Sovereign wealth funds are politically so hot now that they have competed successfully with the financial crisis for media attention during July and August. American Congressmen and the German Chancellor propose heightened surveillance, and possibly restrictions on capital inflows from this particular source. Even advocates of financial openness like the Financial Times are seriously concerned about the activities of these behemoths. Not many corporates have complained, however, and some like Barclays and Blackstone have welcomed sovereign wealth fund investment.
Are private-sector firms simply greedy or gullible to accept major sovereign wealth fund stakes? Perhaps. Are the polticians just exploiting xenophobic public reactions? Undoubtedly – but their concerns may not be entirely unfounded. Is this issue overblown and ephemeral? Certainly not.
Sovereign wealth funds are already a major force in international capital markets. They will become increasingly important, as long as financial globalisation is not reversed and emerging market countries and oil producers continue to run large balance-of-payments surpluses. One need not accept the Morgan Stanley forecast of $12 trillion in sovereign wealth funds by 2015 – just look at the enormous buildup over the past five years of investible funds under the control of these countries’ governments. The chart shows only the amounts identified as foreign exchange reserves of the top reserve holders. By the end of 2007, the non-industrial countries will hold about $3.5 trillion in foreign exchange reserves and a further $1.5-2.5 trillion in other forms, including sovereign wealth funds.
Source: E. Papaioannou and R. Portes, ‘The euro as an international currency vis-à-vis the dollar’, paper for Euro50 Group meeting, Rome, 3 July 2007.
The reserves have for some time exceeded what these countries need as precautionary liquidity (insurance against sudden capital outflows). Some of the reserve accumulation has already been set aside in sovereign wealth funds. There will be much more, as the balance-of-payments surpluses continue. China has announced intentions to put $300 billion of its $1.3 trillion of reserves into the China Investment Corporation. But those reserves are currently growing at the rate of $400 billion a year! The Chinese authorities are unlikely to see much point in further purchases of low-yielding, short-term dollar, euro or yen government securities, so this sovereign wealth fund will grow very rapidly indeed. The Table shows the countries with major sovereign wealth funds and recent estimates of their assets.
Large sovereign wealth funds
||Current sizs (US$ bn)
|United Arab Emirates
||Adu Dhabi Investment Authority
||500 to 875
||Government of Singapore Investment Corporation
||100 to 330
||Goverment Pension Fund-Global
||Future Generations Fund
||Stabilization Fund of the Russian Federation
||Central Huijin Investment Company
||Qatar Investment Authority
Source: E. Truman, 'Sovereign wealth funds: the need for greater transparency and accountability', Peterson Institute Policy Brief PB 07-6, August 2007.
Protection against competition from foreign goods and workers was a major force in reversing the first globalisation of 1870-1913. Financial protectionism now poses a clear threat of backlash against the globalisation of the past twenty years. It is not confined to sovereign wealth funds – recall France classifying yoghurt as a strategic industry when Pepsi was interested in acquiring Danone. Only somewhat more plausible were the American reactions against incursions from Dubai Ports and China National Offshore Oil Corporation. But even if British reservations about a Qatari bid for Sainsbury are purely sentimental, it is clear that a sovereign wealth fund’s entry as a controlling shareholder of a major company is not quite the same as, say, EDF supplying my electricity in London.
From the corporate viewpoint, the key issue is potential control by a state-run entity. European countries have gone through a wave of privatisations since the early 1980s. Managers, shareholders and governments are not likely to sit by passively in the face of cross-border renationalisation. Foreign government interference in business decisions is much less palatable than domestic government intervention. And even the Norwegian sovereign wealth fund is pulling out of its Wal-Mart investment because of its disapproval of some of that company’s non-commercial policies.
Private investors might behave similarly, but the implications are clearly different, and the scale of sovereign wealth funds could give them unprecedented scope for foreign political influence over private corporate behaviour. It is not sufficient to reply that these investors will not behave ‘irrationally’. They may behave very rationally but with some very different motivations from private investors.
Those motivations may raise legitimate political as well as business concerns. Suppose a major firm were controlled by the sovereign wealth fund of a geopolitically important ally, and this firm seemed headed for a collapse. Would a European or American government give in to pressure to override ‘state aid’ prohibitions and bail out the failing firm?
There are other broader economic and financial issues. The investments of sovereign wealth funds will be so large that sudden shifts in their portfolios could disrupt financial markets. And in a financial crisis, would their behaviour be likely to be stabilising or destabilising? Looking longer-term, it is fairly clear that the existing currency composition of most sovereign wealth fund portfolios is heavily weighted towards dollar-denominated assets. As they develop active investment strategies, they are more likely than their countries’ central banks to make significant shifts out of dollars. This could affect exchange rates and eventually even the relative importance of the dollar as an international currency.1
Even those of us who oppose protectionism and believe strongly in open financial markets can see reasons why host-country firms and governments might want to develop explicit policies towards foreign sovereign wealth funds. But it is hard to think of realistic measures that might alleviate the concerns. The United States needs foreign investment of $2 billion per day to finance its current account deficit. The financiers – increasingly foreign governments with their central banks and sovereign wealth funds – will not continue to accumulate US Treasuries. Is the US likely to enforce policies that will drive them away and require a painful current account adjustment? Of course, reciprocity is desirable, in the sense that openness to Chinese sovereign wealth fund investment should require equivalent Chinese openness to foreign investment. But that is not on offer, and the US cannot compel it through the WTO. So will the US treat all Chinese investment as it did China National Offshore Oil Corporation? Unlikely.
One proposal is to limit sovereign wealth fund acquisitions to non-voting shares, in order to avoid political interference in business decisions or strategies. Another possible restriction would put a cap – say 15-20 % - on their share in any company. But this kind of discrimination against one category of foreign investors probably would not get broad support among potential host countries. Without such agreement, it is not enforceable – host countries will not want to see all the investment go to others. There might, however, be broad agreement on a ‘code of conduct’ for sovereign wealth funds, perhaps negotiated through the OECD or IMF. This would require transparency: annual or more frequent sovereign wealth fund reports on portfolio composition and investment strategies.
We might like to see the sovereign wealth funds behave like institutional investors, or better still, do their investment through intermediaries (our asset management firms!). But they are more likely to offer good money to their own nationals now working on Wall Street or in the City to come back so they can do it well themselves. And they will often want not just to take stakes in private equity firms, but to behave like private equity firms. The prospects for easy resolution of the foreseeable conflicts are not good.
This article first appeared in Real IR on 18 September 2007.
1 See E. Papaioannou, R. Portes and G. Siourounis, ‘The asset composition of international reserves’, available at http://faculty.london.edu/rportes/