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Sovereign Wealth Fund: Navigating the Dichotomy of Good and Evil

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Hisham Farag discuss the opportunities and challenges the creation of a Sovereign Wealth Fund could bring for the UK in relation to its sustainable development goals.

Image courtesy of interviewee. May 3, 2024

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This video video discusses the significance and impact of Sovereign Wealth Funds (SWFs), which are state-owned investment funds that have gained prominence since the 2000s. The assets managed by SWFs nearly doubled from $6.07 trillion in 2012 to around $11 trillion by 2021, highlighting their growing importance in the global economy.

The speaker mentions ongoing debates in the UK regarding the establishment of its own SWF, emphasizing that these funds can stabilize economies and generate long-term wealth. However, concerns have been raised about the policies and strategies of some SWFs, which could potentially damage the reputations of the companies they invest in.

The research conducted by the speaker and co-authors aims to explore the effects of SWF ownership on the environmental, social, and governance (ESG) reputation risks of investee firms. They analyze 68 SWFs across 80 countries, identifying two main views in the literature: the Contracting View, which posits that SWFs can lead to positive outcomes through state regulation, and the Predatory View, which warns of possible opportunistic behavior by SWFs that may prioritize political objectives over shareholder interests.

The findings indicate that higher SWF ownership correlates with increased reputation risk for companies, but this impact can be mitigated by institutional proximity, good governance practices, and by being a signatory to responsible investment principles. The study recommends that governments prioritize transparent sovereign funds and advises companies to design contracts that lower the influence of SWFs to manage reputational risks effectively.

Future research avenues are suggested, focusing on the potential conflicts between fiduciary and political goals of SWFs and the regulatory environments in which they operate.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

00:00.185 --> 00:02.605
Let me highlight using what Sovereign Wealth Fund.

00:03.285 --> 00:06.625
It's a unique type of institutional investor owned

00:06.685 --> 00:09.185
by government or a sovereign state.

00:09.895 --> 00:13.425
They typically pursue long-term,

00:13.425 --> 00:16.625
investment strategies, sovereign wealth funds,

00:16.765 --> 00:18.665
by the way, they are not new.

00:19.095 --> 00:21.105
They are around since 1950s,

00:21.885 --> 00:24.465
but they recently have increased popularity

00:24.465 --> 00:28.835
and momentum since probably the starting of the, decade

00:29.355 --> 00:31.475
starting of the year, of 2000.

00:31.935 --> 00:33.675
So, for example, in, in terms

00:33.675 --> 00:36.515
of the asset under management in 2012,

00:37.175 --> 00:40.035
the asset under management was around,

00:40.255 --> 00:43.115
$6.07 trillion.

00:44.285 --> 00:48.745
And surprisingly, this almost doubled by the end of 2021 to

00:48.845 --> 00:50.825
around $11 trillion.

00:51.165 --> 00:53.385
So this shows the, the size

00:53.405 --> 00:56.745
and the significance of the Sovereign Wealth Fund

00:57.165 --> 01:01.145
and the role they play in modern economy from now.

01:01.145 --> 01:05.265
And then we hear some debate, amongst politicians,

01:05.265 --> 01:08.185
political parties and, and the UK government

01:08.205 --> 01:11.505
and the Parliament about whether the UK should start

01:12.005 --> 01:15.465
and establish its own sovereign wealth fund or not.

01:16.205 --> 01:18.545
The rationale, by the way, is very clear and

01:18.945 --> 01:20.065
provided by the literature.

01:20.845 --> 01:25.735
Sovereign Wealth Fund could be a tool to invest excess,

01:25.735 --> 01:29.175
capital to stabilize country's economy,

01:29.575 --> 01:30.655
whatever the country is,

01:31.155 --> 01:34.855
and also to generate longer term wealth

01:35.075 --> 01:36.415
for future generations.

01:36.415 --> 01:38.975
Because the nature of sovereign wealth funds,

01:39.365 --> 01:43.135
they pursue long-term, investment policies.

