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The International Lawyer

The International Lawyer, Volume 57, Number 1, 2024

Governing the Wealth of Nations: The Santiago Principles at Fifteen

Gary Paul Rose

Summary

  • The Santiago Principles, a set of “generally accepted principles and practices” (GAPP) adopted by most of the world’s sovereign wealth funds (SWFs), are a product of a very different political and economic moment.
  • But as SWF assets under management grow beyond $10 trillion and SWFs play an increasingly visible role in many countries’ political economies, the Santiago Principles are likewise growing in importance as a form of international soft law. 
  • This essay considers the continuing relevance of the Santiago Principles, and whether the principles will (and should) persist in their current form.
Governing the Wealth of Nations: The Santiago Principles at Fifteen
© 2018 Antonio Busiello via Getty Images

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The Santiago Principles, a set of “generally accepted principles and practices” (GAPP) adopted by most of the world’s sovereign wealth funds (SWFs), are a product of a very different political and economic moment. But as SWF assets under management grow beyond $10 trillion and SWFs play an increasingly visible role in many countries’ political economies, the Santiago Principles are likewise growing in importance as a form of international soft law. Sovereign wealth funds contest the distinctions between politics and finance across domestic and international dimensions, and the Santiago Principles serve as a mechanism to manage some of the concerns arising from SWFs’ unique position as public actors in private markets. While the Santiago Principles have proven resilient, they have also been static. As the principles reach their fifteenth anniversary, this essay considers the continuing relevance of the Santiago Principles, and whether the principles will (and should) persist in their current form. Acknowledging that any voluntary set of practices are inherently limited in their power as a signal of governance credibility, the Santiago Principles provide a compelling example of how international soft law develops over time. And, as sovereign funds continue to grow in number and in wealth, the importance of the principles has never been greater.

I. Introduction

Sovereign wealth funds (SWFs) are a financial irony. They are enormously powerful in terms of their assets under management—with over $10 trillion in assets under management, SWFs as a class control more wealth than hedge funds, venture capital funds, or private equity funds—yet in practice are often bounded by strict internal and external regulations that are designed to blunt and soften their financial, economic, and political impact. The softened impact of sovereign wealth funds comes by design and is partly the result of a remarkably modest, collaboratively developed set of “soft law” rules known as the Santiago Principles.

Designed through the combined efforts of IMF representatives, U.S. government officials, and SWF sponsor government officials, the Santiago Principles germinated in the shadow of the Financial Crisis of 2008. Much has changed in the intervening decade and a half, with a global pandemic and a more hostile environment for foreign direct investments posing two of the greatest challenges to the operation and growth of sovereign funds in recent years. Domestic expectations for SWFs have changed as well, with many countries now looking to their SWFs to solve longstanding social and environmental problems, such as climate change adaptation or the development of new technologies and industries that will help countries transition from dependence on resource extraction to a more diverse service- and knowledge-based economy.

This essay reflects on the development of the Santiago Principles, a set of “generally accepted principles and practices” (GAPP) adopted by most of the world’s SWFs. The Santiago Principles are a product of a very different political and economic moment, yet are still growing in importance as a form of international soft law. The essay describes the phenomenon of sovereign wealth funds as entities straddling politics and finance across domestic and international dimensions and retraces the development of the Santiago Principles as a mechanism to manage some of the concerns arising from SWFs’ unique position as public actors in private markets. While the Santiago Principles have proven resilient, they have also been static. As the principles reach their fifteenth anniversary, this essay considers the continuing relevance of the Santiago Principles, and whether the principles will (and should) persist in their current form.

II. The Origins of “Sovereign Wealth” and the Santiago Principles

Sovereign wealth can be defined any number of ways, and depending on one’s definition, sovereign funds have existed in various forms for centuries. The term itself is less than twenty years old, dating back to Andrew Rozanov’s 2005 description of national-level currency reserve and commodity stabilization funds as “sovereign wealth funds,” a term sufficiently capacious and exotic that it quickly succeeded in sticking as the new preferred conceptual category for a well-established class of government-owned and controlled funds. A 2008 International Monetary Fund (IMF) publication picked up the appellation, and defined sovereign wealth funds as “government-owned investment funds, set up for a variety of macroeconomic purposes and which are typically funded by foreign exchange assets that invest long term overseas.” The IMF definition focused on one of the key concerns with SWFs at the time the definition was composed: the investment by foreign states into other countries’ (potentially unwelcoming) capital markets.

