Sovereign Wealth Funds [1 ed.] 9781613241189, 9781606923191

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SOVEREIGN WEALTH FUNDS

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SOVEREIGN WEALTH FUNDS

THOMAS N. CARSON AND WILLIAM P. LITMANN

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EDITORS

Nova Science Publishers, Inc. New York

Copyright © 2009 by Nova Science Publishers, Inc. All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transmitted in any form or by any means: electronic, electrostatic, magnetic, tape, mechanical photocopying, recording or otherwise without the written permission of the Publisher. For permission to use material from this book please contact us: Telephone 631-231-7269; Fax 631-231-8175 Web Site: http://www.novapublishers.com NOTICE TO THE READER The Publisher has taken reasonable care in the preparation of this book, but makes no expressed or implied warranty of any kind and assumes no responsibility for any errors or omissions. No liability is assumed for incidental or consequential damages in connection with or arising out of information contained in this book. The Publisher shall not be liable for any special, consequential, or exemplary damages resulting, in whole or in part, from the readers’ use of, or reliance upon, this material.

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CONTENTS Preface Sovereign Wealth Funds: Background and Policy Issues for Congress Martin A. Weiss

1

Chapter 2

China’s Sovereign Wealth Fund Michael F. Martin

21

Chapter 3

State Capitalism: The Rise of Sovereign Wealth Funds Gerard Lyons

41

Chapter 4

Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the United States:Assessing the Economic and National SecurityImplications: Testimony before the Committee on Banking, Housing, and Urban Affairs, United States Senate, November 14, 2007 Edwin M. Truman

Chapter 1

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ix

Chapter 5

Chapter 6

Testimony of Patrick A. Mulloy before the Senate Committee on Banking, Housing & Urban Affairs Hearing on “Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the U.S.: Assessing the Economic and National Security Implications”, November 14, 2007 Foreign Government Investment in the U.S. Economy and Financial Sector: Joint Hearing before the Subcommittee on Domestic and International Monetary Policy, Trade, and Technology and the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises of the Committee on Financial Services U.S. House of Representatives One Hundred Tenth Congress Second Session, March 5, 2008

83

107

117

vi Chapter 7

Chapter 8

Chapter 9

Chapter 10

Chapter 11

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Chapter 12

Chapter 13

Chapter 14

Chapter 15

Chapter 16

Contents Statement of Scott G. Alvarez, General Counsel, Board of Governors of the Federal Reserve System before the Committee on Banking, Housing, and Urban Affairs United States Senate

273

Investments and Acquisitions in the United States by Government Entities, Testimony by Alan Larson, Senior International Policy Advisor, Covington & Burling LLP, before the Senate Committee on Banking, Housing and Urban Affairs, November 14, 2007

283

Sovereign Wealth Funds and Implications for Policy, Testimony by Jagdish Bhagwati, before The Senate Foreign Relations Committee, Wednesday, 11th June 2008

291

U.S. Regulatory Framework for Assessing Sovereign Investments, Testimony by Jeanne S. Archibald, Director, International Trade Practice, Hogan & Hartson LLP, Before the Senate Committee on Banking, Housing and Urban Affairs, April 24, 2008

297

The Foreign Policy Implications of Sovereign Wealth Funds Daniel W. Drezner

303

Testimony of David Marchick, Managing Director and Global Head of Regulatory Affairs, the Carlyle Group, before the United States Senate, Committee on Foreign Relations, June 11, 2008

309

Testimony of David Marchick, Managing Director and Global Head of Regulatory Affairs, the Carlyle Group, before the United States Senate, Committee on Banking, Housing, and Urban Affairs, April 24, 2008

315

The Regulatory Framework for Sovereign Investments, Testimony Before the Committee on Banking, Housing, and Urban Affairs, United States Senate, April 24, 2008, by Ethiopis Tafara, Director, Office of International Affairs, U.S. Securities and Exchange Commission

319

U.S. Senate Committee on Foreign Relations, Senator Richard G. Lugar, Opening Statement for Hearing on Sovereign Wealth Funds, June 11, 2008

325

Statement of Chairman Dodd, “Turmoil in U.S. Credit Markets: Examining the U.S. Regulatory Framework for Assessing Sovereign Investments”

327

vii Chapter 17

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Index

The Committee on Foreign Investment in the United States (CFIUS) James K. Jackson

331 353

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PREFACE Sovereign wealth funds (SWFs) are investment funds owned and managed by national governments. Such funds currently manage between $1.9 and $2.9 trillion and are expected to grow to over $12 trillion by 2015. This is due to the rapid growth of commodity prices and large trade surpluses in several emerging market economies. During the second half of 2007, interest in SWFs increased as Asian and Middle Eastern SWFs, fueled by surging foreign exchange reserves, invested large sums of capital in U.S. and other Western companies. Policy makers in the United States have raised two broad policy concerns about SWFs: (1) their lack of transparency and (2) their possible misuse for political or other non-commercial goals. Hearings have been held by several congressional committees including the House Financial Services Committee and the Senate Foreign Relations and Senate Banking Committees. Additional congressional hearings are expected in 2008. SWFs pose a complex challenge for policy makers. On one hand, SWFs are long-term investment vehicles looking beyond quarterly results and therefore serve as stable funding sources during financial turbulence. On the other hand, however, there are operational concerns stemming from government control (i.e., lack of transparency and possible non-commercial investment goals). Without transparency, it is difficult to attain a clear picture of SWF investment activity. A lack of SWF transparency can also obscure governance and risk-management problems within SWFs. Many are also concerned that countries will use SWFs to support what one analyst has called “state capitalism,” using government-controlled assets to secure stakes around the world in strategic areas such as telecommunications, energy and mineral resources, and financial services, among other sectors. In response to these concerns, many analysts and policy makers are evaluating the operations of existing SWFs and are looking to the international financial institutions such as the International Monetary Fund, World Bank, and the Organization for Economic Cooperation and Development to establish guidelines for SWF operations. All of these institutions are currently developing proposals that will be deliberated during 2008.

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In: Sovereign Wealth Funds Editors: T. N. Carson, W. P. Litmann

ISBN: 978-1-60692-319-1 © 2009 Nova Science Publishers, Inc.

Chapter 1

SOVEREIGN WEALTH FUNDS: BACKGROUND AND POLICY ISSUES FOR CONGRESS *

Martin A. Weiss Analyst in International Trade and Finance Foreign Affairs, Defense, and Trade Division, USA

ABSTRACT

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Sovereign wealth funds (SWFs) are investment funds owned and managed by national governments. Such funds currently manage between $1.9 and $2.9 trillion and are expected to grow to over $12 trillion by 2015. This is due to the rapid growth of commodity prices and large trade surpluses in several emerging market economies. During the second half of 2007, interest in SWFs increased as Asian and Middle Eastern SWFs, fueled by surging foreign exchange reserves, invested large sums of capital in U.S. and other Western companies. Policy makers in the United States have raised two broad policy concerns about SWFs: (1) their lack of transparency and (2) their possible misuse for political or other noncommercial goals. Hearings have been held by several congressional committees including the House Financial Services Committee and the Senate Foreign Relations and Senate Banking Committees. Additional congressional hearings are expected in 2008. SWFs pose a complex challenge for policy makers. On one hand, SWFs are longterm investment vehicles looking beyond quarterly results and therefore serve as stable funding sources during financial turbulence. On the other hand, however, there are operational concerns stemming from government control (i.e., lack of transparency and possible non-commercial investment goals). Without transparency, it is difficult to attain a clear picture of SWF investment activity. A lack of SWF transparency can also obscure governance and risk-management problems within SWFs. Many are also concerned that countries will use SWFs to support what one analyst has called “state capitalism,” using government-controlled assets to secure stakes around the world in strategic areas such as telecommunications, energy and mineral resources, and financial services, among other sectors. *

Excerpted from CRS Report RL34336, dated March 26, 2008.

Martin A. Weiss

2

In response to these concerns, many analysts and policy makers are evaluating the operations of existing SWFs and are looking to the international financial institutions such as the International Monetary Fund, World Bank, and the Organization for Economic Cooperation and Development to establish guidelines for SWF operations. All of these institutions are currently developing proposals that will be deliberated during 2008. This report will be updated as events warrant.

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INTRODUCTION Sovereign Wealth Funds (SWFs) are investment funds owned and managed by national governments. Originally created in the 1950s by oil and resource-producing countries to help stabilize their economies against fluctuating commodity prices, and to provide a source of wealth for future generations, they have proliferated considerably in recent years. Although their lack of transparency makes estimating SWF investment levels difficult, it is estimated that they currently manage between $1.9 and $2.9 trillion.[1] Estimates of their growth over the next several years vary, with the consensus hovering around Morgan Stanley’s projection of $12 trillion by 2015.[2] SWFs can be funded through a variety of means, including profits from the sale of commodities (such as oil) or a current account surplus. SWFs can be established to serve several different objectives. These may include diversifying national assets, stabilizing the domestic economy against volatile commodity prices, saving for future generations, getting a better return on investment than traditional foreign exchange reserves, and promoting political or strategic interests. During the second half of 2007, Asian and Middle Eastern SWFs, fueled by surging foreign exchange reserves, invested large sums of capital in the United States and other developed countries. While SWFs are invested broadly throughout Western markets, investments have been particularly concentrated in financial institutions. Following losses stemming from the August 2007 U.S. sub-prime mortgage crisis, many financial institutions sought large investments from foreign SWFs and other large institutional investors.[3] According to Dealogic, a financial data provider, SWFs invested $37.9 billion in U.S. financial institutions in 2007, 63% of their total activity.[4] The dramatic recent increase in SWF activity has raised concerns about this relatively unexamined class of international investors. This report provides background on SWFs, including what countries operate SWFs and the size of the SWF market, and discusses two broad areas of concern to Members of Congress and the international financial community: • •

governance and transparency-related issues, and possible non-commercial investment goals, including the potential use of governmentcontrolled investment vehicles to attain global strategic and political goals.

Some U.S. policy makers stress that their concerns about SWFs are not meant to undermine the U.S. commitment to open investment. They maintain that the United States is one of the most open economies in the world and note that foreign investment in the United States provides many benefits, including lower interest rates, increased employment, productivity, and access to capital for American enterprise. Indeed, for countries such as the

Sovereign Wealth Funds: Background and Policy Issues for Congress

3

United States, which have both a high national budget deficit and historically low levels of public savings, foreign investment has been crucial.[5]

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BACKGROUND The rising profile of SWFs is a direct consequence of the massive accumulation of global foreign reserve assets over the past decade. While reserve accumulation has occurred in many emerging market economies, it has been especially sharp among oil producers and Asian countries that have large trade-surpluses with the United States and other developed countries. In these countries, reserves have swelled to levels far in excess of the amount needed for balance of payments support, thus presenting an opportunity for foreign exchange reserve managers to maximize returns. Foreign exchange reserves are traditionally invested in low-risk assets such as U.S. Treasury bills, but their recent growth has seen an increasing shift of excess reserves to higher-risk, higher-return investments. In contrast to traditional foreign exchange reserves, SWFs invest in a much broader array of assets, including stocks, bonds, fixed assets, commodities, derivatives, and alternative investments such as real estate and hedge funds. Like private hedge funds and government pension funds, SWFs often rely on outside expertise and professional fund managers.[6] Two key forces drove interest in SWFs during the second half of 2007: (1) the introduction of new funds and (2) major acquisitions by existing SWFs following large losses by Western financial institutions from the U.S. sub-prime mortgage crisis. Many point to the September 29, 2007, launch of the new China Investment Corporation, Ltd. (CIC), with $200 billion of capital as a catalyst of the initial Western interest in SWFs.[7] In addition to the introduction of the CIC, several Middle Eastern and Asian SWFs have recently announced or completed large deals, with a focus on multinational financial institutions following the market turmoil in the second half of 2007. During the fourth quarter of 2007, Morgan Stanley estimates that SWFs invested $44.5 billion in Western financial institutions (Figure 1). Presumably, as long-term investors, SWFs see these investments as currently undervalued. In addition, many emerging market countries are looking to boost their own domestic financial institutions, which would likely be facilitated by the transfer of knowledge gained from major investments in more experienced Western financial institutions. Large recent deals include the following: • • • •

On September 20, 2007, the Mubadala Development Company, which is owned by the government of Abu Dhabi, announced a deal to buy a 7.5% stake in the Carlyle Group, a U.S. buyout investment firm, for $1.35 billion.[8] On November 26, 2007, the Abu Dhabi Investment Authority (ADIA), the world’s largest SWF, announced a deal to buy a 4.9% stake in Citigroup for $7.5 billion.[9] On December 10, 2007, UBS AG, a Swiss bank, announced that the Government of Singapore Investment Corporation is investing $9.75 billion for a 9% stake, while a Saudi investor is investing $1.77 billion to UBS AG.[10] On December 19, 2007, Morgan Stanley, a U.S.-based investment bank, announced that the China Investment Corporation would invest $5 billion for a 9.9% share.[11]

Martin A. Weiss

4 •

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•

On December 24, 2007, Merrill Lynch announced a $6.2 billion private placement from Singapore’s Temasek and New York-based Davis Selected Advisors. Temasek is expected to invest $4.4 billion in Merrill Lynch common stock, with the option to buy an additional $600 million in stock by March 2008.[12] On January 15, 2008, Citibank announced that it is receiving $14.5 billion from investors including the governments of Singapore and Kuwait, former Chairman Sanford Weill, and Saudi Prince Alwaleed bin Talal. On the same day, Merrill Lynch announced that it is to receive $6.6 billion from a group led by Tokyo-based Mizuho Financial Group Inc., the Kuwait Investment Authority, and the Korean Investment Corp.[13]

Source: Morgan Stanley. Figure 1. SWF Investments in Western Financial Institutions ($ billions).