01:44.005 --> 01:47.505
On the other hand, there are some recent reports

01:47.685 --> 01:50.105
by the media in the, the last few years

01:50.615 --> 01:54.385
raising some concerns about the policies

01:54.845 --> 01:57.545
and investment strategies, followed

01:57.725 --> 01:59.625
by some sovereign wealth funds

02:00.085 --> 02:04.105
and how this may impact the reputation of investee companies

02:04.365 --> 02:07.905
and may damage the in investment environment in

02:07.905 --> 02:09.625
different jurisdictions.

02:10.045 --> 02:13.505
So this is why we were motivated myself

02:13.525 --> 02:14.625
and my co-authors

02:15.045 --> 02:17.665
to investigate this important research question,

02:17.665 --> 02:21.345
which is briefly, we want to look at the impact

02:21.725 --> 02:23.025
of sovereign wealth funds

02:23.605 --> 02:27.065
and how they impact the investee firms,

02:27.625 --> 02:30.865
ESG reputational in reputation risk.

02:31.715 --> 02:35.055
We look at wide range of sovereign wealth funds

02:35.115 --> 02:37.255
around 68 across the world,

02:37.795 --> 02:42.495
and almost, their env companies

02:42.955 --> 02:45.855
around 80 countries across the world.

02:46.005 --> 02:50.175
Okay, so, so this area of research, they have some,

02:50.405 --> 02:54.415
seminal strands of the literature I could mention,

02:54.415 --> 02:58.775
different, seminal authors like Meson in 2015

02:59.065 --> 03:03.885
and, Goodell in 2022 and stalls in 2005.

03:04.385 --> 03:07.845
But just briefly, the, the literature, they argue

03:07.915 --> 03:10.805
that Sovereign Wealth Fund as a new form

03:11.025 --> 03:15.805
of state capitalism, they might be, as a owner

03:15.945 --> 03:20.205
or principle, they may pursue two opposing goals.

03:20.905 --> 03:24.005
The first one is fiduciary goals, which is,

03:24.145 --> 03:26.565
by definition, they, they should,

03:26.675 --> 03:27.725
they should be doing that.

03:28.065 --> 03:30.285
But the other one is the political goals.

03:30.865 --> 03:35.445
So the literature interestingly develop, two,

03:35.955 --> 03:37.365
competing arguments.

03:37.785 --> 03:41.405
The first one is called the Contracting View,

03:41.825 --> 03:44.565
and the other one is called Predatory View.

03:45.185 --> 03:47.805
Let me briefly explain what does it mean.

03:48.755 --> 03:52.335
So the contracting view, which reflects the positive impact

03:52.395 --> 03:55.855
of sovereign wealths fund ownership on VT companies,

03:56.565 --> 04:01.495
they claim that the state, through its regulatory,

04:01.625 --> 04:04.655
frameworks, they could lower market fictions

04:05.315 --> 04:09.615
and hence facilitate the corporate sectors to engage

04:10.235 --> 04:11.855
and to allow them to them

04:11.855 --> 04:15.415
to engage in mutually beneficial contracts.

04:16.035 --> 04:19.215
So this is a positive side of the Sovereign Wealth Fund.

04:19.315 --> 04:21.775
So how about the negative side, the other opposing view,

04:21.775 --> 04:25.695
which is called predatory, the predator predatory view,

04:25.695 --> 04:28.455
which is showing the negative role of sovereign wealth fund.

04:28.885 --> 04:32.095
They, they, they, they claim that maybe the state

04:32.555 --> 04:37.175
as a ruler, they are, some of them could be opportunistic

04:37.915 --> 04:42.095
and deploy their powers to appropriate corporates

04:42.435 --> 04:44.015
to extend their influence

04:44.355 --> 04:45.975
and rent seeking activities,

04:46.235 --> 04:50.895
rather than just pursuing shareholder,

04:50.995 --> 04:53.815
wealth maximization, as we always say.

04:54.315 --> 04:56.055
So our work,

04:56.195 --> 05:00.055
or our paper, is well placed in this literature.

