Time to Panic?

Source: Exec Digital UK

Date :07/05/2008 16:01:08

A raised global profile and investments in banks hit by the credit crunch have thrown a spotlight on Sovereign Wealth Funds. Exec finds out whether they should be feared or welcomed

By Ruari McCallion

In 2006, when Dubai World acquired P&O Ports – and with it, ownership of activities in various American seaports – the issue of foreign-owned investments in the USA was thrown into stark relief. Despite active support from President Bush, the upshot was that Dubai World divested itself of its holdings in the United States. The fuss over foreign ownership was a bit paradoxical, as P&O Ports was foreign-owned, too, and it had been operating without any kind of comment for some years. But then, P&O Ports was British, rather than Arab-owned, which may have had something to do with it.

The P&O transaction helped to put the issue of sovereign wealth funds (SWFs) high up the political and financial agenda. There are a number of factors that have raised adverse comment and concern, and have led to closer investigation than these traditionally conservative and low-profile investment vehicles have been used to. First is their ownership: generally, foreign. The fact that they are government-owned has caused problems for some champions of free-market economic liberalism; Europe and North America have been selling off government-owned assets for more than a quarter of a century and have encouraged emerging economies to do the same. And then along come these government-owned investment vehicles, laden with liquidity, apparently buying up private-sector companies across the globe.

It’s a dilemma with amusingly sharp horns and has led to what one commentator described as an outbreak of ‘hyperventilating’ observations, such as the reaction to the Chinese Government’s investment of $3 billion into Blackstone’s, the US private equity company (rather than the British publishers of police manuals). One commentator talked of the arrival of a ‘sharecropper economy’ into the US. In early April 2008, the Chinese invested in BP but without generating quite the same fuss: share price popped up two percent and the Board said they ‘welcomed all shareholders’.

The public fretting seems to have died down since a number of SWFs took positions in American and global banks, almost seeming to be cast in the role of saviours of the banking system in the midst of the credit crunch. As Prof Fred Halliday of the LSE said, “…after three decades of policy, propaganda, and hype about ‘freeing up markets’, ‘reducing the role of the state’, and ‘promoting the private sector’, the SWFs embody a massive and unstoppable shift of influence back to what are in effect state-owned entities. Take that, neo-liberalism! The cunning of history has done it again.” Notwithstanding the US government’s launch of an investigation into about $35 billion (£17.9 billion) of SWF investments into various American banks, ‘it’s all gone quiet over there’, as the football chant has it.

From the size and emotion of some headlines, one would think that SWFs are huge organisations, with the power to move markets on their own. Within the Paterson Institute’s estimated total of $2.5 trillion, which may grow to £12 trillion by 2015, some of them are, indeed, very big – Dubai World has revenues of $30 billion a year and employs over 100,000 people in around 60 countries, all over the world. But it is an active trading company: most SWFs are in the role of investors only, with no apparent desire to get involved – they don’t tend to demand seats on the Board or powers of veto, for example.

The first SWF is generally regarded to be the Kuwait Investment Authority which, like most others, was established in order to accumulate and build on the wealth generated by oil revenues to sustain the country when the oil ran out. Early entrants into the market – and an unusual one – were the Singapore Government, which used compulsory national insurance and housing savings scheme resources to build itself two SWFs – Temasek Holdings and Government of Singapore Investment Corporation.

Together, they control assets worth around $200 billion, on behalf of a country that has no oil or natural resource wealth at all. SWFs aren’t all from ‘over there’, either; the State of California has CalPens, which runs its pension funds; Canada does the same, as do New Zealand and Alaska and Norway. But if SWFs have been around for decades, why have they started attracting attention only recently?

“It’s almost ironic – the funds have been criticised for many years for not being more adventurous. When they engage in more diverse investments, they’re criticised again,” says Jenny Connolly, a trust lawyer with Freshfields Bruckhaus Deringer. The change in investment strategy is partly linked to the decline in the US Dollar, she believes. “It’s also a view of where they think growth will be found – not in T-bonds, but in European companies, in Africa and Brazil. They’re slightly more speculative, with slightly more risk.” But banks, oil companies and ports aren’t exactly dot-com, penny shares or the 3.30 at Newmarket. Property Week recently (April 2008) reported that German bank, Eurohypo, suggested that SWFs could invest up to $100 billion a year in property.

Discussing the possibility could give estate agents something to do in the morning in the current market downturn, before they spend the afternoon looking out the window. While property does meet several criteria, such as long-term investment, revenue stream, etc, it doesn’t meet one crucial element: liquidity. It takes a while to sell a lump of real estate. And the current market does not look attractive, so prices are unlikely to be driven even further up by money from overseas.

“SWFs are seeking high returns in a low-return environment,” says Gabriel Stein, a director of Lombard Street Research. “They tend to appear where countries have a large stream of income and find they can’t spend the money all at once – if they tried to, they’d create havoc with the rest of their economy; it would be very inflationary.” He’s reasonably sanguine about their role and likely impact.

“The fear of SWFs isn’t so much about what they have done but what they might do. They are important, as they are large investors, but they’re nowhere near as big as hedge funds.” In stark contrast to the latter, SWFs tend to be in it for the longer term and their practice hitherto has been to allow company managers to get on with their jobs, without interference. Many businesses would love to have investors like that. The nature of the people behind the funds is important, as well.

“The Arab rulers are very clever but very conservative. Their hold on power is narrowly based; they want good relations with their foreign backers and with their people and a large source of income that can benefit the people – not just buy them off – is just the ticket. The Russians and Chinese could be an issue but the Chinese funds aren’t really for foreign investment,” he continues.

The Chinese ‘stability funds’ have been used to prop up their banking system; the Russians have done much the same, after the financial crisis of 1997-8, but they may be different in the future. They seem to be more inclined to use state assets – oil and gas reserves and supplies – for policy ends but their SWF is still small, in relative terms. “Ideologically, I don’t like state funds buying assets but, if there are enough of them for a competitive environment, then that’s OK. They are important but they don’t all act in concert.” Their home countries should possibly be more concerned.

“If not used properly, a SWF may run the risk of weakening private sector competitiveness of the country owning the SWF,” Andrew K P Leung, SBS, FRSA said recently. “Because of their very nature, SWFs tend to be less transparent and are less able to meet full disclosure requirements. They deserve to be closely monitored and regulated. But a balance needs to be struck between suspicion, caution, and genuine commercial considerations, especially if the stake is not large proportionally, if the investment does not carry any voting rights, and if such investment does not compromise national security.”

The ongoing debate is about transparency but attempts to regulate could prove difficult, as the reaction to the EU Commission’s proposal indicated; at least one Mid-East SWF threatened to withdraw investments completely. Governments don’t like other governments seeking to regulate them. From what Connolly says, the need for regulation, beyond the existing regime of requirements for companies to disclose large stakes, is arguable.

“We haven’t seen that [any sign of SWFS becoming more active investors],” she explains. “The bigger the stake, the more exposed they are as investors. They tend to have modest shareholdings.” She believes the current excitement is more about fear than reality. “We’re in an uncertain economic climate; people feel more nervous and more vulnerable. They’re concerned about foreigners coming in – but, at the same time, liquidity is very important, especially in the US, and stabilising institutions is very important. As progress is made in transparency, understanding of what the funds are for and of their investment policy, I expect there will be less steam.”

Click here to view the full article on Sovereign Wealth Funds