Concerns about sovereign wealth funds

As sovereign wealth funds become an increasingly important source of capital in the world’s financial markets, new questions are emerging about the potential benefits and risks of governments investing heavily in economies outside their own borders.

For example, some economists and lawmakers expressed concern when sovereign funds from Singapore, Kuwait, Abu Dhabi, South Korea, and China recently purchased small but significant stakes in several large U.S. banks. The deals provided much-needed capital and liquidity to banks facing steep losses due to bad subprime investments. While these investments may have helped to shore up the U.S. financial sector in the wake of the crisis, some critics worried about their potential impact on some of the nation’s largest financial institutions and the U.S. economy.

What’s the worry?

Critics suggest that sovereign funds could possibly be used as a tool to exert economic and political influence by overseas governments whose interests are not always aligned with those of the United States. These concerns are heightened because of the lack of transparency and regulatory oversight of sovereign funds.

Like hedge funds, sovereign wealth funds are not required to publish information regarding their holdings and investment strategies — and the funds rarely make such information public. Because there is no way of knowing exactly what sovereign wealth funds own or the strategies they pursue, some critics contend that there may be unforeseen financial implications — not only for the economies in which the funds invest, but for financial markets around the world.

For instance, some express concern regarding the financial impact if, for instance, a large and highly leveraged sovereign fund suffered steep losses, potentially jeopardizing the stability of financial markets. In addition, they say, rogue traders with access to sovereign fund assets could conduct unauthorized trades and incur huge losses. While at their current size, sovereign wealth funds may not pose an immediate worry, some suggest that if they continue to grow at the rate they have in recent years, these could become very real concerns.

Measuring global influence

Proponents of the funds say that worries about the potential size and economic influence of the funds are overstated. They counter that the amount held in sovereign funds is in fact a small percentage of the total capitalization of the world financial markets, which is estimated at $165 trillion. Even if sovereign wealth funds continued to grow dramatically, they still wouldn’t exert the influence on the global economy to the extent that critics fear.

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