05:00.235 --> 05:02.735
So we have few contributions

05:02.755 --> 05:05.015
or incremental contributions to the literature.

05:05.385 --> 05:10.215
First, we claim that our work is the first to the best

05:10.215 --> 05:12.855
of our knowledge to examine the impact

05:13.115 --> 05:17.815
of Sovereign Wealth Fund on firm's ESG reputation risk.

05:18.475 --> 05:20.095
We also contribute

05:20.095 --> 05:22.695
to the literature on international relations

05:22.845 --> 05:26.015
because we interestingly find that the

05:26.935 --> 05:29.975
negative impact on reputational, risk

05:30.315 --> 05:34.335
for those investment investee companies could be mitigated

05:35.425 --> 05:39.765
by, some, like inter like,

05:39.955 --> 05:42.485
bilateral relationships where they exist.

05:42.585 --> 05:44.365
For instance, if the two

05:44.885 --> 05:47.765
countries like the Sovereign Wealth Fund country

05:47.825 --> 05:52.125
and the, firm country, they have, similar,

05:52.745 --> 05:57.045
political, proximity or social proximity,

05:57.815 --> 06:01.445
Those relationship could reduce the negative impact.

06:01.865 --> 06:05.525
And finally, we also contribute to the corporate governance

06:06.165 --> 06:10.205
literature in which we, we also claim based on our results

06:10.555 --> 06:13.685
that the, the, moderating role

06:13.785 --> 06:16.285
of Sovereign Wealth Fund, they could,

06:16.615 --> 06:18.205
there could be a moderating role

06:18.655 --> 06:23.525
where a sovereign wealth fund has more transparency and more

06:23.585 --> 06:25.405
and better governance quality.

06:25.835 --> 06:28.445
This could mitigate the negative relationship.

06:28.795 --> 06:32.125
Okay, so without going through deli literature and,

06:32.185 --> 06:35.365
and the theories and the arguments, so they,

06:36.255 --> 06:38.835
it is well documented that there are some arguments

06:38.935 --> 06:42.235
for establishing a, a sovereign wealth fund briefly,

06:42.385 --> 06:44.195
such as what this is.

06:44.305 --> 06:47.595
This provides any country the tool

06:47.615 --> 06:49.275
to diversify their revenues.

06:50.055 --> 06:52.945
They provide long-term wealth prevention.

06:53.865 --> 06:57.795
They, they, they play a, a key role in stabilizing the

06:58.355 --> 07:00.555
economic or the economy where in,

07:00.555 --> 07:02.195
in whatever the jurisdiction.

07:02.655 --> 07:06.235
And also they play a key role in infrastructure development.

07:06.835 --> 07:10.555
I would add one additional, argument

07:11.095 --> 07:13.595
to support Sovereign Wealth fund establishment

07:14.175 --> 07:16.315
is their role,

07:16.535 --> 07:20.275
or potential role in investment in adaptation finance

07:20.425 --> 07:22.315
initiatives to mitigate

07:22.375 --> 07:25.715
or to help mitigate the climate finance crisis

07:25.745 --> 07:27.315
that we are suffering from.

07:27.935 --> 07:31.195
On the other hand, there are some arguments against

07:31.665 --> 07:34.875
establishment, any sovereign wealth fund, such as what,

07:35.455 --> 07:40.235
as I mentioned in the predatory, view, like the risk

07:40.255 --> 07:41.955
of, mismanagement.

07:42.375 --> 07:43.435
Uh, maybe some

07:43.435 --> 07:46.435
of the sovereign wealth funds may pursue some political

07:46.465 --> 07:49.155
influence on thet companies.

07:49.155 --> 07:50.395
And we can see some

07:50.395 --> 07:53.715
of those examples happening in the UK at the moment.

07:54.085 --> 07:57.155
There might be some opportunity cost of the, of the,

07:57.155 --> 07:58.275
of those investments,

07:58.655 --> 08:01.475
and actually there might be potential distortion

08:01.475 --> 08:03.355
of financial markets eventually.

