UK Sovereign Wealth Fund

 

WEEKLY COMMENT 23-07-2015

By Barry Edwards

UK Sovereign Wealth Fund

On Monday this week in the Financial Times (FT) in the FTfm section there was an article about establishing a UK sovereign wealth fund. This has been a topic that has come up on regular occasions but never really explored properly by the financial community. The ultimate purpose is to provide a mechanism to fund infrastructure in the UK. The government has tried to attract interest from pension funds and other institutional investors but the initial construction risk has been the limitation for their involvement.

The FT article refers to a conference held by Newton Investment Management and Cambridge University about creating a sovereign wealth fund. It also mentions a paper by Rob Thomas of the Wriglesworth Consultancy (now part the Instinctif Group) published last year that suggests using the government bonds purchased by the Bank of England to be progressively sold in the market to provide the funds for infrastructure investment. His paper is very informative about the procedures the central banks have used to control the financial system during the financial crisis and the effectiveness of their actions with a conclusion suggesting the creation of an infrastructure fund. If you would like to read his paper click on the link below;

http://www.wriglesworth.com/images/Unconventional_monetary_policy_explored_-_the_case_for_replacing_QE_with_a_sovereign_wealth_fund.pdf

The first part of the conclusion in the paper is below;

  ‘’we believe that the authorities should consider establishing a sovereign wealth fund with the proceeds from the sale of the gilt portfolio built up through QE, to invest in UK infrastructure projects.

This policy solution offers a direct mechanism for boosting demand without the suspicion that the central bank is underpinning political decisions to run fiscal deficits, while it avoids the need to stimulate further debt accumulation in the private sector. Because it would use the funds created by QE, this new body could be described technically as a “monetary investment fund”.

A new body would need to be established as a subsidiary of the Bank of England but with operational independence to make the investment decisions and oversee the operation of the fund. QE could be unwound through a gradual sale of gilts back into the market to be co-ordinated with the new fund’s investments in UK infrastructure projects.’’

This weekly comment has been proposing something similar to this for some time and you can see the papers in the right hand column of this page in ‘categories’ namely ‘The Economic Growth Plan’ and ‘Suggestions for the Resolution of EU Bank Recapitalisation’.

The fundamental point about this concept is that the financial system has not yet evolved to provide the funding for infrastructure or commercial projects in a format that is accessible by governments or the majority of businesses which has been restricting investment in this country and all developed economies for some time. In the main it is only governments and very large companies that can borrow with guarantees to fund projects.

Changing the whole structure of project finance would be of enormous benefit to all countries by creating a stimulus for capital investment and growth potential for many companies. It would generate substantial tax revenue for governments and increase growth in all economies as the benefits of the investment filter through. Most countries require infrastructure modernisation; the financial demands are so vast that they are way beyond most government budget capabilities, especially in periods of recession. The EU has recognised this problem and has created the Juncker fund solely for this purpose which we have discussed in this weekly comment several months ago (27-11-2014).

The advantages of adopting the proposal presented in Rob Thomas’s paper are that there is no cost to the finely balanced government budget and the country will be able to invest substantial sums in the infrastructure which badly needs upgrading in all regions. The boost this will give to the economy, if the plan is adopted soon, will transform the commercial opportunities for the country making it a very attractive place for investment. It is also important that part of this money is made available to companies to achieve their ambitions to develop a high quality technology based manufacturing capacity to be able to compete with the best in the world. This should be done in conjunction with more investment in research and development which has been lacking in the long-term planning that is required to create new products to meet the demands of the modern digital and biotechnology age.

A sovereign wealth fund that can incorporate all these aspects would incentivise many businesses to invest and grow with the knowledge that the funding will be available for advanced technologies which require long-term investment schedules. This kind of funding has never been accessible in any size in the UK and would allow companies to incorporate this investment with their own capital expenditure in exchange for an equity return for the fund.

Fortunately, the country has recovered from the devastating recession recently experienced and is in a position to respond to the request to take advantage of this opportunity that has never been offered by any organisation previously. The fund would play an effective positive role in the progress of the economy and should be well received in all quarters.

That’s all for this week, more observations next week.