Game theory and sovereign wealth funds
| Published date | 04 February 2014 |
| Date | 04 February 2014 |
| Pages | 61-76 |
| DOI | https://doi.org/10.1108/JFRC-12-2012-0049 |
| Author | Harry McVea,Nicholas Charalambu |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
Game theory and sovereign
wealth funds
Harry McVea
School of Law, University of Bristol, Bristol, UK and
Institute of Advanced Legal Studies, London, UK, and
Nicholas Charalambu
University of Bristol, Bristol, UK
Abstract
Purpose – The purpose of this article is to assess strategies available to recipient states for managing
the putative risks posed by sovereign wealth funds (SWFs) in the context of global, liberalized, and
capital markets.
Design/methodology/approach – The paper employs a game theory analysis in assessing these
risks. Four basic scenarios are outlined whereby recipient states may interact with SWFs: “unselfish
recipientstate – unselfish SWF” (Option 1);“unselfish recipient state – Selfish SWF” (Option 2); “Selfish
Recipient State – unselfish SWF” (Option 3); and “Selfish Recipient State – Selfish SWF” (Option 4).
Findings – In the light of this analysis, and the balance of risks which the authors perceive recipient
states are exposed to in practice, the authors claim that recipient states ought, rationally, to adopt a
selfish regulatory strategy irrespective of the strategy which SWFs adopt in practice.
Originality/value – This claim does not deny the importance of voluntary international measures –
such as the “Santiago principles” – in the way SWFs are regulated. Rather, it seeks to show that
according to a game theory analysis, and an attempted application of that analysis in practice, undue
reliance by recipient states on international “soft law” regulatory initiatives to regulate SWF activity
(which constitutes the current international consensus) is strategically unwise.
Keywords Sovereign wealthfunds, Santiago principles, Gametheory, Prisoners’ dilemma, Softlaw
Paper type Viewpoint
1. Introduction
Although there is currently no agreed definition of the term “sovereign wealth fund”
(SWF), the International Working Group of Sovereign Wealth Funds (IWG) has defined
such entities as (IWG, 2008, p. 3):
[...] [s]pecial purpose investment funds or arrangements, owned by the general government
[...] for macroeconomic purposes[.] SWFs hold, manage or administer assets to achieve
financial objectives, and employ a set of investment strategies which include investing in
foreign financial assets [...] SWFs are commonly established out of balance of payments,
surpluses, official foreign currency operations, the proceeds of privatisations, fiscal surpluses,
and/or receipts resulting from commodity exports (footnotes omitted).
As investment vehicles which are, in effect, owned, funded and operated by sovereign
states, SWFs provoke a variety of reactions. For some, they are “saviours” in
straightened economic times (McCreevy, 2008); for others, they are the “new barbarians
at the gate” (Kleinman, 2007) – little more than a modern form of “Trojan horse”
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1358-1988.htm
The authors are grateful to Peter Cumper, Marc Moore, AJ Eriksson, Simon Modal, Karim Yeung,
Sophie Lens, Alison Kelso, and Moira O’Hagan for comments on previous versions of the paper.
Journal of Financial Regulation and
Compliance
Vol. 22 No. 1, 2014
pp. 61-76
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/JFRC-12-2012-0049
Game theory
and sovereign
wealth funds
61
(Fleisher, 2008, p. 96). For most, however, SWFs are actors – if increasingly important
ones – in a broader story about the liberalization of international capital flows. Set
within this context, SWFs offer the prospect of unlocking latent economic wealth in
ways that are mutually beneficial to donor and donee states, albeit that they
simultaneously pose potential, if diffuse, dangers to the longer term economic interests
of recipient states. Characterised in these more moderate though nonetheless
problematic terms, there has existed for some time widespread recognition – both
nationally and in global for a – of the need for some form of reasonable
accommodation of the interests of donor and donee/recipient states.
In addressing the broader question of how best to approach the regulation of SWFs,
this article considers the issue from the perspective of recipient states. Such states have
much to gain from the injection of SWF capital, but also potentially much to lose from
the operation of these funds within their territorial borders. By employing a version of
game theory, which allows for an analysis of the choices made by competing “players”
(here recipient states and SWFs), the article seeks to identify and assess strategies
available to recipient states for managing the perceived risks posed by SWFs in the
context of global, liberalized, capital markets. Four basic scenariosare outlined whereby
recipient states may interact with SWFs: “unselfish recipient state – unselfish SWF”
(Option 1); “unselfish recipient state – selfish SWF” (Option 2); “selfish recipient state –
unselfish SWF” (Option 3); and “selfish recipient state – selfish SWF” (Option 4).
In the light of this analysis, and the balance of risks as we perceive them in practice,
we argue that a form of selfish recipient state regulation should be employed when
responding to SWF activity within their borders. Simply put, we suggest that recipient
states ought actively to manage the potential risks associated with SWF inv estments,
and that undue reliance on international “soft law” efforts to regulate SWFs represent
at best an unreliable and at worst an irresponsible policy choice. This argument does
not, however, deny the importance of international initiatives – such as the Santiago
principles – to improve levels of transparency and accountability in SWF
management, since such efforts are likely to contribute to higher levels of certainty,
particularly in the context of SWF investment in the financial sector – an area which
has been a major focus of recent SWF investment and one which remains susceptible to
systemic risk. Rather, the point we seek to make is that according to a game theory
analysis and an application of that analysis in practice, over reliance on such
international “soft law” initiatives is strategically unwise.
2. The rise and rise of SWFs
SWFs have existed for over half a century. For example, the Kuwait Investment
Authority has existed since 1953 and the Kiribati Revenue Equalization Reserve Fund
since 1956. Nevertheless, around 60 percent of the SWFs active today have been set-up in
the past decade or so[1]. Many of these funds are associated with Middle Eastern
countries which have experienced windfall oil revenues, such as the Abu Dhabi
Investment Authority (ADIA) in the United Arab Emirates – the world’s largest SWF –
or the Future Generations Fund located in Kuwait. Also popular as a place of origin for
SWFs are a number of developing Asian nations experiencing high surpluses in trade
over the last ten years or so – such as the China Inv estment Corporation of China and
Temasek Holdings of Singapore. That said, SWFs are also located in many other
jurisdictions experiencing simi lar oil or trade surpluses, such as in Norway,
JFRC
22,1
62
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