More low carbon or green investment is needed to achieve the Paris Agreement’s objective of net-zero emission by 2050. To facilitate such green investment, both public and private funds must flow into emerging green technologies. When examining avenues to nudge corresponding investment in global markets, which in turn impacts trade, it is imperative to turn our attention to Sovereign Wealth Funds (SWFs).  SWF’s are “special purpose investment funds or arrangements, created and owned by the general government to hold, manage, and administer assets, including foreign assets, to achieve certain financial objectives.”  

When it comes to the integration of sustainability into investment decision making, SWFs face an array of impediments, which include gaps in climate assessment, and sourcing suitable green investment into their portfolios. This piece argues that while the One Planet SWF Network’s (OPSWF) new climate-sensitive investment framework is a significant step towards alignment with the Paris Agreement’s net-zero goals, incorporating climate sensitivity into the Santiago Principles, the established international standard is needed to stimulate greater investment by SWFs into renewable technologies.

Redefining Governance: The Santiago Principles as Soft Law

To gain insight into sustainability and its potential relationship with SWF investment decision making, it is necessary to briefly peruse their history. Predominantly, a consequence of trade surpluses, sovereign states create SWF’s to pursue macroeconomic objectives through a wide variety of foreign investment strategies. For example, sovereign reserve funds (SRF), pursue high return-long term investments in foreign assets as a means to limit exposure away from domestic economics. On the other hand, a sovereign stabilization fund (SSF) utilizes surpluses from natural resource export and trade to cushion the impact of price volatility through low risk, short term investment. Though SWFs may differ in their underlying mandate, most presentday SWFs comprise diverse legal, institutional and governance structures that simultaneously pursue diversified investment strategies. 

At this juncture, it is important to bear in mind that SWFs possess vast capital at their disposal which grows each year. From the perspective of trade, when viewed domestically, investments from these vast pools of capital are critical to improving public finances, macroeconomic stability, and growth. When viewed globally, long term investments into foreign assets and private firms provide critical diversity to global financial markets. Those facts, apart from establishing that SWF investments are beneficial and critical to international trade, illustrate the need for a flexible structure of governance for SWFs to reduce protectionist pressures, and help maintain open and stable investment by SWFs. 

Recall that SWFs are portfolio management entities governed by host and home country legal and regulatory frameworks. The Santiago Principles, formalized as a set of voluntary non-binding commitments, do not impose obligations but rather reflect, among other things, good fund governance and best practices in investment decision-making in order to ensure the free flow of capital and that investment decisions are made independently, transparently, in compliance with foreign regulatory requirements. Intriguingly, the Principles approach the status of soft law for a variety of reasons. First, the Principles are based on widely accepted practices and existing principles in the realm of foreign investment and international trade. Second, as a set of operational standards, they provide a focal point for incremental harmonisation in risk management, financial diligence, and transparency among diverse legal frameworks that govern SWFs. Concomitantly, the Principles enable newly established countries to develop, strengthen, and harmonize their investment practices with existing SWFs. Overarchingly, periodic self-assessments of existing SWF practices under the framework of the principles contain pertinent nudges towards harmonization. Distinctly, the flexible and general nature of the principles permit a variety of governance and legal structures that embody essential precepts and, in so doing provide for a greater degree of inherent compliance to the principles, cementing their crystallization into an instrument of soft law. 

Fostering Sustainability: The Intersection of OPSWF, Santiago Principles, and Climate Action

In the realm of investment, to address sustainability several SWFs, asset managers and private equity funds have committed to align and integrate climate sensitivity into investment decision making through the OPSWF. While the OPSWF may be useful in bolstering sustainability in light of the Paris Agreement’s objective of net-zero emissions, within the realm of SWF governance, integrating the principles of sustainability into the Santiago Principles would better promote green investment. Although there may be ways to view the OPSWF and the Santiago Principles in harmony, the OPSWF has the potential to divide the SWF community through a network with separate, albeit more focused, best practices.  Furthermore, as state actors/public investors, SWFs differ from private equity funds in fundamental ways.  Their relationship to the public purse, notably the sovereign budget, their reporting obligations and oversight by ministries, legislative bodies, and the public, to which they are accountable and their governance structures, are aspects that bear little in common with opaque private investment vehicles. 

Taking a step back, the Paris Agreement is structured as a treaty or compact, which provides each sovereign signatory discretion in implementing the climate mitigation and adaptation measures.  Concomitantly, State and private entities, in attempting to comply with the principle object of the Paris Agreement may pursue a number of pathways both within and outside the umbrella of the agreement. The OPSWF is one such pathway that serves as a focal point of coordination for sustainability in investment decision making. For example, the OPSWF addresses critical issues such as the development of agreed standards to promote the publication of material climate-related data and analytical assessments tools for strategic decision-making, both of which are impediments to sustainable cross-border investments. 

Conclusion

Though the OPSWF addresses critical gaps in sustainable investment, integration of sustainability into the Santiago Principles would seem to be better route to incentivize SWF investment into green technologies. While the OPSWF is a salutary development, it does not require its members to meet any performance metrics or even to meet self-determined targets each year. For example, some OPSWF members maintain sizeable exposures to oil, gas and other carbon polluting assets. As opposed to pursuing sustainability through a competing framework, integration of climate sensitivity into the Santiago Principles capitalizes on the consensus the Principles embody and the authority they have acquired over time.  Furthermore, recall that the Principles address investment practices by SWFs. In this light, incorporating sustainability as a value in the Principles would encourage the integration of sustainability into portfolio management in individual SWFs.  Moreover, an integration of climate sensitivity into the Principles not only lends credence to their position as soft law but also nudges domestic legal change in the form of regulatory frameworks that encourage, or at the very least do not impede, investment in green technologies.

Alissa Ardito Ashcroft is a Senior Counsel at the Legal Department of the International Monetary Fund. Faiz Sait is an LLM Candidate at the Georgetown University Law Center.

Disclaimer: The views expressed are the personal views of the author and should not be attributed to the Fund, its Executive Board, or its Management.