Investor concerns over Libya’s SWF are justified

February 23, 2011

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

By Una Galani

LONDON — Libya’s $70 billion sovereign wealth fund was just starting to show some ambition before the country was plunged into crisis. Now investors who sit alongside the Libyan Investment Authority are understandably nervous. There’s no precedent for what will happen to the fund’s stakes in various Western entities if the regime falls, and there has never been much transparency around the institution’s inner workings.

Consider a world-class sovereign fund, for example Norway’s. A change of government in the fully democratic country almost certainly wouldn’t alter the strategy of the fund, which has over $500 billion in assets. That’s because it is managed mainly by the country’s independent central bank, which in turn mandates asset managers to make investment decisions.

But funds in autocratic regimes are more opaque and the government tends to be closely involved. Libya’s fund was only established in 2006. It is ultimately run by the country’s prime minister, according to the International Forum of Sovereign Wealth Funds, scoring a transparency rating of two on the Linaburg-Maduell Transparency Index, the same score as Saudi Arabia’s and China’s sovereign funds.

This helps explain the 7 percent drop in UniCredit  shares since tensions escalated in Libya. The country owns 7.5 percent of the Italian bank. In an extreme scenario, a new Libyan regime might decide to cut ties with the West and liquidate international positions — which also includes stakes in carmaker Fiat and British publisher Pearson. The fund has $8 billion held in long-term equity investments in North Africa, Asia and Europe, according to its 2009 annual report. Alternatively, a new administration might decide to shift strategy and gradually sell stakes down.

Liquidation would not be a rational policy, however. Sovereign funds are designed to be funds of last resort and Libya has an additional $80 billion in net foreign assets held by the central bank, according to the International Monetary
Fund. The oil-dependent country badly needs to diversify its finances — hence the creation of the fund in the first place. Without an urgent need for cash, there’s no reason to believe Libya would hit the sell button. But given the escalating uncertainty, banking on a rational outcome is a gamble.

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Many concerns over the LIA’s historic lack of transparency, original source of wealth and the fund’s strategic investments in Africa (which coincidentally could be viewed as an extension of Gaddafi’s intent to head a “United States of Africa”) were clearly pushed aside for short term financial expediency. This article finally defines the possible future consequences of such an investment decision. Consequences will likely be hardest felt in Italy, a long-time ally of the falling Libyan regime. However, research conducted by CEIP indicates that other sovereign wealth funds (SWF) based in countries deemed “low” on the democracy index in the MENA region – UAE, Qatar, Kuwait – are considerably more compliant to the Santiago SWF principles than the LIA. The possible exception, and concern, is the Bahrain FGRF, considered to be equally low on the compliance index as the LIA and currently unstable.

Risk appetite varies greatly from one institution to another. While no-one can see into the future, we should all be aware of the need for thorough and considered due diligence before investing in those parts of the world where instability and a lack of transparency are rife. Although such caution may never triumph over financial expediency in the boardroom, without a thorough treatment of risks, companies can be badly exposed to financial loss, regulatory exposure and reputational damage.

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