Annexes to COM(2008)115 - A common European approach to Sovereign Wealth Funds - Main contents

Please note

This page contains a limited version of this dossier in the EU Monitor.

dossier	COM(2008)115 - A common European approach to Sovereign Wealth Funds.
document	COM(2008)115
date	January 1, 1945

agreements provides a number of international obligations framing what the EU can do.

The EC and its Member States are bound by these obligations when considering measures on investment by SWFs as for measures pertaining to any other investment. At the same time, both the WTO and the EC bilateral agreements foresee exceptions for reasons of public order or of public security, which allow measures to be taken for genuine national security reasons.

With regard to the EU legal framework, investments by SWFs in the EU are subject to the same rules and controls as any other form of investment, either foreign or domestic, where the principles of free movement of capital between Member States, and between Member States and third countries stipulated in Article 56 EC apply.

The free movement of capital is not absolute. As a fundamental principle of the Treaty, it may be regulated in two respects at the European level under Article 57 (2) EC: first, the Community may adopt by qualified majority measures on the movement of capital from third countries involving direct investment Second, it is not excluded that the Community can introduce – by a unanimous decision - measures that restrict direct investments.

The Merger Regulation allows Member States to take appropriate measures to protect legitimate interests other than competition. Such measures must be necessary, non- discriminatory and proportionate as well as compatible with other provisions of Community law. Public security, plurality of the media and prudential rules are regarded as legitimate interests, whilst other interests can be considered legitimate on a case by case basis on notification to the Commission.

Turning to national legislation, Member States have national instruments which could be used to control and condition SWF investments or any other investors and they can also develop new measures suitable to tackle specific needs if these arise, as long as those measures are compatible with the Treaty, are proportionate and non-discriminatory, and do not contradict international obligations.

The European Court of Justice has provided further guidance on how Member States can take these national measures in full compatibility with the Treaty, stressing that purely economic grounds can never justify obstacles prohibited by the Treaty[4]. The Court has also provided criteria to assess the proportionality of authorisation systems: these must aim at the protection of a legitimate general interest and foresee strict time limits for the exercise of opposition powers, assets or management decisions targeted must be specifically listed, and the system’s objective and stable criteria must be subject to an effective review by the courts[5].

Lastly, there is scope to monitor and control the behaviour of SWFs as investors on an ongoing basis via the regulatory framework, which offers an effective tool to protect public interests irrespective of ownership. This is particularly the case in network industries.

3.2 . The case for a common approach

The EU therefore has tools to address problems which may result from the operations of SWFs. Likewise, Member States have adequate powers under the Treaty to deal with public order and public security considerations. Furthermore, SWFs have behaved so far as reliable investors and their activities have not resulted in problems for the functioning of the internal market. However, recent experience shows that the opacity of some SWFs risks prompting defensive reactions. Indeed, in recent months, several Member States have been under pressure to update national legislation and to explore applying exceptions to the application of the principles of free movement of capital and establishment. This pressure can only be increased by SWFs future expected growth in size and importance. There is therefore a case for enhancing the transparency, predictability and accountability of SWF operations. Clearing away unnecessary concerns makes it easier to maintain an open investment environment that allows the EU and its Member States to continue reap the benefits of SWF investments.

There are three reasons that require a common EU approach to SWFs.

- First, as SWFs are a global issue, multilateral solutions offer greater advantages than individual national responses. An international approach can bring a degree of certainty, and allow SWFs to take investment decisions against the backdrop of a common approach. The initiatives now under way at the multilateral level will promote common understanding of the challenges raised by SWFs and the possible mechanisms through which these can be addressed. A common EU approach would maximise European influence in these wider discussions. The same is true of further dialogue with third countries, including those that own and/or operate SWFs.

- Second, the imperative of maintaining a well-functioning internal market based on open and non-discriminatory rules requires that a common approach is followed. An un-coordinated series of responses would fragment the internal market and damage the European economy as a whole. In an integrated single market, the advantages of individual measures can be illusory. Diversity of interpretation and approach risk creating new ways to by-pass the rules and steering investment away from Europe – a disincentive effect that could spread from SWFs to other potential investors. Such risks are real if Member States were to act alone, and in an uncoordinated way, and develop burdensome and binding mechanisms to control or condition investment. By applying the provisions of the Treaty, we guard against this.