The early definitional spadework helped prepare for the development of common principles to guide the governance of these government funds, as well as to reduce fears that the funds could be used in ways that harmed other countries. Several years prior to the drafting of the Santiago Principles, the IMF had begun to track “the accumulation of foreign currency assets through state investment funds,” in order to “identify and track . . . foreign official holdings not otherwise reported as official reserves.” The impetus for this work was simply to more accurately and transparently account for foreign reserves, as well as to assess the potential impact of asset allocation strategies. Through this “rather technical” assessment, the IMF identified concerns with its ability to surveil balance of payments data that might affect the macroeconomic stability of IMF member countries.

Against this backdrop, investment by sovereign funds between 2005–2008 triggered protectionist sentiments in the US and in Europe. Sovereign funds had grown significantly between 2000 and 2007, with both trade- and fossil-fuel-funded SWFs increasing rapidly in assets under management. In Asian countries alone, currency accounts (from which many SWFs are funded) grew from $53 billion in 2000 to around $443 billion in 2007.

The Financial Crisis of 2007 and 2008 provided investment opportunities for sovereign funds, suddenly flush with cash and eager for profitable returns. SWFs invested in numerous marquis firms in the United States, and it is no exaggeration to say that the SWFs were a key player in the financial services bailout that helped Wall Street recover from the failures that led to the Financial Crisis. In a span of about six months, from mid-2007 to early 2008, sovereign funds from around the world provided an infusion of much-needed capital to a number of high-profile U.S. companies, as shown in Table 1.

Table 1: Major Sovereign Wealth Transactions, May 2007–Jan. 2008

Date

Company

Investor

Investment (in billions USD)

May 2007

Blackstone Group

China Investment Corporation

3.0

Aug. 2007

CityCenter Holdings

Dubai World

2.8

Sept. 2007

Carlyle Group

Mubadala

1.35

Oct. 2007

Och-Ziff Capital

Dubai International Capital

1.26

Nov. 2007

Advanced Micro Devices

Mubadala

0.62

Nov. 2007

Citigroup

Abu Dhabi Investment Authority

7.5

Dec. 2007

Morgan Stanley

China Investment Corporation

5.0

Dec. 2007

Merrill Lynch

Temasek

6.2

Jan. 2008

Citigroup

Government of Singapore Investment Corporation; Kuwait Investment Authority; Capital Research; Private Investor

12.5

Jan. 2008

Merrill Lynch

Kuwait Investment Authority; Korean Investment Fund Inc; Mizuho Financial Group Inc

6.6

 

Numerous other smaller deals were signed during this short period of time; in total, nearly $43 billion in capital was provided by sovereign investors to U.S. financial firms in 2007 and early 2008, with Citigroup alone receiving $20 billion in that period.

As isolated investments, perhaps these investments would not have caused concern. But they came on the heels of a controversy in 2006 surrounding the attempted purchase of six major U.S. port operations by DP World, a Dubai-owned enterprise. DP World conducted the transaction transparently and secured the approval of the Bush administration and the Committee on Foreign Investment in the United States (CFIUS), the interagency committee with responsibility to review foreign investments that potentially implicate the national security of the United States. But fierce bi-partisan congressional resistance pushed back against the deal. Coming not five years after the events of 9/11, members of Congress were concerned that “port operations could be ‘infiltrated’ by terrorists exploiting the ownership in Dubai, an emirate known for its open trade.” Despite Bush administration arguments that the opposition was driven by racial bias and that obstructing the transaction suggested an isolationism that would be detrimental to U.S. efforts to engage other nations on anti-terrorism fronts, Congress firmly resisted approval of the transaction and introduced legislation prohibiting the sale. Dubai ultimately abandoned the transaction.