Several international bodies, including the IMF, the U.S. Treasury, and the European Central Bank have drawn attention to the positive impact that this SWF investment appears to have exerted so far by providing liquidity and stability during the U.S. sub-prime mortgage crisis that began during the summer of 2007.[14] In its December 2007 six-month Financial Stability Review, the European Central Bank wrote: As SWFs, in particular those that put the emphasis on savings for future generations, are likely to have a long-term horizon for their investments, they may also contribute to the broadening of the long-term investor base for risky assets, such as equities, corporate bonds, emerging market assets, private equity and real estate. In this regard, such funds could become a more stable investor base for risky assets in certain markets. In addition, provided that the investments of such funds are driven entirely by risk and return considerations, SWFs may contribute to a more efficient allocation and diversification of risk at the global level.[15]

Sovereign Wealth Funds: Background and Policy Issues for Congress

5

While SWFs represent a small percentage of all investment classes globally, their rapid and projected growth could increase demand for riskier assets, including equities and bonds. Deutsche Bank estimates that future SWF asset allocation could lead to a gross capital inflow of over $1 trillion into global equity markets and $1.5 trillion into global debt markets over the coming five years.[16] Merrill Lynch, using more aggressive assumptions, estimates that $3.1 to $6 trillion is likely to be invested in riskier assets by SWFs in the next five years.[17]

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What Are Sovereign Wealth Funds (SWFs)? While the term “Sovereign Wealth Fund” was coined only recently, SWFs have a more than 50-year history, with the first fund established by Kuwait in 1953.[18] There is no universally agreed upon definition of SWFs. The U.S. Treasury Department narrowly defines SWFs as “a government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from the official reserves of the monetary authorities (the Central Bank and reserve-related functions of the Finance Ministry).”[19] The U.S. Treasury Department’s definition is meant primarily to distinguish SWF investment from official reserves managed by a country’s central bank. Because the primary goals of official foreign reserves are liquidity and security, the investment horizon for these for reserves is short. Some observers provide a more detailed definition of SWFs. Stephen Jen, a currency analyst at Morgan Stanley, expands on the Treasury definition to provide a broader understanding of SWFs and how they differ from official foreign reserves and other government-sponsored funds. According to Jen, there are five key traits of SWFs. They are (1) sovereign government entities with (2) high foreign currency exposures, (3) no explicit liabilities (such as a national state pension fund), (4) high- risk tolerances, and (5) long investment horizons.[20] The IMF divides SWFs into several categories based on their stated goals. In practice, however, many SWFs combine elements of the following three categories. The three primary types of SWFs, according to the IMF, are as follows: 1

2

Stabilization funds — Volatile international market prices are a primary concern for resource- and commodity-intensive economies. Some commodities face price fluctuations of an average of 20%-25% per year. To mitigate this volatility, several countries have established funds to sterilize capital inflows[21] and stabilize fiscal revenues. Because stabilization funds serve a more immediate function than long-term savings funds, they tend to be more conservative in their investment decisions, focusing on fixed income rather than equity investments.[22] Examples include Russia’s Stabilization Fund of the Russian Federation and Kazakhstan’s National Oil Fund. Savings funds — Savings funds are intended to share wealth across generations. For countries rich in natural resources, savings funds convert nonrenewable natural resources into a diversified portfolio of international financial assets to provide for future generations or other long-term objectives. According to the IMF, while newer oil funds predominantly focus on stabilization objectives, the recent increase in oil prices has allowed SWFs to emphasize savings objectives. Becuase savings funds have longer investment horizons than pure stabilization funds, they invest in a broader

Martin A. Weiss

6

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3

range of assets, including bonds and equities, as well as other forms of alternative investments, such as real estate, private equity, hedge funds, and commodities. Examples include the Abu Dhabi Investment Authority, Kuwait Investment Authority, Singapore’s Government Investment Corporation, and the China Investment Corporation. Reserve investment corporations — Reserve investment corporations are funds established to reduce the opportunity cost of holding excess foreign reserves or to pursue investment policies with higher returns. Reserve investment corporations adapt more aggressive investment strategies, including taking direct equity stakes. These funds typically seek higher returns than other SWFs and use leverage (i.e., debt) in their investments. Historically, theses vehicles tend to be more secretive than other SWFs that are primarily portfolio investors.[23] Examples of such funds are Singapore’s Temasek, Qatar’s Investment Authority, and Abu Dhabi’s Mudabala.[24]

Among funds, there are substantial differences in risk-return profiles, investment horizons, asset allocation, eligible instruments, risk tolerances, and constraints.[25] Because each fund is different and has varying goals and objectives, it is difficult to generalize about the investment strategies of SWFs as a class. For example, an oil-exporting economy may initially establish a SWF for stabilization purposes. However, if the assets under management by the SWF grow to exceed the levels needed for stabilization, the country may either change the priorities and investment strategy of the fund or establish a separate fund with a more aggressive investment approach. Thus, several countries have multiple sovereign wealth funds. For example, the United Arab Emirates’s primary fund, the Abu Dhabi Investment Authority (ADIA), was established in 1974 to invest surplus cash in assets that provide steady gains and returns over a long timehorizon using a portfolio investment strategy. In 2002, the United Arab Emirates established Mubadala Development to pursue direct investment projects targeted at higher returns.

What Countries Operate SWFs? The first SWF was established by Kuwait in 1953 as a means to help stabilize the economy from fluctuating oil prices.[26] In 1956 the Gilbert Islands (now Kiribati) established the Revenue Equalization Reserve Fund to manage profits from phosphate mining. Following Kuwait and Kiribati, the next major SWFs were created in the 1 970s in the wake of the oil shock. The most recent wave began in the 1 990s with the Norway Government Pension Fund-Global in 1990 and continues to this day. In the last five years, funds have been established by China, Iran, Russia, Qatar, and the United Arab Emirates. As noted previously, the recent growth of SWFs is a consequence of rapid growth in emerging market reserves driven by (1) the impact of rising oil prices for Middle Eastern economies and (2) large trade surpluses, net foreign direct investment flows, and high savings rates among Asian economies. Reserve accumulation has been especially sharp in the case of China, where there has been extensive intervention in the foreign exchange markets to limit the yuan’s appreciation against the dollar.[27] Analysts estimate that foreign assets held by sovereign nations currently exceed $5 trillion and are, as the growing U.S. current account imbalance would indicate, increasing at a

Sovereign Wealth Funds: Background and Policy Issues for Congress

7

significantly more rapid rate in emerging market countries with high savings rates than in the industrialized countries. Table 1 provides information on the 10 largest holders of foreign reserves (as of the end of 2006) and five additional countries that have large SWFs. Table 1. Foreign Exchange Reserves and Current Account Balances

2006 (USD Billions)

Change ‘01‘06 (Percent)

Share of GDP 2006 (Percent)

Reserves/GD P (Percent)

Current Account/GDP 2002-2006 (Percent)

ChinaS

1,066

403

41

8.6

5.5

Japan

875

126

20

2.2

3.5

RussiaSR

295

807

30

8.4

9.7

Foreign Exchange Reserves

Taiwan

266

118

75

8.9

7.1

KoreaSR

238

133

27

3.9

1.9

India

170

276

19

3.7

-0.3

SingaporeSR

136

81

103

11.3

22.5

Hong Kong

133

20

70

2.6

9.9

Brazil

86

139

8

1.4

1.0

82

185

54

8.9

13.3

Malaysia Algeria

S

S

78

333

68

14.0

17.2

56

153

17

2.6

14.3

EmiratesS

28

98

16

2.4

12.3

KuwaitS

12

32

13

0.9

32.9

QatarS

5

346

10

2.4

20.0

NorwayS

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United Arab

Source: Peterson Institute for International Economics. Notes: S = has one or more sovereign wealth funds; R = reserves include sovereign wealth fund in whole or in part.

Middle East The Middle East region is currently experiencing a substantial economic boom due to record high oil prices. The value of oil and gas exports from the Middle East was approximately $650 billion in 2007 and is expected to rise to almost $750 billion in 2008. Because these countries either largely control or heavily tax oil production, government revenue from oil and gas is now estimated at $510 billion for 2007, and will likely rise above $580 billion in 2008.[28] According to RGE Monitor, between 2002 and 2007, the Gulf Cooperation Council (GCC) countries (excluding Saudi Arabia) transferred over $300 billion to their SWFs.[29] Like other GCC countries, Saudi Arabia, as the world’s largest producer and exporter of oil, has benefitted from increasing oil revenues in recent years. Although Saudi Arabia has not formally established a SWF, its central bank holds a significant amount of international investments outside of traditional foreign reserves, and thus is not reflected on the previous chart. Separately, the Saudi central bank controls an estimated $320 billion in foreign assets, with “additional reserves that are not made public for national security reasons.”[30] In December 2007, Saudi Arabia announced plans to establish a sovereign wealth fund likely to be the world’s

8

Martin A. Weiss

largest. According to the Financial Times, the proposed Saudi fund would dwarf the world’s largest SWF, the United Arab Emirates’ Abu Dhabi Investment Authority (ADIA).[31] The effort is likely to be spearheaded by the government’s Public Investment Fund, which has a mandate to invest only within Saudi Arabia.

Asia Among Asian economies, the expansion of reserves has been even more dramatic. By 2006, Asia held 54% of the then $4.2 trillion of worldwide reserves, more than the global total 10 years earlier.[32] Asian reserve accumulation is largely the result of persistent and sustained current account surpluses with the United States and other Western countries.[33] Following the 1998 Asian financial crisis, many Asian economies began accumulating large amounts of reserves to provide adequate insurance against any future currency fluctuations or macroeconomic insecurity.[34] Two additional factors motivate Asian reserve accumulation. First, several countries have pursued an export-led growth strategy targeted at the United States involving significant market intervention (especially by China) to maintain a stable undervalued exchange rate.[35] Second, many Asian emerging market economies have financial markets that are not developed enough to absorb the traditionally high levels of private savings seen in Asia.[36]

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The Size of SWFs It is difficult to accurately measure the amount of assets under management by SWFs because many funds do not disclose much information about their operations and assets. The funds believed to be the largest do not disclose their size, investment strategies, or current holdings. Estimates for the size of the largest fund, the United Arab Emirates’ ADIA, for example, range widely between $500 and $900 billion. Reportedly, ADIA has achieved a 20% rate of return for many years and rarely considers deals less than $100 million.[37]

Source: Norges Bank. Figure 2. Segments of the Global Capital Market, USD trillion, 2007.

