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Stung by political resistance to their global investing ambitions, a group of leading sovereign wealth funds met three years ago with representatives of the U.S., European governments and the International Monetary Fund to agree on a code of conduct. They approved a document that called on funds to adhere to good governance standards, be more transparent about their activities and invest on economic — not political — grounds. The so-­called Santiago Principles, named after the Chilean city where the two camps met, were lauded by the participants as an achievement that would reassure skeptics and maintain free flows of capital. Few outsiders were convinced, though. The wording of the principles was vague, compliance was voluntary, and there were few signs that sovereign funds took the initiative seriously. The principles seemed like little more than a public relations exercise aimed at keeping Western markets open to these giant pools of money.

Today that modest beginning is spawning a quiet revolution. Under the auspices of the International Forum of Sovereign Wealth Funds, which was established in 2009, the Santiago Principles are gaining wider acceptance among a range of leading sovereign wealth funds. As a result, some of the largest and most opaque funds are changing the way they interact with their domestic stakeholders, governments of recipient countries, external fund managers and even each other. The principles are also influencing the design of a whole new generation of sovereign funds being created in Africa and Latin America, and that impact in turn is making transparency increasingly the norm rather than the exception. The changes are happening gradually, but momentum is discernible in every annual report, executive profile and investment strategy now published and discussed.

Nowhere is this trend more evident than at China Investment Corp., the sovereign fund of the world’s largest creditor nation. CIC was seemingly born in controversy. Its big investments in Blackstone Group and Morgan Stanley back in 2007, the year the fund was founded, raised hackles in the U.S. Congress, where some politicians expressed fears that Beijing might use the fund to pursue its geopolitical objectives. Almost as quickly, CIC took a bashing at home when the value of those holdings plunged during the 2008 financial crisis, and Chinese bloggers criticized the fund for squandering the nation’s wealth.

Beijing-based CIC has responded to the criticism with a degree of openness that’s remarkable for a Chinese institution — and stands comparison with such entities as Australia’s Future Fund and ­Norway’s Government Pension Fund Global, which are among the most transparent of sovereign funds in disclosing information about their investment practices. In its annual report for 2010, released in July, CIC provided the richest detail yet about its holdings, including a shift in its asset-­allocation strategy to reflect the growing importance of long-term investments and its decision to adopt a ten-year time horizon for its portfolio. The fund also disclosed a big move into alternative investments last year, as well as providing information about its purchases of stakes in U.S. and Canadian utilities and resource companies.

The benefits of the fund’s new openness are clear, says Jin Liqun, chairman of CIC’s board of supervisors and newly appointed chairman of the International Forum. “The positive effect of implementing the Santiago Principles has helped change the perception of CIC, and that is really important for other members to understand,” he tells Institutional Investor. “This will not do them any harm. On the contrary, implementing the Santiago Principles can help a particular sovereign wealth fund to be better understood and accepted by the countries in which it invests. But implementation of the principles is equally important for the corporate governance of the fund itself. If you are investing for your own country, these kinds of standards are critical to the sustainable growth, development and operational health of your fund, and I think this could be better appreciated by our members.”

With the number of sovereign wealth funds set to rise significantly and the assets at their disposal expected to surge, the importance of the Santiago Principles can only grow. At the time of their formulation, the Generally Accepted Principles and Practices, as the guidelines are formally called, were endorsed by 23 countries with sovereign funds. Malaysia’s Khazanah Nasional joined the International Forum last year, raising the number of countries to 24. Brazil, Ghana and Nigeria have established sovereign wealth funds in the past three years, and another 20-odd countries — including Colombia, India, Israel, Japan and Lebanon — are considering doing so, according to Ashby Monk, co-­founder of Oxford University’s Sovereign Wealth Fund Project.

“Over the next five years, we could have another 20 sovereign wealth funds in the world — maybe even as many as 30,” says Gary Smith, London-based global head of official institutions at BNP ­Paribas Investment Partners. “Prospective members of the ­International Forum are now going along to its meetings. Many more countries are going along as observers. This is a growing club, and it is extremely powerful because it represents the new world, not the old.”

