FG may dump Excess Crude Account for Sovereign Wealth Fund

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FG may dump Excess Crude Account

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By Everest Amaefule, Abuja


Published: Wednesday, 26 Nov 2008

The Presidency may have concluded plans to dump the controversial Excess Crude Account, which currently warehouses more than $22bn of revenues generated from the sale of crude oil in excess of budget benchmarks.

Investigations by our correspondent showed that in place of the contentious account, the Presidency intended to introduce a fund to be known as the Sovereign Wealth Fund.

It was learnt that the Presidency had already started lobbying National Assembly members to facilitate the passage of a bill to create the SWF when presented to them.

Apart from transferring the funds in the ECA to the SWF, the Presidency also plans to transfer a good proportion of the country’s foreign reserves to the new fund, which would belong to the three tiers of government.

The nation’s foreign reserves are currently put at over $58bn.

Our correspondent gathered that the decision to dump the ECA arose as a result of President Umaru Yar’Adua’s concern for the rule of law and due process.

The decision was also said to have been informed by concerns in some quarters over what could happen to the economy in the event of ECA’s disbandment and the sharing of its proceeds among the three tiers of government.

The SWF, according to a Presidency source, is a compromise to address the perceived illegality of the ECA as well as the need to avoid pumping too much money into the economy .

The 36 state governments and the Revenue Mobilisation and Fiscal Allocation Commission, headed by Alhaji Hamman Tukur, are currently in court over the legality of the ECA.

According to them, the ECA which was created by the administration of former President Olusegun Obasanjo to keep earnings from the sale of crude oil in excess of the budget benchmarks, was unconstitutional.

Our correspondent also learnt that the Presidency was worried about the volatile nature of the oil market, and therefore, wanted to create a buffer to cushion the effects of downturns.

It also desires to follow the footsteps of about 40 countries that created the SWF to manage their oil earnings.

Kuwait created the first SWF in 1953. The United Arab Emirates, Singapore, Brunei, Norway and Malaysia are among the other countries that operate such a fund.

The latest of the 40 nations is Russia, which after the accumulation of $157bn from the recent high oil prices, created a SWF of $32bn.

Worldwide, about $2.5tn are said to be under the management of SWFs.

Another reason for the creation of the fund is the concern over the little interest yielded by the foreign reserves and the unending agitations by states, local governments and some agencies for sharing the excess crude funds and a drawdown on foreign reserves.

SWF as a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments.

Some SWFs are held solely by central banks, which accumulate the funds in the course of their management of banking systems.

Other SWFs are state savings, which are invested by various entities for the purposes of returns, and which may not have significant role in fiscal management.

While foreign exchange reserves serve short term currency stabilisation and liquidity management purposes, SWFs are aimed at maximising long term returns.

SWFs have gained world-wide exposure by investing in several Wall Street financial firms, including Citigroup, Morgan Stanley and Merrill Lynch.

However, with the entities enmeshed in global financial crisis, it is not certain whether some nations will rethink the pattern of investment of their sovereign funds.

A Presidency source, who spoke with our correspondent on the condition of anonymity, confirmed that if the National Assembly approved the SWF, it would be invested in high interest-yielding instruments.

He added that the profit from the fund would be shared among the three tiers of government in accordance with the prevailing revenue-sharing formula.



An Introduction To Sovereign Wealth Funds by Richard Wilson (Contact Author | Biography)

Sovereign wealth funds have attracted a lot of attention in recent years as more countries open funds and invest in big-name companies and assets. Some experts estimate that all sovereign wealth funds combined to hold more than $3 trillion in assets in 2008, a number that is expected to grow relatively rapidly. This has given way to a wide concern over the influence these funds have on the global economy. As such, it is important to understand exactly what sovereign wealth funds are and how they first came about.

What Is A Sovereign Wealth Fund?A sovereign wealth fund is a state-owned pool of money that is invested in various What Are Central Banks?)

The motives for establishing a sovereign wealth fund vary by country. For example, the United Arab Emirates generates a large portion of its revenue from exporting oil and needs a way to protect the surplus reserves from oil-based risk, thus it places a portion of that money in a sovereign wealth fund. Many nations use sovereign wealth funds as a way to accrue profit for the

The primary functions of a sovereign wealth fund are to stabilize the country’s economy through
diversification and to generate wealth for future generations.

HistoryAlthough sovereign wealth funds have attracted a lot of publicity only recently, the first funds originated in the 1950s. Sovereign wealth funds came about as a solution for a country with a budgetary surplus. The first sovereign wealth fund was the Kuwait Investment Authority, established in 1953 to invest excess oil revenues. Only two years later, Kiribati created a fund to hold its revenue reserves. Little new activity occurred until three very major funds were created: 

  • Abu Dhabi’s Investment Authority (1976)
  • Singapore’s Government Investment Corporation (1981)
  • Norway’s Government Pension Fund (1990) 

Over the last few decades, the size and number of sovereign wealth funds have increased dramatically. In 2008, there are more than 50 sovereign wealth funds, and the U.S. Department of Treasury estimates that these funds hold more than $3 trillion dollars in assets. (For more on the role of the U.S. Treasury, read The Treasury And The Federal Reserve.)

