In an in­ter­view in June that was pub­lished in the sum­mer edi­tion of the Sov­er­eign Wealth Fund Bul­letin, for­mer Gov­er­nor of the Cen­tral Bank Ewart Williams sug­gests that con­sid­er­a­tion should be giv­en to us­ing T&T's for­eign re­serves for short-term sta­bil­i­sa­tion pur­pos­es and leav­ing the Her­itage and Sta­bil­i­sa­tion Fund for long-term sav­ings.Williams was in­ter­viewed by Eliot Kalter and Patrick Schena, the co-heads of the Sov­er­eign Wealth Fund Ini­tia­tive at the Cen­tre for Emerg­ing Mar­kets En­ter­pris­es at The Fletch­er School at Tufts Uni­ver­si­ty.

Eliot Kalter (EK): This month's Sov­er­eign Wealth Fund Bul­letin is about ca­pac­i­ty de­vel­op­ment, get­ting at how to build a fund and how to run and staff it ef­fec­tive­ly. I think yours is a great ex­am­ple to think about. One of the things we want­ed to get a sense for is whether, as you think back, the fund evolved in a way that is con­sis­tent with your ear­li­est ob­jec­tive in putting the fund to­geth­er. Did it evolve as you an­tic­i­pat­ed?

Ewart Williams: Our econ­o­my ben­e­fit­ted tremen­dous­ly from the two oil booms of the 1970s. But, like many coun­tries, we spent the wind­fall and more. When the col­lapse of oil prices came in the 1980s, we were un­pre­pared in part be­cause the in­creased spend­ing did not con­tribute suf­fi­cient­ly to an in­crease in pro­duc­tive ca­pac­i­ty. Our econ­o­my was forced to go through a pe­ri­od of ro­bust ad­just­ment. We need­ed an IMF pro­gramme: we had a large ex­ter­nal debt so we need­ed to get through the clas­sic resched­ul­ing. Al­so, we had a struc­tur­al ad­just­ment pro­gramme with the World Bank. The ad­just­ment pro­gramme im­posed a tremen­dous amount of hard­ship on the peo­ple and we learned our les­son.

When oil prices start­ed to re­cov­er, the Gov­ern­ment, at the time, start­ed to put mon­ey aside in an in­ter­im rev­enue sta­bil­i­sa­tion fund, and that went on for about five or six years.

The new ad­min­is­tra­tion, which as­sumed of­fice in 2002, start­ed work­ing on a per­ma­nent sta­bil­i­sa­tion or her­itage fund-one backed by a leg­isla­tive frame­work.

It took five years to do the re­quired prepara­to­ry work and in ear­ly 2007, the Her­itage and Sta­bil­i­sa­tion Fund (HSF) was for­mal­ly ap­proved by Par­lia­ment. It was, in a way, com­pro­mise leg­is­la­tion.

We start­ed to think about a fund along the lines of the Nor­we­gian mod­el. We were think­ing about es­sen­tial­ly a sav­ings fund, putting mon­ey aside for fu­ture gen­er­a­tions, recog­nis­ing that oil and gas were wast­ing as­sets. The idea was to build up a nest egg, to be able to live on the re­turns from these funds when oil and gas sup­plies dwin­dled.

But it wasn't easy to con­vince the gov­ern­ment of the day to sim­ply save when we had so many im­me­di­ate needs. The ques­tion was bal­anc­ing im­me­di­ate con­sump­tion with long-term sav­ings. Some peo­ple ar­gued that if you want­ed to pro­vide for gen­er­a­tions, the strat­e­gy should be to quick­ly de­vel­op our pro­duc­tion ca­pac­i­ty.

While the Gov­ern­ment agreed with the need for sav­ings, they in­sist­ed on a sta­bil­i­sa­tion com­po­nent to main­tain ex­ports when oil prices fell.

Was part of that com­pro­mise be­cause some peo­ple said that you want­ed the mon­ey to build up re­serves as a Cen­tral Bank rather than save it or spend it?

At that time the is­sue was not build­ing up re­serves. The coun­ter­ar­gu­ment was to build a fund for in­fra­struc­tur­al in­vest­ment to ac­cel­er­ate the de­vel­op­ment ef­fort. It was not easy to con­vince the gov­ern­ment to put mon­ey aside to in­vest in for­eign as­sets for the long term. The ar­gu­ment, at the time, was spend­ing to meet our de­vel­op­men­tal needs rather than putting mon­ey aside.

