Chapter 4 ‒ sovereign fund co-operation 60 CENTRAL BANK-SOVEREIGN FUND CO-OPERATION GPI 2020

‘Reinventing borrowing and investing in the post-Covid era’

The economic shocks of the past decade provide an opportunity to rethink, redesign and reposition the role and management of sovereign funds, writes Udaibir Das, assistant director and regional adviser, monetary and capital markets department, International Monetary Fund.

A state is an influential borrower and investor meet capital commitments. in the global financial system. Its stature stems Thus, funds face two challenges in managing from its important responsibility: their financial assets: how best to configure it is a custodian and manager of state-owned dynamic and longer term strategic asset allocation financial liabilities and assets. The 2008 financial priorities, and how to be candidly accountable for crisis and the Covid-19 pandemic have reinforced lower levels of risk-adjusted returns, volatility, and the importance of this responsibility, reminding prospective erosion of wealth. Some funds have sovereign fund managers that they must help been reinventing themselves to succeed for the strengthen countries’ resilience, protecting against long term. They have been actively adjusting their downside risks and abrupt market disruptions. institutional and governance framework alongside A key element is how funds approach this more effective ways to manage duration, maturity, responsibility. Sovereigns’ risk tolerance and credit, liquidity and leverage risks. Nevertheless, time horizon differ vastly, as does their ability to although assets could serve any economic find an optimal risk-return metric or purpose, evaluating the associated robust models for funding, liability costs, benefits and policy trade-offs is ‘As the 2008 and and asset management. Proper becoming even harder. integration between their economic 2020 shocks Sovereign debt management is the policy framework and their balance expose ever- other side of the coin. The more aligned sheet structure is a constant concern, growing economic the SDM and the sovereign’s asset or requiring continuous adjustments and social fault wealth management functions are, the and evaluation of sustainability lines, investors stronger its financial readiness to deal considerations. need to contribute with the unforeseen. An appropriate The aftermath of both the 2008 crisis to mending SDM helps reduce any abrupt recourse and the pandemic presented a severe those schisms to financial assets for servicing stress test for every government’s by encouraging liabilities and domestic financing, balance sheet. For sovereign investors especially where the foreign greater social that typically operate with explicit component of liabilities is large. or implicit liability considerations, responsibility from Several sovereigns have the context has proven even more their portfolio demonstrated that strengthening the challenging. companies.’ overall SDM function pays off over To prevent short-run sociopolitical the long run. The traditional focus on and fiscal considerations from simply financing current cash flow dominating sovereigns’ longer term goals of needs is shifting to proactively structuring sovereign financial management and good governance, there debt to minimise costs subject to risk constraints, are calls to allow funds to independently manage determining currency composition and maturity intergenerational savings. profile, along with the adequate size and liquidity More than any ordinary institutional investor, a of liabilities. Disjointed sovereign asset and SDM sovereign fund has to carefully weigh its strategies functions can negatively impact the balance of across various investment horizons and evaluate payments and impede sovereign access to financial the possible outcomes mindful of its policy buffers. Where held in less liquid or more risky goals. After the 2008 and Covid-19 shocks, the assets, buffers can only be sold at a substantial balance of returns and risks is likely to have shifted discount or with considerable delay. Some countries permanently, and each fund will need to be more use their reserves with their central banks, draw conscious about liquidity needs and its ability to down on foreign currency swap lines, or use liquid OMFIF.ORG CENTRAL BANK-SOVEREIGN FUND CO-OPERATION 61

