed, the Government Pension Fund Global (NGPF-G), as the Norwegian fund is officially known, has demonstrated how an SWF’s responsible conduct can shape best practices in the private sector and thereby set global standards of responsible investment. In fact, the internal investment policies of the NGPF-G have influenced the investment practices of several Norwegian private institutional investors such as pension funds and investment funds. In addition, the NGPF-F’s Council on Ethics draws up a yearly exclusion list in which companies that should be excluded from Norway’s investment universe are publicly listed. In doing so, the Norwegian SWF not only contributes to the professionalization of RI principles, but also exercises a form of normative pressure for RI on private investors.

To sum up, SWFs have not only a financial but also an ethical mandate towards their beneficiaries—the citizens. Through their leverage and impact, SWFs have the potential to contribute substantially to the improvement of the financial markets and the global economy. However, in the context of international frameworks, responsible investment obligations of SWFs have not received sufficient attention yet. In this respect, I advise that the Santiago Principles include a requirement that SWFs commit to ethically responsible investment behavior. Not only should SWFs avoid investing in companies that cause harm to the environment or that violate human rights, but SWFs should also serve as active promoters of sustainable development.

 

Leave a Reply

Your email address will not be published.