Iain Morse outlines the development of Russia's two sovereign wealth funds
Will Russia buy bonds and help the euro-zone out of trouble? Not so long ago the idea would have seemed laughable. Not now. Russia has huge asset reserves, unlike most European countries. This reversal of fortune has yet to be fully appreciated. How did it come about?
In 2004, then President Vladimir Putin set up the Stability Fund (SF) to receive tax and duties derived from natural resources. By 2008, the Stability Fund held €116bn. A decision was taken to split the Stability Fund into a Reserve Fund, and a National Wealth Fund. The Reserve Fund was charged to balance federal budgets in the event of oil and gas price volatility. The National Wealth Fund augments the pay as you go first pillar pension system.
These funds are closely linked to Vnesheconombank (VEB), a state owned bank which also functions as an asset manager for public funds. The VEB's history stretches to the earliest days of the Bolshevik regime. It is an instrument of state policy, crisis ridden under Gorbachev and Yelstin, reconditioned and revived under President Putin. Putinist management of the Russian economy has developed around the exploitation of natural resources as a means of paying for the state.
This model of vertical integration, the state overseeing enterprises which own, extract, process and deliver oil and gas to market is core to the Putinist system. For instance, in 2008 VEB received €11bn from the ministry of finance, re-lending this to Russian companies seeking to refinance loans from foreign lenders in foreign currencies taken before 2008. Of this amount, 65% went to the Russian smelting industry, 15% to oil production and 16% to high technology.
Despite the state's proactive role in the economy, even sceptics admit that the Reserve Fund has been adequately run. Putin's bitterest critics, and there are many, have failed to demonstrate any level of theft or misappropriation from the fund. Like so much else, management is executed by the ubiquitous ministry of finance, with the Bank of Russia as a default operational manager. However since inception it has also used non-domestic, notably German and American banks.
This is hardly surprising given the range of investments permitted to the fund which has a current value of €19.6bn. These are through the purchase of three foreign currencies: dollars, euro and sterling. The fund has no allocation to rouble assets. Respective allocations to assets denominated in each of these currencies should not exceed 45%, 45% and 10% of the total value of the fund. In addition, the fund can purchase a range of financial assets denominated in these currencies. Broad investment guidelines for the fund are laid out in the Russian Federation's annual budget code. The ministry of finance then sets strategic asset allocation limits within these constraints.
The current guidelines are as follows; debt securities in foreign governments, 50-100% of fund value, debt securities of foreign state agencies and central banks, 0-30%, supranational debt securities, 0-15%, and deposits in foreign banks and deposit takers, 0-30%. Eligible countries are Austria, Belgium, Canada, Denmark, Finland, France, Germany, Luxembourg, the Netherlands, Sweden, the UK and the USA.
The current tactical allocation for each eligible asset class is currently set at 100% in sovereign debt and 0% in all the others. The fund may hold instruments outside this allocation but will not purchase any new ones without a stated change of policy.
Stringent eligibility controls are also in force using the credit ratings of any entity issuing debt instruments; these must be given a long term AA+ rating or better by Fitch and S&P, or a Aa3 rating from Moody's. Debt instruments must have a fixed maturity date, cannot be redeemable, or callable, and cannot carry a put option. Coupon rates and face values must also be fixed at issue. Both the face values and any interest paid must also be denominated in one of the three permitted currencies. The outstanding value of each eligible debt issuance is also subject to minimum limits; $1bn (€747m), €1bn and £500m (€585m). Euro and dollar denominated instruments are permitted a maturity range of three to 36 months at purchase, those denominated in sterling have an extended maturity range of three to 60 months. In addition, the fund should purchase no more than 10% of the notional value of any individual issue of debt instruments.
These investment limits are rigidly enforced leaving no discretion to the fund's managers. This is a different situation to that of many broadly comparable sovereign wealth funds from the Middle East where wide discretion is permitted and some investments are made for overtly political reasons. Investment guidelines are equally transparent and only slightly more permissive for the National Wealth Fund (NWF), with a currently holding assets worth €67.6bn.
Like the Reserve Fund, the NWF is managed on a day to day basis by the ministry of finance. Current investment guidelines include debt securities of foreign state, 0-100% of the total fund value, debt securities in foreign state agencies and central banks, 0-30% , supranational debt securities, 0-15%, banks deposits, including VEB, 0-40%, deposits in the Bank of Russia, 0-100%, debt securities issued by corporate entities, 0-30% and listed equities 0-50%. In the past, the Reserve Fund was encouraged by President Putin to purchase shares in crisis hit Russian companies and has periodically done so.
Unlike the Reserve Fund, the NWF funds can be denominated in US dollars, euros, sterling and roubles. As with the Reserve Fund the guidelines are subject to current tactical asset allocation limits set by the minstry of finance which includes currency allocations. At present these allow the NWF to hold up to 90% of fund value in debt securities issued by foreign countries and denominated in one or more of the approved currencies, up to 10% in bank deposits one of the three permitted foreign currencies and up to 100% in rouble denominated bank deposits.
The same eligibility criteria apply to debt issuing entities for the NWF as for the Reserve Fund. When tactical asset allocation guidelines permit the NWF to purchase equities, these must be listed on a recognised exchange; foreign equities must also be included in the MSCI World index and FTSE All World index, while Russian equities must be in the MICEX or RTS Indices. The NWF also uses the VEB; it has a series of fixed term and interest deposits with the bank. These include deposits maturing in 2020 with a fixed interest of 7.25%. The NWF, incidentally, will not receive new monies until 2014, a reflection of its current funding position.
Whether Russia helps bail out the euro remains to be seen. But it has helped Cyprus, the offshore financial centre through which many Russian oligarchs channel their monies, with no less than €2.5bn.