- Finally, one of the main goals of EU trade policy is to open third country markets to EU investors, on the basis of the same principles used to govern the internal market. These efforts would be more difficult if the EU was seen as imposing barriers within the EU.

IV. Moving forward: principles for an EU policy response to SWF issues

4.1 . Options for a common EU approach to SWF issues

The EU approach aims at maintaining a clear, predictable and reliable legal environment, fostering open capital markets and investment worldwide. The EU and its Member States can and should be able to protect legitimate policy objectives without falling into the trap of protectionism. At the same time, the EU has to keep the balance between measures taken vis-à-vis third countries investments and actions taken in the context of the internal market with respect to EU investments.

Various suggestions have emerged in the public debate as possible avenues to step up the European response to SWFs. These have included an EU committee on foreign investments to mirror arrangements in the US, an EU-wide screening mechanism or some "golden shares" mechanism for non-EU foreign investment. All these suggestions run the risk of sending a misleading signal – that the EU is stepping back from its commitment to an open investment regime. They would also be difficult to reconcile with EU law and international obligations.

Instead, the Commission considers that the right approach is to promote a cooperative effort between recipient countries and SWFs and their sponsor countries to establish a set of principles ensuring the transparency, predictability and accountability of SWFs investments. It is essential that all relevant actors are actively involved and have ownership in the creation of a balanced and stable framework covering SWF investments.

There are two dimensions to this approach. The EC expects SWFs to voluntarily commit to certain standards with regard to transparency and governance – to provide sufficient clarity to assuage public concerns. In this respect, the efforts already undertaken by the IMF to design a code of conduct for SWFs and by the OECD to identify best practices for SWF investments in recipient countries should be fully supported. The EU should be a driving force to furthering international work in that regard. At the same time, the SWFs adherence to these standards will help guaranteeing investor countries a clear, predictable and stable investment framework in the EU and its Member States, as well as in other recipient countries.

The Commission therefore proposes a common approach, which should be the EU contribution to efforts at international level to establish a framework to improve transparency, predictability, and accountability of SWFs.

4.2 . Principles for a common EU approach to the treatment of SWFs as investors

The common EU approach to the treatment of SWFs as investors should be based on the following principles:

- Commitment to an open investment environment : in line with the Lisbon Strategy for growth and jobs, the EU should reaffirm its commitment to open markets for foreign capital and to an investor-friendly investment climate. Any protectionist move or any move perceived as such may inspire third countries to follow suit and trigger a negative spiral of protectionism. The EU prospers from its openness to the rest of the world – and from its investments abroad – and hence would be among the first to suffer from a trend towards protectionism. At the same time, the EU should endeavour to open SWFs owners' countries to EU investors and secure a fair and equitable treatment for them, notably through FTA negotiations.

- Support of multilateral work: the EU should actively drive forward work carried out by international organisations, in particular the IMF and the OECD. The EU welcomes an open dialogue with SWFs owners and recognises the benefits of a global approach to a common framework for SWF investment.

- Use of existing instruments : the EU and the Member States already have specific instruments that enable them to formulate appropriate responses to risks or challenges raised by cross-border investments, including investments by SWFs, for reasons of public policy and public security.

- Respect of EC Treaty obligations and international commitments: the EU and its Member States will continue to act in a way fully compatible with the principles laid down in the Treaty establishing the EC and with international obligations of the EU.

- Proportionality and transparency : measures taken for public interest reasons on investment should not go beyond what is necessary to achieve the justified goal, in line with the principle of proportionality, and the legal framework should be predictable and transparent.

These basic principles should define the common EU approach which should be proposed as the basis for an understanding between recipient countries on the treatment of SWFs investments. Transposed at international level, this common approach should draw on the above principles of openness to cross-border investments, preference for multilateral solutions, respect of existing international obligations, proportionality and predictability of rules.

4.3. Building confidence in the operation of SWFs: the European contribution to a code of conduct for sponsor countries and for SWFs

There are two keys to effectively addressing concerns about the uncertainty and unpredictability of SWFs, and they should be at the heart of the European contribution to global work on a common framework for SWF investment. The first is to obtain greater clarity and insight into the governance of SWFs. The second is to deliver greater transparency on their activities and investments. These two elements need to be addressed by the sponsor countries and the sovereign funds.