Commodity Vs. Non-Commodity Sovereign Wealth FundsSovereign wealth funds can fall into two categories, commodity or non-commodity. The difference between the two categories is how the fund is financed. 

Commodity sovereign wealth funds are financed by exporting commodities. When the price of a commodity rises, nations that export that commodity will see greater surpluses; conversely, when an export-driven economy experiences a fall in the price of that commodity, a deficit is created that could hurt the economy. A sovereign wealth fund acts as a stabilizer to diversify the country’s money by investing in other areas. (Read more in Commodity Prices And Currency Movements.)

Commodity sovereign wealth funds have seen huge growth as oil and gas prices increased between 2000 and 2008. At the end of 2007, commodity financed funds totaled more than $2 trillion. (Before getting in on the oil and gas markets, read Oil And Gas Industry Primer.)

Non-commodity funds are typically financed by an excess of foreign currency reserves from current account surpluses. Non-commodity funds totaled $1.2 trillion at the end of 2007, which is three times the total three years earlier. 

Currently, the majority of funds are financed by commodities, but non-commodity funds may reach 50% of the total by 2015. 

What Do Sovereign Wealth Funds Invest In?Sovereign wealth funds are traditionally passive, long-term investors. Few sovereign wealth funds reveal their full portfolios, but sovereign wealth funds invest in a wide range of asset classes including:

However, a growing number of funds are turning to alternative investments, such as hedge funds or private equity, which are not accessible to most retail investors. The International Monetary Fund reports that sovereign wealth funds have a higher degree of risk than traditional investment portfolios, holding large stakes in the often volatile emerging markets. (Read about how private equity has become more accessible in recent years in Private Equity Opens Up For The Little Investor.)

Sovereign wealth funds use a variety of investment strategies

  • Some funds invest exclusively in publicly listed financial assets.
  • Others invest in all of the major asset classes

Funds also differ in the level of control they assume when investing in companies: 

  • There are sovereign wealth funds that place a limit on the number of shares bought in a company and will enforce restrictions to either diversify their portfolios or to adhere to their own ethical standards. (Read about one role of ethics in investing in Change The World One Investment At A Time.)
  • Other sovereign wealth funds take on a more active approach by buying larger stakes in companies.   

International DebateSovereign wealth funds represent a large and growing portion of the global economy. The size and potential impact that these funds could have on international trade has led to considerable opposition, and the criticism has mounted after controversial investments in the United States and Europe. Following the mortgage crisis of 2006-2008, sovereign wealth funds helped rescue struggling Western banks CitiGroup (NYSE:C), Merrill Lynch (NYSE:MER), UBS (NYSE:UBS) and Morgan Stanley (NYSE:MS). This led critics worry that foreign nations were gaining too much control over financial institutions, and that these nations could use that control for political reasons. This fear could also lead to investment protectionism, potentially damaging the global economy by restricting valuable investment dollars. (Read more about protectionist strategies in The Basics Of Tariffs And Trade Barriers.)

In the United States and Europe, many financial and political leaders have stressed the importance of monitoring and possibly regulating sovereign wealth funds. Many political leaders assert that sovereign wealth funds pose a threat to national security, and their lack of transparency has fueled this controversy. The United States addressed this concern by passing the Foreign Investment and National Security Act of 2007, which established greater scrutiny when a foreign government or government-owned entity attempts to purchase a U.S. asset. (Read more about issues of transparency in foreign investment in Why Country Funds Are So Risky.)

Western powers have been guarded about allowing sovereign wealth funds to invest and have asked for improved transparency. However, as there is no substantive evidence that funds are operating under political or strategic motives, most countries have softened their position and even welcomed the investors. 

ConclusionThe size and number of sovereign wealth funds continues to grow, assuring that these funds will remain a crucial part of the global economy in the future. One report projects that if sovereign wealth funds continue to grow at their current pace, they will exceed the annual economic output of the United States by 2015 and that of the European Union by 2016. The emergence of sovereign wealth funds is an important development for international investing, and as regulation and transparency issues are resolved in the coming years, these funds are likely to take on a major role in shaping the global economy. 

by Richard Wilson, (Contact Author | Biography)

In addition to writing for Investopedia, Richard Wilson runs a popular hedge fund blog and is the founder of the Hedge Fund Group (HFG). Wilson is a hedge fund consultant for a third party marketing firm and also runs ThirdPartyMarketing.com.

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