DP World was not the only foreign party transaction that concerned U.S. policymakers. In June 2005, shortly after U.S. oil company Chevron made a bid for rival Unocal, China National Offshore Oil Company (CNOOC) made a competing bid for Unocal. Although CNOOC’s $18.5 billion offer was two billion higher than Chevron’s initial offer, the potential acquisition met immediate and intense opposition. The deal potentially impacted a variety of national interests. As the Congressional Research Service framed the issues, these interests were of the utmost importance, as the deal implicated “security (protection of life and property), prosperity (protection of economic wellbeing and commerce), and value preservation (protection and projection of core values of democracy, freedom, human rights, etc.).” As with the DP World transaction, Democrats and Republicans were united in their opposition. CNOOC eventually determined to drop its bid, citing the “unprecedented political opposition” to the bid.

As a result of these public intragovernmental squabbles—and growing Congressional consternation over the approval by CFIUS of foreign investment in U.S. firms—the U.S. Department of the Treasury became increasingly concerned by the political reaction to acquisitions by foreign government-linked entities. In public statements, Department of Treasury Acting Under Secretary for International Affairs, Clay Lowery, attempted to allay some of these concerns by noting that sovereign investment “can bring benefits to countries in which these funds are invested. From the U.S. perspective, we unequivocally support international investment in this country. . . .” He also highlighted risks, including potential impacts on financial market stability, lack of transparency, and lack of regulation. But, of course, another significant risk that the Treasury hoped to combat was that “over the medium term, the size, investment policies, and/or operating methods of these funds [will] fuel financial protectionism.” As part of that speech, Lowery proposed the creation of a task force to develop best practices for sovereign investment.

Deputy Treasury Secretary Robert Kimmitt also contributed to the Treasury’s public relations campaign, writing an article in the January/February 2008 edition of Foreign Affairs that outlined an influential set of practices for sovereign funds. Kimmitt opined that sovereign funds should follow five basic principles in their investments in foreign markets. First, SWFs should invest commercially, not politically, and should make a commitment to commercial investment a formal part of their investment policies. Second, SWFs should be committed to institutional integrity and transparency, and put in place appropriate governance and risk management structures. Third, SWFs should compete fairly with the private sector, such as by using government funding to secure financing at lower rates than private competitors. Fourth, SWFs should promote international financial stability and, during times of market stress, should communicate “ . . . effectively with the official sector to address financial-market issues.” Finally, SWFs should respect host-country rules and should comply with all the applicable regulatory and disclosure rules.

Not relying on public pronouncements alone, the Treasury tried to shape sovereign investment (and the reaction to it) by engaging directly with sovereigns on the creation of best practices for SWF investment. Among other initiatives, the Treasury encouraged the Government of Singapore Investment Corporation (GIC) and the Abu Dhabi Investment Authority (ADIA) to begin work on a set of best practices, efforts that would later be folded into the drafting of the Santiago Principles. In March 2008, The U.S. Treasury, Singapore and Abu Dhabi reached an agreement on a set of “policy principles” for both SWFs and for countries receiving SWF investment. Following the signaling by Kimmitt in Foreign Affairs a month earlier, the best practices for SWFs as outlined in the agreement included:

1. SWF investment decisions should be based solely on commercial grounds, rather than to advance, directly or indirectly, the geopolitical goals of the controlling government. SWFs should make this statement formally as part of their basic investment management policies.
2. Greater information disclosure by SWFs, in areas such as purpose, investment objectives, institutional arrangements, and financial information – particularly asset allocation, benchmarks, and rates of return over appropriate historical periods – can help reduce uncertainty in financial markets and build trust in recipient countries.
3. SWFs should have in place strong governance structures, internal controls, and operational and risk management systems.
4. SWFs and the private sector should compete fairly.
5. SWFs should respect host-country rules by complying with all applicable regulatory and disclosure requirements of the countries in which they invest.

As described in the following sections, these basic principles laid the groundwork for the more fulsome Santiago Principles, though the principles did not take shape without fractious negotiation and considerable effort.