Sovereign Wealth Funds: Background and Policy Issues for Congress

9

Official and private sector analysts estimate that there is between $1.9 and $2.9 trillion under management by SWFs. This is significantly smaller than other investment classes (Figure 2). Table 2. Large Sovereign Wealth Funds

Country United Arab Emirates

Date Est. 1976

500-875

Oil

2002

10

Oil

2003 1990

4 329

Oil Oil

Norway

Mubadala Development Company Isithmar Government Pension Fund — Global Government of Singapore Investment Corporation

1981

100-330

Other

Singapore

Temasek Holding

1974

108

Other

Russia

Kuwait Investment Authority Stabilization Fund of the Russian Federation

1960 2004

213 141

Oil Oil

China

China Investment Corporation

2007

200

Other

Qatar

Qatar Investment Authority

2005

50

Oil

Australia

Future Fund

2006

49

Other

Algeria

Revenue Regulation Fund

2000

43

Oil

United States

Alaska Permanent Fund

1976

40

Oil

Brunei

Brunei Investment Agency

1983

30

Oil

Korea

Korea Investment Corporation

2005

20

Other

Kazakhstan

National Oil Fund

2000

19

Oil, Gas

Malaysia

Khazanah Nasional

1993

18

Other

Venezuela

National Development Fund 2005 Macroeconomic Stabilization 1998 Fund Alberta Heritage Savings Trust 1976 Fund

15

Oil

1

Oil

15

Oil

Chile

Economic and Social Stabilization Fund

2006

10

Other

New Zealand

Superannuation Fund

2001

10

Other

Iran

Oil Stabilization Fund

2000

9

Oil

Kuwait

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Name Abu Dhabi Investment Authority and Corporation

Current Size Source of Funds ($ billions)

Canada

Source: Peterson Institute for International Economics.

However, analysts expect that if oil prices remain, and there no immediate correction of current global imbalances, SWFs will grow rapidly over the next few years. Morgan Stanley estimates that if foreign reserves continue to increase at a current pace, they could grow to $12 trillion by 2015.[38] Several factors could weaken these growth projections, including a cyclical economic downturn, a reduction in oil prices, or a weakening of competitiveness in Asian exporting economies. On the contrary, given the rapid increase in emerging market foreign exchange reserves, if countries decide to increase transfers from official reserves to SWFs,

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Martin A. Weiss

projected figures could be substantially higher. SWFs financed by oil and gas exports are estimated to account for around two thirds of SWFs by amount invested. Asian funds financed by current account surpluses make up the rest.[39] Table 2 provides a list of the largest funds. Figure 3 combines global foreign reserve growth with recent growth of Asian and oil SWFs.

Source: RGE Monitor.

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Figure 3. Global Reserve Growth and SWFs (USD Billion, rolling 4th quarter sums).

POLICY ISSUES FOR CONGRESS The government control of SWFs has raised two broad policy concerns, namely (1) the lack of SWF transparency and (2) the potential use of SWF capital for strategic or political (i.e., non-commercial) purposes. These concerns as applied to specific SWFs are mapped in Figure 4. The X axis illustrates fund transparency, or levels of disclosure. The Y axis measures the active, or strategic, nature of their stated (or perceived) investment philosophy. For example, the funds of Norway, Alaska, and Alberta, Canada, are conventionally invested in a wide range of investments and are highly transparent. Malaysia’s SWF and Singapore’s Temasek, while also highly transparent, pursue a more strategic approach to their investments, targeting various industries that are of interest to their respective governments. The funds in the upper-left quadrant are of most concern to Western policy makers. These are the funds that disclose the least information about their funds and are the most strategic in their investment philosophy.

Sovereign Wealth Funds: Background and Policy Issues for Congress

11

Source: Standard Chartered and Oxford Analytica. Figure 4. Standard Chartered Ranking of SWFs, by Investment Approach and Transparency.

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Transparency and Governance-Related Concerns Given the recent and projected growth of SWFs, many analysts stress the need for increased transparency of SWF activity. There are no supra-national regulations or disclosure requirements for the size of SWFs, their investment strategies, or their current holdings. Unlike privately owned, nationally regulated funds, SWFs are not required to provide information to stock-holders and stake-holders. “In terms of disclosure on fund performance, investment strategy, or even basic philosophy, many [SWFs] rank below the most secretive hedge fund,” according to Gary Kleiman, a senior partner at Kleiman International Consultants, an emerging financial markets consulting group.[40] Of the existing national funds, only Norway’s fund is universally considered to be transparent and publically accountable. Minimal SWF transparency masks SWF investment activity and can obscure governance and risk-management problems within the funds. This can have distressing consequences for policy makers. First, without insight into SWF activity, it is difficult to assess systemic risks or to determine whether SWFs are in fact pursuing strategic, non-commercial investment strategies (see next section). Second, limited disclosure makes it difficult to assess the management and governance of the funds and therefore difficult to identify mismanagement or corruption by fund mangers. Conflating this problem, many of these SWFs are established in countries that currently lack the underpinnings for good SWF governance or SWF oversight. This is of concern to policy makers, because sizable failures due to poor management, particularly if concentrated within certain sectors, could affect national or global markets.

Martin A. Weiss

12

Some analysts have tried to empirically measure the lack of SWF transparency. The Peterson Institute of International Economics (IIE) has tabulated a SWF scorecard, that among other variables, looks at transparency and accountability.[41] For its transparency and accountability figure, IIE scored several questions, including the following: • •

•

Do regular reports on the investments by the SWF include the size of the fund? Information on the returns it earns? Do reports provide information on the types of investments? Information on the geographic location of investments? Information on the specific investments, for example, which instruments, countries, and companies? Information on the currency composition of investments? Is the SWF subjected to a regular audit? Is the audit published? Is the audit independent?

Consistent with Figure 3 above, the IIE found that the largest funds (i.e., those owned by the United Arab Emirates, Qatar, Kuwait, and China) scored very low on the transparency and accountability rankings.

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Non-Commercial Investment Motives While the ostensible goal of SWF investment is long-term value creation, government control could mean that a SWF may be motivated by non-commercial considerations in its investment decisions. Felix Rohatyn, a prominent investment banker and former U.S. official, has noted that for many funds, political and commercial objectives are closely intertwined. According to Mr. Rohatyn, “they are making investments that they probably think are O.K. but not spectacular.”[42] However, for these funds, “there has to be a political objective over and above the rate of return.”[43] Many U.S. policy makers are concerned that countries will use SWFs to support what one analyst has called “state capitalism,” using government-controlled assets to secure strategic stakes around the world in areas such as telecommunications, energy resources, and financial services, among other sectors.[44] Recent deals in the energy and finance sector suggest that securing access to natural resources and developing domestic financial markets appear to be the two primary SWF strategic objectives.[45] A report by Citigroup notes that “some sovereign wealth funds invest purely to achieve financial returns and portfolio diversification while others have a broader economic or social agenda.”[46] Such an agenda could be benign; many countries have expressed their interest in using investments in foreign financial institutions to acquire knowledge and technology to help build their own domestic financial institutions. On the other hand, many are concerned that countries may use their SWFs to gain access to other countries’ natural resource industries or other politically sensitive sectors. Such concern is not limited to Western countries. In January 2006, one of Singapore’s SWFs, Temasek, purchased from the family of then-Prime Minister Thaksin Shinawatra a controlling stake in the Thai telecom company Shin Corporation, which included

Sovereign Wealth Funds: Background and Policy Issues for Congress

13

taking control of space satellites used by the Thai military. This purchase sparked a political crisis in Thailand, which eventually led to the ousting of Thaksin’ s government.

U.S. AND INTERNATIONAL POLICY RESPONSES TO SWFS For many developed countries, SWFs are a double-edged sword that provide both benefits and risks. Many industrialized countries are struggling with how to take advantage of the additional liquidity that SWFs can provide while at the same time mitigating challenges raised by the lack of transparency and politically driven nature of some of these funds.

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United States The Bush Administration has been generally supportive of SWF investment, maintaining that the United States is open to foreign investment and that “money is naturally going to gravitate toward dollar-based assets because of the strength of our economy,” according to Treasury Secretary Henry Paulson Jr.[47] Secretary Paulson further noted, however, that “I’d like nothing more than to get more of that money. But I understand that there’s a natural fear that they’re going to buy up America.”[48] The magnitude of financial impact combined with the limited transparency and potentially noncommercial investment motivations of government-sponsored entities has sparked concern among some analysts and Members of Congress. Senator Richard Shelby has requested a study from the Government Accountability Office (GAO) to ensure that SWFs are “effectively monitored,” according to a Shelby aide.[49] The Senate Banking Committee held hearings on SWFs on November 13, 2007. In his opening remarks, Senator Evan Bayh summarizes the two primary concerns about SWF activity in the United States: A lack of transparency that characterizes many sovereign wealth funds undermines the theory of efficient markets at the heart of our economic system. In addition, unlike private investors, pension funds and mutual funds, government owned-entities may have interests that will take precedence over profit maximization. Just as the United States has geopolitical interests in addition to financial ones, so do other countries. Just as we value some things more than money, so do they. Why should we assume that other nations are driven purely by financial interests when we are not?[50]

In a December 2007 speech before the Gulf Cooperation Council in Bahrain, U.S. Deputy Treasury Secretary Robert Kimmett said that SWF investments “may raise legitimate questions about national security” and “their scale/number and tendency toward lack of transparency raise the possibility of potentially negative impacts on global financial stability if funds operate without prudent governance and investment management standards.”[51] Christopher Cox, Chairman of the U.S. Securities and Exchange Commission (SEC), has raised concerns about the conflict of interest that may arise when a fund is owned and managed by the government that is legally required to regulate it. Cox has stated that in

14

Martin A. Weiss

some cases, foreign governments may not be fully cooperative with insider-trading investigations. Cox also expresses concern that SWFs may be the beneficiaries of economic intelligence from national security services. Laws exist in the United States to regulate foreign investment in the U.S. economy. Foreign investments that raise national security concerns are subject to review by the U.S. Government’s Committee on Foreign Investment in the United States (CFIUS) for review.[52] It is unclear, however, to what extent sovereign wealth funds investments would be covered by the Exon-Florio National Security Test for Foreign Investment and thus subject to the CFIUS for review.[53] According to one analyst, because most SWF transactions are non-controlling, involve non-voting shares, and comprise less than a 10% stake, the current review process is not set up to review SWF investments. However, in July 2007, Congress passed the Foreign Investment Security Act of 2007 (P.L. 110-49), which among other things, enhanced the review process for non-U.S. acquisitions and added critical infrastructure and foreign governmentcontrolled transactions to the factors for review.[54]

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Europe The response to SWFs in Europe has been largely divided into two camps: countries that are considering heavier restrictions on SWF activity versus those that would like to maintain open investment principles enhanced by additional SWF transparency. France and Germany fall primarily into the first camp. According to many, Germany has taken the most aggressive stance against SWF investment. German Chancellor Angela Merkel has stated, “with those sovereign funds we now have new and completely unknown elements in circulation. One cannot simply react as if these are completely normal funds of privately pooled capital.”[55] Reportedly, Germany is redrafting an investment law that would allow it to block takeovers by SWFs or other large state-sponsored investment agencies.[56] German Chancellor Merkel has expressed particular concern that large Russian energy firms, such as Gazprom, would attempt to purchase Germany’s private energy utilities.[57] A similar response has been seen in France. Just prior to a Middle East trip in early 2008, French President Nicolas Sarkozy expressed strong concerns regarding SWF investments in Europe, focusing specifically on the lack of reciprocity within the home markets of many of the largest SWF holders. According to President Sakozy, “I don’t accept that certain sovereign wealth funds can buy anything here and our own capitalists can’t buy anything in their countries. I demand reciprocity before we open Europe’s barriers.”[58] In contrast, the United Kingdom has presented, arguably, a more nuanced approach to SWFs. Alistair Darling, the U.K. Chancellor of the Exchequer, has said that as long as SWFs do not threaten national security or pursue political purposes, they should be free to invest as they please. “ I intend to make the point that we welcome [SWF] investment, but I think crucially, people, companies, and sovereign wealth funds have to act on a commercial basis.”[59] A similar reception has been seen in Switzerland. Phillip Hildebrand, Vice Chairman of the Swiss National Bank (SNB) has stated, “the challenge [of SWFs] is to preclude an outcome where the activities of SWFs trigger policy responses in mature markets that ultimately lead us down the path of financial protectionism. A set of guidelines addressing the threat of politically-driven investment decisions and resurgent state involvement in the global economy represents the best currently available option to respond to the challenge of SWFs.”[60]

Sovereign Wealth Funds: Background and Policy Issues for Congress

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The response from the European Commission, has been equally nuanced. According to Charlie McCreevy, European Commissioner for Internal Market and Services: [W]e must not allow the discussion on Sovereign Wealth Funds to be used as an excuse to raise unjustified barriers to investment and the free movement of capital. Protectionism and domestic focus is the instinctive response of some politicians.... But I do believe there are issues relating to transparency and governance that we need to engage on with certain Sovereign Wealth Funds.... We need Sovereign Wealth Funds to be transparent in their operations, preferably on the basis of an international code of best practice.[61]

