Central to any revenue management law is the set of rules and basic principles governing the management of the oil fund. Good governance, professional management, and broad oversight can go a long way in protecting the value of oil fund assets.
Oil Fund Management Functions
The law must provide a clear governance structure covering the main oil fund asset management functions: setting investment policy, selection and oversight of investment managers, and selection and oversight of the custodial institution. The custodial function encompasses solely the custody of the oil fund assets and is carried out by the account custodian. The oil revenue management law should establish clear mandates, compensation policy, and governance rules for the investment committee, for the portfolio managers, and for the custodial bank.
Investment Policy Making and Oversight
The overall responsibility for the management and investment of oil fund assets should be assigned to an investment committee charged by law with creating and periodically reviewing the investment policy and overseeing the oil fund asset management. The investment committee should have a clear mandate, advisably in the body of the law, which spells out its membership and selection process, and its main functions, powers, and responsibilities. The oil revenue management law should not charge the investment committee with making investments itself; rather, the investment committee should be charged with establishing general investment policy and selecting and overseeing qualified professional portfolio managers who will carry out the investment policy. Many emerging countries such as Guyana will have to look overseas for their oil fund portfolio managers as the full level of expertise may not be found locally.
The membership of the investment committee should be broad enough to ensure political support from the different branches of government and political constituencies. The committee should be structured to include people who are likely to have financial knowledge and experience. It almost certainly should include representatives of the ministry of finance and the central bank. In some cases, the committee has included a member appointed by the President and two members appointed by the National Assembly, one of whom must be from the opposition. Where experience is limited, representatives of international financial institutions could participate in the investment committee as non-voting members. In addition to providing technical assistance, international observers and other non-voting members could act as a further check on conflicts of interest or other inappropriate activity.
Some applicable examples include; Timor-Leste, where the executive branch has the overall responsibility for investment policymaking, oversight, and management of the Timorese Petroleum Fund portfolio. The minister of finance, in particular, plays a key role in making investment decisions with the operational management delegated to the central bank, pursuant to a management agreement. Similarly, in Sao Tome and Principe, the policymaking, oversight, and asset management functions are all assigned to a single committee-the Management and Investment Committee. The Management and Investment Committee has the authority to delegate investment management responsibilities to qualified professionals. It is the responsibility of the committee to delegate or exercise the investment management function directly once the country’s oil fund is set up and begins operations. Kuwait’s permanent oil fund, the Future Generations Fund, is also subject to executive branch policymaking and management, which is carried out by the Kuwait Investment Authority (KIA). Similarly, the Norwegian Petroleum Fund is by law managed by Norway’s Minister of Finance, which it does through the country’s central bank, Norges Bank, pursuant to a management agreement. To promote transparency, an oil revenue management law should require the investment committee to report its activities periodically to the government and to the public, and its activities should also be subject to audits by independent international auditing firms. Voting members should be subject to fiduciary duties and, in case of breach, to the appropriate sanctions. Finally, the law should address compensation of nongovernmental members (Bell and Faria 2007).
Selection and Oversight of Portfolio Managers
An oil revenue management law should set forth clear rules and procedures that delineate the selection process for portfolio managers. The process should be subject to open and competitive public procurement pursuant to rigorous qualification requirements, which should include proven experience in the management of large portfolios for large investors.
An oil revenue management law should also establish objective criteria for assessing the performance of portfolio managers, who should be subject to periodic performance reviews against pre-agreed benchmarks. Specific benchmarks can facilitate the oversight of government spending and rims help protect against political manipulation and diversion of funds. A clear benchmark also provides a specific guide to the ministry of finance for developing the budget. Either the law should itself establish clear benchmarking procedures with which to evaluate the investment managers’ performance in managing and investing oil fund assets, or it should charge the investment committee with the task, following consultation with the portfolio managers.
As the size of the oil fund grows, it may be advantageous from a performance standpoint to break the oil fund into separate investment-specific portfolios that may be more profitably managed by specialized managers. The larger the oil fund, the easier it is to justify the transactional costs and institutional burden involved with selecting, overseeing, and evaluating the performance of multiple portfolio managers. The Norwegian Petroleum Fund, for example, selects various external portfolio managers to manage different financial asset-specific portfolios, and the Alaska Permanent Fund is divided into more than 40 financial asset portfolios that are managed by more than 20 managers.
By the members of the investment committee, as in the case of Sao Tome and Principe, trustees as in the case of Alaska, or outside professional asset managers, portfolio managers should be held to appropriate standards of care when carrying out management duties and exercising whatever discretion with which they are vested. In common law jurisdictions, this is often expressed as a fiduciary duty that requires trustees, for instance, to meet a “prudent investor” standard or similar rule. In the United States, virtually all states have adopted their respective versions of the Uniform Prudent Investor Act, which sets out the required standard of care for the fiduciary investment in trust of another’s assets; e.g. the provisions in the Alaska Oil Fund (Trillas 2005). In Alaska, the “prudent investor rule” means that in making investments, the portfolio manager should exercise the judgment and care, under the circumstances then prevailing, that an institutional investor of ordinary prudence, discretion, and intelligence exercises in the management of large investments entrusted to it not in regard to speculation but in regard to the permanent disposition of funds, considering probable safety of capital as well as probable income. Sao Tome and Principe have adopted a similar approach that provides that investment management functions shall be discharged pursuant to the “prudent investor rule,” as defined in the law. The Timor-Leste law, on the other hand, has opted for a more open approach with no further criteria being provided but for the duty of the portfolio manager to take actions to maximize the return on the investments taking into account the appropriate risk as evidenced by the investments permitted under the applicable law.
Underlying the formulation of any of these rules are the questions of who can elaborate the standard (should it be the courts or the government through contract, regulation or statute?), who can enforce whatever standard is applicable (should it be citizens or particular governmental entities?), and which institution can decide whether the standard is met (should it be domestic or foreign courts?). Although the reference for trustees or governmental investment committees may typically be domestic law and domestic institutions, it would be possible to give jurisdiction in certain instances to foreign courts that possess more developed expertise and stronger institutional history to enhance the protection of the oil fund’s assets. Indeed, contracts with foreign asset managers are very likely to be governed by foreign law and subject to arbitration or some form of adjudication outside of domestic courts.
General Investment Policy
The oil revenue management law may give broad discretion to the investment committee for devising an investment policy or it may set out a specific investment policy that gives very little room for committee discretion. The oil revenue management law of Sao Tome and Principe, for instance, charges the executive branch to submit for the approval by the National Assembly an investment policy proposed by the Management and Investment Committee. Timor-Leste, on the other hand, opts to give the executive branch greater discretion to design an investment strategy for the oil fund, subject only to statutory limits and to consultation with an investment advisory board by the minister of finance.
Where separate accounts are set up (e.g., a main oil fund account, a permanent reserve account, and a stabilisation reserve account), the law may provide for a different investment policy (with the appropriate investment horizon and adequate investment requirements) for each account. Such legal flexibility will allow for the re-examination of investment strategies, horizons and restrictions if needed, as the size of an oil fund increases and the institutional capacity and experience in oil fund portfolio management develop.