The new lords of global finance

What's special about these funds?
The fact that they're owned by governments. Variously known as sovereign funds, "sovs" or SWFs, these huge state-owned investment funds usually amass their cash from oil and commodity revenues or foreign exchange. The first sovereign fund was set up by Kuwait in 1953, but numbers have multiplied in recent years. There are now around 40 active globally, worth around $3 trillion in total. The most prominent are based in Asia and the Middle East (the Abu Dhabi Investment Authority, with assets of $875bn, is the 'big Daddy' of the sovs), but they also crop up in eastern Europe, Russia, Latin America and Africa; even Libya has a $50bn fund. Norway has one of the largest, formed in 1990 to finance future pensions provision.

And what lies behind all the recent fuss about them?
A growing fear that these opaque and sometimes secretive funds, many of which are owned by undemocratic governments, are becoming the new rulers of global finance. After years of operating quietly in the shadows, investing in uncontroversial assets such as US Treasury bonds, SWFs have begun taking sizeable stakes in Western companies and banks in a quest for better returns. Many analysts now argue that 2007-08 will go down as a watershed year in the shift of economic power to the East. Some even fret about the spectre of "reverse imperialism".

But can't that threat be rebuffed?
Until recently, it often was: two years ago the US snubbed Dubai's attempt to buy several of its ports, citing "national security"; and there was a similar fuss in Britain when Qatar seemed bent on acquiring Sainsbury's. But the onslaught of the credit crunch has scotched most of these scruples: crumbling banks had little choice but to welcome some $70bn of emergency cash injections from the giant funds of the East, signing over large chunks of Wall Street equity to Abu Dhabi, Singapore and China. Last month the British bank Barclays called on foreigners for a second time: SWFs have pledged to meet nearly half of the £4.5bn share issue.

And are fears of the growing power of sovs justified?
Sceptics argue that lurid stories of power-crazed Arab sheikhs and Chinese communists bent on world domination are the product of hype and xenophobia; and that at $3 trillion, SWF assets are small beer compared with the $53 trillion that "mature market" institutional investors oversee. But that discounts the breathtaking speed at which sovs are accumulating cash: the Gulf states alone are thought to pull in $1.5 billion a day from oil revenues, and the IMF estimates that sovs will be worth $12 trillion by 2012. Some economists predict that in five years theyll be able to buy a third of all equities listed on world stock markets. They've already plucked several national "crown jewels": for example over a third of the London Stock Exchange is owned by Qatar and Dubai.

But have SWFs acted improperly?
Not at all, to date. On the contrary, long-established funds such as Kuwait's have been models of apolitical financial deployment. Indeed, many Western bankers claim that, in marked contrast to the short-termist profiteers in the hedge fund and private equity worlds, they are dream investors. As Mark Bradley of Morgan Stanley notes, sovs tend to be "massive, passive and patient", taking longterm positions that should, in theory, reduce volatility in markets.

Then what's the problem?
Hitherto, the main motivation of SWFs has been, just like any private investor, financial returns. But this may not always be so. Russia's sovs, for example, are a far cry from the market-savvy funds of Singapore, and it would be naive to dismiss the idea that these huge state-owned funds might one day be used to exercise political power in ways deeply uncomfortable for the West. Then there is the problem of transparency. Few sovereign funds have embraced the example of Norway, which has an exemplarily open policy of disclosing its full investments. Most, according to the IMF, are "black boxes". Under such circumstances, it seems only prudent to draw up new rules to regulate them.

And what steps are being taken in that regard?
The World Bank and IMF are working on a voluntary code of conduct of practice, but there is nothing to compel sovs to sign up to it. The upshot is a fragmented series of rules, with some countries taking more draconian steps than others. Germany, for instance, has drafted a law enabling it to veto non-EU takeovers and has plans to create a super-fund to defend national "crown jewels". Some in the US Congress are lobbying for similar action. Britain takes a more fl exible line, saying that existing competition laws are suffi cient to prevent market abuse, but there are moves afoot to persuade sovs to sign up to the same transparency guidelines now applied to private equity investors. In practice, however, the greatest restriction on SWF foreign expansion is likely to spring from a backlash in their home countries. There is growing concern in China, for example, at the huge paper losses incurred by two state corporations, following earlier forays into Barclays and the US private equity giant Blackstone.

Does Britain have its own sovereign wealth fund?
No. It's a sad case of what might have been. As John Hawksworth of PriceWaterhouseCoopers recently argued in his essay Dude, Where’s My Oil Money?, Britain's North Sea oil wealth, had we chosen to save it, could have financed a national fund far larger than Norway's $380bn pensions stash. Instead, successive governments spent most of the cash, as Hawksworth puts it, on keeping taxes "lower than would otherwise have been possible without rising debt levels or sharp cuts in public spending". A good deal of it ended up in bricks and mortar. ·