On February 27, the European Commission (EC) adopted a Communication on sovereign wealth funds (SWFs) that will be presented to the Spring European Council on March 13-14, 2008. The report builds on earlier statements by EU Internal Market Commissioner Charlie McGreevey for a coordinated European response to SWF investment in Europe. The Communication proposes guidelines that SWFs may wish to adopt to support good governance practices and increased transparency of investment decisions

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Multilateral At the G7 Finance Ministers meeting in October 2007, ministers discussed SWFs for the first time, noting that they are “increasingly important participants in the international financial system and that our economies can benefit from openness to SWF investment flows.” The final G7 communique for the meeting stated that the IMF, World Bank, and the OECD should explore best practices for SWFs in key areas such as institutional structure, risk management, transparency, and accountability.[62] Secretary of the Treasury Henry Paulson further elaborated on this in his remarks to the International Monetary and Finance Committee of the IMF: The United States believes a multilateral approach to SWFs that maintains open investment policies is in the best interest of countries that have these funds, and countries in which they invest. The IMF is uniquely positioned to identify best practices for SWFs, building on the existing Guidelines for Foreign Exchange Reserve Management. Best practices would provide multilateral guidance to new funds on how to make sound decisions on how to structure themselves, mitigate any potential systemic risk, and help demonstrate to critics that SWFs can be constructive, responsible participants in the international financial system. Recipient countries of SWF investment also have a responsibility to maintain openness to investment and should work through the OECD to develop best practices for inward government-controlled investment.[63] To address concerns related to the lack of SWF transparency, some have called for an international body, such as the IMF, to establish guidelines and monitor countries’ compliance with transparency efforts. Proponents maintain that increased transparency would limit the potential negative impact of greater SWF investment by allowing financial markets to better observe SWF activity and exercise any necessary market discipline. Edwin Truman, of the Peterson Institute for International Economics, argued during November 2007 Senate Banking Committee hearings on SWFs that

16

Martin A. Weiss [t]he development of a set of best practices for sovereign wealth funds, and similar understandings covering other cross-border government investments, offers the most promising way to increase the accountability of these activities, which are likely to increase in relative importance over the next decade. The associated increase in transparency, which is a means to the end of greater accountability, would help to reduce the mysteries and misunderstandings surrounding these governmental activities. At the same time, the environment for them would become more stable and predictable.[64]

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While firm IMF guidelines for the operation of SWFs could be beneficial, none of the countries concerned (i.e., the large SWF owners) are borrowers from the IMF and therefore not subject to IMF conditionality. Thus, there are no direct means by which the IMF could secure compliance with any proposed best practices. That said, most SWF owners are members of the IMF and are formally committed to a stable international monetary system. Efforts are underway to increase emerging market countries’ vote and overall representation at the IMF.[65] As part of these efforts, countries may be willing to subject themselves to guidelines on SWF transparency.[66] During the October 20 G7 finance ministers meeting, U.S. Treasury Secretary Henry Paulson hosted an outreach dinner with top SWF managers from around the world to begin the process of negotiating increased levels of SWF transparency. There appears to be some positive reception from leading SWFs. According to Dr. Tony Tan, Executive Director of Singapore’s GIC: We believe there is a case for further disclosure on the part of sovereign wealth funds in the interest of transparency. Such disclosure can include clarity on the relationship between the funds and the respective governments, their investment objectives and general strategies, and their internal governance and risk management practices.... Any guidelines on sovereign wealth funds should encourage them to operate according to commercial principles with a long- term orientation, free from political motivations. Singapore will participate in formulating a set of principles and best practices for sovereign wealth funds.[67]

In November 2007, the IMF convened the first of a proposed annual roundtable of sovereign asset and reserve managers. At the meeting, delegates from 28 countries discussed how best to address the policy and operational issues faced by managers of growing reserves and sovereign assets.[68] The IMF’s work agenda on SWFs was approved at a meeting of the IMF Executive Board, which includes representatives from both sovereign investors and recipients of sovereign wealth, on March 21. 2008. While the IMF is working to establish guidelines for the management and operations of sovereign wealth funds, the OECD has an ongoing work program to establish a set of best practices for recipients of investments from SWFs[69] These guidelines would draw on the OECD’s extensive work on the treatment of foreign investment in OECD economies. OECD work will also draw on the OECD Guidelines for Corporate Governance of State Owned Enterprises (the SOE Guidelines).[70] The Guidelines are applicable to both SWFs and SOEs.

Sovereign Wealth Funds: Background and Policy Issues for Congress

17

REFERENCES [1] [2] [3] [4] [5]

[6] [7] [8] [9] [10]

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[11] [12] [13] [14] [15] [16] [17] [18]

All figures are in U.S. dollars. Stephen Jen, “Currencies: How Big Can Sovereign Wealth Funds Be by 2015,” Morgan Stanley Global Research, May 3, 2007. Peter Goodman and Louise Story, “Overseas Investors Buy Aggressively in the United States,” New York Times, January 20, 2008. David Rothnie, “Sovereign wealth spending on banks exceeds $50bn,” Financial News Online, January 14, 2008, at [http://www.financialnews-us.com/?page=ushome&contentid= 2449561453]. For more information on foreign investment in the U.S. economy, see CRS Report RS21857, Foreign Direct Investment in the United States: An Economic Analysis, and CRS Report RL32964, The United States as a Net Debtor Nation: Overview of the International Investment Position, both by James K. Jackson. Stephen Jen, “Economics: How Much Assets Could SWFs Farm Out?” Morgan Stanley Global Research, January 10, 2008. See CRS Report RL34337, China’s Sovereign Wealth Fund, by Michael F. Martin. Thomas Heath, “Government of Abu Dhabi Buys Stake in Carlyle,” Washington Post, September 21, 2007. “Citi to Sell $7.5 Billion of Equity Units to the Abu Dhabi Investment Authority,” Business Wire, November 27, 2007, at [http://online.wsj .com/public/article/PR-CO200711 26-908539.html?mod=crnews]. “Sovereign Wealth Funds bet on Banks,” Associated Press, December 10, 2007, at [http://biz.yahoo.com/ap/07 121 0/soverign_wealth_funds_glance.html?.v=1]. Chris Oliver, “Details of CIC’s stake in Morgan Stanley Revealed,” MarketWatch, December 24, 2007, at [http://www.marketwatch.com/news/story/details-cics-stake-morganstanley/story.aspx?guid=%7B6 1 75589F-C8D 1 -49AE-8FA4-EB6 1BF8F7AC2%7D]. “Merrill Lynch Will Sell Stake to Temasek Holdings,” Reuters, December 25, 2007, at [http://www.cnbc.com/id/22395384/]. Yalman Onaran, “Citigroup, Merrill Receive $21 Billion From Investors,” Reuters, January 15, 2007, at [http://www.bloomberg.com/apps/news?pid=2060 1 087&sid=anjGW hqi0PSE&refer=home]. For more information on the sub-prime crisis, see CRS Report RL34 182, Financial Crisis? The Liquidity Crunch of August 2007, by Darryl E. Getter, Mark Jickling, Marc Labonte, and Edward Vincent Murphy. Financial Stability Review, European Central Bank, December 2007, at [http://www.ecb.int/pub/pdf/other/financialstabilityreview2007 1 2en.pdf]. Steffen Kern, “Sovereign Wealth Funds - State Investments on the Rise,” Deutsche Bank Research, September 10, 2007. Alex Patelis, “The Overflowing Bathtub, the running tap and SWFs,” Merrill Lynch Economic Analysis, October 6, 2007. For the first use of the term Sovereign Wealth Fund, see Andrew Rozanov, “Who Holds the Wealth of Nations,” State Street Global Advisors, August 2005, at [http://www.ssga.com/library/esps/Who_Holds_Wealth_of_Nations_Andrew_Rozanov_ 8.15.05REVCCRI1 145995576.pdf].

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18

Martin A. Weiss

[19] “Report to Congress on International Economic and Exchange Rate Policies,” Department of the Treasury, December 2007, at [http://www.treas.gov/offices/ internationalaffairs/economic-exchange-rates/]. [20] Stephen Jen, “Currencies: The Definition of a Sovereign Wealth Fund,” Morgan Stanley Research, October 25, 2007. [21] Currency sterilization is a form of monetary action in which a country’s central bank attempts to insulate itself from the foreign exchange market to counteract the effects of a changing monetary base by selling or buying the domestic currency in the foreign exchange market to stabilize the value of the domestic currency. For more information, see Jang-Yung Lee, “Sterilizing Capital Inflows,” International Monetary Fund, 199, at [ttp://www.imf.org/ external/pubs/ft/issues7/issue7.pdf]. [22] Rachel Ziemba, “Responses to Sovereign Wealth Funds: Are ‘Draconian’ Measures on the Way?,” RGE Monitor, November 2007. [23] Similar entities to SWFs that raise many of the same concerns are state-backed companies engaged in foreign acquisitions. For example, in 2005 an attempt by the China National Offshore Oil Cooperation (CNOOC) to purchase the U.S. energy company Unocal raised substantial congressional concerns and was eventually abandoned. For more information on the CNOOC case, see CRS Report RL33093, China and the CNOOC Bid for Unocal: Issues for Congress, by Dick K. Nanto, James K. Jackson, Wayne M. Morrison, and Lawrence Kumins. [24] “Global Financial Stability Report: September 2007,” International Monetary Fund, September 2007. [25] For more information on the challenges of establishing a SWF, see Andrew Rozanov, “Sovereign Wealth Funds: Defining Liabilities,” State Street Global Advisors, May 2007. [26] The first Kuwaiti SWF was called the Kuwait Investment Board. It was later acquired by a separate fund, the Kuwait Investment Authority, which was founded in 1960. [27] CRS Report RL32 165, China’s Currency: Economic Issues and Options for U.S. Trade Policy, by Wayne M. Morrison and Marc Labonte. [28] Regional Economic Outlook: Middle East and Central Asia, International Monetary Fund, October 2007. Included oil exporters are Algeria, Azerbaijan, Bahrain, Iran, Iraq, Kazakhstan, Kuwait, Libya, Oman, Qatar, Saudi Arabia, Syria, Turkmenistan, and the United Arab Emirates. [29] Brad Setser and Rachel Ziemba, “Understanding the New Financial Superpower — The Management of GCC Official Foreign Assets,” RGE Monitor, January 2008. Member countries of the GCC are: Bahrain, Kuwait, Qatar, Oman, Saudi Arabia, and the United Arab Emirates. [30] Nawaf Obaid, “Assessing Saudi Power,” Middle East Times, November 13, 2007. [31] Henny Sender and David Wighton, “Saudis Plan Huge Sovereign Wealth Fund,” Financial Times, December 21, 2007. [32] Steffen Kern, “Sovereign Wealth Funds-State Investments on the Rise,” Deutsche Bank Research, September 10, 2007. [33] Joshua Aizenman, “Large Hoarding of International Reserves and the Emerging Global Economic Architecture,” National Bureau of Economic Research Working Paper 13277, July 2007.