assets in their sovereign funds. Others use their among other things, protecting and developing their exchange rate and investment regimes. A further human capital. As they invest in the wellbeing of option is external borrowing to accumulate financial future generations, sovereigns have a clear interest assets and build up buffers. in championing responsible corporate behaviour and promoting it through their investments. Metamorphosis Financial assets are only one part of a country’s defences against shocks. A broader approach could It will take a while to assess the combined long- help, such as by including swap lines, sovereign term net financial impact of the two shocks on funds, contingent financial assets ‘below the sovereign balance sheets. Some studies suggest ground’, assets with multilateral institutions, and that sovereign asset managers have so far fairly portfolio reprofiling techniques. A more complete successfully handled recent market volatility. approach would incorporate elements to enhance Funds seem to have faced few issues with meeting a sovereign’s resilience by including sustainable their liquidity requirements, including making levels of sovereign debt and liabilities and choice of good on their capital commitments. They appear investment instruments, and an integrated approach to be maintaining their discipline with respect to monetary, exchange rate and macroprudential to rebalancing portfolios towards their strategic policies. Effective financial system supervision that allocations, thereby serving as a stabilising has the ‘will and the ability’ to pre-emptively limit countercyclical force during times of high asset any imprudent build-up of contingent risks in the price volatility. Several sovereigns have been able non-financial and financial sectors would also be to raise funds on international capital markets, important. although they did so by paying a higher risk This approach will allow for the operational premium. independence and flexibility that sovereign liability From a policy imperative viewpoint, a and asset managers need to focus on their core transmogrification could happen. Sovereign wealth, objectives. While a strong macroeconomic policy particularly the liquid portion, could be framework is the most direct path to more actively called upon as a reserve limiting risks to a sovereign balance and balance-of-payment complement ‘Sovereign fund sheet, asset and liability management to counter adverse macroeconomic assets, particularly outlook could be used to coordinate conditions and uncertainty. Sovereign the liquid portion, the risk profile of sovereign assets and funds geared to commodity price could be more sovereign debt and liabilities. stabilisation may need to disburse more actively called Many countries do take ad hoc ALM cash when commodity prices weaken upon as a reserve considerations into account. Only a and may need to support their countries’ and balance- few recognise it as a policy tool that balance of payments even when they of-payment could help reduce systemic risks and have no explicit function to do so. Some complement vulnerabilities. sovereign held assets may provide Finally, the institutional quality of to counter liquidity for domestic stabilisation or those who manage the sovereign preserving financial stability. macroeconomic balance sheet – their judgement, agility, Sovereign fund managers must uncertainty.’ and responsiveness – will always adopt a more holistic mindset than remain a key determinant in pursuing a typical institutional investor – an such an approach. A growing body of approach that preserves wealth, helps foster empirical evidence shows that a country with a sustainable living standards and keeps a focus higher percentile of institutional quality distribution on environmental, social and governance issues. would have, all else being equal, a lower current Climate change and technology are causing rapid account balance. Sovereigns face a confluence shifts in financial dynamics. Much could be done of challenging factors that will affect their long- in this regard to fully maximise the impact of asset run risk preferences, modelling approaches, and management practices. governance. As the two shocks expose economic and social The 2008 and 2020 global shocks should be fault lines across and within countries, investors seen as an opportunity to adopt more far-sighted need to contribute to mending those schisms by ways of managing sovereign wealth and liabilities. encouraging greater social responsibility from their This provides the key to ensuring security for portfolio companies. That would entail giving a future generations while upholding public policy greater weight to entities that are more focused on, responsibility. 62 CENTRAL BANK-SOVEREIGN FUND CO-OPERATION GPI 2020

Navigating national wealth management

Central banks and sovereign funds are closely interlinked, though how these relationships function, both officially and in practice, varies across jurisdictions, write Danae Kyriakopoulou and Pierre Ortlieb.

IN the inaugural edition of the Global investment strategies. Norges Bank Investment Public Investor in 2014, we defined Management, for example, is best ‘commonality of purpose and practice’ Sketching the legal and institutional described as an internal asset as one of the principles guiding landscape manager governed by its parent performance and behaviour in this Two broad categories of legal central bank, Norges Bank. Its board investor community. We argued that relationships define a fund’s status consists of central bank staff who this applies across the dividing lines vis-à-vis the corresponding central appoint senior management, such of the three institutional groups bank: the ‘manager’ model and the as the chief executive, giving the as well as within the categories ‘investment company’ model, defined a supervisory but themselves. Today, the interlinkages by the degree of independent legal not executive capacity in the fund’s between the types of institutions identity held by the fund. strategy. Other examples include making up the GPI community are In the ‘manager’ model, the the sovereign funds of Colombia and even stronger. This chapter focuses sovereign fund manages a pool of Botswana. on central banks and sovereign funds, assets owned by the central bank (or Singapore’s GIC can be considered exploring the evolution of their the state) without a separate legal an external asset manager – the relationships to governments and to identity. Rather, the legal owner of the central bank or ministry of finance each other. We investigate models assets gives an investment mandate has given a mandate directly to an of co-operation and competition to an asset manager (in this case the external fund manager that it has set between these two types of actors sovereign fund) to meet a certain up, although, as the International across different jurisdictions when it investment or other target. The Monetary Fund underlines, the comes to the fungibility of reserves, legally attached asset manager can government remains the ‘legal owner their crisis response mechanisms, be either internal or external to the of the pool of assets constituting the transparency and accountability, and central bank or ministry of finance. sovereign fund’. The manager in this OMFIF.ORG CENTRAL BANK-SOVEREIGN FUND CO-OPERATION 63