So we have a com­pro­mise. We have a fund that is both for sta­bil­i­sa­tion pur­pos­es and sav­ings. But then you have to fig­ure out the gov­er­nance and man­age­ment struc­ture. Did you use Nor­way as your pro­to­type for that?

We had to use a hy­brid. Sim­ply be­cause the fund was a hy­brid, it meant that in the de­vel­op­ment of the strate­gic as­set al­lo­ca­tion, we had to pro­vide for the sta­bil­i­sa­tion com­po­nent. The Nor­we­gian mod­el does not have a sta­bil­i­sa­tion com­po­nent. It is just a sav­ings fund and that al­lows for a more ag­gres­sive strate­gic as­set al­lo­ca­tion. But we start­ed off with a con­straint. Since we had to pre­pare for sta­bil­i­sa­tion, 25 per cent of the fund was au­to­mat­i­cal­ly al­lo­cat­ed to short-term in­vest­ments, so it lim­its flex­i­bil­i­ty straight away. The hy­brid na­ture of the fund cer­tain­ly had a very im­por­tant in­flu­ence on the strate­gic as­set al­lo­ca­tion. The oth­er as­pects we took from the Nor­we­gian ex­am­ple as re­gards the gov­er­nance struc­ture for in­stance, what we have is best prac­tice. Par­lia­ment ap­proves the fund. The Min­istry of Fi­nance has a ma­jor role in the se­lec­tion of the HSF board. The HSF board del­e­gates its pow­ers to the Cen­tral Bank, and the Cen­tral Bank, as the man­ag­er of the fund, out­sources the man­age­ment to ex­ter­nal man­agers. The gov­er­nance struc­ture mir­rors the Nor­we­gian mod­el. The hy­brid na­ture of the fund de­ter­mines the sav­ings and with­draw­al rules. We al­so got all the trans­paren­cy pro­vi­sions from the Nor­we­gian fund.

Did you work close­ly with the Chilean fund?

No, we were a mem­ber of RAMP, a World Bank pro­gramme, the Re­serve As­set Man­age­ment Pro­gramme run by the bank's Trea­sury De­part­ment. We were one of the ear­ly mem­bers. This pro­gramme was ini­tial­ly for the man­age­ment of the Cen­tral Bank re­serves. How­ev­er, be­cause we were mem­bers, when we start­ed to think about the her­itage and sta­bil­i­sa­tion fund, we sought tech­ni­cal as­sis­tance from the World Bank. We worked close­ly with them in the le­gal draft­ing and in think­ing through the strate­gic as­set al­lo­ca­tion.

You men­tioned out­sourc­ing man­age­ment but then you al­so men­tioned build­ing a man­age­ment team. Please speak specif­i­cal­ly about build­ing the team lo­call and al­so to what ex­tent, in fact, do you use out­side man­agers.

That is one of the ar­eas where we got the tech­ni­cal as­sis­tance from the World Bank. Un­der RAMP, the Cen­tral Bank is now man­ag­ing about 60 per cent of its re­serves. We worked very close­ly with the World Bank in the se­lec­tion of the new man­agers for the HSF.

We start­ed with this long list of a few hun­dred, and then we cut this list down.

We in­ter­viewed a short list, we made lots of site vis­its. The World Bank could not par­tic­i­pate in the in­ter­views be­cause they in­sist­ed that be­ing an in­ter­na­tion­al in­sti­tu­tion they could not help us choose a com­pa­ny. It was a very trans­par­ent and de­tailed process.

By that time we had de­cid­ed on the strate­gic as­set al­lo­ca­tion, so that we knew we were look­ing for two kinds of man­agers: man­agers of fixed in­come in­stru­ments and in­ter­na­tion­al and US eq­ui­ties. This elab­o­rate process led us to the se­lec­tion of eight man­agers.

Two man­agers in each of the as­set class­es: short-term fixed in­come, core fixed in­come, and core eq­ui­ties mean­ing US eq­ui­ties and in­ter­na­tion­al eq­ui­ties. Cen­tral Bank staff has re­ceived train­ing from the World Bank. We now in­vest about 60 per cent of our re­serves and our staff close­ly mon­i­tors the op­er­a­tions of the ex­ter­nal man­ag­er of the HSF. We hope that over time our staff will al­so be in­volved in the in­vest­ment of part of the HSF.