With most of these countries continuing to accumulate large currency reserves because of high commodities prices and trade surpluses, the power of sovereign wealth funds looks set to grow dramatically. Steffen Kern, a director of research at Deutsche Bank in Frankfurt, projects that sovereign funds will increase their collective assets to some $10 trillion by 2020 from an estimated $4.5 trillion currently.

“If you look at the wealth accumulation in emerging markets, and if you look at economic development and the change in market structure on a global basis, then it is not difficult to predict that more sovereign wealth funds will be appearing,” says Jin. “Existing sovereign wealth funds will probably increase in size, too, so I expect the pool of sovereign wealth funds to further swell.”

Persuading sovereign funds to embrace transparency hasn’t been easy. David Murray, chairman of the board of guardians of Australia’s Future Fund and honorary chair of the International Forum, campaigned intensively during his two-year tenure as the group’s inaugural chairman, which ended in May, to urge sovereign funds to comply with the principles, contending that it would demonstrate to other countries that they were professional, long-term investors. At the Forum’s annual meeting in Sydney in May 2010, the group announced it would undertake an internal survey of members’ experiences in applying the Santiago Principles and publish relevant sections. Two months ago the Forum made good on its promise and surprised the global investment community by releasing the results of the survey in full.

The report makes for compelling reading. Twenty-one members from 20 countries responded to the survey, and virtually all of them claimed to have developed a heightened level of trust and domestic legitimacy because of their greater openness. Transparency has been a “key element in building trust, both internationally and domestically,” the State Oil Fund of the Republic of Azerbaijan said, according to the report. Botswana’s Pula Fund observed that transparency mitigated the potential use of the fund by politicians for ­development projects “against the spirit of saving for future generations” and has helped create “the checks and balances needed for preservation of capital.” Sovereign wealth funds also indicated that transparency has translated into a stronger appreciation of their professionalism among their peers and other financial market ­participants.

The trend of greater openness has some notable gaps, though. Among some of the largest, most powerful sovereign wealth funds in the Middle East, compliance with the Santiago Principles has been minimal at best. Although Abu Dhabi co-­chaired the group that drafted the principles, the Abu Dhabi Investment Authority, which ranks as the largest sovereign wealth fund in II’s annual survey, with assets estimated at $600 billion, has done little to fulfill the code. Market sources believe the notoriously secretive fund suffered significant losses during the financial crisis. In addition, Abu Dhabi extended a $10 billion bailout to its debt-­plagued fellow emirate, Dubai, in late 2009, significantly reducing the amount of oil revenue available to ADIA. In March 2010 the sovereign fund released its first annual report, which detailed its organization and management structure but gave little insight into its investment portfolio. Less than two weeks later, its managing director, Sheikh Ahmed bin Zayed Al Nehayan, was killed in a glider crash in Morocco. Since then, ADIA has said little about its activities under the leadership of the new MD, Sheikh Hamed bin Zayed Al Nehayan, Ahmed’s brother.

The Kuwait Investment Authority, whose managing director, Bader Al Sa’ad, is deputy chairman of the International Forum, has arguably done even less than ADIA. The fund, No. 3 on II’s list, with $292 billion at the end of March, has tightly managed its disclosures to the outside world, claiming that the reports it provides to Kuwait’s National Assembly are sufficient. In his rare public statements, Al Sa’ad has rejected demands for more information about KIA’s investments, saying it would serve no purpose except to whet the curiosity of outsiders.

Another small group of funds has been even more resistant, openly defying the International Forum’s efforts. The sovereign funds of Iran, Libya and Equatorial Guinea refused to participate in the group’s internal survey. The Forum now must decide what, if anything, to do about the holdouts. In its July report the organization indicated that it intends to review its membership and discuss adherence to the Santiago Principles before the next annual meeting, in Mexico in May 2012.

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