Macro-level management: A sovereign wealth fund is in the process of being set up

The country is set to join the ranks of the leading oil producers in establishing a sovereign wealth fund (SWF) to manage the excess proceeds of its production in times of high pricing. Yet despite legislative progress in 2011, the initiative has been met with political uncertainty – not concerning its objectives as such, but rather the funding structure. A balance between state and federal interests was struck in mid-2012, which led to the establishment of a much-needed additional tool of macroeconomic management.

EXCESS CRUDE: The Excess Crude Account (ECA) was established in 2004 by then-President Olusegun Obasanjo in an effort to stabilise and insulate government spending against shortfalls in oil revenues below budgeted levels. As the budgetary assumptions for the oil price rose from $40 a barrel in 2007 to $60 in 2010, and withdrawals from it increased in tandem with preparations for the 2011 elections and drops in world oil prices linked to the global slowdown, the ECA’s capitalisation declined from roughly $20bn at the start of 2007 to $11.2bn in 2010 and stood at $5.8bn in 2011. However, this figure had rebounded to almost $7bn by July 2012 due to lower budgetary oil price assumptions ($72 instead of $75 a barrel), and the Federal Ministry of Finance (FMF) expects the ECA to reach $10bn by the end of 2012.

The ECA was also intended to be used to help fund local infrastructure investments; however, transfers to the three government tiers have accounted for the majority of withdrawals. States receiving only subsistence levels of federal allocations were forced to use the ECA when their revenue shortfalls began to compromise their ability to cover recurrent expenditures such as staff salaries. While the legality of the ECA has been questioned, the ECA funds were typically shared among the government tiers according to the existing revenue distribution ratio for federal allocations. However, with a relatively ad-hoc timing for the disbursement of funds, reformers have sought to update the system of excess crude revenue savings.

NSIA: The idea of establishing a formal SWF with longer-term investment goals in addition to its stabilisation function came from the then-minister of finance, Olusegun Aganga, (a former hedge fund manager at Goldman Sachs and now minister of trade and investment) in 2010. In addition to the stabilisation function currently fulfilled by the ECA, the proposed Nigeria Sovereign Investment Authority (NSIA) was to include two additional funds: one for infrastructure and one to invest in long-term instruments aimed at yielding dividends for future generations. In May 2011 both chambers of the National Assembly (in their sixth session) passed the NSIA bill, which was then signed into law by the president.

The NSIA’s three funds have been designed with separate investment horizons. The Stabilisation Fund, while similar in aim to the ECA, provides stricter checks and balances on withdrawals, which would only be allowed on a quarterly basis with approval from the FMF to cover specific revenue shortfalls below budgeted levels. The Infrastructure Fund, meanwhile, would follow five-year investment plans and provide financing for infrastructure investment and social projects, particularly in the power, water and transport sectors. Finally, the Future Generations Fund was established to invest in long-term instruments according to rolling five-year plans and will reinvest all of its proceeds to expand its investment portfolio.

In the months after the bill’s enactment, the FMF opened an account at the Bank of International Settlements, with seed capital of $1bn taken from the ECA. The original funding structure envisioned transfers from the federation account of all oil revenue over budgeted levels, above the budgetary smoothing account (10% of monthly federation revenue).

While state governors are to be represented on the NSIA’s governing board, ultimate authority would rest with the federal government. Though the governing board would have a purely advisory role, the executive board would be the only body with the power to veto NSIA decisions. Audit firm KPMG was charged with recruiting the authority’s management in November 2011– which was concluded by the end of August 2012 – but the lack of governor control has caused friction with state governments.

TWO-TIER POLITICS: While the bill successfully sailed through the legislature in 2011, political frictions between state and federal government have delayed its rapid implementation. Though the creation of the SWF has carried the support of a number of governors, including the Northern Governors’ Forum (NGF), which expressed its support in June 2012, a lack of consensus in the NGF has sustained debate over the constitutionality of the funds.

The main argument concerns the NSIA’s funding structure. While the bill required the authority to transfer all excess crude proceeds directly from the federation account, a number of governors have questioned the legality of this arrangement. Numerous Supreme Court decisions since 1983 have found that withdrawals from the account can only be concluded by one of three government tiers: federal, state and local. A new Supreme Court hearing on this case was still uncertain in mid-2012, but the majority of lawyers expect that any new court decision would maintain these precedents. According to the Santiago principles of best practice for SWFs, the establishment of such funds must conform to existing laws domestically. In addition, given that withdrawals from the funds would only be allowed following five years of profitable investments by the NSIA, many governors are of the opinion that a lot of the benefits from such funds would only accrue to their potential successors following the next electoral cycle in 2015.

This friction came to a head in July 2012, when a compromise between the FMF and the NGF seemed to have been reached. The federal government increased the ECA from $5.3bn to $10bn in June 2012, with a proposal to maintain the ECA in parallel to the NSIA. The higher sum would provide a protective buffer, covering up to three months of imports, and operate in the same way as before. While questions remain concerning the duplication of roles between the ECA and the NSIA’s Stabilisation Fund, this concession on the ECA went some way to resolving the dispute, although doubts on the legality of the exercise still lingered in July 2012. A possible way of circumventing such concerns might be to fund the NSIA through contributions from the federal allocations of the three tiers of government, but only once they are disbursed. Yet such a clawback of funding would run the risk of leakages at all three levels.

Other concerns have been raised about the need for a separate fund for future generations given Nigeria’s pressing infrastructure development needs. “I don’t see the use of a fund for future generations within the NSIA: if we use most of the fund for infrastructure development, this in itself would be a fund for future generations,” said Bode Agusto, the co-chairman of the Lagos Economic Summit Group and former director general of the Budget Office. Yet the three funds are expected to have distinctive investment missions and time horizons.

ASSET ALOCATION: While politicking continues, most investment bankers expect the NSIA to begin operating by the start of 2013. A minimum of 20% of NSIA revenues is earmarked for the Stabilisation Fund, while the other two funds will each receive at least 20% as well, up to a maximum level reassessed every two years. The Stabilisation Fund will be placed in the most liquid instruments possible. The other two funds will have different investment horizons. The Infrastructure Fund is expected to fund infrastructure projects directly as well as co-invest alongside the private sector via instruments such as private equity and venture capital. The Future Generations Fund will adopt the longest of all investment horizons.

Model SWFs around the world like those of Singapore or the UAE typically place half of their holdings in equities with a buy-to-hold approach – 30% in bonds and 20% in other types of investments such as private equity or collective investment vehicles. In the midst of the management selection process, the World Bank has been working with the FMF to create a set of specific guidelines for asset allocations of the funds. Some preliminary guidelines have already emerged. An estimated 10% of the Infrastructure Fund is expected to go towards financing agriculture and state-government-backed projects that are aimed at promoting economic development in the least connected and underserved of Nigeria’s states.

While political friction has delayed the NSIA, its establishment in August 2012 is a clear victory for transparent and effective macroeconomic management. With the average oil price rising from $45 a barrel to $78 in the past 15 years, Nigeria would benefit from diverting its excess crude revenue to a more accountable instrument of macroeconomic management. Moving from stabilisation to concerted development will underpin the much-needed structural changes in the continent’s second-largest economy.