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Striking a Balance between Sovereign Wealth Funds and National Security

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About The Author

Konstantina Michalopoulou (Guest Contributor)

Konstantina is a law graduate from Sussex University. After completing her LLB, she has worked as a legal trainee in a Greek civil law firm and as a legal secretary in a company related to International Business Affairs. Outside the law, Konstantina works as a volunteer with autistic children in her hometown of Kastoria, Greece.

There is a lot of worry about sovereign wealth funds, but all of them are assumptions, they are not about real cases.

Badr Al Sa’ad – Managing Director of the Kuwait Investment Authority

In recent years, some of the most striking developments in the world of finance stem from the emergence of Sovereign Wealth Funds (SWFs). Having grown rapidly over recent years, these funds have both provided significant benefits to world capital markets and courted controversy in regards to their interaction with international financial regulation.

Indeed, as this article examines, one of the prime issues of concern is the potential collision of SWFs with the national security of host states (those countries that receive the investments of SWFs). Questions remain as to whether a balance can be found between, on the one hand, the global community’s collective interest in sustaining the openness of capital markets, and, on the other hand, the legitimate national security concerns of individual host countries. Certainly, whether the existing law in this area – and the somewhat modest reforms to it that have been proposed – can resolve this quandary is up for debate.

The Historical Development of Sovereign Wealth Funds

A SWF consists of a pool of assets that are owned and managed directly or indirectly by a state (usually one with a budgetary surplus) in order to achieve national objectives. Examples of SWFs making investments include the Brunei Investment’s Agency portfolio of the luxury Dorchester Hotels and the Qatar Investment Authority’s purchasing of real estate in London, such as the Chelsea Barracks, the Olympic Village, and the Shard.

Most observers have recognised three standard elements to identify SWFs:

  • They are state owned.
  • They have no significant liabilities.
  • They are managed separately from the rest of the state’s Central Bank reserves.

The concept of SWFs firstly appeared in 1952 when Saudi Arabia established the SAMA Foreign Holdings and assigned it the task of holding and investing surplus oil revenue in foreign assets. Yet the idea was slow to catch on, notwithstanding some minor exceptions, the emergence of SWFs throughout the 1960s and early 1970s was not extensive or swift.

Indeed, it was not until the 1970s and 1980s that waves of growth began to show; states such as the UAE, Brunei, Oman, and Singapore began to adopt the Saudi model. By the early 1990s, states like Botswana, Hong Kong, Malaysia, and Norway had followed suit before the biggest wave of SWFs arrived towards the end of 1990s in the form of the Hong Kong Monetary Authority Investment and Venezuela’s Investment Fund for Macroeconomic Stabilization. This striking rise in the number of SWFs continued until the first decade of the twenty-first century, when their numbers doubled from 20 to 43.

One of the most significant aspects of SWFs is their potential to hold behemoth levels of size and influence. Indeed, research from the Sovereign Wealth Fund Institute – outlined in the table below – discovered that in October 2017, the top ten largest Sovereign Wealth Funds collectively accounted for $3.239.4 trillion in assets, a figure which represents around 82.5% of the world’s SWF assets. 

State of Origin

Name of Fund

Assets (Billions)

Fund Inception

Focus of Investment


Government Pension Fund-Global





Abu Dhabi Investment Authority





China Investment Corporation





Kuwait Investment Authority




Saudi Arabia

SAMA Foreign Holdings




China-Hong Kong

Hong Kong Monetary Authority Investment Portfolio





SAFE Investment Company





Government of Singapore Investment Corporation





Qatar Investment Authority



Oil & Gas


National Security Social Fund




The reason for this rapid development is that prices for commodities such as oil increased, which led SWF managers to abandon conservative investments, such as foreign government securities, and take higher risks in their investment capital choices. Thus, SWFs have offered access to sizeable inflows of capital to host countries that, as Thomas Hemphill has pointed out:

[A]re useful to supplement domestic savings, finance external deficits or help stabilize capital markets in moments of stress.

However, concerns have been raised about the danger of SWFs. Intriguingly, the intensity of these criticisms rises and falls with the extent to which SWFs receive public exposure. Indeed, until the financial crash of 2008 – which saw the spotlight shine upon large-scale SWF investments into the West’s financial institutions – and the resulting awareness of global wealth inequality, concerns were sporadic at best.

Nonetheless, though transient, these criticisms are powerful. For one thing, SWFs undermine the arm’s-length relationship between government as a regulator and business as the regulated. Furthermore, SWFs can distort competition by profiting from access to information and markets held by government which are generally not available to their private counterparts.

There is also a lack of transparency that potentially allows SWFs to make investment decisions based on a political agenda. Indeed, the IMF has observed that the lack of publicly available information generally ‘makes it difficult to assess the SWFs’ asset management activities and their impact on the capital markets’.

This article focuses on one final, and major, concern about SWFs: the threat that they may pose to national security. In the eyes of some, SWFs might be able to function as quasi-agents for foreign governments and may be used for overt or tacit political purposes.

Implications for National Security Created by SWFs

If left unchecked, the financial clout that SWFs possess could potentially put a host country’s national security at risk. Under the guise of investment, SWFs may be used instrumentally to give foreign governments the ability to gain control of industries of strategic importance, to influence (directly or indirectly) the governments of the host countries, or even to extract vital governmental information.

Such concerns about SWFs were not raised during the first few decades since their conception. Indeed, it was not until two SWF-related controversies in 2005 and 2006 that host countries – largely in the West – began to express concern about, and react to, the perceived risks that SWFs could pose to national security. As an example, the so-called CNOOC controversy – in which a takeover battle between a US-owned corporation and CNOOC (the China National Offshore Oil Corporation) for the control of an US oil procedure sparked congressional intervention – highlighted how western countries began to realise that many SWFs derive from authoritarian regimes in areas that are characterized by political instability or are involved in conflicts with western interests.