III. Negotiating the Santiago Principles

As sovereign fund officials met in the Spring of 2008 to negotiate the Santiago Principles, SWFs faced a precarious political and financial environment. The Financial Crisis was deepening, and central banks, finance ministers, and other regulators were desperate to shore up systemically important financial firms. Yet, at the same time, the political backlash from the CNOOC and DP World deals chilled SWF enthusiasm for significant investment in any sensitive market sector. SWFs appear to have been keenly aware of—and troubled by—the potential for the extended regulatory reviews and uncertain outcomes associated with sovereign investment, with some SWFs expressing concern that “ . . . negative sentiment might lead to the perception that they needed to be ‘monitored and regulated,’ to ensure that they were investing solely on financial grounds without political involvement in investment decision-making.” The need for ground rules for both SWFs and host countries was never more clear.

Using the basic framework developed by the U.S. Treasury, GIC, and ADIA, on April 30 and May 1, 2008, leaders from a group of twenty-six sovereign funds gathered in Washington D.C. to form the International Working Group of Sovereign Wealth Funds (IWG). Working with staff from the IMF, SWFs also drew from IMF surveys on established SWF structures and practices, as well as from generally accepted principles and practices for official reserves management. While benefitting from these foundational efforts, the drafting process was complicated by the significant differences in the funds themselves: some with wealth based on commodities revenues, others based on trading revenues; some with a developmental focus, others seeking to purely maximize returns on assets under management; some operating in countries with well-established institutional intermediaries (such as lawyers and accountants), others from countries with developing markets and thinner supporting institutional structures; some from democratic regimes, others from autocracies. As a result, the IWG had to balance differing views on transparency, disclosure, and the “relationship between standards and institutional credibility.”

On the first day of negotiations, SWFs made little progress, as the funds struggled with the notion of “self-regulation,” particularly as some funds were already subject to significant domestic oversight. The day closed with a “strong and continuing lack of consensus.” By the end of the second day, however, the funds were able to agree on several guiding principles that would help push the drafting forward: first, any principles produced by the working group would be voluntary; second, they would be characterized as “general” principles as opposed to a set of “best practices;” finally, and most importantly, the principles would be subordinate to domestic regulations. As Ahmad Bastaki of the Kuwait Investment Authority bluntly recounted,

[t]he Santiago Principles is more of a comfort document for recipient countries to be reassured that what we do will be done responsibly. However, it is voluntary. We have considerably greater oversight [in Kuwait] than [implied] by the Santiago Principles. The domestic laws of Kuwait are more stringent that the Santiago Principles, so we consider [the Santiago Principles] to be secondary.

The tension between host-country preferences and domestic regulations and political dynamics is perhaps best exemplified by the struggle to outline basic principles of transparency and disclosure. Many countries do not operate government entities transparently, and some countries even restrict their employees from providing any disclosure unless specifically directed. For example, Kuwait’s 1982 decree establishing the Kuwait Investment Authority states that board members and employees of the fund “may not disclose data or information about their work or the position of the invested assets” without permission from the board chair, a prohibition that continues even after the board member or employee has left the fund. To underline the importance of the prohibition, Kuwaiti law also provides that unauthorized disclosure may be punished by up to three years in prison. For a country like Kuwait, which has in place strict restrictions on disclosure for its SWF’s employees, domestic law and a set of principles encouraging transparency are fundamentally at odds. Because the principles call for disclosure of total assets and investment policies and strategies, for example, KIA could never be fully compliant with the principles if they were viewed as superseding home country regulations. A compromise, proposed by the KIA, clarified that the principles would be “subject to home country laws, regulations, requirements, and obligations.”

IV. The Final Structure of the Santiago Principles

As the Santiago Principles took final shape, they ultimately accomplished three primary objectives: First, the principles set out a series of general governance practices that could apply to any investment fund, including private funds; second, resonant from the time period—the Santiago Principles drafted during the height of the Financial Crisis—focused on how SWFs could support macroeconomic stability; and finally, some provisions set expectations with respect to host countries, both in establishing accepted practices for SWFs and for host countries in how they regulate SWF investment activity. Each of these three types of principles are highlighted in the following sections.