So, is this on­ly for HSF or is it al­so for the re­serves of the Cen­tral Bank?

Here I was talk­ing about HSF. We had done a sim­i­lar but not as de­tailed process with the of­fi­cial re­serves. In the case of the Cen­tral Bank, un­der RAMP, the World Bank al­so was an ex­ter­nal man­ag­er. That's one of the con­di­tions of RAMP. We re­ceived tech­ni­cal as­sis­tance, in part, by work­ing with a shad­ow in­vest­ment man­date with the World Bank.

The whole pur­pose of RAMP was that over time, the Cen­tral Bank would take re­spon­si­bil­i­ty for more and more of the in­vest­ment port­fo­lio.

Of course, you are aware that the Cen­tral Bank's port­fo­lio is rather con­ser­v­a­tive­ly man­aged, en­tire­ly in mon­ey se­lect in­stru­ments and in fixed in­come se­cu­ri­ties. Now that our Cen­tral Bank re­serves have grown be­yond a cer­tain thresh­old, we are now think­ing about be­ing a bit more ag­gres­sive.

Is there a dif­fer­ence be­tween the man­age­ment style of the Cen­tral Bank re­serves and the one quar­ter of the HSF that's sta­bil­i­sa­tion?

Great point. In fact, there isn't. And for that rea­son, now that we are re­view­ing the HSF, one is­sue on the ta­ble is whether there is a cer­tain in­ef­fi­cien­cy in hav­ing the 25 per cent sta­bil­i­sa­tion and yet al­so hav­ing these size­able Cen­tral Bank re­serves that are con­ser­v­a­tive­ly man­aged. The ques­tion on the ta­ble is: is there some way of in­tro­duc­ing an as­set-li­a­bil­i­ty man­age­ment ap­proach where there is greater con­sis­ten­cy in the as­sign­ment of all the coun­try's for­eign as­sets-the of­fi­cial re­serves, as well as the HSF?

Of the $10 bil­lion, how do you de­ter­mine when some of that goes to the HSF? Is there some op­ti­mal lev­el of re­serves of the Cen­tral Bank ver­sus those of HSF, of which a quar­ter have the same strat­e­gy of the Cen­tral Bank?

We now man­age both in sep­a­rate com­part­ments. We were man­ag­ing the re­serves ac­cord­ing to one set of prin­ci­ples. It's a stan­dard ap­proach to cen­tral bank re­serve man­age­ment: a work­ing tranche based on the vari­abil­i­ty of your trade and oth­er trans­ac­tions, a pre­cau­tion­ary tranche rep­re­sent­ing a sec­ond line for trade fi­nanc­ing, and the re­main­ing 40 per cent in an in­vest­ment tranche that is man­aged a bit more ag­gres­sive­ly reach­ing as far as in­vest­ment grade agency bonds and so on. Then we have the strate­gic as­set al­lo­ca­tion for the HSF.

With an in­te­grat­ed ap­proach any need for sta­bil­i­sa­tion could be ac­com­mo­dat­ed by the re­serves be­cause we have "ex­cess" re­serves. The chal­lenge is how these prin­ci­ples are im­ple­ment­ed in prac­tice.

You need to sim­u­late a cri­sis shock and, in the worst-case sce­nario, how many re­serves would you use up, and if you con­clude you have more than the sce­nario would re­quire, then do you pro­ceed ac­cord­ing­ly?

You know that de­cid­ing on the op­ti­mum lev­el of of­fi­cial re­serves is a very dif­fi­cult propo­si­tion. An­oth­er chal­lenge we face is that there are tight lim­its on Cen­tral Bank cred­it to the Gov­ern­ment, but if you want to use the Cen­tral Bank's re­serves as a sec­ond buffer for bud­getary short­falls, it would trans­late in­to Cen­tral Bank cred­it.

The HSF is de­signed to fi­nance en­er­gy-rev­enue short­falls di­rect­ly, if need­ed. If ac­tu­al re­serves fall short of the bud­get pro­jec­tions, then the Gov­ern­ment is al­lowed to with­draw from the HSF.

The point is if you wish to use the re­serves as a source of fund­ing for the Gov­ern­ment, you will have to do it through Cen­tral Bank cred­it to the Gov­ern­ment. That's what we have to work out.

Does the HSF have a pro­fes­sion­al staff? What func­tions have you re­tained?

