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Sovereign Wealth Funds


Maintaining an open and transparent investment climate

Whilst the debate surrounding SWFs is relatively new, the funds themselves have been around for decades. There are a number of reasons for the heightened interest.

SWF investment offers potential opportunities to recipient country economies.

As the foundations of global financial system are challenged, SWFs may offer potential benefits in terms of investment, liquidity and stability. The "credit crunch" has

Openness to capital from abroad can be a source of economic strength not economic vulnerability. SWFs, like any other foreign or domestic investor, are well placed to provide capital for global investment. In addition, SWFs generally take a long-term strategic outlook and may, therefore, contribute to greater stability in the international economy.

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The asset base of SWFs is expanding and the size of their offshore investments is increasing. Morgan Stanley has forecast that SWF assets will increase from an estimated $2-3 trillion today, equivalent to half the gross official reserves of all the world's countries, to $12 trillion by 2015. The number of SWFs is increasing and they are emerging in a diverse range of economies. Around 25 countries have SWFs and many have expressed an interest in establishing one. In particular, the creation of funds by countries with pronounced geo-political ambitions has attracted attention.

Sovereign Wealth Funds ("SWFs") continue to attract significant attention from politicians, policy makers and commentators on global economic issues. Why? At the heart of the answer is the uncertainty surrounding the current economic climate. Uncertain times necessitate a review of government policies. Policy makers, regulators and legislators face increasing pressure to reassess both inward foreign participation in their markets. In the case of SWFs, the debate is driven by the emergence of new economic players raised regarding whether SWF investment decisions are free from political interference or geo-political motivation. In addition, concerns remain that SWFs might acquire strategic national assets or sensitive information and technology.

squeezed liquidity in financial markets and increased the pressure on global financial institutions. In some cases, SWFs have helped to strengthen the global banking system and "shore-up" confidence in the international financial system. However, many SWFs have begun to reassess their overseas investment options. A number of high-profile SWF investments have resulted in significant losses. This may dissuade SWFs from investing further and could potentially stifle global economic growth, innovation and job creation.

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Over the past few years, international decision makers have debated the policy implications of the emergence of SWFs as economically powerful players in global investment markets.

On 8 October 2008, the OECD Investment Committee completed its work on recipient country policies towards SWFs: "SWFs and Recipient Countries: Working together to maintain and expand freedom of investment". This work is part of a wider OECD project on Freedom of Investment and National Security, launched to combat investment protectionism and to maintain open global investment markets. The OECD aims to ensuring that recipient countries are well placed to deal confidently with new types of investors and reiterates that OECD and partner countries welcome SWF investment. There are three main elements to the OECD work: The June 2008 OECD Ministerial Statement on SWFs. The Ministerial Declaration, adopted by thirty-three recipient countries, represents a high-level political commitment to preserving and expanding an open international investment environment for SWFs. Reaffirmation of OECD investment principles. The guidance reaffirms that OECD investment principles, established in 1961, are relevant for SWFs. These include; "non-discrimination" (SWFs should be treated in the same way as domestic investors), "standstill" (no new measures should be introduced for SWFs), "progressive liberalisation" (gradual opening up of investment markets to all investors, including SWFs), and "unilateral liberalisation" (openness to SWF investment should not be based on "reciprocity").

In October 2007, G7 finance ministers and central bank governors issued a communiqué tasking the International Monetary Fund ("IMF"), World Bank and Organisation for Economic Cooperation and Development ("OECD") with identifying best practices for SWFs in areas such as institutional structure, risk management, transparency and accountability; and encouraging countries in receipt of SWF investment to take a proportionate response building on principles such as non-discrimination, transparency and predictability.

Identifying best practices for SWFs.

On 11 October 2008, the International Working Group ("IWG") of the IMF on Sovereign Wealth Funds unveiled its Generally Agreed Principles and Practices ("GAPP") for SWFs, the "Santiago Principles". The 24 Santiago Principles set out overarching objectives for SWFs covering: compliance with applicable regulatory and


A number of recipient countries have raised concerns that SWFs may be motivated by political, rather than purely economic, motives. There is unease that investment in "strategic" sectors, such as energy, telecommunications, or high-tec manufacturing, may reflect a desire to obtain technology and expertise rather than a commercial business decision to expand into new products or markets. Recipient countries continue to call for greater transparency by SWFs, including disclosure of: value of assets, investment objectives, risk management systems and internal controls. In addition, recipient countries have focused on appropriate governance structures, such as: a clear division of rights and responsibilities between SWF governments and managers and checks and balances in respect of investment decisions.