case may also hold mandates from the assets require more sophisticated risk ministry of finance. GIC, for instance, management. manages part of the reserves of the Even these formally separate A partnership Monetary Authority of Singapore. relationships are not always clear- Note that despite its treatment as an cut. The Banca d’Italia is a minority for the long haul asset manager, GIC is a separate legal shareholder in Cassa Depositi e entity which has nonetheless been Prestiti, for example, while the David Park, chief investment given a non-ownership mandate by People’s Bank of China is the officer, Korea Investment the central bank (via its client, the formal holder of the debt issued to Corporation government of Singapore). finance the establishment of China Figure 1 (on p.64) presents the legal Investment Corporation. In both of VARYING estimates put the and financial relationships between these cases, there is a non-trivial number of sovereign funds central banks and sovereign funds. relationship with the central bank globally between 70-125, Overall, the general trend since the with potential investment and policy depending on definition – and no turn of the millennium has been for implications that adds nuance to the two are alike. They are all owned sovereign funds to move in a south- legal status. by their respective government but western direction along this figure This spectrum of options differ in terms of funding source, – that is, to become more independent highlights the institutional and functions, goals and relationship and diversified, distancing themselves legal complexity of the relationship with their central bank. from central banks along both axes. between a central bank and sovereign At Korea Investment The way the relationship with fund. They can range from entirely Corporation, we manage the central bank is governed has distinct with independent, complex assets entrusted by the Korean important implications for the fund’s governance structures to fully government and Bank of Korea institutional set-up. A fund like housed within the central bank. In to increase sovereign wealth and GIC, which is legally independent of either case, the fund may be tasked contribute to the development of the central bank and government, with managing its central bank’s Korea’s finance industry. but manages its assets as a public reserves. The Hong Kong Monetary Our relationship with the BOK investor, will typically have clear Authority’s Exchange Fund is based is that of sponsor and trustee. differentiation between owner, board, within the central bank but manages The BOK entrusts KIC with and operational management of the reserves separately, as it was foreign reserves, equipping us the fund. Meanwhile, internal asset established to optimise management with funds we need to invest, managers will usually have their of Hong Kong’s growing pile of foreign generate returns on and build operational independence enshrined currency liquidity. Other funds, such sovereign wealth with. The BOK, within a clear legal framework, while as GIC, are legally distant from the in turn, benefits from KIC’s global also requiring clarity on the decision- central bank but tasked nonetheless investment capabilities. making and oversight role of the with managing foreign exchange The president of the BOK central bank within which they are reserves. Meanwhile, a fund borne is a member of KIC’s steering housed. out of resource wealth may be entirely committee. We value the The ‘investment company’ separate from the central bank given BOK’s long-held management model contains a clear transfer of its potential role as a budgetary knowhow – and we also value ownership away from the central stabiliser. At the same time, some, our operational independence. bank or ministry of finance and to such as Timor-Leste’s Petroleum Fund Our bylaws stipulate that the the sovereign fund itself. The fund or Norway’s Government Pension asset trust contract between KIC will exist as an entirely separate legal Fund Global, are housed within the and the BOK may not include entity and manage assets on its own central bank. There is a range of any restrictions on KIC’s asset behalf. Funds such as Australia’s possible constellations that do not management, but that it can Future Fund and New Zealand’s clearly depend on either the ultimate include restrictions on investment Superannuation Fund would fall source of wealth or the purpose instruments. into this category. These funds’ of the fund. The National Bank of Over the past 15 years, the governance structure will similarly Kazakhstan houses the Kazakh KIC-BOK relationship has evolved provide clear distinctions between National Fund, which is typically from that of sponsor and trustee ownership, board, and management. considered both a ‘stabiliser’ and a into a unique and meaningful Given that these legally and national long-term savings pool. The partnership, one that will continue institutionally separate funds tend range of options is broad. to pursue mutual development to have more complex strategic asset The question of transfers – of while preserving KIC’s asset allocations, it is important that their reserves, budgetary stabilisation management independence.  governance reflects this – complex funds, or otherwise – needs to be 64 CENTRAL BANK-SOVEREIGN FUND CO-OPERATION GPI 2020

Maximum institutional union General stabilisation fund area

Hong Kong Norway Monetary Government Pula Fund Authotity Pension Exchange Fund Fund Global Colombia Savings and Stabilisation Fund Timor-Leste Petroleum 1: Mapping the institutional Fund relationships between central banks and sovereign funds Source: Annual reports, OMFIF analysis The representations in this chart are not exact and only serve to illustrate the range of institutional constellations available to central banks and sovereign funds. Analysis displayed here is based on public information and annual reports.

More illiquid, Conventional diversified reserves portfolio portfolio

Social/National Development Funds

Korea Cassa Depositi e Singapore Investment Prestiti GIC Corporation

Temasek

Khazanah

Ireland Strategic Investment Fund Nigeria Germany Sovereign Saudi Arabia Nuclear Investment Public Investment Waste Authority - Fund Management Stabilisation Fund Fund Nigeria Sovereign Investment Authority - Future Generations and Infrastructure Funds Bpifrance

Maximum institutional separation OMFIF.ORG CENTRAL BANK-SOVEREIGN FUND CO-OPERATION 65