A. Governance

Many of the Santiago Principles set standards for basic governance structures for SWFs, including principles providing for accountability and transparency. Because different countries have varying levels of external governance (such as through SWF-specific statutes and regulations, regulations applicable to intermediaries, or general business laws or state-owned enterprise laws that apply to a given SWF), the importance of internal governance structures will also vary. The Santiago Principles do not assume any particular kind of regulatory structure, but instead provide general principles that will cover a wide range of legal environments. Within this category fall thirteen of the twenty-four principles. Among them are principles that support the development of sound legal framework for the fund, that provide for clear policies on funding, withdrawal, and spending operations, and that encourage reporting to the SWF owner. The Santiago Principles also set out broad expectations for governance, including “a clear and effective division of roles and responsibilities in order to facilitate accountability and operational independence in the management of the SWF to pursue its objectives.” Finally, the Principles establish a set of objectives for the fund, fiduciary principles for fund managers, political independence of the fund, and accountability devices such as annual reports and audits.

B. Macroeconomic Stability

Two principles relate directly to the potential for SWFs to impact domestic economic stability, as well as concerns that sovereign investment could have a destabilizing effect on foreign economies and on global markets generally. As noted above, this concern resulted in part from the looming of the Financial Crisis over the drafting of the Santiago Principles. The IMF had begun work on SWFs in part because of their potential impact on macroeconomic stability, and among Kimmitt’s initial principles for SWF investment included the promotion of international financial stability. Principles that reflect these concerns include GAPP three, which states that “[w]here the SWF’s activities have significant direct domestic macroeconomic implications, those activities should be closely coordinated with the domestic fiscal and monetary authorities, so as to ensure consistency with the overall macroeconomic policies,” and GAPP seventeen, which encourages disclosure of relevant SWF financial information to “demonstrate its economic and financial orientation, so as to contribute to stability in international financial markets and enhance trust in recipient countries.”

Other principles also affect macroeconomic stability. As explained in the commentary to the Santiago Principles, for example, GAPP four states that “[p]olicies, rules, procedures, or arrangements for the SWF’s funding, withdrawal, and spending operations on behalf of the government should be clearly set out and be consistent with the policy purpose of the SWF,” and that such a system “promotes macroeconomic stability and accountability.”

C. Commercial Investment

Finally, many of the Santiago Principles were designed to allay fears that SWFs would be used as tools of mercantilism or espionage, and encourage SWFs to continue operating as commercially-oriented investment vehicles. Some of these principles directly address SWF investment behaviors, while others are designed merely to provide transparency into SWF investment policies. Principles falling into this category include GAPP two, which encourages the disclosure of the “policy purpose of the SWF,” as well as GAPP fourteen, fifteen, sixteen, eighteen, and nineteen, which, among other things, encourage compliance with host country rules, disclosure of the SWF’s governance framework and investment policies, and suggest that SWFs should “aim to maximize risk-adjusted financial returns in a manner consistent with its investment policy, and based on economic and financial grounds.”

To summarize, the Santiago Principles provide a sturdy yet flexible framework for SWFs. They do so through a relatively skeletal structure that must invariably be strengthened by home country regulations, adequate internal policies, and procedures if it is to function effectively for a given fund. But, of course, such a thin and soft framework is not without its critics. Bismuth persuasively argues, for example, that the Santiago Principles are an inadequate regulation in that they do not provide sufficient protection against the political use of SWFs, nor an adequate governance structure for regulating the relations between SWFs and their sponsor countries.

As a standalone set of governance regulations, the Santiago Principles are indeed deeply flawed. A government could not run a fund by the Santiago Principles alone, nor would any country offer free rein to a SWF to invest within its borders without constraint merely because it was fully compliant with the Santiago Principles. But the Santiago Principles should not be expected to carry such weight. Indeed, it would be a stretch to even characterize the principles as “regulations” in any meaningful sense, as there is no enforcement mechanism for the Santiago Principles other than to be kicked out of the IFSWF.

What the Santiago Principles do, and do reasonably well, is provide a set of governing and operational standards that countries with vastly different legal frameworks, market intermediaries, and political economies can use as a basis for incremental harmonization. Such harmonization reduces transaction costs for SWFs and regulatory costs for home countries. Admittedly, such harmonization will be slow and backtracking may occur. Yet, the Santiago Principles hold promise as a form of soft law even if the actual product (hastily constructed in a moment of crisis) leaves much to be desired. The following section considers other regulatory possibilities, and the chance of incremental harmonization and “hardening,” to map out the likely future of the Santiago Principles.

