What Exactly are the Santiago Principles For?

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The Santiago Principles date from a period that today feels like ancient history, a pre-financial crisis world in 2007 when developed-world nations suddenly noticed a curious reversal. For generations – centuries, even – they had exported capital to the developing world, but just lately, it had started to come back the other way.

A year earlier, Dubai Ports had controversially become owner of several US ports through its takeover of P&O, a prospect that led to a US House of Representatives vote blocking the deal unless the Emiratis sold on those US assets to an American buyer. A year before that, the Chinese National Offshore Oil Corporation had tried to acquire Californian petroleum group Unocal, only to end up withdrawing its bid after it was referred to President Bush on national security grounds.

“In 2007, we began to notice that flows had reversed,” says Costello. “Emerging economies were beginning to invest in developed economies and it was creating some political trouble. The developed world was so leveraged at that point, it needed the savings of the emerging world. But there was a reluctance, a concern about where this would lead.”

Costello, back then still in government, was part of a working group put together by the IMF to analyse the impact of these flows on recipient and donor countries, and in 2008 they came up with a set of voluntary guidelines for sovereign wealth funds. These were the Santiago Principles. The International Forum of Sovereign Wealth Funds – the institution this IMF working group evolved into, and at whose conference in Milan Costello was speaking – says today that four goals drove the principles: to help maintain a stable global financial system and free flow of capital and investment; to comply with all applicable regulatory and disclosure requirements in the countries in which they invest; to invest on the basis of economic and financial risk and return-related considerations; and to have in place a transparent and sound governance structure that provides for adequate operational controls, risk management and accountability. But the point, really, was to get western governments comfortable with these huge and shadowy institutions that suddenly seemed to be enormously ambitious and powerful.

As it happened, the global financial crisis swiftly followed, and that caused global attitudes to sovereign wealth funds to change dramatically, because suddenly the west – and in particular the west’s banking sector – desperately needed capital no matter where it came from. “The developed world,” Costello says, “no longer had the luxury of being able to reject investment from sovereign wealth funds.” Nevertheless, the principles were in place, seeking transparency and good governance from all signatories.

In one respect, one could argue that the Santiago Principles are quite remarkable things. They have, at the time of writing, 31 signatories from 28 countries according to the IFSWF’s website, representing at least US$4 trillion of assets. “I’m fascinated by the Santiago Principles per se: a voluntary conduct that everyone has agreed on, both developed and emerging economies,” says Sven Behrendt, managing director of GeoEconomica, a Geneva-based group studying sovereign wealth funds. And he’s right: not many voluntary groups based on governance, accountability and transparency can boast a membership that binds New Zealand and Kazakhtan, Libya and the USA, Timor-Leste and Canada, Russia and Iran, or Qatar and Nigeria. The principles do this, tying all of them to a robustly-expressed collection of 24 principles to make them all good and accountable investors.

But there’s a problem. No signatory actually has to implement the principles. And many of them don’t.

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In Geneva, Sven Behrendt has been studying the behaviour of the signatories relative to their stated commitments for some years, and has come up with something called the Santiago Compliance Index. It shows the degree to which individual funds had implemented the principles’ standards as of October 2014. There are five grades: A, for full compliance, B, for broad compliance, C, for being partially compliant, D for non-compliant, and then there are four funds that are not rated at all, either because they disclose insufficient information for a meaningful assessment, or because they are busy revising their mandates.

It makes for sobering reading. GeoEconomica looked at 29 funds and found just eight to be fully compliant, and precisely two to be worthy of an A grade rather than an A-. (If you could correctly guess the two at the very top, you would truly be worthy of recognition as an SWF-nerd: they are the Petroleum Fund of Timor-Leste, and Chile’s PRF/ESSF). In the A- category – apparently stripped of the very top rank because of an arcane aspect of a principle on self-assessment, but generally fully compliant – are most of the developed-world heavyweights like Norway’s Government Pension Fund Global, and the funds of Australia, New Zealand, Alaska and Alberta, plus the Heritage & Stabilisation Fund of Trinidad & Tobago.

It’s at the bottom end that things become interesting. The worst offender is the Qatar Investment Authority, the only institution to be given a D. A signatory to the Santiago Principles from the outset, seven years on it does not comply with the governance or financial disclosure principles at all. Despite an alluring ‘coming soon’ banner on its web site, it produces no annual report, does not disclose its assets under management, says nothing about its returns, and mentions only some of its holdings.