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Sovereign Wealth Funds: Background and Policy Issues for Congress

19

[34] For more information on the Asian Financial Crisis, see CRS Report 98-434 E, The Asian (Global?) Financial Crisis, the IMF, and Japan: Economic Issues, by Dick K. Nanto. [35] “New paradigm changes currency rules,” Oxford Analytica, January 17, 2008. [36] Euro riding high as an international reserve currency, Deustche Bank Research, May 4, 2007. [37] Henny Sender, Live at Apollo (Management): Plan to Cash In, Limit Scrutiny, Wall Street Journal, July 17, 2007. [38] Stephen Jen, “Currencies: How Big Can Sovereign Wealth Funds Be by 2015,” Morgan Stanley Global Research, May 3, 2007. [39] 39 Stephen Jen, “How Big Could Sovereign Wealth Funds Be by 2015,” Morgan Stanley Perspectives, May 3, 2007. [40] Tony Tassell and Joanna Chung, “The $2,500 Question,” Financial Times, May 25, 2007. [41] Edwin M. Truman, “Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the United States: Assessing the Economic and National Security Implications,” Testimony before the Committee on Banking, Housing, and Urban Affairs United States Senate, November 14, 2007. Testimony is available at [http://iie.com/ publications/papers/truman 11 07.pdf]. [42] Andrew Ross Sorkin, “What Money Can Buy: Influence,” The New York Times, January 22, 2008, at [http://www.nytimes.com/2008/0 1/22/business/22sorkin.html?dlbk]. [43] Ibid. [44] Gerald Lyons, “State Capitalism: The Rise of Sovereign Wealth Funds,” Standard Chartered, October 15, 2007. Document is available from the author. [45] Richard Portes, “Sovereign Wealth Funds,” VOXEU, October 17, 2007, at [http://www.voxeu.org/index.php?q=node/636]. See also Huw Van Stenis, “Banks & Financials: Sovereign Wealth Funds — building stakes in financials,” Morgan Stanley Research Europe, September 24, 2007. [46] The World Economic Forum ranks the United States first in its 2007 competitiveness report. The Global Competitiveness Report 200 7-2008, World Economic Forum, at [http://www.gcr.weforum.org/]. [47] Steven R. Weisman, “Concern About ‘Sovereign Wealth Funds’ Spreads to Washington, International Herald Tribune, August 20, 2007. [48] Ibid. [49] Christopher S. Rugaber, “Agency Investigates Sovereign Funds,” Associated Press, January 11, 2008, at [http://www.forbes.com/feeds/ap/2008/ 01/11/ ap4522903.html]. [50] Senate Banking, Housing and Urban Affairs Committee Hearing on Foreign Government Investment in the United States, November 14, 2007. Transcript available from Congressional Quarterly at [http://www.cq.com]. [51] Tessa Moran, “US Treasury’s Kimmitt says sovereign wealth funds not cause for alarm,” Forbes. com, at [http://www.forbes.com/markets/feeds/afx/2007/1 2/04/afx4403 204 .html]. See also, Robert M. Kimmett, “Public Footprints in Private Markets,” Foreign Affairs, January/February 2008. [52] CRS Report RL33388, The Committee on Foreign Investment in the United States (CRIUS), by James K. Jackson. [53] CRS Report RL333 12, The Exon-Florio National Security Test for Foreign Investment, by James K. Jackson.

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Martin A. Weiss

[54] Steven Davidoff, “A Guide to Speed Dating with Sovereign Wealth Funds,” The New York Times Dealbook, at [http://dealbook.blogs.nytimes.com/2008/01/1 5/a-guide-tospeeddating-with-sovereign-funds/?ref=business]. [55] Carter Dougherty, “Europe Looks at Controls on State-Owned Investors,” International Herald Tribune, July 13, 2007, at [http://www.iht.com/articles/2007/07/13/ business/protect. php]. [56] Marcus Walker, “Germany Tinkers With Foreign-Takeovers Plan,” The Wall Street Journal, January 14, 2008. [57] Ibid. [58] “Sarkozy attacks wealth funds on eve of MidEast trip,” Reuters, January 12, 2008, at [http://www.reuters.com/article/oilRpt/idUSL1 220023020080112]. [59] Sumeet Desai, “Darling Says Sovereign Funds Need to Follow Rules,” Reuters, October 19, 2007, at [http://uk.reuters.com/article/businessNews/idUKWBT0077872007 1019]. [60] “Sovereign wealth funds need rules-SNB’ s Hildebrand,” Reuters, December 18, 2007. [61] Charlie McGreevey, European Commissioner for Internal Market and Services, “The Importance of Open Markets,” Speech before Council of British Chambers of Commerce i n C o n t i n e n t a l E u r o p e ( C O B C O E ) , L o n d o n , J a n u a r y 1 0 , 2 0 0 8 , a t [http://www.edubourse.com/finance/actualites.php?actu=35306]. [62] Statement of G-7 Finance Ministers and Central Bank Governors, October 19, 2007, at [http://treas.gov/press/releases/hp625 .htm]. [63] Statement by Henry M. Paulson, Jr. Secretary of the U.S. Treasury before the International Monetary and Finance Committee, International Monetary Fund, October 20, 2007, at [http://www.imf.org/external/am/2007/imfc/statement/eng/usa.pdf]. [64] Edwin M. Truman, “Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the United States: Assessing the Economic and National Security Implications,” Testimony before the Committee on Banking, Housing, and Urban Affairs United States Senate, November 14, 2007. Prepared testimony is available at [http://banking.senate.gov/_files/1 1 1407_Truman.pdf]. [65] CRS Report RL33626, International Monetary Fund: Reforming Country Representation, by Martin A. Weiss. [66] For proposals on increasing SWF transparency, see Edwin M. Truman, “Sovereign Wealth Funds: The Need for Greater Transparency and Accountability,” Peterson Institute for International Economics, August 2007, at [http://iie.com/publications/pb/pb07-6.pdf]. [67] Cited in Huw van Steenis and Huberty Lam, “Sovereign Wealth Funds and Chinese Financials,” Morgan Stanley Research, January 15, 2008. [68] IMF Convenes First Annual Roundtable of Sovereign Asset and Reserve Managers, IMF press release No. 07/267, November 16, 2007. [69] OECD Investment Newsletter, October 2007, Issue 5, at [http://www.oecd.org/dataoecd/ 0/57/3953440 1 .pdf]. [70] The OECD Guidelines on Corporate Governance of State-Owned Enterprises is available at [http://www.oecd.org/document/33/0,3343,en _2649 _37439 _34046561_1_1_1_ 37439,00. html].

In: Sovereign Wealth Funds Editors: T. N. Carson, W. P. Litmann

ISBN: 978-1-60692-319-1 © 2009 Nova Science Publishers, Inc.

Chapter 2

CHINA’S SOVEREIGN WEALTH FUND

*

Michael F. Martin Analyst in Asian Trade and Finance Foreign Affairs, Defense, and Trade Department, USA

ABSTRACT

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China established its major sovereign wealth fund, the China Investment Corporation (CIC) on September 29, 2007 — six months after it first announced its intention to create such a fund. Financed with $200 billion in initial capital, the CIC is one of the largest sovereign wealth funds (SWFs) in the world. Although many of the CIC’s initial investments were apparently political in nature, the CIC’s top management have repeatedly asserted that future investments will be commercially-based, seeking to maximize the return on investment. Since its creation, the CIC and its subsidiaries have already made several investments, including the purchase of 9.9% of the U.S. financial firm, Morgan Stanley, on December 19, 2007. According to top Chinese officials, the CIC was created to improve the rate of return on China’s $1.5 trillion in foreign exchange reserves and to soak up some of the nation’s excess financial liquidity. Depending on its performance with the initial allotment of $200 billion, the CIC may be allocated more of China’s growing stock of foreign exchange reserves. A number of experts in international finance have expressed some concern about the recent growth in SWFs and China’s creation of the CIC. Analysts have cautioned that major shifts in SWF investments potentially could disrupt global financial markets and harm the U.S. economy. Other experts are less concerned about SWFs and the CIC, and welcome their participation in international investment markets. China has responded by maintaining that the CIC will prove to be a source of market stability. China has also stated that it has no intention of using its SWF to cause harm to the U.S. economy or global financial markets. Despite China’s reassurances, there have been calls for greater oversight and regulation of the activities of SWFs. A senior official in the Bush administration has called on the International Monetary Fund and the World Bank to develop guidelines for SWFs. Some international financial experts have suggested elements to be included in such guidelines, *

Excerpted from CRS Report RL34337, dated January 22, 2008.

Michael F. Martin

22

including standards for transparency, governance, and reciprocity. Other experts have suggested that the United States should review its current laws and regulations governing foreign investments in the United States, and possibly implement special procedures or restrictions on proposed investments by SWFs. These include financial reporting requirement, limits on SWF ownership of U.S. companies, and restrictions on the types of equity investments SWFs can make in U.S. companies. This report will be updated as circumstances warrant.

INTRODUCTION China announced in March 2007 that it would be creating a sovereign wealth fund (SWF) in the near future as a vehicle to invest its accumulated foreign exchange reserves more profitably.[1] In May 2007, China Jianyin Investment Company, a government agency that was designated to manage any asset purchases until the SWF was set up, bought a $3 billion non-voting stake in Blackstone Group, a U.S. private equity firm. After a few delays, China’s new sovereign wealth fund — the China Investment Corporation (CIC) — officially started operations on September 29, 2007. The CIC may prove to be of interest to Congress for several reasons. First, some observers are concerned that its investment activities might have adverse effects on certain financial markets and possibly the U.S. economy. Second, its creation signals China’s intention to diversify its foreign exchange holdings away from U.S. government securities into other forms of investment. Third, specific proposed investments by the CIC could arguably raise national security concerns. Fourth, some see the possibility that China could use the CIC as a mechanism to pursue geopolitical objectives.

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Table 1. Leading Sovereign Wealth Funds Country

Fund

Size ($ Billion)

Year Created

United Arab Emirates

Abu Dhabi Investment Authority (ADIA)

500 - 875

1976

Singapore

Government of Singapore Investment Corporation (GIC)

100 - 330

1981

Norway

Government Pension Fund - Global (GPFG)

308

1990

China

China Investment Corporation, Ltd. (CIC)

200

2007

Kuwait

Future Generations Fund

174

1976

Russia

Stabilization Fund for the Russian Federation

122

2004

Singapore

Temasek Holdings

108

1974

Source: Edwin Truman, “Sovereign Wealth Funds: The Need for Greater Transparency and Accountability,” Peterson Institute for International Economics, August 2007.

With an initial capital fund of $200 billion, the CIC is a significant new addition to the existing pool of SWFs (see Table 1). The CIC augments the over $3 trillion under management by SWFs worldwide. In addition, the SWF provides China with another avenue by which it can invest its growing foreign exchange reserves, which totaled $1.5 trillion as of

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December 2007.[2] Also, the conversion of the foreign exchange reserves into capital for the CIC may help mop up some of the excess financial liquidity in China that is reportedly contributing to China’s recent inflationary pressures.[3] However, China’s decision to create the CIC has reawakened some concerns about the impact of SWFs on global financial markets and engendered new misgivings about China’s involvement in the international equity markets. David R. Francis, columnist for the Christian Science Monitor, started his November 26, 2007 article, “Will Sovereign Wealth Funds Rule the World?,” with the words, “Sovereign wealth funds are huge scarily big.”[4] During a November 30, 2007 interview on National Public Radio’s Morning Edition, Brad Setser of the Council on Foreign Relations stated, “The rise of sovereign wealth funds represents a shift in power from the U.S. to a group of countries that aren’t transparent, aren’t democracies, and aren’t necessarily U.S. allies.”[5] In June 2007, Clay Lowery, U.S. Treasury’s acting Undersecretary for International Affairs, indicated in an interview that the rise in governmentowned investment funds could cause major changes in global markets and bring about “financial protectionism.”[6] Although the current value of CIC ’ s working capital is small when compared to global capital flows, China could increase the size of CIC to over $1 trillion if it makes more of its foreign exchange reserves available. The growth potential of CIC may prove important because, according to Setser, somebody with a working capital of $1 trillion dollars (such as the CIC) would have the ability to push the U.S. economy into a recession.[7] There are also concerns about how China (and other nations) will invest the capital of their SWFs. Before the creation of the CIC, China had invested much of its foreign exchange reserves in U.S. government debt, such a U.S. Treasury bills (T- bills), that were relatively risk-free, but offered relatively low rates of return on the investment. Kenneth Rogoff, former chief economist for the International Monetary Fund (IMF), indicated in a recent interview, “Countries like China just don’t need to hold any more T-bills. There’s just no point.”[8] As a result, most analysts expect the CIC to invest in equities and/or acquisitions in order to obtain higher rates of return on their investments. With its current capital stock, the CIC has the theoretical ability to purchase controlling interests in or acquire major corporations, raising potential national security concerns. According to financial journalist James Surowiecki, “Were China so inclined, it could buy Ford, G.M., Volkswagen, and Honda, and still have a little money left over for ice cream.”[9] Surowiecki’s observation was echoed by well- known investor Warren Buffett, who added that the annual U.S. trade deficit of approximately $700 billion means the United States has to “give away a little part of the country” every year.[10] Buffet continued by auguring that if these trade deficits continue the United States could wind up as a “sharecropper economy,” in which U.S. citizens largely work for foreign-owned firms.[11] In the opinion of Securities and Exchange Commission Chairman Christopher Cox, “the fundamental question presented by state-owned public companies and sovereign wealth funds does not so much concern the advisability of foreign ownership, but rather of government ownership.”[12] However, others are less apprehensive about the potential impact of SWFs on the global economy. Rogoff thinks the SWFs will do “more good than bad.”[13] Surowiecki maintains that “some of the worries about the dangers posed by sovereign wealth funds are overstated,” and that the SWFs “will act much like other investors, and focus primarily on the bottom line.”[14] Preston Keat of the global risk consulting firm Eurasia Group echoes Surowiecki’s assessment,

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pointing out, “It’s a context of mutual dependence. Blowing somebody else up does you at least as much financial damage.”[15] The investment activities of several SWFs, including the CIC, since the outbreak of the subprime-mortgage crisis tend to support the views of Rogoff, Surowiecki and Keat. Struggling major financial firms have received much needed injections of capital from SWFs. On December 19, 2007, CIC invested $5 billion in Morgan Stanley not long after the financial firm announced it was writing off $9.4 billion of loss-making mortgage investments.[16] On January 15, 2008, SWFs from Abu Dhabi, Kuwait, Singapore, and South Korea provided a $21 billion infusion of capital to Citigroup and Merrill Lynch.[17] During a period of global market uncertainty, SWFs appear to be providing a source of stability.

