The need to increase the transparency of SWF operations should not be allowed to eclipse their potential benefits. As long-term investors, SWFs can help to reduce market volatility through financial intermediation, as well as contribute to financing projects with positive but long-term rates of return.
Furthermore, SWFs have comparative advantages over other kinds of institutional investors. Unlike insurance companies and pension funds, they have no long-term debt or future payment obligations. And, as public investors, they are likely to have a better understanding of investment projects that depend on public policy. Given these advantages, SWFs play a large — and growing — role in infrastructure finance.
New financial regulations — Basel 3 for banks and Solvency 2 for insurers — are reinforcing these advantages. While the regulations are likely to reduce the likelihood and impact of financial crises, they will also make long-term loans more expensive and investments in illiquid assets riskier.
As a result, banks and insurers might disengage from infrastructure finance, creating more opportunity at lower cost for SWFs. Given that infrastructure is crucial to sustainable development, this could eventually lead SWFs to become key players in this area.
To achieve this, SWFs must alter their investment pattern. In 2011, SWFs invested US$35.2 billion in financial services, US$13.4 billion in property, US$13.2 billion in fossil-fuel resources (mainly oil and gas), US$6.5 billion in infrastructure and utilities, and US$3.4 billion in aircraft, car, ship and train manufacturers. Given that SWF’s primary objective is to transfer wealth to future generations, their high level of exposure to fossil-fuel markets is unsustainable.
Indeed, the remaining carbon-emissions “budget” until 2050, adherence to which is required to limit the global temperature increase to 2oC, is five times smaller than the carbon equivalent of proven fossil-fuel reserves. This means that only 20 percent of these reserves, based on which SWF assets are valued, can be burned unabated.
Some SWFs in the Middle East and Asia seem to understand the risks associated with carbon-heavy investment portfolios and are ready to work together to create a platform to finance resource-efficient, low-carbon, environmentally friendly infrastructure projects. Indeed, the idea was discussed in January at the World Future Energy Summit and the International Renewable Energy Conference in Abu Dhabi.
This initiative should be supported unequivocally, serving as a springboard for a stronger focus on green investment among SWFs. With the right approach, SWFs can offer significant long-term benefits to all.
Emmanuel Guerin is program director for climate at the Institute for Sustainable Development and International Relations in Paris.
Copyright: Project Syndicate