Sovereign funds falling short on risk and governance

The chairman of the global association for sovereign wealth funds says the vehicles are not progressing quickly enough in their adoption of risk controls and governance issues.
Sovereign funds falling short on risk and governance

Sovereign wealth funds (SWFs) are falling short of their self-imposed commitment to display high standards of risk control and governance, according to the chairman of the global association of the state investment vehicles.

The world’s sovereign investors are gathered this week in Auckland, New Zealand for the annual conference of the International Forum of Sovereign Wealth Funds (IFSWF).

Addressing the opening of the conference today, Adrian Orr, chief executive of the NZ$31 billion ($22 billion) New Zealand Superannuation Fund, who is the current chairman of the IFSWF, warned delegates against complacency on their commitments to the Santiago Principles. These are the guidelines set for the maintenance of a stable global financial system, based on proper risk controls and sound governance. They are the principles on which the IFSWF was founded in 2009

“We told the world that the Santiago Principles are a benchmark against which we can be measured,” said Orr. “We cannot be surprised if the world measures us against them. In my view, our progress on this front has not been fast enough, and IFSWF’s relevance as a forum of sovereign peers is threatened.”

A lack of accountability is still evident in the way funds operate and Orr says more commitment is needed.

“Commitment can be difficult and uncomfortable. Transparency isn’t easy; accountability isn’t easy," he said. "People ask questions. People criticise what you do, even when you’re trying to do the right thing. Good governance isn’t easy. It’s time-consuming, inconvenient. It requires a lot of thought about what you should be doing and how.”

Despite all the obstacles and criticism, Orr said that SWFs should attempt to offer full transparency “because the result will be better understanding of our activities and stronger support for them through both good times and bad. The results will also include more efficient access to opportunities, better performance by each member fund and a stronger financial system overall”.

Uncertain climate

The theme of this year’s annual SWF meeting is investing in a climate of uncertainty. The word climate is being used deliberately because climate change sits high on the agenda for many SWFs.

Orr said of the current state of climate debate, “We’ve moved on from the science. The reality is that governments adopted the Paris Agreement on climate almost a year ago. Governments around the world are taking action to limit greenhouse gases. There will be an inevitable shift towards a less carbon-intense economy."

He added that this would require investment strategy and portfolio shifts to take into account these changes. "Our investment strategies must necessarily address this, either actively – looking at opportunities in carbon-friendly energy – or reactively, in terms of dealing with the consequences, such as failed investments and stranded assets.

The NZ Super Fund recently announced it will follow new environmental investment rules, which are designed to reduce its carbon footprint and create a more sustainable portfolio.

Orr said the exclusionary investment strategy represented a fundamental shift for the fund, which is seeking to cut its exposure to energy companies deemed vulnerable to rules changes around carbon emissions.

The fund intends to be proactive and has set up its own methodology for managing and measuring this new policy.

“Climate change, and the coming transition to a low-carbon energy system, also present investment opportunities for long-term investors that we intend to capture,” said Orr.

NZ Super appears to be something of an outlier among SWFs. A report in May this year from the Asset Owners Disclosure Project (AODP) claimed that while half of the asset owners surveyed are now taking some action in managing investment climate risk, as much as $14.3 trillion in assets is still being managed without any concern for how climate change will impact those assets.

The number of ‘X-rated’ asset owners in the Global Climate 500 Index, which are considered to be doing nothing to manage climate risk, has grown from 232 (of the 500) in 2015 to 246. The 10 biggest X-rated funds, worth a total of $4.9 trillion, include China’s State Administration of Foreign Exchange (Safe), Hong Kong Monetary Authority (HKMA) and China Life. HKMA declined to comment, while the other two institutions did not respond to requests for comment.

Japan ranked 25th, lagging every other major pensions market. The country has 26 institutions on the list, with total AUM of $4.9 trillion.

¬ Haymarket Media Limited. All rights reserved.