spelled out clearly in the context of whether the debt is owed to domestic the legal identity of the fund. The or foreign creditors, to the private or legal separation of ownership does not official sector, what interest it carries, totally clarify this issue, as transfers when it is due, and how quickly the may still be required as part of a burden grows compared to the size of mandate given by the ministry of 10x the economy. The wider set of foreign finance. This is why the contiguity Most importantly, however, the between central bank and sovereign assets of oil exporters asset side is deeply misunderstood. fund is best regarded as a spectrum such as Canada, Norway, Central bank foreign exchange rather than a series of options. Kuwait and the UAE is reserves tend to be the first port more than 10 times that of call at times of crisis to stabilise Competing investment forces of their central bank portfolio outflows and defend the The institutional framework and reserves alone value of the currency under a floating legal status of central banks and exchange rate regime. Yet they are not sovereign funds in each jurisdiction the only source of external liquidity will determine the similarities the high allocation of funds such as available. In jurisdictions with and differences in their respective NBIM to listed equities, which is one sovereign funds, their size and legal investment strategies. These can step further away from central bank framework for the use of assets will be be complementary, distinct, or reserves than stabilisation funds. an important criterion in determining conflicting. The range of investment At the same time, funds carved out external resilience. Similarly, there strategies available to sovereign of the ‘liquidity tranches’ of foreign are examples where the foreign funds is a product of national context, exchange reserves, such as HKMA’s assets held in institutional investors’ mandate, and global investment Exchange Fund, tend similarly portfolios have been used at times of conditions. Yet the distinctive to exhibit higher levels of risk vulnerability. features of each fund will place tolerance, with a greater allocation to The differences can be stark. them in a particular relationship unconventional asset classes. Looking at just central with domestic monetary and fiscal This variety of funds extends to for a selection of emerging markets institutions. the far end of the ‘risk tolerance’ would suggest weakness in the Starting by looking at mandates, spectrum where the investment position of economies such as South stabilisation funds created for the strategy is entirely dissimilar to that Africa and Malaysia, whose central purpose of, say, smoothing an oil price of the local central bank. For instance, bank reserves stand at $52bn and shock typically invest in highly liquid Saudi Arabia’s Public Investment $104bn respectively. But including the assets such as government bonds, so Fund holds a significant allocation foreign asset share of their pension that they can respond quickly to any to private equity. HKMA’s Exchange and sovereign funds increases their unforeseen, exogenous developments. Fund, which is housed within the total considerably, and in the case The asset allocation of funds of this central bank, holds a significant of Malaysia more than doubles it. type will overlap significantly with private market allocation, showing The wider set of foreign assets for that of the accompanying central the range of options available. Denmark and Singapore, or for oil bank seeking to build up foreign exporters such as Canada and Norway, exchange buffers, which are equally Measuring external resilience is, similarly, many times that of their held in highly liquid securities. Mapping out these relationships can central bank reserves alone (Figure 2). ‘Savings’ or ‘reserve’ funds seek lead to rethinking ways of assessing to transform resource wealth into exchange rate management and Use of reserves for stabilisation more permanent sources of income, external resilience. purposes for instance by more aggressively Conventional assessments of Considering the totality of foreign avoiding the onset of ‘Dutch countries’ financial strength and assets as opposed to merely central disease’, the tendency for commodity vulnerability to external shocks bank reserves will be appropriate in -exporting countries to suffer mostly focus on high-level measures some cases but not in others. The set harmful exchange rate appreciation of their assets and liabilities: the value of institutional and legal frameworks which arrests domestic economic of foreign exchange reserves held that govern the usability of these development. Typically, they will stray at the central bank and the levels of assets is an important variable. The further from the conservative, liquid public debt. The degree of financial origins and purposes of different strategies of stabilisation funds, given openness is also usually considered. types of sovereign funds are crucial their long-term investment horizons But such measures do not tell the full factors. These often relate to their and the absence of any immediate story. origins and purposes. Commodity need for fiscal transfers. Their On the liabilities side, the funds are more likely to be used as greater risk tolerance is reflected in modalities of the debt matter: a stabilisation fund, compared with 66 CENTRAL BANK-SOVEREIGN FUND CO-OPERATION GPI 2020

2: Potential reserve investments in domestic stocks. This Singapore assets outside the intervention is different to outright central bank Norway use of foreign assets of the pension Central bank reserves, Canada funds for stabilisation purposes. But it $bn, and estimates South Korea still presents a case where a national of foreign assets of sovereign and public Saudi Arabia public investment institution is asked pension funds where Denmark to shift its portfolio allocation from applicable, $bn foreign to domestic assets as part of Malaysia Source: OMFIF GPI crisis response. 2020; annual reports; Chile Fitch ratings; fund South Africa websites, OMFIF Risks to entanglements analysis Nigeria While such practices can be necessary 0200 400600 800100012001400 and helpful at times of crisis, these Central bank reserves Sovereign and public pension fund foreign assets cross-institutional entanglements * In some cases, estimates use currency exposure as a proxy for foreign assets. For two small pension funds, we applied a weighted average of other, similar pension funds’ foreign assets to the fund’s assets. Generally, figures refer to end 2019; in a handful of cases, disclosures were only available for end 2018 or mid 2019. can bring significant risks. These may appear secondary considerations when the focus is on crisis management, but special investment funds and future ‘In recent years, global over the long run they can produce generations funds that may not have investment conditions have serious inefficiencies and conflict. as favourable frameworks to enable started playing a greater In recent years, global investment them to be used as intervention role in determining the conditions have started playing liquidity. a greater role in determining overlap between sovereign This will be possible only for the the overlap between sovereign portion of the fund’s liquidity that funds’ investment funds’ investment strategies and is allocated to foreign currency strategies and their their respective central banks. assets. Holdings of domestic respective central banks.’ Traditionally, central banks have telecommunications firms, for invested their exchange reserves in example, will be of little use in liquid, safe, foreign currency assets. serving as an exchange rate buffer. Meanwhile, sovereign funds have The covert use of sovereign wealth been growing in sway as asset owners, (or even pension fund wealth) as a ballooning in number and AUM. This tool for exchange rate management Crisis action growth, combined with the global has become increasingly common. The Covid-19 crisis has prompted savings glut and a perceived shortage For instance, Japan’s Government further similar actions (See table on of safe assets, has directly affected Pension Investment Fund, with more p.71). In mid-April, the Nigerian investment strategies and may cause than $1.6tn in assets, earlier in 2020 government drew $150m from tension between the two types of was reported to be indirectly assisting the Nigeria Sovereign Investment institutions. the ministry of finance and Bank Authority to defend the naira in the Central banks have responded of Japan in currency management face of the global oil price collapse. to the conditions created by their by raising its allocation to foreign Similarly dependent on oil, Azerbaijan unconventional monetary policies fixed income assets, dampening mobilised its State Oil Fund assets and resulting low yields on traditional upward pressure on the yen. The to protect the currency in the face of assets, such as government bonds, by GPIF is a moderately conservative downward pressure. In April, Sofaz increasingly diversifying into riskier investor, with significant allocations assets recorded a $2bn decline, which asset classes, such as equities. Even to foreign equities and bonds as well were reported to have been foreign within the liquid government bond as domestic Japanese securities. Yet exchange sales to help stabilise the market, they may have felt subject it is clear that it holds an important manat against the backdrop of oil to competition from the presence of role in currency management market-related volatility. sovereign stabilisation funds. alongside the BoJ, despite the absence In some cases, the use of public Meanwhile, sovereign funds may of any direct formal relationship investment institutions’ assets have believed that central banks were between the two institutions. As a has taken a more indirect form. encroaching on their typical territory result, investors need to consider For example, in mid-March, the by seeking out deals in corporate the consolidated sovereign balance Philippine ordered bond and public equity markets. sheet when thinking about the total public pension funds to support the In some instances, coordination assets available for foreign exchange domestic stock market that was under between the central bank and management. pressure from the wider Covid-19 sovereign fund has taken a direct global shock, by increasing their daily form, explicitly acknowledging the OMFIF.ORG CENTRAL BANK-SOVEREIGN FUND CO-OPERATION 67

