At last, the West has persuaded the 26 governments, which own sovereign wealth funds, to abide by a voluntary code of practices and principles brokered by the International Monetary Fund (IMF) to ‘demystify’ their investment operations.

The agreement was reached on September 2 in Santiago, Chile, between the two sides under the auspices of the International Working Group of Sovereign Wealth Funds (IWG), organised by the IMF and co-chaired by Abu Dhabi. The draft agreement which covers 24 generally accepted principles and practices is yet to be officially approved by each country’s government before being presented to the IMF on Oct 11.

The accord also commits the funds to avoid, what the western media and business leaders have so stridently been pointing out, investing “to achieve political goals” which means the sovereign wealth funds should make their investment transparent and only commercially motivated, which in fact it already is.

Observers interpret this clause to mean that the SWFs are required to restrict their investments to a certain extent for many (hawks) in the West fear that if the Arab and Asian governments were to ‘ over-invest’ in their countries, they could one day assume “a colonial role” there and “play a political role” as they themselves did in the non-West world in the past centuries.

It is interesting to observe that The Independent, a British daily, used the word “ban” to say that the agreement prevents the SWFs from taking ‘investment decisions on political grounds.’ Although it is obvious that purpose is to show contempt for and portray the SWFs as “undisciplined” investors and hence a threat to host economies, one may ask, can the West also consider to “ban” its multinationals which openly play ‘political roles’ in binging down ‘democratic’ governments in the Third World, as did the ITT in Chile in the 1970s?

Anyhow, the Santiago accord removes the ‘political obstacles’ in the way of the SWFs and should put to rest the protectionist rhetoric against them. A notable manifestation of this attitude was the attempted buyout of UK port company P&O’s US port operations by a Dubai-owned investment fund, which was vigorously opposed by the Bush administration in 2006. Later, the US operations were instead sold to American company AIG.

The agreement also strives to avoid promising any disclosures that makes it difficult for SWFs to invest profitably. In fact, intensive negotiations took place in the two-day meeting on the need to preserve the economic and financial interests of the sovereign wealth funds, so as not to put them at a disadvantage when compared to other types of investors such as hedge funds, insurance companies, and other institutional investors.

The group agreed to publish a survey of SWFs this month to shed more light on what they are and how they invest. A permanent group of SWFs will soon be set up to monitor the agreement’s impact, facilitate dialogue between the funds and recipient nations and make any necessary modifications to principles and practices.

Many western economists hold the SWFs in high esteem for helping to recycle massive trade surpluses back into the global economy, a practice that has helped keep global interest rates lower, particularly in the United States, where the funds are important buyers of US debt. As they have grown in size, however, they have begun to make larger investments in a more diverse range of assets, including hedge funds, private equity firms and buying direct stakes.

And when their investments began playing a positive role amid this year’s financial crisis in rescuing ailing banks, from Morgan Stanley to UBS, the size and stature of some recent investments — like Abu Dhabi Fund’s $7.5 billion purchase of a 4.9 per cent stake in Citigroup last year — was seen enough to raise protectionist clamours. The benign aspect of the investments was simply ignored by the media.

Now some governments have decided to scrutinise key sovereign investments. Germany, for instance, last month approved a bill that will require any purchase of more than 25 per cent of a local company by investors from outside the EU to seek government approval. The new law would allow the government to veto such investments in German companies that threaten public order and security.

To defuse this kind of pressure and ‘politicised’ discrimination, Abu Dhabi and the other governments set up in May the IWG within the IMF. The group includes four of the six members of the GCC as well as Australia, Azerbaijan, Botswana, Canada, Chile, China, Equatorial Guinea, Iran, Ireland, South Korea, Libya, Mexico, New Zealand, Norway, Russia, Singapore, East Timor, Trinidad and Tobago, and the US.

Oman, Saudi Arabia, Vietnam, the Organisation for Economic Co-operation and Development (OECD) and the World Bank are included as permanent observers.

Some SWFs, annoyed at the criticisms levelled against them, explained that they have only tended to be long-term investors, taking only small stakes in companies and rarely exerting influence over management, much less politics.

After four months of talks, the IWG gathered early this month at Santiago for two days of tense bargaining. The delegates from both investor nations and recipients debated how much transparency and disclosure was necessary or fair. Some delegates argued that divulging more details about themselves and their investments would put SWFs at a disadvantage in markets to other investors that do not offer the same levels of disclosure. And that higher levels of transparency would make some investors reluctant to invest alongside SWFs, and even make some potential recipients of funds reluctant to take sovereign investments.

John Lipsky, deputy managing director of the IMF, was quite fair in his comments at the Santiago meeting and made it clear that that sovereign wealth funds have played a positive “shock-absorbing role” during the credit crisis, helping to recapitalise distressed financial companies and stepping in to replace traditional investors. It is their increasing prominence which has, in fact, raised national security questions, he said. Although it is clear, he said, these concerns have little or no basis in the way SWFs, which manage around $2-3 trillion in assets between them, have operated up to now, it is, however, important to avoid negative perceptions or run the risk of a protectionist backlash. “In practice, sovereign wealth funds play a stabilising and positive role in international markets,” Lipsky said.

According to Gerard Lyons, the chief economist at Standard Chartered Bank, the whole noise is a reflection of a shift that is taking place in the world economy under which developing countries and the SWFs, in particular, are becoming more important. The fact remains that the SWFs are not new, it is the acceleration of their investment that has changed the temperature.

The shift in financial power, some economists think, is of historic magnitude, a much bigger shift than that took place for example after the oil shocks of the 1970s and 1980s. One has to appreciate the scale of what is taking place. The facts suggest that governments in the Middle East and Asia are now the largest category of net investors in western equity and bond markets.

Writing in The Independent, Hamish McRae says the power will shift, there is no doubt about that. And the ethical and environmental values of these “new” investors will come to rank higher in the spectrum, and the values of the present investment community will tend to lose sway. The shift will be gradual, of course. Different SWFs will have different objectives.