Sovereign wealth funds and the euro area: preliminary evidence

Prepared by Mar Domenech Palacios and Maurizio Michael Habib

Published as part of The international role of the euro, June 2024.

Sovereign wealth funds (SWFs) are state-owned investment funds or entities that are commonly established to manage the foreign assets of national states. They are typically categorised as stabilisation funds to finance budget deficits or balance-of-payments needs, savings funds for future generations, pension reserve funds, or reserve investment corporations established to reduce the carrying costs of foreign exchange reserves.^[1] Total assets of SWFs reached USD 12 trillion at the end of 2023 (Chart A), matching the equivalent held in global foreign exchange reserves.^[2] China hosts the largest SWFs, but other large SWFs are located in resource-rich economies or emerging markets with large current account surpluses. SWF assets are also highly concentrated: the SWFs of China, the United Arab Emirates, Norway, Singapore and Kuwait combined hold about two-thirds of total SWF assets.

Chart A

Total assets and annual gross purchases by SWFs

(USD billions)

The academic literature on SWFs is limited, largely due to a paucity of data and the limited transparency of their portfolios. The growing size of the assets managed by SWFs has attracted interest in their strategies and their impact on capital flows and financial markets, notably asset prices.^[3] However, SWF strategies in terms of investment destinations and currency preferences remain unexplored. This box presents preliminary evidence aimed at filling this gap. It uses data on a subset of transactions by 96 SWFs in 59 countries over the past 24 years, sourced from the Sovereign Wealth Fund Institute. The dataset is restricted to purchases of assets (i.e. it excludes sales). It provides information on the sizes and types of investment, including equities, hybrid financial instruments (such as convertible bonds), real estate private equity funds and venture capital funds. Purchases of debt securities are not covered in the dataset.^[4] The dataset provides information on the currency in which purchases have been executed. Currency considerations are generally more relevant for bonds than equities,^[5] but they are especially relevant for investments involving companies with dual listings, hybrid securities or depositary receipts, as well as for deals involving unlisted companies, which may be executed through financial conduits that may not use the currency of the country in which the target company is resident.^[6] Nonetheless, the available data cover a significant share of investments by SWFs. For instance, the ten largest reporting funds have seen cumulated transactions of around USD 2 trillion since 2000, or about one-quarter of their reported assets and about one-third of their equity holdings in 2023.^[7] Annual reported transactions peaked at around USD 250 billion in 2017 and have averaged about USD 150 billion subsequently (Chart A). The whole dataset covers cumulated transactions totalling USD 2.5 trillion since 2000.

Chart B

Destination and origin of purchases by SWFs since 2000

a) Breakdown of SWF purchases by region of destination of investments	b) Breakdown of SWF purchases by region of origin
(percentages)	(percentages)

Chart B shows how SWFs have allocated their purchases of assets since 2000. Panel a) breaks down investments by region of destination, while panel b) breaks them down by region of origin. Reported purchases of assets by SWFs are largely located in major advanced economies, such as the United States and the euro area, and in other advanced economies (Chart B, panel a).^[8] These account for around 70% of total reported purchases of SWFs since the beginning of the sample, while investment in emerging economies accounts for the remainder. Investment in the euro area, in particular, accounts for 14% of total reported purchases. Chart B, panel b shows that a significant share, almost 50%, originates from SWFs located in emerging economies, about 20 p.p. more than the share of these economies as a destination of investment. As a result, capital channelled through SWFs flows from poorer to richer countries in line with a well-known paradox in academic literature on international economics.^[9]

In terms of currencies, the US dollar is dominant in reported SWF investments, while the euro is the second most important currency. The US dollar accounts for more than two-thirds of SWF investment flows (Table A).^[10] The euro accounts for about 9% of total transactions in the dataset.^[11] Interestingly, more than 40% of purchases of euro area assets were in US dollars. For instance, this concerns purchases of equity of euro area firms listed in the United States.^[12], ^[13] Similarly, the US dollar shares of investments targeting assets in other advanced economies and emerging market economies are significantly large, at about 40% and 60% respectively. Admittedly, there may be reporting bias as regards acquisitions of unlisted equity.

Interestingly, there is also evidence that the euro is used in deals involving SWF acquisitions outside the euro area. A small share of purchases of assets outside the euro area, around 5-6%, was in euro, but only where the target company was located outside the United States. Deals involving US companies were almost exclusively denominated in US dollars. Euro-denominated deals often involved financial intermediaries or special purpose companies providing bridge financing in major currencies, such as the euro, to finance local projects.^[14]

All in all, preliminary analysis of SWFs suggests that the US dollar is often used as a vehicle currency for purchases of assets not involving US-based firms. The euro remains a distant second and is occasionally used to finance acquisitions by SWFs of firms located outside the euro area.