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E-MailThis post is based on a client memorandum by Adam Emmerich, Mark Gordon, Sabastian V. Niles, Shaun J. Mathew, and Jason M. Williams from Wachtell, Lipton, Rosen & Katz.
With the explosion in natural resource prices and trade surpluses, the corresponding
increase in the size and investing profile of sovereign wealth funds (SWFs), and the unprecedented stress on the global financial system, SWFs have faced substantial and increasing political and popular suspicion and pressure from the international community to address concerns that their investment decisions may be motivated by political, rather than economic, considerations. (See our December 2007 and June 2008 memos.) In a much-anticipated response, on October 11, a group of 26 nations with SWFs (the “International Working Group”) unveiled a set of 24 non-binding best practices, known as the “Santiago Principles,” designed to safeguard the operational independence of SWFs from political influences, promote greater transparency and accountability, and enhance internal investment and management frameworks, thereby encouraging continued political and popular acceptance of SWF investment in the developed world.
Intended to demonstrate that SWFs are soundly established and that investment decisions will be made on an economic and financial basis, the Santiago Principles address three broad areas of concern regarding SWFs: (i) their legal structure and relationship with the state, policy and investment objectives, and degree of coordination with their sovereign’s macroeconomic policies; (ii) their institutional structure and governance mechanisms; and (iii) their investment and risk management framework. While much will turn on how SWFs actually implement these aspirational guidelines (and it is worth noting that all of the principles are well caveated and subject to home country laws, regulations, requirements and obligations), the Santiago Principles may help reduce political influence in SWF investing and encourage the flow of sovereign wealth across borders.
Notably, the Santiago Principles provide for public disclosure of an SWF’s legal relationship with state bodies, general investment policies and goals, details of funding, withdrawal and spending arrangements, and audited financial information compliant with international or national auditing standards. In addition, the guidelines call for public disclosure of relevant financial information to demonstrate the SWF’s economic and financial orientation. Preferred governance frameworks would establish clear divisions of responsibilities to facilitate the operational independence of the SWF, and governing bodies would be appointed in accordance with defined procedures and with adequate authority to function in an independent manner. Disclosure regarding the SWF’s approach to exercising ownership and voting rights is provided for as is an explicit prohibition on seeking or taking advantage of privileged information or inappropriate influence by the broader government in competing with private entities. The Santiago Principles also make explicit that SWFs will comply with applicable recipient country regulatory and disclosure requirements. Of course, the capacity of the Santiago Principles to allay concerns about the transparency of SWF operations and objectives and their investment motivations will ultimately depend on the level and robustness of each SWF’s compliance with the letter and spirit of these voluntary guidelines.
While it very much remains to be seen what role the vast pools of investment capital currently held by SWFs will play on the world economic stage, and particularly whether the current economic and financial market turmoil will have a negative impact on the free flow of investment capital, adoption of the Santiago Principles does suggest certain guidelines for U.S. and other companies considering an investment by or sale to an SWF. These include:
• An Edge for Santiago-Compliant Acquirers/Investors? Given the very favorable responses of the IMF and U.S. Treasury Department to the Santiago Principles, transactions involving an SWF that has adopted the Principles should have a greater chance of satisfying the enhanced CFIUS review process in the U.S. (discussed in our April, June and July 2008 memos), and otherwise avoiding actual or perceived political problems. Similarly, investments by an SWF adhering to the Principles may be received more favorably by shareholders and other constituencies of the investee company.
• Contractual Reinforcement of the Santiago Principles. Since the Santiago Principles are voluntary and lack any enforcement mechanism, SWFs and the companies in which they invest would do well to proceed with sensitivity to political concerns, including with regard to contractual rights and obligations. Parties should consider provisions requiring disclosure of the SWF’s legal relationship with other state bodies, policy-purpose, governance framework, financial statements, general approach to voting securities and risk-management framework. Even if such provisions require only disclosure to the contracting parties and regulatory bodies (rather than public disclosure), such transparency may help ensure the transaction is well received in both the formal regulatory review process and the informal court of public perception.
The current state of the global economy and investment environment remain parlous at best, and it is far too early to know what the political and financial community attitude will be to future SWF investment in the developed world, what the attitude of the SWFs to such investment will be – and indeed what role direct governmental investment in the developed world will play in the financial sector and beyond – and how the recent rapid and profound change in this area will impact attitudes towards and by SWF investors. Despite the great uncertainty of the current environment, the Santiago Principles represent a positive step toward depoliticizing SWF investing and disarming potential political confrontation with SWFs and their sovereign sponsors. Companies and investors considering cross-border sales and investments are well advised to take careful cognizance of the Principles and the broader special sensitivities towards cross-border investment. As we have previously advised, careful advance planning is the key to successful cross-border transactions.