The HSF as of now has no staff. The HSF is large­ly a board, and the board has del­e­gat­ed its pow­ers to the Cen­tral Bank. In the re­view now be­ing con­duct­ed, the need for a small re­search staff will be con­sid­ered.

So for any­thing re­lat­ed to risk man­age­ment de­ci­sions, for ex­am­ple, these are made by Cen­tral Bank staff for the HSF?

Yes, that is cor­rect. But those de­ci­sions are ul­ti­mate­ly re­viewed by the board.

What about po­lit­i­cal ap­pointees at the Cen­tral Bank which, ac­cord­ing to the act, must in­clude a rep­re­sen­ta­tive from the Cen­tral Bank and the Min­istry of Fi­nance? How can they in­flu­ence things?

The HSF is not a cor­po­rate body. The Min­is­ter of Fi­nance ap­points the mem­bers of the board. The up­com­ing re­view will al­so re­con­sid­er the le­gal struc­ture. Per­haps an ex­am­ple to con­sid­er is that of our na­tion­al in­sur­ance board where the stake­hold­ers-the busi­ness com­mu­ni­ty, the Gov­ern­ment, and the trade unions-are all rep­re­sent­ed.

One can en­vis­age a sit­u­a­tion where the HSF board rep­re­sents var­i­ous sec­tors of so­ci­ety: the busi­ness sec­tor, the trade union move­ment, per­haps the en­er­gy sec­tor, the bank­ing sec­tor and so on. A struc­ture like this will keep the fund and se­cure na­tion­al buy-in.

You have said you would like to see the HSF work in an as­set-li­a­bil­i­ty man­age­ment frame­work, but I haven't heard you tell me what the ac­tu­al man­date is of the 75 per cent that is the her­itage part of the HSF. Is it a man­date that would be able to meet pen­sion needs if de­mo­graph­ics change? Or is it for when oil starts to run out?

The HSF al­lows us to con­vert oil in the ground in­to a pool of fi­nan­cial as­sets, the re­turns from which will ac­crue to the bud­get when oil re­sources have dwin­dled. The Nor­we­gian fund has been con­vert­ed in­to a pen­sion fund.

Our fund aims to build a nest egg, so that when oil and gas re­sources are dwin­dling, the re­turns from the nest egg will con­tribute to the bud­get and take the place of the oil and gas rev­enues. Our HSF con­cept does not ear­mark HSF rev­enues to meet pen­sion oblig­a­tions or any spe­cif­ic type of ex­pen­di­ture.

Have you pro­ject­ed oil rev­enues over the next 30 years and tried to match those to rev­enue goals?

Yes, we did. Orig­i­nal­ly, we used a mod­el where we said that oil and gas would be around for 30 years (along with cer­tain price as­sump­tions). Then we said that if you con­tributed a cer­tain amount over the next 30 years and in­vest­ed at a re­al rate of re­turn of 3.5 per cent, the fund would ac­cu­mu­late about US$30 to US$40 bil­lion. But things have changed. For ex­am­ple, a re­cent re­port sug­gests a small pool of oil and gas re­serves, ex­clud­ing new dis­cov­er­ies, of course.

In these cir­cum­stances, one of the ques­tions we need to ad­dress im­me­di­ate­ly is whether we should be chang­ing our rules to in­crease our rate of sav­ings.

An­oth­er ques­tion is whether we should con­tin­ue to have a hy­brid on strate­gic as­set al­lo­ca­tion to tar­get a high­er rate of re­turn.

To the ex­tent that you were to mod­i­fy your strate­gic as­set al­lo­ca­tion, does it make sense to har­vest liq­uid­i­ty pre­mi­ums? Maybe you're look­ing at dif­fer­ent kinds of in­vest­ment struc­tures with much longer time hori­zons?

Al­so, how would you pro­pose to rec­on­cile what be­comes a very short-term re­port­ing hori­zon, with year-over-year scruti­ny on re­turns, against this no­tion of har­vest­ing high­er re­turns from less liq­uid in­vest­ments.

Re­spond­ing to your last ques­tion, we face a ma­jor chal­lenge of get­ting the politi­cians and the pub­lic to recog­nise that it's a long-term fund that will be sub­ject to short-term volatil­i­ty.

There is a ten­den­cy for the pub­lic to fo­cus on short-term re­turns and to ex­pect changes in the in­vest­ment strat­e­gy based on these short-term re­sults. There is need for more ed­u­ca­tion and greater buy-in to the long-term sav­ings strat­e­gy.

