From Russia with NO Love: A New Sovereign Wealth Fund

Russia officially announced that it’s splitting the Oil Stabilization Fund into two separate entities (International Herald Tribune):

The larger of the two funds, now called the Reserve Fund, retains the initial purpose of the Russian rainy day fund of insuring the country’s budget against a steep fall in oil prices. It will hold $125 billion and be maintained in future years at a size that is roughly 10 percent of Russia’s gross domestic product, as it is now.

 

The other, called the National Welfare Fund (NWF), with $32 billion, is intended to buoy the pension system. Under a law passed last spring, it can be invested in foreign stocks and bonds.

Morgan Stanley, in a report titled, “Celebrating the Birth of Russia’s SWF,” (PDF) says that the NWF will initially invest conservatively:

…for now, the NWF will initially be invested very conservatively, with the following guidelines:

 

(i) All must be in foreign debt, denominated in USD, EUR or GBP, rated at least AA-, from Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Luxembourg, the Netherlands, Spain and the US.

(ii) At least 50% in foreign government debt, with the rest in foreign private/corporate debt.

(iii) Up to 30% in foreign agency debt and central bank debt.

(iv) Up to 15% in debt of international financial organisations (ADB, EIB, etc.).

(v) Up to 30% in foreign bank deposits.

Morgan Stanley estimates that if oil remain at current levels the NWF could reach $320 billion in the next 5 years, with their best guess being $140 billion.

The rhetoric coming from political leaders in the Russian government announcing the NWF does not seem like the most diplomatic, tactful way to announce the creation of a new SWF, especially given the concerns over possible political motivations that certain SWF host countries might have (Financial Times):

Dmitry Medvedev, Russia’s most likely next president, called on Russian business people on Thursday to copy China and go on a global buying spree of foreign companies to bolster the economy and cut dependence on technology from abroad.

 

In his first speech to Russian big business since being named by Vladimir Putin as his preferred successor, Mr Medvedev pledged Kremlin support for companies seeking assets abroad.

 

“This is a very important task. The majority of powerful countries are engaged in this. Many of them are very active, like China. And we should be active, too,” he told a conference for Russia’s most influential business lobby in the southern Russian city of Krasnodar.

 

“This will allow us to re-tool Russian enterprises with technology, boost their production culture and grant them the opportunity to diversify investments and win new markets,” he said.

Remarkably, Russian finance officials are puzzled at why the NWF is being singled out for criticism (Financial Times):

Pyotr Kazakevitch, the 34- year-old head of the Russian Finance Ministry’s $127.5bn stabilisation fund, is puzzled by the fears in the west about the threat posed by sovereign wealth funds.

 

“The sovereign wealth funds of the Arab world and Singapore have been buying equities in Europe and America for decades and there was no discussion at all,” Mr Kazakevitch told the Financial Times. “I find it really strange that when Russia only starts discussing such a possibility we hear a lot of concerned speeches … I don’t understand why we hear a lot of voices that demonize our activity.”

Russia has disclosed a fairly robust governance structure for the NWF (see Morgan Stanley report (PDF)). The Ministry of Finance will manage the NWF. The Ministry will publicly report monthly, quarterly, and annually on government accumulation, investing, and spending of the NWFs capital. It has also announced pretty clear investment guidelines and objectives (see above).

The rhetoric coming out of the Kremlin leaves a lot to be desired with regards to motive and the potential for politicization of the NWF, but I think it would be best for financial markets, regulators, and government officials to err on the side of not rushing to judgment. Despite what Russian political leaders are saying, the Ministry of Finance has, on its’ own volition (which is the key with SWFs), created a relatively transparent and accountable SWF.

Russia’s leaders would do well to follow China’s example and put on a PR blitz to highlight the NWFs governance structure and assuage some of the regulatory, governmental, and financial communities’ concerns (New York Times):

The head of China’s $200 billion government investment fund, seeking to reassure Americans nervous about the possibility of foreign takeovers, said Thursday that China would invest mostly in portfolios rather than individual companies — except when a “big fat rabbit” like the investment banker Morgan Stanley came along.

 

Mr. Lou, a former finance ministry official in Beijing, was on a visit to the United States to tell American officials that China had no intention of gaining controlling interest in any companies, and that it would be a “good corporate citizen” and not invest in companies that damage the environment, waste energy or produce tobacco.

 

He said he understood that Americans “have concerns about the size of our capital and also people have concerns about our motives” but that his fund was established to invest part of China’s estimated $1.4 trillion in foreign exchange reserves, most of which is in dollar-denominated Treasury securities, to meet Chinese monetary policy needs.

 

Echoing what he said was a pledge by Prime Minister Wen Jiabao, Mr. Lou said that the Chinese government would not interfere in the operations of the Chinese fund or dictate its investment decisions, and that the fund would have its own corporate governance structure.