08:03.585 --> 08:04.595
Yeah. Okay.

08:04.615 --> 08:06.515
So just, I, I will, I will briefly

08:07.275 --> 08:08.555
summarize our findings.

08:08.615 --> 08:13.475
So we, find consistent evidence that show

08:13.475 --> 08:16.715
that the higher the Sovereign Wealth fund ownership

08:17.455 --> 08:22.035
is the higher or the greater reputation risk of, of ESG

08:22.375 --> 08:23.715
for T companies.

08:24.605 --> 08:26.705
And this negative impact

08:26.765 --> 08:30.625
or reputational damage, interestingly, is mitigated

08:31.315 --> 08:34.545
where the pers, when I say the p is just the,

08:34.565 --> 08:35.745
the EE companies

08:36.005 --> 08:37.265
and the Sovereign Wealth Fund,

08:37.615 --> 08:40.825
they share an institutional proximity or innocence.

08:40.935 --> 08:42.465
They are political ally,

08:42.855 --> 08:45.105
they have proximal national governance,

08:45.445 --> 08:47.625
or they, maybe they share dominant religion

08:48.005 --> 08:52.465
or they may have some, proximal social connectedness.

08:53.055 --> 08:57.485
This negative impact is mitigated by those,

08:57.905 --> 08:59.205
relationship.

08:59.745 --> 09:03.285
And also we found that, important role of transparency

09:03.465 --> 09:06.885
and accountability where a sovereign wealth fund is

09:07.155 --> 09:12.085
characterized by, more transparent or more accountable,

09:12.385 --> 09:13.965
and they have good governance.

09:14.475 --> 09:18.405
This relationship also this negative impact is mitigated.

09:18.865 --> 09:21.045
And finally, we found where those

09:21.045 --> 09:24.645
of Green Wealth Fund are signatory of the PRI

09:24.705 --> 09:28.085
or the principle of responsible investment, we found

09:28.085 --> 09:32.085
that this negative reputational damage is also mitigated.

09:32.675 --> 09:37.325
Okay, so I, based on the results of our research, we again,

09:37.505 --> 09:39.125
we find consistent

09:39.585 --> 09:43.765
and robust, evidence of the negative impact

09:43.905 --> 09:45.845
of Sovereign Wealth Fund,

09:45.955 --> 09:50.085
ownership on some NBC companies in different jurisdictions.

09:50.905 --> 09:54.045
For that, and to mitigate such negative impact,

09:54.465 --> 09:58.485
we have some recommendations to, probably to governments

09:58.745 --> 10:00.765
and for NBC companies.

10:01.265 --> 10:04.125
For governments, I guess we would recommend that

10:04.705 --> 10:08.525
any government to prioritize where they want

10:08.525 --> 10:11.685
to have any relationship with Sovereign Wealth Fund,

10:11.715 --> 10:15.495
they should prioritize sovereign wealth funds originating

10:15.605 --> 10:19.095
from countries with transparent practices,

10:19.945 --> 10:22.045
higher standard of national governance,

10:22.585 --> 10:25.605
higher predictable legal environment and, and,

10:25.625 --> 10:26.685
and, and rule of globe.

10:27.115 --> 10:30.925
This will mitigate, excuse me, any negative impact.

10:31.615 --> 10:36.475
And for, and for investee companies, what we are

10:37.155 --> 10:39.195
recommending that investee companies,

10:39.195 --> 10:40.795
they should play a role as well.

10:41.345 --> 10:43.555
When they are exposed to a reputation risk

10:44.175 --> 10:45.635
by a sovereign wealth fund,

10:46.065 --> 10:49.155
they should carefully design those contracts,

10:49.575 --> 10:51.995
giving those EE firms, for instance,

10:52.275 --> 10:56.275
differential voting rights to lower where needed

10:56.695 --> 10:59.155
to lower the influence of such negative impact.

