Sovereign Wealth Funds

The Pension Reserve Fund is earmarked as backing for the government’s guarantee to basic old-age and disability solidarity pensions and solidarity pension contributions for low-income pensioners.

Annual withdrawals from July 2008 to July 2016 are allowed for a maximum amount equal to the returns on the fund in the prior year. After that, the maximum withdrawal amount will be equal to a third of the difference between the pension expenses of the respective year and equivalent expenses in 2008 (inflation-adjusted). After September 2021, the fund will be extinguished if the payments from the fund in the calendar year do not exceed 5% of total spending on the government’s guarantee to basic old-age and disability solidarity pensions and old-age and disability solidarity pension contributions stipulated in the respective year’s budget.

The objective of the Economic and Social Stabilization Fund is to operate counter-cyclically, receiving resources during boom periods, and paying out funds when the economic growth rate falls. This provides adequate coverage for risks derived from declines in copper prices and in the economy.

Funds’ contributions come from fiscal surpluses that are very dependent on the price of copper and economic growth. Nonetheless, the PRF must receive a minimum contribution equal to 0.2% of the previous year’s GDP independently of fiscal results.

The Pension Reserve Fund was established on December 28th, 2006, with an initial deposit of US$ 604.5 million, from the fiscal surplus generated in 2005.

The Economic and Social Stabilization Fund was established on March 6th, 2007, with an initial deposit of US$2.58 million, which included US$ 2.56 million from the Copper Compensation Fund.

The Pension Reserve Fund must receive an annual minimum amount equal to 0.2% of the previous year’s GDP. If the fiscal surplus is greater than 0.2% of GDP, the fund will receive an amount equal to the surplus up to a maximum amount equal to of 0.5% of GDP. Yearly deposits into the fund should only be made until the fund’s size reaches 900 UF (inflation adjusted currency units). The law also includes the possibility of making extraordinary deposits from the Economic and Social Stabilization Fund.

The government may also contribute capital to the Central Bank of Chile for an annual amount equal to the effective fiscal surplus less the contribution made to the Pension Reserve Fund, as long as that amount is positive. This annual contribution to the bank may not exceed 0.5% of prior year’s GDP. The authority to make these transfers is effective for a five-year period beginning in September 2006.

The Economic and Social Stabilization Fund receives each year the remainder of the effective fiscal surplus after payment to the PRF and capitalization of the Central Bank. Repayments of public debt (including recognition bonds) and advanced payments to the ESSF during the previous year may, however, be subtracted from this contribution.

Payments to the Pension Reserve Fund must be made during the first half of the year, while transfers to the Central Bank may be made at any time during the year, but only after contributions to the Pension Reserve Fund have been effected. Payments to the Economic and Social Stabilization Fund must be made before the end of the year. Notwithstanding the above, payments to the ESSF may be made in advance, anticipating future required contributions.

As announced by the Finance Minister on August 22, 2008, the 2009 budget law includes a cyclical adjustment to the returns generated by the government’s financial assets.

Specifically, structural revenues arising from returns on fiscal assets are estimated based on long-term predictions. Thus, the total cyclical adjustment is equal to the annual average of assets’ nominal value multiplied by the difference between the actual return and the estimated long-term return. This methodology takes into account the differences between the respective returns for each type of fiscal asset.

The Finance Minister appointed the Central Bank, as fiscal agent, to manage the assets of both funds. The bank must comply with the investment guidelines and parameters set by the Finance Ministry.

Currently, the funds are invested in sovereign and agency bonds, time deposits and inflation-indexed sovereign bonds.

The current investment policy considers asset classes that are similar to those selected by the Chilean Central Bank in the management of international reserves.  The selection of these asset classes was in keeping with the extensive experience the Central Bank has had with its investment. Nonetheless, given that the main purpose of the international reserves is to provide liquidity to address potential financial distress in the Chilean economy, the reserve’s policy has a very short-term investment horizon. Conversely, the Financial Committee deemed the Chilean sovereign funds have a longer investment horizon. As a result, a new policy was designed allowing them to be invested in a more diversified portfolio, which would include equity and corporate bonds. This policy is expected to generate additional returns and wealth in the long-term vis-à-vis the current policy. Although the implementation of the recommended policy was scheduled by the end of 2008, the aggravation of the financial crisis by the end of that year resulted in its delay. Currently, the Financial Committee is constantly monitoring financial markets and the funds with a view to providing the Minister with a recommendation as to the right time for implementation.