need to take advantage of sovereign over the past 20 years have tended funds’ expertise and legal frameworks to situate themselves at arm’s length for investing in more sophisticated from parent institutions and pursue assets. For example, in April the m greater risk-taking, understandably Saudi Arabian Monetary Authority $150 given the continued low yield on transferred $40bn from its foreign In mid-April, the government bonds. Yet the case reserves to the Public Investment Nigerian government for coordination is clearer than Fund to provide dollar liquidity and ever. The consolidated sovereign drew $150m from the enable the sovereign fund to invest balance sheet remains important for more aggressively overseas. Nigerian Sovereign and stability, At the same time, the consolidated Investment Authority to and optimising it holistically should balance sheet view brings about defend the naira in the be a key task for central bank and new responsibilities for the central face of the global oil sovereign fund staff. Conceptually, bank and, more pointedly, the price collapse situating sovereign funds in the sovereign or public pension fund. middle of these extremes – where For example, if the total balance they are not too distant to serve a sheet should be regarded as potential regardless of their legal relationship. public purpose, nor too similar to take intervention liquidity, it is essential advantage of their distinct investment that the exposure of the total reserves Policy implications and horizons – may maximise the portfolio is allocated efficiently. safeguarding against entanglement potential of both institutions as public risks investors. Optimising balance sheets There is evident potential for conflict The rules and realities defining the This is especially important at times between the roles and strategies relationships between central banks of low global yields on traditional of different types of sovereign and sovereign funds are manifold, reserve assets. Stabilisation funds are investment institutions. complex and opaque. More research more often prominent in countries In considering how to safeguard is required to provide an exhaustive with low central bank reserves, and against entanglement risks, it is and systematic understanding of thus their allocation to liquid assets not clear that legal proximity to their institutional intertwinement. is responsible and even required. the central bank has any consistent Ultimately, it is the parent Yet in the case of the PBoC, which impact on the strategic allocation of a governments that construct the holds a large volume of reserves, sovereign fund. Rather, mapping out overarching framework in which these excessively similar asset allocations the sovereign funds based on their organisations interact. Governments between the central bank and China institutional status and investment have the responsibility and the Investment Corporation would result similarity suggests that transparency, means to change existing structures in significant foregone earnings. governance, and institutional design – always keeping in mind the wider Optimising public sector balance are more important in achieving international environment that can sheets in currency and asset terms is credibility and efficiency in the provide both constraint and support.  crucial. As such, it is important that investment process. Funds that are the degree of fungibility of reserves is legally distinct from the central bank spelled out clearly and coordination can have both very similar investment strategies are considered carefully. strategies and very different ones, Uncoordinated transfers can yet in either case their standing significantly damage a sovereign as a credible institutional investor fund’s international credibility as an can be tarred by politicisation and institutional investor. It may produce poor governance. A fund like NBIM, the perception that the fund is a housed within its parent central politicised agent, and jeopardise its bank yet maintaining an increasingly ability to access certain asset classes diversified asset allocation, is a more beyond its borders. This is more credible institution. Its investment urgent for large, formally independent mandate, governance structure, and institutions with significant global supervisory mechanisms are well- holdings. Spelling out the rules for designed, producing a consistently fungibility and fiscal transfers, and stable risk tolerance. This latter factor explicitly delineating the liabilities is an important variable in allowing a of the sovereign fund is essential to fund to credibly diversify on a global ensuring stable relationships between scale. central banks and sovereign funds New sovereign funds established 68 CENTRAL BANK-SOVEREIGN FUND CO-OPERATION GPI 2020

