How US Regulatory Changes Are Impacting the Way Sovereign Wealth Funds Invest

September 19, 2023

Several US regulatory agencies have proposed or enacted new rules in 2023 aimed at making the investment process more transparent. Many of those changes, including amendments to the Investment Advisers Act of 1940 by the US Securities and Exchange Commission (SEC), new beneficial owner requirements under the Financial Crimes Enforcement Network’s (FinCEN’s) Corporate Transparency Act, sweeping new Hart­Scott-Rodino Act (HSR) rules by the US Federal Trade Commission (FTC), and Internal Revenue Service (IRS) regulations regarding the exemption for “qualified foreign pension funds” from taxation under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), are directly affecting how sovereign wealth funds (SWFs) are structuring their investments.

SEC’s Investment Advisers Act of 1940

Despite dissent from a split Commission, the SEC voted 3-2 to adopt new and amended rules under the Investment Advisers Act of 1940 that will impose additional requirements on registered investment advisers and restrict certain activities for all advisers to private funds. Of particular interest to SWFs are the changes to the preferential treatment rule for private fund investors, which could significantly impact side letter and “most favored nations” election practices.

These rules targeting side letters—documents used to tailor limited partnership agreements for individual private equity fund investors—have been closely watched by SWFs since they were first proposed more than a year ago. According to S&P Global, SWF-funded private equity deals fell nearly 48% year over year to $39.03 billion in 2022 as SWFs awaited the final version of this rule.

The SEC acknowledged in its proposal that some investors would likely find it difficult to secure preferential terms, but went on to state that these types of preferential treatment are “contrary to the public interest and protection of investors.”

While the SEC will not require advisers to make a prediction on what terms or information could be considered preferential, advisers will be required to form a “reasonable expectation” as to whether redemption terms or certain information would have a material, negative effect on investors that do not receive the terms or information. SWFs have historically claimed immunity from contractual claims and other lawsuits by including a reservation of sovereign immunity in the investor’s side letter.

Six private equity and hedge fund trade groups have sued the SEC, arguing that the agency overstepped its statutory authority when adopting sweeping new expense and disclosure rules.

More information on how the Advisers Act aims to overhaul the private fund industry is provided in our report Split SEC Adopts New and Amended Rules Overhauling Private Fund Industry.

Corporate Transparency Act

Effective January 1, 2024, FinCEN will begin enforcing the Corporate Transparency Act’s (CTA’s) beneficial ownership requirements. The CTA was first enacted in January 2021 with the intention of creating uniform beneficial ownership information (BOI) reporting requirements for certain business entities created or registered to do business in the United States.

At the end of 2022, FinCEN, a bureau of the US Department of the Treasury and the US financial intelligence unit, published a final rule that implements the CTA’s BOI reporting requirements, which may significantly increase the BOI disclosure requirements of any SWF or similar non-US governmental institution that invests and/or conducts other business in the United States through an affiliated entity that is created or registered to do business in the United States.

Absent further guidance, SWFs and similar non-US governmental institutions should evaluate whether and to what extent the rule will apply to them, whether any exemptions are available, and whether operations can be restructured to take advantage of an available exemption.

More information on what is considered a reporting company, whose and what information must be reported, and what’s next for the rule is provided in our LawFlash How Will the US Corporate Transparency Act Impact Sovereign Wealth Funds and Other Non-US Government Institutions?

Hart­-Scott-Rodino Act

The FTC has proposed sweeping changes to the Hart-Scott-Rodino premerger notification form. If the FTC decides to adopt the proposed new form, the merger review process will take longer and be more burdensome.

In addition, the changes could have a direct impact on funds, including SWFs, by requiring buyers to identify and provide information about fund investors in the following circumstances:

  • An investor is a “foreign entity of concern,” as defined in the Infrastructure Investment and Jobs Act, and has provided “subsidies” to the buyer or seller;
  • An investor owns 5% or more of the LP interests of any entity that directly or indirectly owns a controlling interest in the buyer; or
  • An investor has provided credit or holds nonvoting securities of any entity that directly or indirectly owns a controlling interest in the buyer.

More information on the significant proposed changes and key takeaways can be found in our LawFlash New HSR Form Will Transform the US Merger Review Process.

Proposed Regulations Under Section 892 and FIRPTA Relevant to SWFs

In 2022, the IRS issued proposed regulations under Sections 892 and 897 of the Internal Revenue Code of 1986, as amended, that would be beneficial to SWFs. The proposed regulations should benefit foreign government investors in private funds and other entities that own US real estate by making it easier for those investors to structure their holdings of those investments in a manner that preserves such investors’ eligibility for the Section 892 exemption.

While Section 892 generally exempts foreign government investors, such as SWFs, from US federal income tax on investments in stocks, bonds, and other securities, any such income that is derived from a “commercial activity” or that is derived by or from a “controlled commercial entity” is not eligible for the exemption.

A “controlled entity” of a foreign government will be a “controlled commercial entity” if it is engaged in any “commercial activity” anywhere in the world. Under a special rule (the Deemed Commercial Activity Rule), a “controlled entity” is deemed to be engaged in a “commercial activity,” and thus is deemed to be a “controlled commercial entity,” if it is a “United States real property holding corporation” (USRPHC).

The proposed regulations to Section 892 provide a relaxation of the Deemed Commercial Activity Rule for “controlled entities.” While SWFs and foreign government investors will still need to monitor their activities to ensure that their “controlled entities” are not USRPHCs and are not conducting “commercial activities” anywhere in the world, they will have greater flexibility in how they choose to hold their US real estate investments, including minority interests in private equity funds that invest in real estate or infrastructure.

The relaxation of the Deemed Commercial Activity Rule should reduce the administrative burden of monitoring compliance with the rule and may, for certain foreign government investors, permit additional US real estate or infrastructure investments.

More information on the background of Section 892 and the practical impact of the proposed changes is provided in our LawFlash IRS Issues Proposed Regulations Applicable to Qualified Foreign Pension Funds and Sovereign Wealth Funds.


If you have any questions or would like more information on the issues discussed in this Insight, or are interested in commenting on the proposed regulations, please contact any of the following:

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