The International Finance Unit of the Finance Ministry has participated in different forums on investment policy and transparency for sovereign funds. The analysts’ consensus is that the proposals of the Financial Committee are prudent regarding exposure to stocks and corporate bonds, and that transparency and public information practices are in keeping with international best practices.

The Financial Committee is an external body whose mission is to advise the Finance Minister, as requested, in areas related to the investments of the sovereign wealth funds.

Article 13 of the fiscal responsibility law states that the Finance Minister will rely on the advice of the committee when deciding how fiscal assets are invested.

The Financial Committee is composed of a team of professionals with extensive experience in the areas of finance and economics:

Andrés Bianchi, President (former President of the Central Bank and former Chilean Ambassador to the U.S.); Ana María Jul, Vice-President (former official with the IMF and a former director for Chile before the IMF); Martín Costabal (former Finance Minister); Andrés Sanfuentes (former President of Banco Estado); Eduardo Walker (Finance Professor, PUC) and Klaus Schmidt-Hebbel (Ph.D. in Economics from the Massachusetts Institute of Technology (MIT))

Committee meetings are held regularly and constitute the primary opportunity for the Committee to discuss and analyze its recommendations to the Finance Minister. These meetings are generally divided into four parts. The meeting opens with a presentation by Ministry of Finance staff on a detailed report about the funds’ investments as well as other relevant information on other sovereign wealth funds, after which the Committee evaluates the funds’ performance.  Then, if deemed necessary, committee members discuss, analyze, and formulate specific recommendations to the Finance Minister. Finally, the Committee approves the press release reporting on its deliberations and recommendations.

In between meetings, committee members remain in contact and exchange information and points of view via email. In addition, the Committee has invited experts and financial institutions to learn from its experience in fund management.

According to the decree law establishing the Financial Committee, meetings must take place at least once every semester. However, its members have held meetings more frequently, as necessary (10 meetings in 2008) to fully carry out its mission.

The International Finance Coordinator is the Financial Committee’s counterpart and liason with the Finance Ministry. Its role is to provide key analyses, diagnoses, and evidence regarding domestic and international markets to the Financial Committee, and to interact with advisors and convey their opinions.

To provide advice in relation to the long-term investment of the funds, such as defining strategic asset allocation, reviewing the inclusion of new investments, determining adequate benchmarks for the funds, defining allowable limits for active risk, and placing limitations on the types of possible investments; to make specific recommendations to the Finance Minister in relation to: investments, custody, structure and content of reports, bid processes and selection of external managers; and to assist in all areas related to the investment of the funds as requested by the Finance Minister.

The sovereign wealth funds are the property of all Chileans. They are a national asset that provides stability in social spending and public investment. Because of this, management of the assets must meet the most rigorous standards for transparency. To guarantee public access to information on the sovereign wealth funds, the Finance Ministry has created this website exclusively for that purpose. This page contains monthly, quarterly and annual reports on the status of the funds, recommendations of the Financial Committee and its annual report, related legislation, and all updated, pertinent information regarding the funds.

All efforts to provide adequate information to the public regarding the sovereign wealth funds were recognized by the Peterson Institute for International Economics, which ranked Chile’s funds in eighth place among 34 sovereign wealth funds in terms of transparency and best practices in 2008. Chile also participates in the International Work Group of Sovereign Wealth Funds, which seeks agreement on principles and practices promoting transparency. A recent accomplishment was an agreement reached among the representatives of the sovereign funds that was called the Santiago Principles, because it was settled at a meeting held in Santiago, Chile. The Santiago Principles reflect Chile’s commitment to promote transparency in activities, investments and institutions related to its sovereign wealth funds.

The International Work Group (IWG) of Sovereign Wealth Funds was established with a view to demonstrating to recipient countries that investment decisions were based only on financial and economic considerations.  A set of voluntary Generally Accepted Principles and Practices was discussed among the IWG members in 2008 and was guided by the following objectives:

To help maintain the stability of the global financial system and the free circulation of capital and investment; to comply with all regulations and public information access requirements of the countries in which they invest; to invest funds based on economic and financial considerations and on risk and return; and to use corporate governance standards that are transparent and that provide adequate operational controls, risk management, and reporting standards.

The work group reached an agreement on Generally Accepted Principles and Practices in Santiago on September 22, 2008 known as the Santiago Principles, which were presented in October 2008 to the International Monetary and Financial Committee, the IMF’s policy advisory body, in Washington DC.