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POLICY RESPONSES TO SWFS In response to the perceived potential risks posed by the SWFs of China and other nations, there has been discussion about ways to regulate or monitor the activities of SWFs, including China’s CIC. Edwin Truman, of the Peterson Institute for International Economics, maintains that “a strong case can be made for a collective effort to establish an internationally agreed standard to guide management by governments of their cross-border investments.”[18] According to Truman, the international standards should cover four topics — 1. Objectives and investment strategy; 2. Governance; 3. Transparency; and 4. Behavior. Jeffrey Garten, professor at the Yale School of Management and former Undersecretary of Commerce for International Trade, also sees a need for rules to regulate SWFs, echoing Truman’s call for greater transparency, and adding reciprocity and ownership guidelines to the list of topics to be included in the international standards.[19] In June 2007, U.S. Treasury’s Assistant Secretary for International Affairs, Clay Lowery, called on the International Monetary Fund and the World Bank to develop guidelines for sovereign wealth funds.[20] Congress recently took action regarding the monitoring and regulation of foreign investment in the United States. The “Foreign Investment and National Security Act of 2007” (P.L. 110-49) requires that the Committee on Foreign Investment in the United States (CFIUS) investigate any foreign investment transaction (including mergers, acquisitions, or takeovers) which results in “foreign control of any person engaged in interstate commerce in the United States” or if the transaction would result in foreign control of “critical infrastructure that could impair the national security.”[21] The new law also adds new criteria for CFIUS to use when determining if an investigation is warranted, including whether the transaction is a “foreign government-controlled transaction.”[22] In addition, P.L. 110-49 increases congressional oversight of CFIUS by requiring more detailed reports on its operations and the results of its investigations. However, the authority to suspend or prohibit foreign investments in the United States remains with the President. Despite the passage of P.L. 110-49, there are commentators that do not believe the new law sufficiently protects the United States from the risks posed by the emerging SWFs. Some maintain that while P.L. 110-49 effectively dealt with the national security risks posed by foreign investments, it did not adequately mitigate against the economic security risks. In his November 14, 2007 testimony before Senate Committee on Banking, Housing, and Urban Affairs, Truman

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mentioned that “some observers” are concerned about the stability implications for the U.S. economy and financial systems of SWF investments in “private equity firms, hedge funds, and regulated financial institutions.”[23] There have been suggestions that the United States should prohibit a SWF from investing in the United States unless its home nation meets certain criteria, such as those proposed by Truman and Garten. On September 5, 2007, the House of Representatives passed H.Res. 552 (1 10th Congress) by a vote of 401 to 4, which included a reciprocity requirement that “United States financial service regulators, in assessing whether applications from Chinese financial institutions meet comprehensive consolidated supervision standards, should consider whether the applications are for operations and activities in the United States that are currently prohibited for United States financial institutions in China ...” However, others warn that such restrictions could lead to a wave of financial protectionism that would cause undue damage to the U.S. economy.

ADMINISTRATIVE DETAILS OF THE CHINA INVESTMENT CORPORATION

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The China Investment Corporation, Ltd. (CIC) is a semi-independent, quasigovernmental investment firm established by the Chinese government to invest a portion of the nation’s foreign exchange reserves. The CIC reports directly to China’s State Council,[24] conferring it with the equivalent standing of a ministry, and the State Council’s leader, Premier Wen Jiabao. According to one source, the CIC will have three major departments for its investment functions — 1. Central Huijin Investment Company (CHIC), which will provide capital to domestic financial firms; 2. China Jianyin Investment, which will manage domestic assets and the disposal of non-performing loans; and 3. A new department to manage overseas investments.[25]

CIC’s Management Team The investment activities of the CIC is to be directed by an 11-member board of directors. The chairman of the CIC’s board is Lou Jiwei, China’s former deputy finance minister and former State Council deputy secretary general. The CIC’s general manager is Gao Xiqing, vice chairman of China’s national pension fund and also one of CIC’s executive directors. Other people serving in CIC’s top management include: • • • • • • •

Zhang Hongli, another of CIC’s executive directors and vice minister of finance; Fu Ziying, assistant minister of commerce; Hu Xiaolian, deputy governor of the People’s Bank of China (PBC) and Administrator of SAFE; Li Yong, vice minister of finance; Liu Shiyu, deputy governor of the People’s Bank of China ; Wang Chunzheng, ex-vice minister of the National Development and Reform Commission (NDRC); Liu Zhongli, former minister of finance; and

Michael F. Martin

26 •

Zhang Xiaoqiang, vice minister of NDRC.[26]

The final member of the board is to be elected by the company’s employees. Initial reports indicate the CIC is to have a staff of about 1,000 employees, including 100 to 200 investment specialists.[27] Many of CIC’s workers will come from the absorption of CHIC and China Jianyin Investment. In the first few months following the formation of the CIC, its chief spokespeople have been Lou Jiwei and Li Yong.

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CIC’s Working Capital The working capital for the CIC is coming indirectly from China’s approximately $1.5 trillion in foreign exchange reserves. Under a plan approved by the Standing Committee of China’s National People’s Congress in June 2007, the Ministry of Finance was to issue up to 1.55 trillion yuan ($200 billion) in special treasury bonds to provide the CIC with capital to purchase foreign exchange from China’s central bank, the People’s Bank of China (PBoC). The CIC is to be responsible for servicing the newly-created debt — at an estimated cost of $40 million per day.[28] The first tranche of the special treasury bonds — worth 600 billion yuan ($77 billion) — was sold on August 28, 2007, to the PBoC, using the Agricultural Bank of China (ABC) as an intermediary.[29] The 10-year bonds had a coupon value of 4.3%.[30] A second tranche of bonds worth 103 billion yuan ($13 billion) was sold to the Chinese public in mid-September. The September bonds were a mixture of 10- and 15-year bonds with coupon rates ranging from 4.46% tp 4.68%.[31] A third tranche worth 96 billion yuan ($12 billion) was sold to the public during November and December, again with varying maturation periods of 10 and 15 years, with coupon rates of 4.5%.[32] The remaining 750 billion yuan ($97 billion) was sold to PBoC on December 10, again using the ABC as an intermediary, with 15-year maturations and a coupon rate of 4.45%.[33] In converting 1.55 trillion yuan of foreign exchange reserves into $200 billion in capital for the newly-created CIC, China limited the amount of new debt issued to the public to 199 billion yuan ($26 billion). Most of the newly-issued bonds ended up in the hands of the PBoC, effectively soaking up some of the perceived excess liquidity in China’s money markets.

INVESTMENT ACTIVITIES OF CHINA’S SOVEREIGN WEALTH FUND The investment objectives of the CIC are yet to be determined. According to Jesse Wang, a member of the CIC’s preparatory group, “The mission for this company [CIC] is purely investment-return driven.”[34] However, the actual meaning of “purely investmentreturn driven” is open to interpretation depending on the investor’s level of risk aversion. Recent developments appear to indicate that the CIC may be a fairly “risk adverse” investor, both economically and politically. In addition, recent statements by senior CIC executives indicate that it wishes to avoid unnecessary controversies when selecting investments.

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CIC’s Existing Investments

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A fair amount of information is available about the existing investments of the CIC. However, because of the manner by which China is publicizing CIC-related activities, it is often difficult to obtain specific information about investment transactions. In particular, China frequently announces planned investments shortly before the financial transaction is to take place and subsequently mentions in passing that the planned investment has occurred, but rarely reports on the investment the day the actual transaction happens. While this pattern demonstrates some relative transparency about CIC activities, it also indicates an apparent reluctance to be completely forthcoming about the details of the CIC’s investments. Figure 1 provides an overview of CIC’s current direct and indirect investments, based on available news reports. The investment options of the CIC are constrained in part by previous commitments made before the formal start of its operations. On May 20, 2007, China Jianyin Investment Company, a wholly-owned subsidiary of the Central Huijin Investment Company (CHIC), signed an agreement to purchase a less than1 0% stake in Blackstone Group in non-voting shares worth $3 billion.[35] The decision to purchase less than 10% of Blackstone’s shares, and to purchase non-voting shares, was apparently not an arbitrary one. According to Blackstone’s CEO and Chairman Stephen A. Schwarzman, “The deal is ‘purely commercial’ and do [sic] not need the U.S. government approval as the stake is less than 10 percent.”[36]

Source: CRS research. Figure 1. CIC’s Major Investments (as of 12/07).

In November 2007, the newly-formed CIC assumed responsibility for the assets and liabilities of the CHIC, which was previously owned by the PBoC. It is reported that the PBoC obtained about 500 billion yuan ($67 billion) in compensation for the CHIC.[37] This transaction utilized approximately one third of the CIC’s working capital. As a result, the CIC became the parent company for CHIC and China Jianyin Investment Company, plus owner of $3 billion in Blackstone Group stock. In addition, CIC indirectly became a major stock holder in China Construction Bank (CCB) and the Industrial and Commercial Bank of China (ICBC)

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Michael F. Martin

by way of the investments of CHIC and China Jianyin Investment Company in those two banks.[38] Also in November 2007, a decision was made that the CIC was to provide capital totaling a reported $67 billion to two of China’s state-owned banks, the Agricultural Bank of China (ABC) and the China Development Bank (CDB).[39] After its investment in the ABC, the CIC would supposedly own one-third of the bank with another third owned by China’s Ministry of Finance.[40] Other sources reported that a financial restructuring plan for the ABC submitted to the State Council for approval was to be announced in late 2007, and the plan would include $40 billion from the CIC, possibly through the newly acquired CHIC.[41] However, on December 5, 2007, a representative of the ABC stated that “overseas media reports concerning the bank’s shareholding reforms were false,” but did not indicate which aspects of those reports were incorrect.[42] As a result, it is uncertain exactly when and how much the CIC has invested in the ABC. More details of the CIC’s investment in the CDB were announced on the final day of 2007. CIC’s subsidiary, the CHIC, signed an agreement on December 31, 2007, to invest $20 billion into the CDB.[43] According to CIC chairman Lou, the actual capital injection would take place “soon,” but no exact date was provided.[44] The CIC has reportedly made two other major investments since its establishment. On November 21, 2007, the CIC supposedly announced plans for its first post-inaugural investment — the purchase of $100 million in shares of Hong Kong’s initial public offering for the new China Railway Group (CRG).[45] China Railway Group is a railway construction company in China, and reportedly the one of the largest construction companies in the world. The Government of Singapore Investment Corporation, another SWF, reportedly also bought shares in CRG.[46] Then, on December 19, 2007, the CIC purchased “around 9.9%” of Morgan Stanley, one of the largest U.S. investment banks.[47] The CIC investment in Morgan Stanley amounted to $5 billion. Morgan Stanley stressed that the CIC will have “no special” rights of ownership and no role in corporate management.[48] CIC’ s newly-acquired subsidiary, the CHIC, also has been making investments. On November 8, 2007, the CHIC announced it intended to purchase a 70.92% stake in China Everbright Bank, a Beijing-based joint-equity commercial bank founded in August 1992.[49] On November 28, 2007, the shareholders of China Everbright Bank agreed to accept a 20 billion yuan ($2.7 billion) capital injection from the CIC.[50] The CIC’s financial support to China Everbright Bank reportedly will be sufficient for it to go ahead with its planned initial public offering (IPO) on the Hong Kong Stock Exchange (HKSE) and China’s A-share stock market.[51] On December 5, 2007, China Everbright Bank announced that it is planning on holding its IPO in June or July of 2008.[52] Overall, the reported existing direct and indirect investments of the CIC total about twothirds of its total working capital, leaving about $70 billion available for future investments. So far, most of CIC’s investments have apparently been made based on non-commercial criteria. For example, there are indications that the State Council, the PBoC and the NDRC insisted that the CIC provide help in the restructuring of these two state-owned banks as a condition of the CIC’s establishment.[53] Similarly, the payment to the PBoC for the CIC’s acquisition of CHIC and its subsidiary, China Jianyin Investment Company, may have been driven more by political considerations than economic ones. The non-commercial character of the CIC’s existing investments may lead to increased interest and surveillance on its future investments.