V. The Political Economy of the Santiago Principles

The Santiago Principles have multiple political and economic functions. On the one hand, they are designed to reduce host countries’ concerns that SWFs will be used as political tools. Of course, all government investment vehicles have a political purpose, even if they invest only domestically; what concerns host countries is the possibility that SWFs will be used as tools of statecraft to harm host countries rather than merely providing economic and political benefits to their sponsor countries. The Santiago Principles provide a form of commitment that any SWF will be invested in accordance with GAPP. For the sponsor country, the Santiago Principles may provide benefits as well. As Park and Estrada explain, while the Santiago Principles provide some reassurance to host countries, they do so by orienting SWFs to maximize risk-adjusted returns. Yet the principles are both thin and soft, and the following section considers the possibility of other, stronger forms of regulation.

A. The Santiago Principles as Soft Law

The Santiago Principles operate as a non-binding set of standards that guide the behavior of SWFs, but do not supplant either home country regulations or host country regulations. For this reason, they may be viewed as inferior to stronger forms of regulation, such as multilateral or bilateral treaties. Establishing treaties to manage such cross-border financial relationships is common in tax, for example, so one might wonder why there has not been a multilateral SWF treaty. In other words, why do we have the Santiago Principles instead of treaty that establishes a “General Agreement on Sovereign Investment”?

Part of the explanation may be in the timing of the Santiago Principles, which were drafted in the midst of a Financial Crisis, in which sovereign investment was desperately needed to shore up Western financial institutions, and shortly following high-profile attempted acquisitions of sensitive US assets by foreign state-owned enterprises (the DP World and CNOOC-Unocal deals). Because sovereigns already had significant investments in US assets—and in a time of market instability were often eager to seek the relative safety of US markets going forward—the need to assuage US and other Western policymakers was acute. A more formal and binding regulatory solution could have been—and still could be—a possible long-term solution, but the sovereign fund owners and host country regulators needed an immediate resolution to what was becoming a crisis of trust.

Even considering the longer-term interests of SWF sponsor countries and host countries, a “soft law” solution may be preferable. In considering a roughly analogous and related area of law—securities regulation—Roberta Karmel and Claire Kelly provide several justifications why soft law “works” in cross-border financial regulation. First, treaties can take years to negotiate and even after they have been successfully negotiated, “[r]atification can be a long and complicated process in many countries and often may not occur.” The United Nations Convention on the Carriage of Goods by Sea and the United Nations Convention on Contracts for the International Sale of Goods both took over twenty years to negotiate, for example.

Second, even despite its nature as a non-binding form of regulation, soft laws can evolve into customary international law over time—“norms that most States follow out of a sense of obligation”—and thus can eventually act as a kind of “hard law.” Initiating a baseline set of appropriate rules for sovereign investing may allow for the development of more detailed and standardized rules, but it would have been politically impossible to start with a more rigid framework, as evidenced by Kuwait’s reaction to the potential limits on sovereignty imposed by early drafts of the Santiago Principles.

Moderated and incremental rulemaking is not uncommon in international agreements. Indeed, such a process occurred with the creation of the General Agreement on Tariffs and Trade (GATT) in 1947. Originally, the charter of the International Trade Organization was intended to result in “binding commitments,” limit states’ ability to withdraw from the compact, and create a robust institutional framework that would limit members’ sovereignty. Consequently, the charter was difficult to negotiate and draft, and the proposed document’s “institutional strength also provoked political resistance within the United States.” Instead of pursuing a more developed, formal agreement, the participating states decided to adopt the GATT as a “low-cost, interim framework.” Unlike the International Trade Organization framework, the GATT did not contemplate substantial institutionalization and allowed members to more easily withdraw from the compact. Over time, however, the GATT grew into the World Trade Organization as states recognized the benefits from “harder legalization in governing international trade.”

Although the Santiago Principles may not ever serve as the basis of an international treaty, the principles have already shown to have “hardened” in how they are used by SWFs. Over the last decade, for example, the IFSWF has built up a regular assessment program—with public disclosures of the assessments—as a means of encouraging SWFs to comply with the GAPP. Although the assessments vary in their level of detail and in their disclosed levels of compliance, they have added a layer of accountability to the implementation of the GAPP. Further, IFSWF staff work closely with member SWFs on their assessments, providing some measure of uniformity and quality control for the disclosures. The principles seem to be hardening into norms.

