The past decade has seen institutional investors become major players in international financial markets, with their size and market impact continuing to increase. In fact, since 2007 the combined assets of sovereign wealth and pension funds have increased from approximately 30 trillion US dollars (USD) to over 50 trillion USD. And a similar growth trajectory is anticipated into the future.
Over the same span of time, taxes have risen to the top of the global agenda. Governments and the public have grown more conscious of the amounts of tax paid by large international organizations. Large organizations are expected to approach tax responsibly and make appropriate tax payments to the jurisdictions where they earn profits. Many countries around the world are adopting complex new international tax rules developed as part of the Organisation for Economic Co-operation and Development’s (OECD) Action Plan on Base Erosion and Profit Shifting (BEPS), including country-by-country tax reporting and other tax transparency measures. We are also now witnessing the march towards globalization slow as a wave of nationalism is being reflected in new trade and tax policies. Often billed as integrity measures, the practical result of such policies is often increased scrutiny of foreign investors.
As these trends converge interesting complexities and opportunities arise. For instance, notwithstanding the desire to increase tax revenue (and the political favor of raising such revenue from foreign sources), governments are competing to attract large sums of investment from global investors for much-needed improvements to their infrastructure networks. The competing goals of generating revenue for the fiscal coffers, while at the same time providing an attractive tax regime for the largest sources of capital, are reflected in legislation such as the U.S. Foreign Investment in Real Property Tax Act (FIRPTA) provisions, as recently amended. These rules impose US taxation on foreign investors into certain real property to raise tax revenue – but also provide substantial carve outs for certain large sources of capital such as certain government pensions.
The accommodations offered to potential sources of capital do, of course, have their limitations. For as much as governments need investment dollars there remains a populist distaste for allowing foreign investors to earn profits from, e.g., infrastructure assets, especially when the extracted profits are subject to low or no tax. Many deals have come under fire as investee countries struggle with the increased political implications of foreign investment into local assets. For instance, in early 2018 a foreign institution’s investment into a UK utility attracted political debate with some factions advancing the argument that such assets should be nationalized by the home government rather than funded by foreign sources. The fact that the foreign investor provided relatively low cost capital, bore risk and brought a very sophisticated approach to a complex asset was lost on many in the debate. And that is the challenge: such important benefits to institutional capital is unlikely to be championed by local politicians in most instances. Global investors must undertake to proactively socialize and inform local populations about these benefits directly, particularly in times of increasing skepticism and nationalism. As sovereign wealth and pension funds continue to grow and deploy capital globally their need to demonstrate tax responsibility will take on increased importance. As a result, investment institutions would do well to communicate key messages.
For instance, the institutional investor industry should make it clear that, unlike many other classes of investors, they generally do not invest with a short-term profit motive. They are interested in sustainable long term returns which are generally much more aligned with the interests of the public. The distinction as between the various sources of investment capital can be an important consideration often lost in the public domain.
Institutional investors can also work to highlight the less obvious positive impacts of their investment activities. This includes broad economic benefits such as the multiplier effects stemming from specific investments and the importance of the strong environmental, social and governance practices frequently championed by institutional investors in markets.
To be sure, many sovereign wealth and pension funds have voluntarily adopted the Global Investment Performance Standards (GIPS), which are based on the fundamental principles of full disclosure and fair representation of investment performance results. GIPS evolved from the ‘Santiago Principles’, developed jointly by a number of funds with the International Monetary Fund. The Santiago Principles’ aim was to improve governance and accountability, and to encourage sound, prudent conduct of investment practices such that the public understanding of institutional capital would be better understood. The discussion and energy around GIPS has diminished to some degree, however. Institutions should work to revisit and elevate these concepts back into the mainstream discussion.
Institutions may also wish to engage directly with policy makers. By engaging in such conversations, institutional investors may help encourage improvements in the regulatory environment that may not be understood by regulators. A frequent area where misunderstandings arise is taxation. Tax policy and legislation is frequently developed with the multinational for-profit corporation in mind. As a result, institutional investors struggle to comply. Regulators will often engage with industry, to the benefit of all involved. For instance, institutional investors have had some success engaging with the OECD in relation to the BEPS project, to explain certain important and relevant differences in relation to provisions that would have had unanticipated and unwarranted impacts.