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CIC’s Future Investments

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Since the day China announced the formation of the CIC, senior representatives of the new corporation and various government agencies have been actively publicizing that China’s SWF would operate with a high degree of transparency utilizing an investment strategy based on commercial principles. China has also shown some sensitivity to existing apprehensions about the possible overseas investments the CIC might make, and CIC representatives have publicly announced that the new SWF will not invest in certain sensitive sectors and markets. However, the Chinese government has also made it known that it is concerned about undue criticism or scrutiny of the CIC, and in particular, is worried that other nations (including the United States) may try to use the creation of China’s SWF as an opportunity to implement protectionist measures targeted at the Chinese economy. In sum, China has handled the creation of the CIC in a fairly common Chinese fashion of combining reassuring statements with veiled warnings.

Investment Strategy Prior to the creation of the CIC, Chinese officials were already making statements indicating that its investment strategy would be to maximize the rate of return on its investments. Jesse Wang, a member of the CIC’s preparatory group, stated on September 10, 2007, “The mission for this company is purely investment-return driven.”[54] On the day the CIC was created, CIC deputy general manager Yang Qingwei stated, “The company’s principal purpose is to make profits.”[55] More recently, during his first overseas trip as CIC’s chairman, Lou provided a more nuanced explanation of the company’s investment strategy, “We will adopt a long-term and prudent investment principle and a safe, professional portfolio strategy that adapts to market changes, which will put emphasis on a rational match of returns and risks.”[56] The CIC’s need for relatively high rates of return on their investments is partially being driven by the manner in which the company has received access to China’s foreign exchange reserves. According to one of the CIC’ s top managers, the company is responsible for servicing the interest on the 1.55 trillion-yuan of bonds issued by the PBoC (see above). According to CIC Chairman Lou, the interest cost on the outstanding bonds amounts to 300 million yuan ($40 million) per day[57] With a minimum return of $40 million per day, the CIC will need to earn at least $14.6 billion per year in profits — or at least 7.3% on its total capital of $200 billion. Plus, as Lou points out, the CIC’s ability to obtain access to more of China’s foreign exchange reserves will depend on its profitability. “If I am making losses every day, how can I face asking the government for more money?” asked Lou.[58] There have also been some indications on the actual types of investments the CIC will be making and where it will be making investments. A CIC representative reportedly stated that it will focus its international investments on a “portfolio of financial products.”[59] CIC Chairman Lou told a group of financial experts in Beijing that most of the CIC’s investments would be in publicly-traded securities, but that it would also make some direct investments.[60] Officials with the CIC have indicated that it is considering making investments in Hong Kong and Taiwan, and it is talking with stock exchange officials in London. The CIC is also expected to set up branches overseas, but the locations of its overseas branches are still to be determined. At the same time, China has also been providing reassuring statements about the types of investments the CIC would not be making. Chinese officials reportedly told German Chancellor

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Angela Merkel during her visit to China in August 2007 that the future CIC “had no intention of buying strategic stakes in big western companies.”[61] CIC Chairman Lou has indicated that the CIC will not invest in infrastructure.[62] China’s Vice Minister of Finance Li Yong also dismissed “rumors that China would try to buy out European and American companies in large numbers.”[63] Vice Minister Li has stated that the CIC would not buy into overseas airlines, telecommunications or oil companies.[64] An unnamed contact at CIC indicated that the SWF also will not make investments in foreign technology companies as a means of obtaining advanced technology, pointing out, “That’s political, and we don’t do that.”[65] Despite the reassurances provided by the CIC, some observers are unconvinced that China’s SWF has a clear investment strategy that is free from political influences. Setser gave a negative answer to his own rhetorical question, “Does the China Investment Corporation (CIC) have a coherent investment strategy?”[66] According to Setser, “There clearly isn’t a consensus inside China on what the CIC should be doing.”[67] A reporter for the Financial Times mirrored Setser’s appraisal, writing, “Such a concentration of the country’s wealth in one entity has inevitably drawn intense interest ... from powerful forces within the state bureaucracy. Each of these groups has its own ideas on how the money can best be spent.”[68]

Transparency CIC officials and other leading economic figures in China have also been making reassuring statements about the transparency of the CIC’s operations and management, but often with a caveat or two. For example, on the day the CIC was launched, Chairman Lou said, “We will adopt a prudent accounting system ... adhere to commercial lines and improve the transparent [sic] on the condition that company interest will not be jeopardized.”[69] The CIC’s pledge of transparency was reiterated by Vice Minister Li in November 2007 during an international investment forum.[70] However, the degree and pace at which China will make the CIC transparent is uncertain. During a dinner at the mayor of London (England)’s mansion, Lou expanded on his previous statement, “We will increase transparency without harming the commercial interests of CIC. That is to say, it will be a gradual process... If we are transparent on everything, the wolves will eat us up.”[71] Reciprocity The creation of the CIC is not being done in isolation from China’s overall policy on inward and outward capital movements. However, while much of the rest of the world would apparently prefer that China focus on liberalizing various aspects of its inward capital flow policies, much of its recent effort has been on laws and regulations governing its outward capital flows. At present, more foreign direct investments (FDIs) are flowing into China than are flowing out of China. The combination of China’s net FDI inflows and overall trade surplus is financing the growth of its foreign exchange reserves. The Bush administration has been pressuring China to make its stock and bond markets more open to foreign investors, matching the comparative openness of its inward FDI policies.[72] However, of late, China has been more concerned about increasing the avenues by which it can redirect more of its domestic foreign exchange holdings towards investments outside of China. In addition to the creation of the CIC, the Chinese government is gradually introducing reforms to its outward FDI laws and regulations.

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For example, China rolled out a program in April 2006 creating “qualified domestic institutional investors” (QDIIs) that would allow Chinese nationals to invest in global investment funds offered by the QDIIs.[73] China has already approved a number of QDIIs — Bank of Communications Schroder, China AMC, China International, China Southern Fund, Fortis Haitong, Fortune SGAM, Harvest Fund, Yinhua — and reportedly plans on approving more QDIIs in the future. As part of China’s controls on foreign exchange, each fund is provided a quota limiting the size of its fund by the State Administration of Foreign Exchange (SAFE). China has also placed restrictions on the overseas markets in which the funds may invest. It has already approved Hong Kong and London, and is considering the United States. By the end of September 2007, just under $11 billion had been invested in the existing QDIIs[74] JP Morgan estimates that about $90 billion will be invested in QDIIs by the end of 2008.[75] The goals of the QDII program are to offer Chinese investors new options, and to soak up some of China’s excess liquidity by moving funds overseas. China’s apparent efforts to improve the reciprocity of its investment policies have been accompanied by warnings to other nations about using the creation of the CIC and the possible rise in Chinese overseas investments as an excuse to raise inward investment barriers, especially on the ground of “national security.” On December 10, 2007, CIC Chairman Lou cautioned during a dinner at the mayor of London’s mansion, “If an economy will use national security as a criteria for entry of sovereign wealth funds, we will be reluctant to tap the market because you are not sure what will happen.”[76] Lou continued by stating that “any protectionist backlash” against SWFs could “change the stability and security of global financial markets.”[77] During the December 2007 Strategic Economic Dialogue (SED) in Beijing, Zhang Xiaoqiang, Vice Minister of the National Development and Reform Commission, made an apparent indirect comment on the recently passed Foreign Investment and National Security Act of 2007 (P.L. 11049), “We hope U.S. policies and regulations do not become a barrier for Chinese investors.”[78] According to Zhang, “Investors both from the U.S. and China have shown a strong desire to invest in each other, and it’s necessary for both countries to create a sound investment environment for them.”[79] Zhang specifically cited China’s concerns about U.S. use of national security as a barrier to Chinese investors, and greater scrutiny and possible discrimination against China’s state-owned enterprises (SOEs) that wish to invest in the United States.

Market Stability China has also indicated that they see sovereign wealth funds (like the CIC) being a “stabilizing force in the international market,” in contrast to hedge funds, which are “a source of market instability.”[80] For example, at a conference in Beijing, CIC Chairman Lou noted that SWFs have been injecting capital into financial institutions “that suffer from the subprime crisis; they are stabilizing the market. CIC will also do the same thing.”[81] According to CIC Chairman Lou, “Judging from our investment strategy and scale, we are unlikely to present a major impact on the international market.”[82] As a precaution, China’s Vice Minister of Finance, Li Yong, has indicated that the CIC’s investments will be made “gradually” and “cautiously.”[83]

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IMPLICATIONS FOR CHINA’S ECONOMY Besides offering a new vehicle for managing its foreign exchange reserves, the CIC is expected to help China soak up some of its excess liquidity. In 2007, China experienced a major inflow of foreign exchange due to its merchandise trade surplus and the continuing stream of foreign direct investment. If the net inflow of foreign exchange is not “sterilized,” the excess liquidity in China’s money supply may contribute to domestic inflation or a speculative bubble in China’s domestic asset markets (principally the real estate and stock markets).[84] Prior to the creation of the CIC, China had been absorbing some of the excess foreign exchange by issuing government bonds, and then purchasing foreign government debt — much of it U.S. treasury bills — with the accumulated foreign exchange.[85] However, this was generating two economic forces considered undesirable by the Chinese government. First, to attract the foreign exchange away from its citizens, China was offering a relatively high rate of return on the government bonds, raising the cost of “sterilization.” Second, because the rate of return was relatively high, overseas investors were attracted to the Chinese bonds, fostering an additional influx of foreign exchange. This influx of so-called “hot money” placed more pressure on China to appreciate its currency when there were already widespread claims that China’s renminbi was undervalued.[86] Ironically, the expectation that the renminbi would appreciate would tend to foster the inflow of even more “hot money,” creating a potentially unstable speculative spiral. In addition, China’s accumulation of U.S. debt in 2007 was not very profitable given the appreciation of the renminbi (RMB) against the U.S. dollar. The yield on 10-year U.S. treasury bills fluctuated between 4.5% and 5.0% throughout the year. However, since the beginning of 2007, the RMB has appreciated 6.0% relative to the U.S. dollar. As a result, the effective rate of return on U.S. treasury bills valued in Chinese currency was negative in 2007.[87] When evaluated in its domestic currency, China lost money on its investments in U.S. government debt in 2007. The CIC offers a new avenue for the government to utilize the accumulated foreign exchange and possibly earn a positive rate of return on its investments. The sale of the “special treasury bonds” places the foreign exchange in the hands of the CIC’s investors, who can then invest the capital in domestic assets other than real estate or stocks, as well as foreign assets. In theory, this could reduce upward pressures on China’s real estate and stock prices, lower China’s investments in U.S. government debt, and generate positive yields on its investments in foreign assets.

IMPLICATIONS FOR GLOBAL FINANCIAL MARKETS AND THE U.S. ECONOMY From a macroeconomic perspective, it is unclear how the arrival of the CIC will affect global financial markets. From a microeconomic perspective, the critical issue will be the types of investments the CIC makes. Furthermore, the entrance of CIC has invigorated discussion of how sovereign wealth funds are regulated, and what standards, or codes of procedure guide their operations.

