On the Political Economy of Sovereign Wealth Funds Artur Grigoryan School of Economic Disciplines Chair for European Economic Policy University of Siegen A thesis submitted for the degree of Dr. rer. pol. Siegen, 2016 gedruckt auf alterungsbeständigem holz- und säurefreiem Papier i ii First reviewer: Prof. Dr. Carsten Hefeker Second reviewer: Prof. Dr. Karl-Josef Koch To my loving family – Shoghik, Lyova, Anna and Nonna – This work would not have been written without their support. Nvirvum է ընտանիքիս՝ Lyovayin, Շողիկին, Annayin Nonnayin: Առանց nranc աջակցության ինձ hamar շատ դժվար kliner avartin hascnel ays աշխատանքը։ Acknowledgements This thesis was written during my time at the Chair for European Economic Policy of the School for Economic Disciplines at the Uni- versity Siegen. I would like to thank my supervisor Prof. Dr. Carsten Hefeker for his support, advice and especially for his role in focusing my research interest on the topic of this thesis. During my studies, he encouraged me with his lectures to become an economist and to start the work on Sovereign Wealth Funds. His way of thinking about economic problems gave me a valuable lesson on how to solve certain problems. The work presented here benefited very much from his advice and our detailed discussions. I am also grateful to Prof. Dr. Karl-Josef Koch for being my second supervisor. I have learned a lot from his helpful suggestions and important hints. Also, I would like to acknowledge the valuable contribution of my academic colleagues. Lisa Schulten read through complete drafts of the thesis and helped me to improve the style and content of the manuscript. This thesis has profited as well from comments of Moritz Bonn and Sebastian Schäfer. Furthermore, I am grateful to partic- ipants of the MAGKS Workshop at Rauischholzhausen Castle and Brown-Bag-Seminar at the University Siegen. I have received many helpful comments. Finally, I am grateful to my family and friends for their encouragement and support. Valerian Stenske and Natalie Brandt-Stenske helped me to eliminate spelling errors and improve the overall clarity of single chapters. Special thanks go to my beloved wife Nonna for her patience and constant support. Siegen, 2016 Artur Grigoryan Contents Contents iv List of Figures vii List of Tables viii List of Acronyms x 1 Introduction 1 1.1 SWFs and the Global Financial System . 1 1.2 Political and Strategic Concerns Raised by SWFs . 8 1.3 Co-Investment Alliances and SWFs’ Investments in Infrastructure 14 2 The Ruling Bargain: Sovereign Wealth Funds in Elite-Dominated Societies 16 2.1 Introduction . 16 2.2 Abu Dhabi’s SWFs and the Ruling Al Nahyan Family . 19 2.3 The Model . 23 2.3.1 The Framework . 24 2.3.2 Analysis . 28 2.3.3 Discussion and Some Evidence . 35 2.4 Conclusion . 38 3 Delegation in Sovereign Wealth Funds 40 3.1 Introduction . 40 3.2 The Model . 43 iv CONTENTS 3.3 Politician as the Manager of the SWF . 45 3.3.1 Politician’s Decision . 46 3.3.2 Voters’ Decision Rule . 47 3.4 External Manager in the SWF . 48 3.5 Delegation of the Decision-Making Power to an External Manager 53 3.6 Conclusion . 58 4 Sovereign Wealth Funds and Infrastructure Investment 61 4.1 Introduction . 61 4.2 Infrastructure Investments and SWFs . 66 4.3 Co-Investment of SWFs and the Hold-Up Problem . 70 4.3.1 The Model Framework . 70 4.3.2 Co-Investment: A Possible Solution to Hold-Up . 74 4.4 How to Foster Co-Investment among SWFs? . 80 4.5 Conclusion . 83 5 Conclusions 86 Appendix A 89 A.1 Generally Accepted Principles and Practices (GAPP) – Santiago Principles . 89 A.2 Truman’s Scoreboard for SWFs . 92 A.3 Linaburg-Maduell Transparency Index . 93 Appendix B 94 B.1 The Ruler’s Investment Decision . 94 Appendix C 96 C.1 Proof of Proposition 3 ........................ 96 C.2 Analyzing Condition (3.28)...................... 98 Appendix D 99 D.1 Types of Infrastructure Investment . 99 D.2 Infrastructure Financing Instruments . 100 D.3 The Game of Figure 4.2 with Perfect Information . 101 v CONTENTS D.4 The Game of Figure 4.2 with Imperfect Information . 103 References 108 vi List of Figures 1.1 SWFs by size (2015) . 2 1.2 SWFs’ assets under management . 4 1.3 SWFs by year of inception . 4 1.4 SWFs by source of capital (2015) . 5 1.5 Official Foreign Exchange Reserves (1999-2015) . 6 1.6 The oil price and new SWFs . 6 1.7 SWFs and the sponsoring country’s political regime . 7 1.8 The Linaburg-Maduell Index and Truman’s Scoreboard . 12 1.9 The correlation between the Corruption Perception Index, the In- dex of Economic Freedom and the SWF Scoreboard . 12 1.10 The correlation between the Corruption Perception Index, the In- dex of Economic Freedom and the Linaburg-Maduell Index . 13 2.1 Analyzing condition (2.7) for 4π < (1 p).............. 31 − 2.2 Analyzing condition (2.7) for 4π (1 p).............. 