After Covid-19, state ownership to the rescue again

THE Covid-19 pandemic has presented countries with equity stake in companies accepting federal aid. There public sector assets held in sovereign funds or public is a precedent to this. In the 2008 financial crisis, the pension funds with important dilemmas on whether US government took an equity stake in companies or not to use them. John Nugée and Gary Smith such as General Motors. Middle Eastern sovereign emphasise (in the comment on p.70) the underlying funds were used to plug holes in government budgets tension in objectives. On the one hand, these funds during the 2014 oil price collapse. are subject to the goal of preserving wealth for Politically, such practices are more likely to future generations. On the other, they also serve the succeed in sectors considered to be of national rationale of acting as ‘rainy day funds’ to support the strategic importance, such as transport and energy economy in a time of crisis (and indirectly supporting infrastructure. This would continue the trend that future generations by preventing the economy from has seen sovereign institutions raise their allocations plunging into long-lasting disruption). to real assets such as infrastructure, as documented in a 2018 report by OMFIF and BNY Mellon. The list Questions over sovereign funds of industries considered to be of national importance The upheaval raises questions over whether new may grow as the pandemic shock forces companies sovereign funds need to be set up – or additional to shorten their supply chains and governments allocations made to existing ones – as governments to balance the importance of self-sufficiency and engage in financial assistance to the private sector. domestic manufacturing against the benefits of global State-driven assistance has so far taken the shape trade and openness. of direct aid and company guarantees. For example, Airlines, automobile manufacturers and railway the European Commission has approved more than operators, hardest hit by the pandemic shock, would €2tn of state aid, in some cases with conditions make strong candidates for sovereign fund portfolios. covering dividends and executive bonus payments The International Air Transport Association estimates (Figure 3). that airlines globally could lose more than $419bn in The use of a sovereign fund could enable a different revenue this year. Sovereign funds such as Temasek, model for the provision of state aid. Instead of tax Khazanah Nasional Berhad and Dubai Investment breaks or subsidies, governments could offer support Corporation have offered financial support ranging to corporates in the form of buying equity stakes at from $2bn-$13bn to their respective national distressed values, which can then be deposited in the carriers. In Europe, Germany, France, Austria and portfolio of a sovereign fund. In March, President the Netherlands have offered or are in the process of Donald Trump responded positively to a question on drafting support to their respective national airlines whether he would support the government taking an (Figure 4). However, this has at times led to tensions,

3: Governments 1000 ramp up support to 900 ‘Airlines, automobile corporate sector 800 manufacturers and Approved state 700 railway operators, aid in March-June 600 2020, highest 10 EU 500 hardest hit by the economies, €bn 400 pandemic shock, Source: European 300 would make strong Commission, 200 Eurostat, Financial candidates for 100 Times, OMFIF sovereign fund analysis 0 portfolios.’ Czechia OMFIF.ORG CENTRAL BANK-SOVEREIGN FUND CO-OPERATION 69

Figure 4: Airlines prime candidates for state support Government support to carriers in response to Covid-19 pandemic Source: Transport & Environment, Bloomberg, OMFIF analysis *These bailouts are currently under discussion/pending parliamentary approval

Airline Group Country Actor Value, $m Type Conditions

EasyJet UK Government 750 Loan No conditions

Regional carriers in Norway Government 137 Loan guarantee No conditions Norway All airlines operating in Sweden Government 359 Loan guarantee No conditions Sweden

SAS Denmark/Sweden/Norway Governments 460 Credit guarantee No conditions

No dividend payments TUI Group Germany Government 2034 Loan in loan period

Norwegian Airlines Norway Government 313 Recapitalisation No conditions

Finnair Finland Government 933 Credit guarantee/Recapitalisation No conditions

Condor Germany Government 622 Loan No conditions

Wizz Air Hungary Government 389 Loan No conditions

No conditions, but seats in Lufthansa Germany Governments 10170 Loan / Partial takeover supervisory board

Austrian Airlines Austria Government 509 State aid and loan Some climate conditions

Swiss Airlines Switzerland Government 1605 ― No dividends until repayment

British Airways* UK Government 388 Loan No conditions

Iberia Spain Government 848 Loan No conditions

Vueling Spain Government 294 Loan No conditions

No dividends in 2020; weak Air France France Government 7910 Loan and loan guarantee climate conditions

KLM Netherlands Government 3616 Loan and loan guarantee C02 reduction, non-binding

Alitalia* Italy Government 3390 Takeover No conditions

Ryanair UK Government 757 Loan No conditions

Virgin* UK Government 647 Loan and credit guarantees No conditions

TAP Portugal Government 1356 Loan No conditions

Air Baltic Latvia Government 283 Recapitalisation No conditions

Nordica Estonia Government 34 Recapitalisation No conditions

Sovereign Fund Singapore airlines Singapore 13000 Equity stake No conditions (Temasek) Sovereign Fund Malaysian airlines* Malaysia 2300 Loan guarantee No conditions (Khazanah) Sovereign Fund (Dubai Emirates UAE - Equity stake No conditions Investment Corporation)