10:59.735 --> 11:03.755
And also we recommend EE companies they have,

11:04.335 --> 11:06.075
or probably it is better for them

11:06.175 --> 11:09.075
to have closer relationship with Sovereign Wealth Fund,

11:09.415 --> 11:11.595
for instance, proximal institutional factors,

11:12.005 --> 11:15.195
maybe national governance, similar language,

11:15.195 --> 11:17.195
similar culture and so on.

11:17.565 --> 11:20.515
Those factors will definitely mitigate,

11:20.515 --> 11:21.835
based on our research results,

11:22.025 --> 11:25.315
will mitigate any negative reputational damage.

11:25.895 --> 11:27.835
Future research there is a big room,

11:27.835 --> 11:29.715
because this is really very interesting,

11:30.375 --> 11:31.515
area of research.

11:31.975 --> 11:36.635
So we could look at potential conflict between FI fiduciary

11:36.975 --> 11:39.435
and political goals of Sovereign Wealth Fund

11:39.735 --> 11:44.155
and how this might be mitigated by some factors like quality

11:44.215 --> 11:46.275
of regulations, rule of law,

11:46.735 --> 11:49.475
and in within different jurisdictions.

00:00 - Let me highlight using what Sovereign Wealth Fund. It's a unique type of institutional investor owned by government or a sovereign state. They typically pursue long-term, investment strategies, sovereign wealth funds, by the way, they are not new.

00:19 - They are around since 1950s, but they recently have increased popularity and momentum since probably the starting of the, decade starting of the year, of 2000. So, for example, in, in terms of the asset under management in 2012, the asset under management was around, $6.07 trillion. And surprisingly, this almost doubled by the end of 2021 to around $11 trillion.

00:51 - So this shows the, the size and the significance of the Sovereign Wealth Fund and the role they play in modern economy from now. And then we hear some debate, amongst politicians, political parties and, and the UK government and the Parliament about whether the UK should start and establish its own sovereign wealth fund or not. The rationale, by the way, is very clear and provided by the literature. Sovereign Wealth Fund could be a tool to invest excess,

01:25 - capital to stabilize country's economy, whatever the country is, and also to generate longer term wealth for future generations. Because the nature of sovereign wealth funds, they pursue long-term, investment policies. On the other hand, there are some recent reports by the media in the, the last few years raising some concerns about the policies and investment strategies, followed

01:57 - by some sovereign wealth funds and how this may impact the reputation of investee companies and may damage the in investment environment in different jurisdictions. So this is why we were motivated myself and my co-authors to investigate this important research question, which is briefly, we want to look at the impact of sovereign wealth funds and how they impact the investee firms,

02:27 - ESG reputational in reputation risk. We look at wide range of sovereign wealth funds around 68 across the world, and almost, their env companies around 80 countries across the world. Okay, so, so this area of research, they have some, seminal strands of the literature I could mention, different, seminal authors like Meson in 2015 and, Goodell in 2022 and stalls in 2005. But just briefly, the, the literature, they argue

03:07 - that Sovereign Wealth Fund as a new form of state capitalism, they might be, as a owner or principle, they may pursue two opposing goals. The first one is fiduciary goals, which is, by definition, they, they should, they should be doing that. But the other one is the political goals. So the literature interestingly develop, two, competing arguments. The first one is called the Contracting View,

03:41 - and the other one is called Predatory View. Let me briefly explain what does it mean. So the contracting view, which reflects the positive impact of sovereign wealths fund ownership on VT companies, they claim that the state, through its regulatory, frameworks, they could lower market fictions and hence facilitate the corporate sectors to engage and to allow them to them to engage in mutually beneficial contracts. So this is a positive side of the Sovereign Wealth Fund.

04:19 - So how about the negative side, the other opposing view, which is called predatory, the predator predatory view, which is showing the negative role of sovereign wealth fund. They, they, they, they claim that maybe the state as a ruler, they are, some of them could be opportunistic and deploy their powers to appropriate corporates to extend their influence and rent seeking activities, rather than just pursuing shareholder, wealth maximization, as we always say.