B. Plotting the Trajectory of the Santiago Principles

Like the GATT, it is possible that the Santiago Principles will follow a similar trajectory and will harden over time into a multilateral agreement. But, if that process does occur, it will likely be slow and deliberate, and will likely always provide for strong exercise of domestic regulation in the management of sovereign funds. Two primary reasons support this view. First, concerns with sovereign investment are not primarily regulated through soft law like the Santiago Principles, but through host country foreign investment regulatory frameworks, such as CFIUS in the United States. The need for a multilateral treaty is thus less critical, and as described below, the political environment that would enable the negotiation of such a treaty is even less amenable than it was in 2007. Second, because of the wide range of purposes, political contexts, and legal frameworks of the Santiago Principles’ signatory sovereign funds, the GAPP were designed to be broad and malleable. While this may have been a necessary feature of the almost desperate, time-constrained negotiations of the Santiago Principles, it has proven to be a virtue as the nature of sovereign investment has shifted over the years. The following section expands on these reasons and looks forward to the role of soft law like the Santiago Principles in shaping sovereign fund governance over the coming decades.

1. Foreign Investment Regulation: Does Soft Law Play a Role?

Countries did not—and will not—wait for sovereign investment to self-regulate. While the Santiago Principles were being drafted, the United States was implementing a significant redrafting of the Exon-Florio foreign investment framework managed by CFIUS. These changes, enacted through the Foreign Investment and National Security Act of 2007 (FINSA), were designed in part to mitigate the particular risks associated with state capitalism. Other countries have also enacted similar regulations in the last fifteen years.

As sovereign investment has changed even since the development of the Santiago Principles and FINSA in 2007, U.S. regulators have been quick to respond. Generalized concerns over sovereign investment dominated the conversation in 2007, as members of Congress considered the rise of China while also seemingly harboring lingering suspicions of Middle Eastern investment. By 2018, however, the focus had shifted almost entirely to China. Donald Trump focused attention on trade with China as a presidential candidate and negotiated aggressively with China once in office. President Trump threatened to make use of the International Emergency Economic Powers Act (IEEPA), for example, to stymie Chinese deals in the United States, and directed the United States’ Trade Representative to investigate whether “China’s laws, policies, practices, or actions that may be unreasonable or discriminatory . . . may be harming American intellectual property rights, innovation, or technology development.”

The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), like FINSA, also responds to concerns raised by state capitalism. Specifically, FIRRMA seeks to address concerns identified by the United States’ Trade Representative and broadens the definitions of what may be reviewed under national security grounds. FIRRMA allows CFIUS to review transactions involving “critical technology,” and widens the range of reviewed transactions to any investment, other than a passive investment, by a foreign person in any United States critical technology or United States critical infrastructure company that is unaffiliated with the foreign person. FIRRMA also imposes enhanced notice and disclosure rules, and requires declarations for transactions for any investment that “results in the acquisition, directly or indirectly, of a substantial interest in a United States [critical infrastructure company or United States critical technology company] by a foreign person in which a foreign government has, directly or indirectly, a substantial interest.” Finally, leaving no doubt that the legislation was devised to respond to Chinese investment activity, FIRRMA also imposes additional reporting obligations on CFIUS, which now must track and report the amount of total foreign direct investment from China in the United States, disaggregated by ultimate beneficial owner; the breakdown of Chinese investments in the United States by deal size, industry, investment type, and by government and non-government investments; a list of companies U.S. firms acquired through Chinese government investment; the number of United States affiliates of entities under Chinese jurisdiction, the total employees at those affiliates, and the valuation for any publicly-traded United States affiliate of a Chinese entity; and an analysis of investment patterns, including by volume, type and sector, and the extent to which those patterns of investments align with the objectives outlined in the Made in China 2025 plan.