American Airlines US Government 5800 Payroll aid/Loan No conditions

Delta US Government 5400 Payroll aid No conditions

Southwest Airlines US Government 3200 Payroll aid No conditions

United US Government 5000 Grants and low-interest loans No conditions

Cathay Pacific Hong Kong Government 340 Tax waivers No conditions 70 CENTRAL BANK-SOVEREIGN FUND CO-OPERATION GPI 2020

with Lufthansa Chief Executive Officer Carsten Spohr stating that while Lufthansa needs government support, ‘We do not need government management.’ Funds could The healthcare sector is rising in importance as a destination for state-driven strategic investments. The Russia Direct Investment Fund, the country’s sovereign fund, has go beyond entered into a joint venture with Russian pharmaceutical and biotech ChemRar Group to help finance the development of a remit Covid-19 drug. Where no sovereign funds exist, their creation could be facilitated by depositing existing government-owned corporate If sovereign funds are unable stakes into these vehicles. For example, the French and Dutch to help countries through the governments own stakes in the KLM-Air France Group, while pandemic, perhaps governments Germany and the UK partly own Commerzbank and RBS, should rethink the way these respectively. institutions operate, write John Nugée, senior adviser, OMFIF, and Opportunities and risks to delivering state aid through Gary Smith, managing director, sovereign funds Sovereign Focus. A key advantage to deploying sovereign funds as guardians and executors of government influence is the existing expertise, SOVEREIGN funds’ expertise, skills and capacity in taking a seat on corporate boards. This skills and capacity in taking a seat can support governments’ objectives to align companies with on corporate boards give them a a more sustainable economic model. Sustainability goals have key advantage in being guardians gained great prominence in the agenda of both central banks and executors of state influence and sovereign funds. The Central Banks and Supervisors and support to companies in the Network for Greening the Financial System has grown to post-pandemic period. A complex 68 members from eight in just over two years, and operates question is how appropriate it is for workstreams focusing on climate risk supervision in the governments to use their sovereign financial services industry and mobilising finance to support funds to bridge the gap between the green transition. Meanwhile, sovereign funds have set up income and expenditure. The key the One Planet Group to share best issues are the duration and volume of practice among the community in allocating investments to required budgetary support, and the green assets. According to the OMFIF GPI Survey 2020, 92% of consequences if it is not forthcoming. sovereign funds implement ESG strategies, and 50% of them It would not make sense for a fund to do so through active ownership and shareholder engagement prioritise the preservation of capital strategies. The importance of ESG-minded direction as if this resulted in the economy being conditions for state aid is already visible, for example through damaged beyond repair. the conditions for French support for Air France which included In the near term, more funds are that the carrier should ‘reduce its CO2 emissions on long and likely to provide emergency support medium-haul routes by 50% per passenger and kilometre by to national budgets. The demands on 2030; on flights within France until 2024’. funds may require rules to be rewritten. However, there can be downsides to using the need for This is legitimate: whatever the state aid as an opportunity to create or boost sovereign organisational relationship between the funds, particularly when such strategies are followed with the sovereign fund and the government, objective of supporting national champions, thus harming the and however independent the former benefits from global competition. is in theory, in practice any sovereign The Covid-19 crisis has added to tensions in an already fund is an organ of the state, and the hostile geopolitical landscape. In the pre-crisis period, western state can always change the terms economies such as the US and EU member states moved to under which it operates. tighten foreign investment screening mechanisms to enable If the fund’s ultimate controllers do them to further insulate strategic industries from targeted not feel able to use the fund to alleviate investment from state-owned enterprises and sovereign the worst economic decline for 100 investment vehicles, especially from China. These tensions are years, when will they?  occurring at the EU-US level, with the latest example being EU action to prevent a US acquisition of CureVac, a German company testing for a Covid-19 vaccine.  OMFIF.ORG CENTRAL BANK-SOVEREIGN FUND CO-OPERATION 71

Key sovereign fund Institution Description responses to In May, the Irish Treasury announced the establishment of a €2bn pandemic stabilisation the Covid-19 Ireland Strategic and recovery fund, housed within ISIF. Its purpose is to invest in companies with more than crisis Investment Fund 250 employees who have been materially affected by the pandemic with a view to preserving employment in the Irish economy. Shareholders are expected to contribute capital as co-investors.

Governor Michelle Lujan Grisham announced the guidelines and structure of the state’s $100m New New Mexico State Mexico Recovery Fund in March. The programme aims to provide loans to domestic businesses Investment Council with a focus on firms with 50 or more employees, supplementing smaller business loans provided by the New Mexico Small Business Investment Corporation.

Italy’s public investment bank announced €4.5bn fund for the disbursement of new loans for liquidity and working capital. These loans included state-guaranteed medium- or long-term loans Cassa Depositi e and short-term liquidity provision. It also partnered with the European Investment Bank to provide Prestiti €1.5bn in working capital loans to struggling firms. In addition, CDP issued Italy’s first social bond to fund part of its Covid-19 relief efforts.

France’s public investment bank launched the country’s first Covid-19 response bond to alleviate the economic shock to French companies. The proceeds will be used to finance loans to small- and Bpifrance medium-sized enterprises. Bpifrance announced a moratorium on repayment of outstanding loans on 16 March, as well as an increase in its loan guarantee level to 90%.