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SWFs are becoming increasingly interested in higher risk investments and companies of strategic importance. The impact of high-profile losses by SWFs is yet to be seen. However, SWFs have demonstrated an increasing appetite to invest in private equity firms and to explore opportunities to invest in sectors recently deregulated or privatized.

disclosure requirements; economic and financial risk and return-related strategies; transparent and sound governance structures; operational controls, risk management, and accountability; and maintaining a stable financial system and free flow of capital and investment. The Santiago Principles help to dispel the mystery and suspicion surrounding SWFs and enhance the perception of SWFs as operating in the same environment as any other investor. SWFs have taken a commitment to openness and increased transparency to widen the understanding of investment objectives. In particular, the GAPP specifically commits SWFs to make a number of public disclosures and calls on SWFs to publicly declare any non-economic considerations in investment policies. An SWF Working Group will be established to review the GAPP and future interaction between SWFs and recipient countries The Santiago Principles have been welcomed by Deputy Secretary of the Treasury, Robert M Kimmitt. Kimmitt has acknowledged that the principles could enhance sound investment policies by recipient countries and reduce the likelihood of a protectionist response to SWFs. Joaquin Almunia, European Commissioner for Economic and Monetary Affairs, has also welcomed the IWG work in helping to foster trust and confidence between sovereign wealth funds, their originating countries and the recipient countries. Maintaining an open and transparent investment climate.

Investment policy and National Security. The OECD reiterates the right to take measures to safeguard essential security interests. However, the OECD Investment Committee provides recommendations to help design effective policies which accommodate legitimate national security concerns, but which are not used as disguised protectionism. In addition, the OECD is seeking to enhance its "peer review" process to ensure that the development and implementation of recipient countries' investment regimes adhere to core OECD principles. And, as part of a wider outreach programme, OECD discussions on investment policy have been opened up to non-members, including: Russia; China; Brazil; and South Africa. The process and outcomes of the IMF and OECD work on SWFs have helped to provide the international community with a robust framework for promoting mutual trust and confidence. The work should help to ensure that SWFs and recipient countries are well placed to maximise the benefits accruing from overseas investment, manage the current financial crisis and maintain the free flow of capital.

The European Commission has engaged, on behalf of Member States, in both the IMF and OECD processes. A common EU approach to SWFs was set out by the Commission in February 2008. The Communication underlines that encouraging openness to investment and free movement of capital remains a long-standing goal of the EU. However, the Communication highlights the interests of market operators in Europe and advocates increased transparency, predictability and coherence from SWFs. Nonetheless, the EU Communication stops short of calling for a new EU investment instrument aimed specifically at SWFs, provided SWFs address the legitimate concerns. The EU operates a comprehensive regulatory framework on the establishment and actions of foreign investors. This regulatory framework does not currently distinguish, or discriminate, between SWFs and any other investor. Article 56 of the EU Treaty establishes the principle of free movement of capital between Member States, and between Member States and third countries. However, third countries cannot rely on the right of establishment provisions of Article 43 of the EU Treaty. The free movement of capital may be restricted by Community or national rules which are justified by certain exceptions eg tax fraud, prudential supervision of financial institutions, public policy or public security or by "overriding requirements of general interest". In addition, the Community can introduce, by unanimous decision, measures which restrict direct investment. The EU Merger Regulation allows Member States to take appropriate measures to protect legitimate interests other than competition. Such measures must be "necessary and proportionate" and compatible with Community law. Legitimate interests include: public security, plurality of the media and prudential rules. However, other interests can be considered on a case-by-case basis. Whilst not explicitly connected to the SWF debate, it is interesting to consider the investment provisions contained within the Commission's current proposal to reform the EU electricity and gas markets. If approved, investments in EU energy markets by third countries would only be allowed if the EU has an existing reciprocal bilateral agreement. Furthermore, the investor would be required to demonstrate that it has no non-commercial or political interest in the acquisition. Many have expressed concern about the signals that this sends regarding European openness. It sets a precedent for reform of other strategic sectors in the EU and may provide an excuse for third countries seeking to block EU investment.