04:54 - So our work, or our paper, is well placed in this literature. So we have few contributions or incremental contributions to the literature. First, we claim that our work is the first to the best of our knowledge to examine the impact of Sovereign Wealth Fund on firm's ESG reputation risk. We also contribute to the literature on international relations because we interestingly find that the

05:26 - negative impact on reputational, risk for those investment investee companies could be mitigated by, some, like inter like, bilateral relationships where they exist. For instance, if the two countries like the Sovereign Wealth Fund country and the, firm country, they have, similar, political, proximity or social proximity, Those relationship could reduce the negative impact. And finally, we also contribute to the corporate governance

06:06 - literature in which we, we also claim based on our results that the, the, moderating role of Sovereign Wealth Fund, they could, there could be a moderating role where a sovereign wealth fund has more transparency and more and better governance quality. This could mitigate the negative relationship. Okay, so without going through deli literature and, and the theories and the arguments, so they, it is well documented that there are some arguments

06:38 - for establishing a, a sovereign wealth fund briefly, such as what this is. This provides any country the tool to diversify their revenues. They provide long-term wealth prevention. They, they, they play a, a key role in stabilizing the economic or the economy where in, in whatever the jurisdiction. And also they play a key role in infrastructure development. I would add one additional, argument

07:11 - to support Sovereign Wealth fund establishment is their role, or potential role in investment in adaptation finance initiatives to mitigate or to help mitigate the climate finance crisis that we are suffering from. On the other hand, there are some arguments against establishment, any sovereign wealth fund, such as what, as I mentioned in the predatory, view, like the risk of, mismanagement.

07:42 - maybe some of the sovereign wealth funds may pursue some political influence on thet companies. And we can see some of those examples happening in the UK at the moment. There might be some opportunity cost of the, of the, of those investments, and actually there might be potential distortion of financial markets eventually. Yeah. Okay.

08:04 - So just, I, I will, I will briefly summarize our findings. So we, find consistent evidence that show that the higher the Sovereign Wealth fund ownership is the higher or the greater reputation risk of, of ESG for T companies. And this negative impact or reputational damage, interestingly, is mitigated where the pers, when I say the p is just the, the EE companies

08:36 - and the Sovereign Wealth Fund, they share an institutional proximity or innocence. They are political ally, they have proximal national governance, or they, maybe they share dominant religion or they may have some, proximal social connectedness. This negative impact is mitigated by those, relationship. And also we found that, important role of transparency and accountability where a sovereign wealth fund is

09:07 - characterized by, more transparent or more accountable, and they have good governance. This relationship also this negative impact is mitigated. And finally, we found where those of Green Wealth Fund are signatory of the PRI or the principle of responsible investment, we found that this negative reputational damage is also mitigated. Okay, so I, based on the results of our research, we again, we find consistent and robust, evidence of the negative impact

09:43 - of Sovereign Wealth Fund, ownership on some NBC companies in different jurisdictions. For that, and to mitigate such negative impact, we have some recommendations to, probably to governments and for NBC companies. For governments, I guess we would recommend that any government to prioritize where they want to have any relationship with Sovereign Wealth Fund, they should prioritize sovereign wealth funds originating from countries with transparent practices,

10:19 - higher standard of national governance, higher predictable legal environment and, and, and, and rule of globe. This will mitigate, excuse me, any negative impact. And for, and for investee companies, what we are recommending that investee companies, they should play a role as well. When they are exposed to a reputation risk by a sovereign wealth fund, they should carefully design those contracts,

10:49 - giving those EE firms, for instance, differential voting rights to lower where needed to lower the influence of such negative impact. And also we recommend EE companies they have, or probably it is better for them to have closer relationship with Sovereign Wealth Fund, for instance, proximal institutional factors, maybe national governance, similar language, similar culture and so on. Those factors will definitely mitigate,

11:20 - based on our research results, will mitigate any negative reputational damage. Future research there is a big room, because this is really very interesting, area of research. So we could look at potential conflict between FI fiduciary and political goals of Sovereign Wealth Fund and how this might be mitigated by some factors like quality of regulations, rule of law, and in within different jurisdictions.

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