As we close, per­haps you would dis­cuss your per­spec­tive on the San­ti­a­go Prin­ci­ples, in­clud­ing the rate of adop­tion and some of the re­lat­ed chal­lenges. Al­so, as you re­flect on your ex­pe­ri­ences in de­sign­ing and build­ing a sov­er­eign in­vest­ment ve­hi­cle, would you please share any spe­cif­ic lessons you have learnt that would ben­e­fit new funds and those con­sid­er­ing a launch?

First, I'll talk about the San­ti­a­go Prin­ci­ples. I was in the first meet­ing. I think that the steps that the IMF took to bring the wealth funds to­geth­er were ab­solute­ly im­por­tant and nec­es­sary. If you re­mem­ber, there was a great deal of hos­til­i­ty and sus­pi­cion about sov­er­eign wealth funds.

Some of it might have been jus­ti­fied due to the opaque na­ture in which the funds were op­er­at­ing, and giv­en the geopol­i­tics just af­ter 9/11. I think the IMF did a good job in try­ing to bring some or­der to sov­er­eign wealth funds when there was fear that they could desta­bilise the glob­al fi­nan­cial sys­tem.

The for­ma­tion of a Sov­er­eign Wealth Fund Group was suc­cess­ful in al­lay­ing the fears of the ad­vanced coun­tries. But from the start, we were aim­ing at a stan­dard­ised blue­print-a tem­plate of trans­paren­cy and good gov­er­nance-not recog­nis­ing that both are ground­ed in your po­lit­i­cal sit­u­a­tion.

So what is trans­paren­cy and good gov­er­nance in Aus­tralia, New Zealand, the US and T&T does not nec­es­sar­i­ly ap­ply to the Chi­nese wealth fund, the Russ­ian wealth fund, or the Abu Dhabi fund.

So while there is a tem­plate, ad­her­ence is go­ing to vary con­sid­er­ably. I think, how­ev­er, a good fo­rum has been set up for dis­cus­sion about is­sues and chal­lenges faced by SWFs. It is go­ing to pro­vide some com­fort to ad­vanced coun­tries that SWFs are not op­er­at­ing to desta­bilise the in­ter­na­tion­al fi­nan­cial sys­tem. But I'm not sure that the kind of ad­her­ence to these pa­ra­me­ters of re­port­ing and trans­paren­cy can be de­pend­ed up­on.

The ones that would have been trans­par­ent, like Nor­way and like the pen­sion funds in the US and so on would oth­er­wise con­tin­ue to ad­here to these high stan­dard of good gov­er­nance.

Many of the new SWFs that have come in­to ex­is­tence in the last ten years from small­er coun­tries or coun­tries that are less de­mo­c­ra­t­ic have not en­gaged the In­ter­na­tion­al Fo­rum of Sov­er­eign Wealth funds.

What do you get from it as a coun­try? Do you get tech­ni­cal ad­vice that is use­ful?

It's an in­sti­tu­tion that will serve a pur­pose, but we have to be re­al­is­tic in our ex­pec­ta­tions as to what we'll get from it. The meet­ings con­sti­tute a fo­rum for dis­cussing ex­pe­ri­ences, and that is al­ways use­ful.

Peo­ple tell you about the kind of chal­lenges they are get­ting with their in­vest­ment man­agers and so on. It pro­vides an op­por­tu­ni­ty for trad­ing in­for­ma­tion on best prac­tices among in­vest­ment man­agers. These kinds of things are very use­ful.

We are now try­ing to get, for in­stance, com­par­a­tive in­for­ma­tion on SWFs based on ex­trac­tive in­dus­tries.

Are oth­er coun­tries sav­ing much more from their wind­fall? But that kind of in­for­ma­tion is hard to ob­tain, as is in­for­ma­tion on rates of re­turn for some funds. I recog­nise the short­com­ings of in­ter­na­tion­al com­par­isons, be­cause you have dif­fer­ent strate­gic as­set al­lo­ca­tions and so on, but even if you al­low for all these caveats, you would like to be able to see how you are do­ing in com­par­i­son to your peers. It is dif­fi­cult to get re­li­able in­for­ma­tion.

Sim­i­lar­ly, it would be use­ful to have more ac­cess to in­for­ma­tion and analy­sis re­lat­ed to ca­pac­i­ty build­ing, gov­er­nance and as­set al­lo­ca­tion is­sues.