what-is-a-sovereign-wealth-fund-swf

Context: Russia's Sovereign Wealth Fund (RDIF) is in talks with Indian firms to manufacture Sputnik-V, Covid -19 vaccine currently undergoing trials.

Analysis

  • A Sovereign Wealth Fund (SWF) is primarily owned by the National Government or an entity that is commonly established from:
  • Balance of payments surpluses
  • Official foreign currency operations
  • The proceeds of privatizations
  • Governmental transfer payments
  • Fiscal surpluses and/or 
  • Receipts resulting from exports
  • These funds generally invest in financial instruments such as bonds, stocks, gold, and real estate. 
  • Some funds may invest indirectly in domestic industries
  • They tend to prefer returns over liquidity, thus they have a higher risk tolerance than traditional foreign exchange reserves
  • Sovereign Wealth Funds may have their origin in:
  • Commodities: Created through commodity exports, either taxed or owned by the government
  • Non-Commodities: Usually created through transfers of assets from official foreign exchange reserves
  • The definition of sovereign wealth fund does not include:
  • Foreign currency reserve assets held by monetary authorities for the traditional balance of payments or monetary policy purposes
  • State-owned enterprises (SOEs) in the traditional sense
  • Government-employee pension funds (funded by employee/employer contributions)
  • Or assets managed for the benefit of individuals

Objective of SWF

  • Generally, the country’s central bank is in charge of managing the reserves of the foreign exchange, and it aims at offering liquidity at times of crisis and market intervention. It doesn’t focus much on providing long-term returns. 
  • On the other hand, an SWF’s primary objective is to generate good returns over a long-term duration
  • SWFs are formed with the intent to protect and stabilise the budget and economy at times when the revenues and exports are excessively volatile
  • The SWFs ensure the long-term growth of the capital and diversifying the export of non-renewable commodities.
  • To assist the monetary authorities to dissipate any unwanted liquidity.
  • To increase savings for future generations.
  • Providing funds for the social and economic development of a country.
  • An SWF can be used to counter a recession and increased government spendings.

Background of SWF

  • Singapore’s Government Investment Corporation (GIC) is known to be the first SWF.

Operating Principle of SWF

  • The operating principles for SWFs were framed in 2008 to ensure that funds would act for economic growth. 
  • Santiago principles’ are laid down which dictates that a sovereign wealth fund must compulsorily invest for good returns and has a transparent structure
  • However, these rules apply only to those countries that volunteer to follow.

India’s Sovereign wealth fund: NIIF

  • The National Investment and Infrastructure Fund (NIIF) is India’s first Sovereign Wealth Fund (SWF). 
  • The NIIF was proposed to build an investment fund which offers long-term capital for infra-related projects, and the Indian Government would provide Rs 20,000 crore.

National Investment and Infrastructure Fund (NIIF)

  • It is a fund created by the Government of India for enhancing infrastructure financing in the country
  • The objective of NIIF would be to maximize economic impact mainly through infrastructure development in commercially viable projects, both greenfield and brownfield, [Terms already covered in Economic Survey] including stalled projects. 
  • It could also consider other nationally important projects, for example, in manufacturing, if commercially viable. [Remember: National Infrastructure Pipeline discussed in Economic Survey 2019-20]. National Infrastructure Pipeline can also financed through this fund.
  • Its creation was announced in the Union Budget 2015-16. 
  • NIIF is different from the National Investment Fund. 
  • NIIF was proposed to be set up as a Trust, to raise debt to invest in the equity of infrastructure finance companies such as Indian Rail Finance Corporation (IRFC) and National Housing Bank (NHB). ["Debt" involves borrowing money to be repaid, plus interest, while "equity" involves raising money by selling interests in the company.]
  • The idea is that these infrastructure finance companies can then leverage this extra equity. In that sense, NIIF is a banker of the banker of the banker.
  • NIIF is envisaged as a fund of funds with the ability to make direct investments as required. As a fund of fund it may invest in other SEBI registered funds.
  • Nature of Government Ownership [Handle with Care, Prelims + Mains] 
  • The proposed corpus of NIIF is Rs. 40,000 Crores (around USD 6 Billion). The initial authorized corpus of NIIF would be Rs. 20,000 crore, which may be raised from time to time, as decided by Ministry of Finance. Government can provide upto 20000 crore per annum into these funds. Government's contribution/share in the corpus will be 49% in each entity set up as an alternate Investment Fund (AIF) and will neither be increased beyond, nor allowed to fall below, 49%. The whole of 49% would be contributed by the Ministry of Finance, Government of India directly.
  • Cash-rich Central Public Sector Enterprises (PSUs) could contribute to the Fund, which would be over and above the Government's 49%. Similarly, domestic pension and provident funds and National Small Savings Fund may also provide funds to the NIIF
  • The contribution of Government of India to NIIF would enable it to be seen virtually as a sovereign fund [Hence, the name QUASI SOVERIGN FUND] and is expected to attract overseas sovereign/ quasi-sovereign/multilateral/bilateral investors to co-invest in it. EG: RUSSIA-INDIA HIGH TECHNOLOGY PRIVATE EQUITY FUND for joint implementation of investments into projects in India
  • The NIIF Funds work on a model whereby equity participation from strategic partners (including overseas sovereign /multilateral / bilateral investors) is invited, alongside Government’s contribution.
  • NIIF got registered with SEBI as Alternative Investment Fund (AIF) [ Discussed Below ]

Functions of NIIF [ Light Reading Suggested]

  • Fund raising through suitable instruments including off-shore credit enhanced bonds, and attracting anchor investors [Will be covered later] to participate as partners in NIIF;
  • Servicing of the investors of NIIF.
  • Considering and approving candidate companies/institutions/ projects (including state entities) for investments and periodic monitoring of investments.
  • Investing in the corpus created by Asset Management Companies (AMCs) for investing in private equity.
  • Preparing a shelf of infrastructure projects and providing advisory services.
  • It can also provide equity/quasi-equity support to those Non Banking Financial Companies (NBFCs)/Asset Management Companies (AMCs)/Financial Institutions (FIs) that are engaged mainly in infrastructure financing. [ Hence, NIIF is a banker of the banker of the banker.] 
  • As per the operational framework, NIIF is not a single entity. There can be more than one fund. 
  • The NIIF has been established as one or more Alternate Investment Funds (AIF) under the SEBI Regulations.
  • Alternate investment funds (AIFs) are regulated by the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, and classified under three categories – Categories I, II and III, from the angle of tax treatment under provisions of Income Tax Act. 
  • Since it was set up as Category II AIFs, the NIIF is eligible for a pass through status under the Income Tax Act. 
  • A 'pass-through' status means that the income generated by the fund would be taxed in the hands of the ultimate investor, and the fund itself would not have to pay tax on the same. 
  • As on date, 3 funds have been established by the Government under the NIIF platform and registered with SEBI as Category II Alternative Investment Funds individually.
  • National Investment and Infrastructure Fund II (“Strategic Fund”) is one of those three funds. 
  • National Investment and Infrastructure Fund (or Master Fund) and 
  • NIIF Fund of Funds – I. 
  • Strategic Investment Fund:  The objective of this fund is to invest mainly in the equity-linked instruments.
  • Master Fund: The master fund is an infra-related fund with the primary objective of developing roads, ports, and airports.
  • Fund of Funds: This fund invests in the funds operated by fund managers having an excellent history in infrastructure.