Locust on how we learned to stop fearing and start loving sovereign wealth funds
Sovereign wealth funds loomed up over the horizon midway through 2007, as if from nowhere.
Commentators were quick to point out that they had been around for decades. They reminded us that in the 1980s the UK’s Conservative government had had nervous dealings with the Kuwait Investment Office over its appetite for an ever-increasing stake in BP.
They drew the parallels between two decades ago, when Japan looked set to buy every golf course in America, and the emerging situation, with Americans fearing that the Chinese and Arabs might snap up swathes of the US financial industry. And they pointed out that there are plenty of benign SWFs, from Australia to Alaska.
But none of this had much relevance to the sudden rise of the new breed of state investors emerging from China, the Middle East and – as yet more quietly – Russia. In the coming years they may have more funds at their disposal than the world’s biggest asset managers, having already surpassed both the private equity and hedge fund industries. In the middle of last year, European fears of hedge funds and US concerns over private equity and taxation gave way to a dread about what sovereign wealth was going to buy and why.
But within just a few months, US and EU attitudes to eastern sovereign wealth and its use to buy western assets changed. The circumstances that drew the funds out into the open in the first place, namely their full-to-bursting coffers on account of sky-high oil prices and the continuing huge US trade deficit, a weakening dollar and a damaged western financial system, soon came to be seen as elements of a malaise for which the funds were potentially part of the cure.
Things moved fast. In November the Abu Dhabi Investment Authority (Adia) took a $7.5 billion stake in an ailing, post-sub-prime Citigroup. In December the Government of Singapore Investment Corporation (GIC) and an undisclosed Saudi second investor together injected a desperately needed $11.8 billion into UBS.
That same month the China Investment Corporation (CIC), the $200 billion fund launched by China at the end of September, took a $5 billion stake in Morgan Stanley, while Singapore’s other sovereign fund, Temasek Holdings, took a $6 billion stake in Merrill Lynch. It immediately became clear that the enormousness of the western financial industry’s problems was – in a market in which liquidity had otherwise dried up – matched only by the enormous size of the eastern sovereign funds that were only too willing to help.
The funds’ timing was impeccable. They may have bought into a dropping market but they definitely also bought into an increasingly frosty political climate before there was a chance – through new legislation or perhaps the injection of increased protectionist will into western foreign investment review processes – to freeze them out. And by instantly transforming their image from predators to saviours, they helped jam open the door for the billions and possibly trillions of dollars worth of foreign exchange reserves they still plan to invest in the west.
There may be a direct economic price to pay for taking stakes so soon while others in the market preferred to wait it out. But the PR bang they achieved for their billions of bucks will no doubt help cover them for years to come.
The US Securities and Exchange Commission’s Christopher Cox and US treasury secretary Hank Paulson were both vocal on the issue of the perceived dangers of sovereign funds while their taking large stakes in major institutions was merely hypothetical. But they remained tight-lipped when the SWFs did actually swoop on some of the world’s biggest banks, with some low-key US announcements of official reviews of the situation, made in January, only following this first wave of investments.
With continuing doubts about the health of the balance sheets of the west’s major banks and suggestions that they may be in need of many more multi-billion-dollar investments, a fear that sovereign wealth funds might start investing heavily in the west has been replaced with a fear that they might stop.
Clear evidence of this turnaround was the threat made by Lou Jiwei, head of CIC, while on his trip to London in December to boycott countries that used national security as an excuse for protectionism. Coming fresh on the heels of Adia’s investment in Citigroup but before CIC’s investment in Morgan Stanley, the threat was clearly aimed at the US.
In fact, Lou’s choice of an open-armed London, not New York or a wary Washington, for his first foreign trip abroad as head of the new investment agency was itself interpreted as a snub to the US, whose financial industry the Chinese now surely knew to be in deep trouble.
But despite having been put to one side these past few months, questions about the dangers of allowing investments by foreign states in domestic companies remain.
Concerns about, say, the Russian government buying US defence companies were always a non-issue, since there are already rules in place to guard against foreign ownership of sensitive US industries. But questions linger about even the Chinese ownership of a stake in a major US bank.
The problem is that none of the mechanisms in place to stop most traditional forms of investors from investing for political rather than financial ends exist for foreign state investors. It is true that domestic public pension funds have over the years made questionable investment decisions after interpreting their fiduciary duties as allowing investment or divestment for non-financial ends. But the threats relating to sovereign investments go deeper than this, as the issue is generally not about their losing money but about their intentionally harming companies, industries or even countries.
The answer here is that if, say, China really wanted to use its foreign exchange reserves as a weapon, it could do so simply by selling off its dollars. There are plenty of other scenarios for how Arab, Chinese and Russian cash could be used to cause mischief. But the chances of any of these things happening are slim-to-non-existent, not least because causing purposeful harm via a strategic investment would hit the investor too, and any attempt to use sovereign wealth funds to achieve strategic, non-financial aims would, in less needy times, lead to their suddenly finding themselves locked out of markets.
More than any threat, the rise of sovereign wealth funds is in fact an opportunity for the global economy to become more interlinked and for countries that in many other ways are competitors and even potential enemies to become increasingly interdependent.
Thankfully, the crisis gave the funds an opportunity to prove themselves as responsible investors before the spirit of protectionism had a chance to take hold. And while certain issues remain, in the recent words of Charlie McCreevy, European commissioner for the internal market, the best approach is now “to be open to investment, avoid protectionism and engage with sovereign wealth funds to encourage transparency”.
Note: An earlier version of this article referred to JPMorgan rather than Morgan Stanley. This has now been corrected. Apologies for the error.