At the next tier up, things are scarcely better. Such leading lights of the sovereign wealth world as the China Investment Corporation, Abu Dhabi Investment Authority and Singapore’s GIC – which probably (we don’t know) have more than $1.5 trillion in assets between them – all rank only a C+. All three produce an annual report, but only CIC out of those three discloses total assets under management and anything other than extremely long-term returns. Graded C, the Kuwait Investment Authority – the oldest sovereign fund of them all – does not produce an annual report or any asset allocation data for public consumption. The Russian Direct Investment Fund is another to earn only a C. All told, GeoEconomica calculates that institutions in this category control $2.1 trillion of assets, which is probably more than half of all sovereign wealth.

Now, it’s important to note that none of these institutions have an obligation to disclose anything more than they do. Particularly in those countries that are not democracies, several leaders no doubt see no reason why they should give any further information to their citizens or anywhere else. But it begs the question: why sign the principles if you are not going to implement them? What, then, are they for?

“There is an assumption that you sign up to the principles and that gives you a carte blanche,” says Behrendt. “I sign up, therefore I am transparent. But just because a fund has signed up to them does not mean that it implements the principles’ individual obligations.

“In the end, we find that there are a couple doing quite well, and a couple somewhere in the middle, and some who couldn’t care less. Early on there was always talk about giving funds time to implement the principles. Seven years later, I don’t see a lot of dynamics towards implementation.

“What is the point of signing up to voluntary principles if you don’t intend to implement them? The Kuwaitis say they are legally prohibited from disclosing a lot of their financial information. Fair enough. But why is it that they have signed up for these principles if they have a national law that prevents them from implementing?”

Kuwait, whose institution is greatly admired and which probably saved the country when it became the de facto central bank during the Iraqi invasion, is a case in point when it comes to disclosure. On a flash new website, there is a link to a lengthy document about compliance with the Santiago Principles, but it’s worth a closer look. Under a section called ‘Public Disclosure’, it says: “KIA’s investments are completely transparent to the State of Kuwait, which is responsible for protecting the interest of KIA’s beneficiaries – the citizens of Kuwait.” That is a magnificently careful piece of wording, followed by this: “Kuwait’s parliament, the National Assembly, is freely elected by all Kuwaiti citizens 21 or older. The elected representatives of the National Assembly are regularly informed, at least annually, of KIA’s investments and investment performance.”

In other words, the KIA discloses to parliament; parliament is elected; therefore, although the public never get to see what’s in the KIA, they’re still being represented by extension.

And that’s in the Gulf’s only democracy. The people power argument carries steadily less weight in Abu Dhabi (where there is at least a report, with long-term return numbers and asset allocation bands), Qatar (where there’s not much of any consequence in terms of disclosure) and Saudi Arabia (which, with perhaps admirable honesty, has never signed up to the Santiago Principles in the first place).

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Are things going to change? Behrendt raises an interesting point. “The ones who are speaking up [about compliance] like Australia and New Zealand: at some stage this becomes a reputational issue for them.” Are the transparent funds going to be happy to continue to be bracketed with those that disclose far less?  And this brings us back to Costello in Milan.

“I’d like to see the day when membership of this forum becomes a stamp that the sovereign wealth fund complies with international best practice,” he says to the room. “I’d like to see the day when this forum can say… our members are people who comply with those principles.”

He draws a comparison with OECD, which requires certain standards on, for example, anti-corruption or harmful tax practices, and publishes the fact if any of its members are non-compliant.

“So within that framework, OECD stamps with approval those members that comply with those standards. I’d like to see that happen with relation to this institution as well.” He argues it is to the benefit of the investor and the recipient country. “Membership of the IFSWF should give a most favoured nation-type treatment to the investor. Recipients ought to know that those funds that are members and are compliant can be trusted with MFN status.” The italics are Euromoney’s, but you could pretty much hear them in speech too: he was emphasising compliance, not just membership.

Questioned later, Costello stepped back from any sense of regulation. “Let me make clear, I would not for a moment suggest IFSWF become a regulator. Not for one moment. These are sovereign wealth funds and they are not going to give up sovereignty.” But nevertheless, the suggestion of a delineation between those signatories that comply and those that do not – and a more favourable investment environment for those that do than those that do not – would be an interesting development.

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The new chairman of IFSWF is Adrian Orr, chief executive officer of the New Zealand Superannuation Fund, an institution that is far more influential than its NZ$28.8 billion size (US$19.38 billion, or one thirty-eighth of a CIC) would suggest, having been an inspiration for Australia’s Future Fund, among other things. As straight-talking as Costello, it will be interesting to see how he tries to drive the group’s reach.

To what extent can his institution instruct its members, asks Euromoney. “The answer, to instruct, is zero,” he says.

“We have voluntarily joined with the single sole purpose to lift and improve ourselves together, by learning, by sharing information, and around a common framework of the Santiago Principles,” he tells Euromoney. “The ability to get comfort, to share ideas, will be an evolving experience. But there is no desire or demand to make this a regulatory authority. It’s voluntary.”