More broadly, investment policymaking increased significantly as a result of the COVID-19 pandemic, and developed countries have been deliberate and consistent in establishing national security review procedures and in protecting domestic strategic companies from takeover by foreign entities. Host countries have not waited for the development of an international SWF investment regime, but have instead crafted their own regulations to govern state-controlled investments. Consequently, the Santiago Principles are not burdened with the responsibility of directly regulating such investments, but instead simply complement host and home country regulatory frameworks.

2. Santiago Principles in the New Era of Sovereign Investment

Perhaps because they focus more on general principles of good fund governance than imposing home or host country regulations, the Santiago Principles have proven to be remarkably resilient. The principles were drafted with flexibility from the beginning. Some signatory SWFs were designed to operate as intergenerational wealth transfer vehicles, like endowment funds, while others served as rainy-day funds or as budget-smoothers that helped mitigate short-term budget crises. Still others were designed to spur development in their home countries, or to help manage nationalized firms. Thus, the Santiago Principles were already built to encompass a wide variety of fund types.

In some ways, the current climate is similar to the era in which SWFs came into prominence: a time of financial instability, accompanied by a rise in protectionist sentiment. Then, as now, regulators may be concerned that state-owned funds could be investing for nefarious purposes. But while the Santiago Principles may have calmed nerves, it is also important to recognize the limitations of sovereign funds as vehicles for mercantilism. Sovereign funds are portfolio-holding entities, meaning that they hold a basket of assets across asset classes. More importantly, sovereign funds tend not to hold controlling stakes in their portfolio investments, and often do not even hold influential stakes. A review of Section 13D and 13G filings, which would indicate large shareholdings in a reporting company, show that China Investment Corp., for example, has almost no large investments in U.S. entities. As portfolio funds managed by professional fund managers, SWFs are not built to operate their portfolio companies. While funds may try to steer the governance of the corporations in which they invest, sovereign funds are not structured to provide operating advice, nor are they even structured as vehicles to obtain sensitive information from operating companies, because they typically don’t have the kind of influence over corporations that would allow them to access such information.

Because they are generally mandated to operate as portfolio management entities, sovereign funds also face significantly greater potential transaction costs than many other investors; because SWFs are “volume” investors—investing relatively small amounts of money in a relatively large number of portfolio assets—they are especially sensitive to increases in transaction costs associated with routine investments. If a sovereign fund were to meddle with a portfolio company in any of the ways that SWF were feared to want to act (such as by pressuring a company to engage in activities that would benefit the SWF’s sponsor country or harm the portfolio country’s home jurisdiction), that country would increase scrutiny of all the SWF’s investments—even ones made through ordinary market trading and which represent relatively small investments in terms of voting power. Other countries would also take notice of the use of such funds and may be wary about allowing the fund to invest (or continue to invest) in their markets. As a consequence, countries might subject the SWF’s investments to increased scrutiny, dramatically increasing the transaction costs for the fund. In other words, the Santiago Principles are successful in part because they are modest and practical—abiding by the principles makes sense for SWFs, and many funds would operate consistently with the spirit of the principles even if the letter of the principles did not exist.

VI. Conclusion

The Santiago Principles may harden over time as more countries join the IFSWF, which already has thirty-seven full members and a number of associate members, and the IFSWF has implemented a program whereby SWFs self-asses their compliance with the principles every two years. Funds are also encouraged to provide case studies on how they observe the principles in practice. Even as the practice around the implementation of the Santiago Principles seems to harden, they still seem supple enough to provide a resilient structure for the evolving nature of sovereign investment, including strategic investment. But important caveats must always accompany the Santiago Principles. They are voluntary, not enforced by independent parties, and not subject to penalties for compliance failures. It is not clear that a SWF would be forced out of the IFSWF if it was not able to comply with the principles. On the other hand, the principles are a clear, if not especially powerful, signal of adherence to basic standards of governance and operation, and all members benefit from a high-quality signal, providing an incentive to members and IFSWF staff to formally and informally pressure non-compliant SWFs. The IFSWF also can (and does) maintain standards by not extending offers of membership to SWFs that are not likely to comply with the principles.

Recognizing the reality that any voluntary set of practices are inherently limited in their power as a signal of governance credibility, the Santiago Principles provide a compelling example of how international soft law develops over time. And, as sovereign funds continue to grow in number and in assets under management, the importance of the principles has never been greater.

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