Norway’s oil fund increased the sales of foreign exchange in March to help support the Norges Bank/NBIM government’s fiscal efforts in response to the pandemic.

Azerbaijan’s sovereign fund has been selling foreign exchange since April to facilitate transferring Sofaz of assets to the state budget.

Saudi Arabian In April, Saudi Arabia’s central bank transferred $40bn from its foreign reserves to the sovereign Monetary Authority fund to enable it to invest more aggressively overseas given pressures on revenue sources from / Public Investment declining oil prices. Fund

Nigeria Sovereign The Nigerian government withdrew $150m from the sovereign fund in June to support its pandemic Investment Authority response.

Chile Economic and The Chilean government drew assets from the sovereign fund to support its Covid-19 response Stabilisation Fund programme.

Singapore’s sovereign fund joined a group of investors to provide a $13bn rescue package for Temasek national carrier Singapore Airlines.

As a shareholder in Malaysia Airlines, the country’s sovereign fund is in ongoing conversations Khazanah Nasional with the flag carrier around providing $1.2bn of support in response to the financial hit from the Berhad pandemic.

Dubai Investment As the state holding company of Emirates, the country’s sovereign fund has worked closely with the Corporation government in providing financial aid to the airline.

Turkey’s sovereign fund gained control of the country’s biggest mobile phone operator, Turkcell, that Türkiye Varlık Fonu was facing financial troubles exacerbated by the pandemic.

Russia’s sovereign fund joined forces with various partners to contribute to the fight against Russia Direct Covid-19, including a joint venture with Russian pharmaceutical and biotech ChemRar Group to Investment Fund finance drug development; a joint project with the Japan Bank for International Co-operation for an EMG diagnostic system; and a project to diagnose pneumonia using artificial intelligence.

The Malaysian sovereign fund donated Rm23m ($5.4m) to the country’s government-linked Disaster Permodalan Nasional Response Network. This included ventilators, and cash transfers to finance essential equipment Berhad and assist underprivileged patients, and was supplemented by financial support to the domestic Crisis Preparedness and Response Centre. 72 CENTRAL BANK-SOVEREIGN FUND CO-OPERATION GPI 2020

‘A new approach to the role of central banks is needed’

With the crisis caused by the Covid-19 pandemic, a taboo has been broken. The use of ‘helicopter ’ has become a reality in several countries, writes Didier Borowski, head of global views, Amundi.

A tax cut or cheques sent to households by dysfunctions in the financing of public goods, the government, if they are financed by money such as education or healthcare. These goods creation, are forms of ‘helicopter money’. could be included in the assets of the central , in its narrowest sense, bank. Indeed, these assets are ‘commons’ that consists of a central bank issuing money to contribute to growth. Their value, however, acquire financial assets. The increase in the cannot be calculated solely based on their market monetary base is reversible, since the central cost. They have a much higher hedonic price. bank can decide later to reduce the size of its The current health crisis illustrates the huge balance sheet to its initial level. economic cost of not having effective public However, this option differs from ‘pure health systems. If central banks directly finance helicopter money’, at least as long as the balance projects of this nature by issuing money, they can sheets of a government and the central bank are value these assets at their hedonic price to keep separated. Indeed, in the ‘helicopter option’, the their balance sheet in balance. transfer to private agents becomes permanent. That the definition of ‘commons’ is imprecise The increase in the balance sheet no longer and funding them is not within the purview of the corresponds to an increase in the government’s central bank are fair objections. However, there is debt to the central bank. Usual no more reason to finance them through national metrics remain unchanged. To public debts since the resulting ensure technical equality between ‘ can increase in well-being is general the liabilities and assets of the be justified to remedy and extends beyond borders. These central bank, the government could market dysfunctions are goods that can be universally issue a perpetual zero-coupon bond. in the financing of recognised as necessary for But this claim on the government is public goods, such sustainable and equitable global fictitious insofar as it has no time as education or development. horizon. Excluding recapitalisation, The current crisis gives us the healthcare.’ the central bank’s balance sheet is opportunity to rethink the role of unbalanced with a negative equity economic policies. The balance position. This option, therefore, has its limits. sheets of governments and central banks have If the money created far exceeds the central become intertwined in Europe, Japan and the US. bank’s assets, there is a risk that the helicopter Yet it is the state, and the state alone, that is the money could eventually lead to a widespread loss ‘guarantor of last resort’. Its missions go beyond of confidence, expectations of inflation and a accounting balances. A new approach to the role flight to real assets. of central banks is needed. The fact that central banks are not economic Nothing would, in theory, prevent the agents like others - they are, in practice, the distinction between the financing operations of only economic agents that can issue money to the ‘commons’ and operations, cover their losses - does not change anything. which could continue to target price stability. Helicopter money only works, in theory, if it The financing of ‘commons’ would not present occurs only once or in exceptional circumstances. the same risks to macrofinancial stability as However, we can conceive of another form of large-scale asset purchases by central banks, money creation that looks like helicopter money which, it should be recalled, have ultimately but has counterparts on the asset side. Money enriched capital holders and thus exacerbated creation can be justified to remedy market inequalities. 