The concerns of western host countries can be divided into two groups: the first revolves around the worries over the lack of transparency in the operations and corporate governance structures of SWFs, while the second focuses on the risks of SWFs being used to destabilise national markets and subvert national objectives to gain a geopolitical advantage over host countries.

Existing Regulation of Sovereign Wealth Funds – National Level

Despite many having existing laws prohibiting or screening the foreign investments, a huge number of states – led by the US Congress (which launched multiple inquiries for the protection against threats posed by SWFs)– passed legislation aimed at establishing a new and more comprehensive regime to regulate SWFs and mitigating national security concerns. Many of these new laws extended the degree of coverage and protection. The financial liberalism of the 1980s and 1990s – such that many of these states had actively encouraged investment from SWFs – was left aside.

The European Commission has also advocated that its Member States take a supra-national approach to the issue: after advocating a common European approach to SWFs in a Communication in 2008, it introduced on 14 September 2017 a proposal for a European framework that would screen foreign direct investment into the EU for the perspective of security or public order. Created in response to a joint request by France, Germany and Italy in February 2017 for the adoption of rules to enable screening and potential prohibition of foreign acquisitions of sensitive technologies and know-how, the proposal shows that even one of the most open markets for foreign direct investment recognises that openness cannot function without some control and protection over its own strategic interests.


Legislation (Primary and Secondary)

National Security Review Element?


Investment Canada Act 1985



Regulations for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors 2006



Foreign Trade and Payments Act 1961

(amended in 2004)



Foreign Exchange Management Act 1999



Foreign Exchange and Foreign Trade Act 1949

(amended in 1991)


The Netherlands

Financial Supervision Act 2006



Federal Law on Foreign Investments 1999


The UK

Enterprise Act 2002


The US

Defense Production Act 1950

(amended by the Exon-Florio Amendment in 1988)


The overarching theme underlying these legislative changes seems to be the host countries attempting to shift the balance between encouraging valuable SWF investments and national security laws to favour the latter.

However, this in itself causes a problem: there is a lack of uniformity of key definitions, such as for the concepts of what constitutes ‘economic security’. This has the potential to cause severe problems, such as the risk of varying levels of discretion vested in public officials allowing for arbitrary protectionism, or ‘forum shopping’ that leads to a race-to-the-bottom, whereby host countries battling to attract investment lower their standards of protection to out-do their rivals. Ultimately, these heterogeneous standards on legislation could easily create a situation of instability in the financial markets.

Existing Regulation of Sovereign Wealth Funds – Global Level

These problems have been vitiated somewhat by the global community’s adoption of universal regulations in the form of two ‘soft law’ documents: the Sovereign Wealth Funds: Generally Accepted Principles and Practices (known as The Santiago Principles) and the OECD’s Guidance on Sovereign Wealth Funds.

The Santiago Principles – which were heavily resisted by countries with SWFs – require SWFs to:

  • Contribute to a stable financial system
  • Comply with regulatory framework of target countries
  • Invest for economic reasons
  • Be transparent

Though initially appearing to be a promising mechanism for countering the threats SWFs pose to national security, the Santiago Principles are insufficient as they constitute a strictly voluntary code; states with SWFs are thus under no obligation to comply with their prescriptions.

The OECD’s Guidance is also beset with problems. Despite being the main global regulation for the discouragement of protectionism and promotion of transparency, proportionality, and accountability, they are informal guidelines of limited enforceability. Furthermore, any limitations that host countries try to establish must be backed up with sufficient justification, but with the OECD’s Guidance not defining key terms like ‘public order’ or ‘security’, what exactly constitutes sufficient justification is unclear.

Making a Change

Both national and global attempts to regulate SWFs clearly fail to achieve the right balance between national security concerns and functional SWFs that preserve the openness of financial markets. Arguably, though, there is no one definitive solution to the problem; instead, any attempted resolution must follow incremental steps that slowly but surely balance the scales.

Any changes that are made should focus on increasing the control that host countries can have on the influence which SWFs investments can have on key aspects of their society without allowing them to impose onerous and protectionist restrictions under the guise of national security. One crucial method by which this could be resolved is through the adoption of standard definitions for a number of the key terms: the lack of consensus here undermines clarity of the law and allows for manipulation, such that activity which would otherwise be prohibited is justified.

In a similar vein, a key second step would involve the formalisation of risk assessment criteria that host countries should refer to when deciding whether to block attempted SWF activity. At present, there is a lack of transparency regarding the screening and scrutinising of investments, which leaves full discretion to policy-makers to restrict SWFs and create arbitrary protectionism.

Thirdly, and most importantly, an independent and centralised appeal body with a uniform process for SWFs must be established that would allow for dispute resolution. This would guarantee that fair treatment is given to both host countries and SWFs and thereby ensure that no unwelcome attempted influence or financial protectionism occurs.


SWFs constitute a great challenge for global monetary governance and raise the difficult question of whether balance between the world community’s collective interest in sustaining the openness of capital markets and legitimate national security concerns of host countries can actually exist. There is no definite answer as to how to achieve this balance.

Indeed, it is arguable that there is no single and readily available solution. Instead, the improvement of existing regulations to enhance their clarity and certainty could significantly reduce controversy. This would facilitate the coexistence between national security policies and SWF investments and simultaneously eliminate suspiciousness between host and fund-owning countries.

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Tagged: Banking & Finance, European Union, International Law, Regulators

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