On 5 March 2008, a joint sub-committee of the US House Financial Services Committee met to discuss the role of "Foreign Government Investment in the US Economy and Financial Sector". The hearing, attended by representatives of the US Department of Treasury, the Securities and Exchange Commission, the Federal Reserve Board, Norway's Ministry of Finance, Temasek Holdings, and the Canada Pension Plan Investment Board, provided an opportunity to examine the role of foreign investment in US businesses and the US economy. The hearing highlighted the need for increased transparency and good governance principles. Of the G7 countries, the US has the most extensive Foreign Direct Investment review process. On 24 October 2007, the Foreign Investment and National Security Act increased the powers of the US President and the Committee on Foreign Investments ("CFIUS") to scrutinise SWF investments. This provides increased scope to define national security and widens the range of companies and sectors which may be subject to protection from foreign acquisition. In addition, the review process is opened up to new parties, including; Congress, advocacy groups, labour unions and competing bidders for acquisition targets. These changes could create an uncertain regulatory environment. The review of potentially legitimate national security concerns may be accompanied by increased delays for international transactions which pose little threat to US interests, together with associated costs for parties to a transaction and heightened sense of political interference.

European Finance Ministers will discuss SWFs at the Economic and Financial Affairs Council meeting, in Brussels under the French EU Presidency, on 4 November.

In France President Sarkozy has recently called for the creation of an SWF to aid national businesses in need of capital and at risk of takeover. As part of the French EU Presidency focus on key economic issues, Sarkozy is trying to build wider EU support for efforts to defend EU companies at risk of foreign takeovers. So far, these measures have received a lukewarm response from European

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partners. In may 2008, France released a report on SWFs. This reaffirms the positive role that SWFs can play in terms of capital provision. However, the report focuses on "reciprocity", Europe remaining open to investors from, for example China, Russia and the Gulf, only if these countries open up to EU investors. Germany has supported the EU-wide introduction of an FDI review body, much like the American CFIUS. In addition, the German Government has introduced new legislation which covers non-EU or EFTA investment. This provides the Economic Ministry with the power to investigate proposed and complete transactions which involve the acquisition of 25 per cent share of a company where the public order and security of Germany is endangered. Italy has recently, October 2008, set up a national interests committee to establish rules regarding SWFs buying more than five percent of any Italian company. A five percent ceiling would make Italy one of the more restrictive markets for SWFs.

Our global trade and investment team brings together international trade and financial services lawyers and practitioners, with political advisors, economists and communications experts. Collectively, we provide clients with an outstanding service which draws upon our knowledge of international law and policy; our practical understanding of how this is implemented and enforced; and our connections within the international organisations, the European and American institutions and individual country governments. DLA Piper is represented in all EU member states and has 28 offices throughout the US, including a regional headquarters in Washington DC. We are in an excellent position to provide:

For further information please contact: Miriam Gonzalez Head of Trade in the European Union T: T: +44 (0)20 7796 6986 (London) +32 (0)2 500 1678 (Brussels)

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Many continue to doubt whether SWFs will adhere to a "voluntary" code of conduct, especially when many recipient countries are in desperate need of foreign capital. In addition, it remains to be seen whether the OECD can develop a robust "peer review" mechanism. Without a workable enforcement mechanism, it is unlikely that "peer review" will be sufficient to ensure that OECD countries do not seek to strengthen existing investment instruments.



It remains to be seen whether the work of the IMF and the OECD will be sufficient to reassure individual governments that current investment instruments are robust enough to manage the current economic crisis. Many EU Member States are considering strengthening existing investment instruments, either specifically aimed at SWFs, or to protect "strategic" assets from foreign takeovers. The Commission is very likely to face increasing pressure to review European investment policy, either at a sectoral level to "ring fence" particular industries, or to manage the increasingly complex network of individual Member State regulations.

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Analysis of the evolving global investment debate in Europe and the US. We provide clients with early warnings of proposed regulatory or policy measures and assist their efforts to influence these processes. In-depth analysis of the European regulatory environment, either at a horizontal, sectoral, or individual Member State level. We provide regulatory risk assessments and compliance advice to help inform investment decisions. Impact assessments of proposed regulations and policies. Where these are inconsistent with our clients' business objectives, we are able to identify any relevant fora where proposed measures might be challengeable, for example WTO rules; international investment treaties; or under US, European or EU Member State law. Litigation assistance in cases where national measures are actionable. Our litigation lawyers are experienced in appearing before a wide range of dispute resolution fora. Advice on how to supplement any investment strategy with targeted diplomatic and media support.

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