34 ≥ − 4.1 A simple investment game with the possibility of hold-up . 72 4.2 A simple investment game with co-investment . 76 C.1 Analyzing condition (3.28)...................... 98 D.2 Types of infrastructure investment . 99 D.3 Infrastructure financing instruments . 100 vii List of Tables 1.1 The 20 largest SWFs . 3 4.1 SWFs and infrastructure investments . 67 viii List of Acronyms ADIA Abu Dhabi Investment Authority ADICO Abu Dhabi Investment Council AuM Assets under Management CDC Caisse des Dépôts International – France CFIUS Committee of Foreign Investment in the United States CIC China Investment Corporation CNOOC China National Offshore Oil Corporation CPI Corruption Perception Index EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization EFI Economic Freedom Index FSI Fondo Strategico Italiano GIC Government Investment Corporation (Singapore) GIF Global Infrastructure Facility GPF–G Government Pension Fund–Global (Normay) IFSWF International Forum of Sovereign Wealth Funds IMF International Monetary Fund ix IPIC International Petroleum Investment Company IWG International Working Group (for SWFs) KIA Kuwait Investment Authority KIB Kuwait Investment Board KIC Kuwait Investment Company LMI Linaburg-Maduell Index MDB Multilateral Development Bank MIGA Multilateral Investment Guarantee Agency OECD Organization for Economic Co-operation and Development PPIAF Public-Private Infrastructure Advisory Facility PPRF Public Pension Reserve Funds QIA Qatar Investment Authority RDIF Russian Direct Investment Fund SAFE State Administration of Foreign Exchange (China) SAMA Saudi Arabia Monetary Authority SOE State-Owned Enterprise SWF Sovereign Wealth Fund UAE United Arab Emirates x Chapter 1 Introduction 1.1 SWFs and the Global Financial System In the article with the intriguing title “Who holds the wealth of nations?” Rozanov (2005) drew readers’ attention to a particular type of public sector players whom he referred to as sovereign wealth managers or sovereign wealth funds (SWFs). It took some time until this moniker became popular, but today SWFs are com- monly discussed both in mass media and academic literature and represent an important class of institutional investors in the global financial system.1 Even though SWFs are well-discussed and a considerable amount of research on this topic has been accumulated during the last decade, one has to recognize that the term “Sovereign Wealth Fund” is very broad and vague. Still, academic and political literature cannot agree on what to consider as a SWF. In fact, these funds represent a very heterogeneous group. According to Schwartz (2012), “This nominal label lumps apples (Norway’s Government Pension Fund–Global, or GPF–G), lobsters (Singapore’s Temasek) and bliss potatoes (the Gulf SWFs) together on the grounds that they are all colored red. But these organizations have different essential political and economic logics and should not be lumped together...”. 1A search of the Financial Times website shows that the term was first used on May 24, 2007, two years after the Central Banking Journal’s issue with Rozanov’s article was published. Compare also Megginson and Fotak (2014). 1 While analyzing specific aspects of SWFs, one has to be aware of differences in particular funds’ strategies and purposes. Nevertheless, it is helpful to use a broad definition by describing the entire community of these state-led investors. This thesis relies on one of commonly used SWF definitions provided by the SWF Institute.2 SWF Institute defines a SWF as “...a state-owned investment fund or entity that is commonly estab- lished from balance of payments surpluses, official foreign currency operations, the proceeds of privatizations, governmental transfer pay- ments, fiscal surpluses and/or receipts resulting from resource ex- ports”3(Sovereign Wealth Fund Institute, 2015c). 30% 25% 20% 15% 25% 24% 10% Proportionof SWFs 15% 17% 13% 5% 6% 0% Less than $1-9bn $10-49bn $50-99bn $100-249bn $250bn or $1bn More SWFs' Assets under Management Figure 1.1: SWFs by size (2015) Source: Based on own calculations, Sovereign Wealth Fund Institute (2015a) and Preqin (2015a). Historically SWFs were present in the world economy since 1953, but the role they play in the global economy has evolved dramatically during the last decades. Today, about 50 national and local governments are sponsoring SWFs which control more than $7 trillion of invested assets. Table 1.1 lists the 20 2For detailed analysis of different SWF definitions see Rozanov (2011). 3This definition excludes, among other things, foreign currency reserve assets held by monetary authorities for the traditional balance of payments or monetary policy purposes, state-owned enterprises (SOEs) in the traditional sense,