(a) Governance

Clarity about the degree of possible political interference in the operation of a SWF is a prerequisite for addressing concerns about the existence of political and other non-commercial considerations in the operation of a fund. The 2001 IMF Guidelines for Foreign Exchange Reserve Management [6] lay down important principles which could be extended to SWF. Equally, the OECD Guidelines on Corporate Governance of State-Owned Enterprises [7] put forward principles relevant for SWFs that undertake cross-border investments.

Principles of good governance include:

- The clear allocation and separation of responsibilities in the internal governance structure of a SWF;

- The development and issuance of an investment policy that defines the overall objectives of SWF investment;

- The existence of operational autonomy for the entity to achieve its defined objectives;

- Public disclosure of the general principles governing a SWF's relationship with governmental authority;

- The disclosure of the general principles of internal governance that provide assurances of integrity;

- The development and issuance of risk-management policies.

(b) Transparency

Transparency provides a disciplinary effect on the management of sovereign assets, as relevant stakeholders can exercise some degree of oversight on the activities of investors, and monitor whether or not funds deviate from their stated objectives. As such, transparency promotes accountability. In the case of SWFs, transparency not only serves to foster market discipline, but also reduces the incentives for any government intervention. It is therefore a critical factor in offering the confidence that underlies an open investment environment.

Since SWFs are managed independently from a country's foreign exchange reserves, they are excluded from transparency mechanisms such as the IMF maintains for foreign exchange reserves (IMF Special Data Dissemination Standard, SDDS). The extension of specific transparency standards to SWFs should be considered. Existing IMF and OECD guidelines already contain such standards, and some SWFs, such as those of Norway and Singapore are governed by principles which could be seen as a reference. However, SWFs should not be expected to follow transparency practices going beyond those developed by the IMF and the OECD and already applicable to similar state-owned investors.

Transparency practices that could be considered would include:

- Annual disclosure of investment positions and asset allocation, in particular for investments for which there is majority ownership;

- Exercise of ownership rights;

- Disclosure of the use of leverage and of the currency composition;

- Size and source of an entity's resources;

- Disclosure of the home country regulation and oversight governing the SWF.

V. CONCLUSION

The Spring European Council offers an opportunity for the Member States to endorse a coherent approach to SWF investments in response to emerging concerns. Such a coordinated approach does not impinge on national prerogatives and existing powers to protect legitimate public policy objective and interests. It aims at setting out shared expectations for increased transparency, predictability and accountability of SWF operations and to bring additional influence to the European contribution to the global search for solutions to this challenge.

In line with its Treaty principles and the renewed Lisbon Strategy, Europe must remain committed to its tradition of openness to capital investments, as they are a vital source of strength for the European economies in a globalised world. At the same time, the case for openness must be sustained by engaging SWFs in a cooperative effort to enhance their governance standards and the quality of information they provide to markets. This is not only to the benefit of the EU, but is in the mutual interest of all recipient countries as well as of sponsor countries.

The EU common approach should serve as a contribution to the IMF efforts to set up a code of conduct for SWFs and for their owners and to the OECD work to define principles applied by recipient countries when dealing with SWFs. It should help to reach an agreement, preferably by the end of 2008, on a set of guidelines that will build the necessary confidence in the fair and transparent operation of SWFs.

[1] This case is set out in detail in "Global Europe: competing in the world" - COM(2006) 567, 4.10.2006 - and in "The European Interest: Succeeding in the age of globalisation" - COM(2007) 581, 3.10.2007.

[2] The biggest funds are sponsored by the United Arab Emirates (two funds), Norway, Russia, Saudi Arabia, Kuwait, China and Singapore (two funds).

[3] Some forecasts predict a fourfold increase in the next decade, putting the possible scale of SWFs at $ 12 trillion by 2015.

[4] In addition, as required by Article 58(3) EC, the measures taken by Member States shall not constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital, Article 56 EC.

[5] See e.g. Judgment of 4 June 2002, case C-503/99, Commission v. Belgium , paras. 48-52.

[6] http://www.imf.org/external/np/mae/ferm/eng/index.htm

[7] http://www.oecd.org/dataoecd/46/51/34803211.pdf