He does, though, go further than his predecessor in the chair, the KIA’s Baader Al Saad, might have done. “On the flip side, it’s not going to be an institution where funds think they can come and hide behind other people doing good work, and they go off and don’t aspire to doing good work,” he says. “That is the collective responsibility of us as a forum to work together and to lift the tide, lift all of the boats as we go. Some funds are far more experienced and sophisticated, with wider capability, and they will be doing the heavy lifting over the next few years. But over time all the boats will be rising.”

Maurizio Tamagnini, chief executive officer of Fondo Strategico Italiano, an Italian sovereign wealth vehicle that was formed in 2011, is a relatively new signatory to the principles, and says that the process of joining was quite exacting. “It is a voluntary application, but the process we have gone through in getting acceptance is a process that needs quite a bit of preparation and does need some negotiation,” he says. “It did involve some changes to what we had.” Orr, too, talks of “quite a considerable time as board members spent looking through… the ability and aspirations to comply with the Santiago principles” among potential members.

It is true that transparency is improving. It is rare to read a profile of Singapore’s Temasek, for example, without a word like ‘secrecy’ or ‘shadowy’, but it’s actually not true, or not any more: the annual Temasek review discloses assets, returns, allocations, holdings, strategy and geographical presence, and presents the lot in a reasonably strident press conference. And ADIA’s public visibility is night and day compared to the time when its web site was just a picture of a building with a phone and fax number underneath, and absolutely nowhere else to click through to.

But there is a clear sense that sovereign funds will not be pushed.

Orr’s deputy at the IFSWF will be ADIA’s Majed Al Romaithi. “None of us join because we have to,” he tells Euromoney. “We chose to become a member because we see the value in this association. It’s a choice, a conscious choice.”

BOX: Out through the in-door

Accumulate, accumulate, accumulate. For many years, that’s all that sovereign wealth funds have done, preserving and building for future generations, waiting for a rainy day.

For the oil-based funds, that rainy day appears to have arrived. In early October, Norway’s government proposed a budget that, for the first time, will withdraw cash from its $820 billion sovereign wealth fund, Government Pension Fund Global. Next year, it will spend NOK208 billion ($25.2 billion) of its oil wealth, which is more than it expects to receive from new offshore oil and gas revenue over the same period.

It scarcely matters. All things being equal, the fund will earn roughly the same amount in interest, dividends and rental income as it proposes to withdraw, and the fund is so enormous relative to the size of its population that the outgoing cash will barely be noticed. But it has a certain symbolism: money coming out instead of in.

“This is yet another sign that the buying activity of oil rich sovereign wealth funds may well be a thing of the past,” says Alexander Free, an analyst with Nasdaq’s Advisory Services. “Asset sales by oil dependent SWFs show no signs of slowing down.”

Yet another? Free is referring to the funds in the Gulf states, which are also believed to be digging into their reserves in order to help governments meet budgets in a low oil price environment. None of these institutions publish data that would tell us that conclusively, but there is other evidence. Free points out that Norges Bank Investment Management (which runs the Norwegian fund), the Saudi Arabian Monetary Agency and ADIA have all been reducing equity holdings in Europe, particularly in the second and third quarter; he says SAMA has sold $1.2 billion worth of equities across Nasdaq’s European client base, Norges $1.1 billion and ADIA $300 million.

That’s not conclusive – the funds could be selling out of Europe on a tactical basis, and be putting it in other parts of the world or asset classes – but there are other signs too. Numerous fund managers are believed to have lost mandates from SAMA in particular in recent months, as the government has sought to plug a major gap in its budget. It’s also for this reason that Saudi Arabia has returned to the debt markets for the first time since 2007, issuing $4 billion-worth of riyal debt in July and potentially more than $20 billion more by the end of the year. ADIA has said that withdrawals take place occasionally during prolonged periods of weakness in commodity prices, and that is exactly the situation today.

One possible knock-on effect of all this is a potential changing of the guard in terms of the biggest and fastest-growing fund. We don’t know how big ADIA is but it is likely not as big as the Norwegian fund, which at the time of writing was worth $820 billion, and therefore assumed to be the biggest in the world. But the 2014 annual report from China Investment Corporation – already almost a year out of date – put its own assets at $740 billion, albeit a large chunk of that is in the Central Huijin subsidiary that holds the state’s stakes in China’s big banks. Since CIC doesn’t get its money from hydrocarbons, but from foreign exchange reserves, it’s entirely possible CIC could overtake the Norwegian fund over the next couple of years.

Indeed, Free’s research shows that just as the commodity funds were selling down in Europe, the bigger non-commodity funds were buying in. China bought $2.1 billion of European equities during the same period, while Singapore’s Temasek and GIC bought $1.1 billion between them.

“The buying activity of oil-rich SWFs across firms may well be something of the past,” Free says.