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Implicit in the creation of the CIC is a shift in China’s overseas portfolio away from U.S. treasury debt into other assets. There has been some speculation that China may be considering shifting most of its $1.5 trillion in reserves to the CIC — if it manages its investments well. According to some analysts, a shift in China’s portfolio away from U.S. debt could put upward pressure on U.S. interest rates at a time when the Federal Reserve is trying to lower interest rates to prevent a possible economic recession.[88] With a reported daily trade volume of existing U.S. debt of $600 billion,[89]a large divestment of U.S. treasury holdings by China might also cause more severe market disruptions. However, there would be little impact on the exchange rate between the renminbi and the U.S. dollar because China’s policy of keeping the exchange rate within a narrow band.[90] The arrival of a new investor with over $70 billion to invest is attracting the interest of many major financial markets around the world. On October 26, 2007, Mayor of London (England) John Stuttard met with CIC Chairman Lou in China to lobby for the new SWF to set up a branch office in the City of London.[91] On November 22, 2007, Hong Kong’s Chief Executive Donald Tsang met with representatives of the CIC in Beijing for similar discussions.[92] In early December 2007, Lou traveled to London, Paris, and Singapore for additional talks about possible CIC activity in those financial centers. However, CIC’s Blackstone Group investment has made some observers wary about the specific types of investments the new SWF will make. There is concern that China may use the CIC to secure energy resources or purchase strategic assets for geopolitical purposes. There are also market apprehensions that the CIC could seek to increase its market share in important industries via targeted acquisitions or takeovers. Others are concerned that CIC might make investments in particular companies in order to obtain access to sensitive technology or information. These various forms of possible strategic investments are fueling the calls for international guidelines for SWFs, including China’s CIC. Even if the investments of the CIC remain “purely commercial,” there are already indications that the global financial markets may be ill-prepared for the introduction of its $70 billion into the marketplace. Shares in the Hong Kong stock market rose in late October in response to rumors that the CIC had secretly invested in Hong Kong stocks. There was a similar jump in the Tokyo stock market following rumors that the CIC was considering investing in undisclosed Japanese companies.[93] Plus, rumors that the CIC was a party to a consortium of Chinese companies planning to bid on Australia’s mining company, Rio Tinto, led to a one-day 7.5% rise in the share price of Rio Tinto and a 4.5% rise in the share price of its other alleged suitor, BHP Billiton, despite repeated denials by CIC representatives.[94] There are also apprehensions about the potential for abuse or corruption created by the greater proximity SWFs create between governments and the private sector. As the existing investments of the CIC reveal, there is a growing network of interlinked investments between banks and other financial firms within China and overseas. Some U.S. financial analysts have expressed concern that CIC’s investment in Morgan Stanley will provide the U.S. financial firm unfair preferential access to China’s domestic financial markets. Others are worried that China will place pressure on overseas financial firms in which it has invested to provide more positive and optimistic assessments of China’s economic prospects and the financial status of major Chinese companies courting international investors. Misgivings about the potential impact of the CIC and other SWFs on financial markets and local economies are fostering calls for greater monitoring and regulation of SWFs. The United States and other nations have asked the IMF to consider developing guidelines for SWFs.

Michael F. Martin

34

Also, individual nations are considering implementing laws and regulations governing SWFs. For example, the Indian government is examining the need for a special investment framework for SWFs because “even a trickle from these funds could have huge ramifications for the Indian stock markets and the economy on the whole.”[95]

CONGRESSIONAL CONSIDERATIONS The initial reaction of the Bush administration to the CIC’s creation was generally favorable. President Bush reportedly said that he was “fine” with foreign investors buying shareholdings in U.S. banks and financial firms.[96] U.S. Treasury Undersecretary for International Affairs David McCormick recently commented the investments of SWFs have “largely been longterm, very commercially-focused, and very stable,” but also indicated that more transparency and governance was needed.[97] To that end, the Bush administration has been pushing the IMF to develop a system of best practices for SWFs.[98] As previously mentioned, P.L. 110-49 broadened the investigatory authority of CFIUS in cases of national security risk, and increased the committee’s reporting requirements to Congress. However, there have been suggestions that the recent changes do not adequately protect the United States from economic risks posed by SWFs. These potential economic risks are seen as including financial market instability, undesirable foreign control or influence over key industries or companies, access to sensitive technology, and other forms of unfair competitive advantages. Among the regulatory changes being suggested are:

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• •

•

Requirements that any SWF interested in investing in the United States publicly release audited financial statements that follow international accounting standards on a regular basis; Restrictions on the percentage of a U.S. company a SWF may own — other nations have such limits; for example, Hong Kong may withdraw the authority of Standard Chartered Bank to issue Hong Kong currency if the share of its stock owned by a Singaporean SWF exceeds 20%; and Restrictions on the type of investment SWFs may make in U.S. companies — alternatives include restricting SWFs to the purchase of non-voting shares, banning SWFs from negotiating a seat on the company’s board of directors or representation in the company’s senior management.

In addition, there have been suggestions that access to U.S. financial markets should be contingent on the successful conclusion of a reciprocity agreement that would allow U.S. banks and financial institutions comparable access to the other nation’s investment and financial markets. However, some commentators are concerned that increasing the regulatory review of SWFs will precipitate a period of financial protectionism.[99] The issue is whether the value of protection obtained outweighs the forgone benefits of investments prevented in a more restrictive global financial market.

China’s Sovereign Wealth Fund

35

REFERENCES [1]

[2] [3]

[4] [5] [6]

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[7] [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18] [19] [20]

According to the U.S. Department of the Treasury, a sovereign wealth fund is a “government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from the official reserves of the monetary authorities.” (U.S. Department of the Treasury, Semiannual Report on International Economic and Exchange Rate Policies, June 2007.) For more information on sovereign wealth funds in general, see CRS Report RL34336, Sovereign Wealth Funds: Background and Policy Issues for Congress, by Martin Weiss. According to China’s State Administration of Foreign Exchange (SAFE), its foreign exchange reserves as of the end of December 2007 totaled $1.53 trillion; monthly data are provided on SAFE’s webpage — [http://www.safe.gov.cn]. For more on the possible role of the CIC in solving China’s excess liquidity problem and inflationary pressures, see the World Bank’s Beijing Office’s Quarterly Update, September 2007; and Michael Pettis, “China’s Sovereign Wealth Fund,” September 24, 2007, available at [http://www.piaohaoreport.sampasite.com/blog/Guestblog-2.htm]. David R. Francis, “Will Sovereign Wealth Funds Rule the World?,” The Christian Science Monitor, November 26, 2007. Adam Davidson, “U.S. Watches Nervously as Oil-Rich Nations Invest,” Morning Edition, National Public Radio, November 30, 2007. David J. Lynch, “U.S.: Secretive Global Funds May Hurt Treasuries Market,” USA Today, June 21, 2007. Davidson, op. cit. Lynch, op.cit. James Surowiecki, “Sovereign Wealth World,” The New Yorker, November 26, 2007. Francis, op cit. Ibid. Christopher Cox, “The Role of Government in Markets,” Keynote Address and Robert R. Glauber Lecture at the John F. Kennedy School of Government, October 24, 2007. Ibid. Surowiecki, op. cit. Davidson, op. cit. “China Fund Grabs Big Stake in Morgan Stanley,” AFP, December 19, 2007 Aaron Kirchfeld, “Sovereign Funds Beat Buffett with Stakes in Citigroup, Merrill,” Bloomberg, January 22, 2008. Edwin Truman, “Sovereign Wealth Funds: The Need for Greater Transparency and Accountability,” Peterson Institute for International Economics, August 2007. Jeffrey Garten, “We Need Rules for Sovereign Funds,” The Financial Times, August 7, 2007. Lynch, op. cit.

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Michael F. Martin

[21] For more information about the Foreign Investment and National Security Act of 2007and CFIUS, see CRS Report RL33388, The Committee on Foreign Investment in the United States (CFIUS), by James K. Jackson. [22] According to Section 2 of P.L. 110-49, “The term ‘foreign government-controlled transaction’ means any covered transaction that could result in the control of any person engaged in interstate commerce in the United States by a foreign government or an entity controlled by or acting on behalf of a foreign government.” [23] Edwin M. Truman, “Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the United States: Assessing the Economic and National Security Implications,” Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, November 14, 2007. [24] China’s State Council is the nation’s highest executive and administrative body, consisting of Premier Wen Jiabao, four Vice Premiers, five State Councilors, Secretary General Hua Jianmin, and the heads of China’s various ministries and special commissions. There are approximately 50 members of China’s State Council. [25] Pettis, op. cit. [26] “China’s Trillion-dollar Kitty is Ready,” Asia Times, October 2, 2007. [27] “China’s Forex Investment Company May Debut this Week,” Xinhua, September 10, 2007. [28] Cost of debt estimate based on a statement by CIC Chairman Lou. [29] The PBoC cannot directly purchase bonds from China’s Ministry of Finance, so it used the ABC as an intermediary in the financial transaction. [30] Rachel Ziemba, “How is China Funding the Chinese Investment Corporation (CIC)?” RGE Analysts’ Economonitor, December 5, 2007. [31] Ibid. [32] Ibid. [33] “China Central Bank Takes Up 750 Bln Yuan in T-bonds to Fund CIC,” AFX News Limited, December 10, 2007. [34] Jason Dean and Andrew Batson, “Beijing to Take Passive Investment Approach,” Wall Street Journal (Europe), September 10, 2007. [35] “China to Invest $3 Bln in Equity Giant Blackstone,” Xinhua, May 21, 2007. [36] Ibid. [37] “$200 Billion Investment Firm Starts Operation,” by Xin Zhiming, China Daily, October, 1, 2007. [38] According to CCB’s webpage [http://www.ccb.com], the CHIC owns 70.69% of CCB’s shares, including 9.2 1% owned by its subsidiary, Central Jianyin Investment Company. According to the ICBC’s webpage [http://www.icbc.com.cn], the CHIC owns 35.33% of ICBC’s shares. [39] “China Investment Co to Invest a Third of Its 200 Bln USD ‘Cautiously’ — Official,” AFX News Limited, November 7, 2007. [40] Yidi Zhao and Janet Ong, “Chinese Banks to get $67 Billion from Sovereign Wealth Fund,” International Herald Tribune, November 8, 2007. [41] “Agricultural Bank of China to Announce Financial Restructuring Plan Soon,” AFX News Limited, December 3, 2007, and “Agricultural Bank of China Sets Up Investment Banking Operations,” AFP, December 4, 2007.

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[42] “Agricultural Bank of China Denies Shareholding Reform Approval Rumor,” Xinhua, December 5, 2007. [43] Xin Zhiming, Huijin to Inject $20b into China Development Bank,” China Daily, December 31, 2007. [44] Ibid. [45] Jamil Anderlini, “CIC to Buy Stake in HK Rail Group Float,” The Financial Times, November 21, 2007. [46] “CIC Invests in China Railway IPO,” China Economic Review, November 21, 2007. [47] “China Fund Grabs Big Stake in Morgan Stanley,” AFP, December 19, 2007. [48] Ibid. [49] Mao Lijun, “Central Huij in Bails Out Everbright Bank,” China Daily, November 8, 2007. [50] “China Everbright Agrees to Capital Injection Plan,” China Daily, November 28, 2007. [51] Ibid. [52] “China Everbright Bank Reportedly Plans IPO Next Summer,” Xinhua, December 5, 2007. [53] Pettis, op cit. [54] Jason Dean and Andrew Batson, op. cit. [55] “China’s Trillion-dollar Kitty is Ready,” Asian Times, October 2, 2007. [56] “CIC to be Stable Force in Global Financial Market,” Xinhua, December 11, 2007. [57] “China’s Sovereign Wealth Fund Seeks to be a Stabilizing Presence in Global Markets,” Xinhua, November 30, 2007. [58] “China Wealth Fund Aims for Stability, Openness,” China Daily, October 16, 2007. [59] Xin Zhiming, “China’s State Forex Investment Company Debuts,” China Daily, September 29, 2007. [60] “China’s Sovereign Wealth Fund Seeks to be a Stabilizing Presence in Global Markets,” Xinhua, November 30, 2007. [61] Pettis, op. cit. [62] “China’s Sovereign Wealth Fund Seeks to be a Stabilizing Presence in Global Markets,” Xinhua, November 30, 2007. [63] “Investment Fund Announces Strategic Plans,” Xinhua, November 9, 2007. [64] “China Investment Corporation Unveils Investment Plan,” Xinhua, November 7, 2007. [65] Keith Bradsher, “$200 Billion to Invest, But in China,” The New York Times, November 29, 2007. [66] Brad Setser, “Does the China Investment Corporation (CIC) Have a Coherent Investment Strategy?” online blog #234551, available at [http://www.rgemonitor.com/blog/setser/23455 1/]. [67] Ibid. [68] Jamil Anderlini, “China Wealth Fund’s Early Coming of Age,” Financial Times, December 21, 2007. [69] Xin, op cit..

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Michael F. Martin

[70] “China Investment Corporation Unveils Investment Plan,” Xinhua, November 7, 2007. [71] “China Investment Corp Warns Western Governments Against Protectionism,” AFX News Limited, December 10, 2007. [72] China does restrict inward FDI in what it considers economic sectors related to national and economic security, including certain agricultural and fishing industries, selected mining industries, traditional Chinese medicine processing, non-ferrous metal industry, electric machinery manufacturing, postal services, geological surveying, news agencies, publications industry, and radio and televisions stations and networks. For a complete list of “prohibited foreign investment industries,” see “Decree of the State Development and Reform Commission, the Ministry of Commerce of the People’s Republic of China, No. 57,” Department of Foreign Investment, November 22, 2007, available online at [http://english.mofcom.gov.cn/column/print.shtml?/ policyrelease/announcement/2007 11/ 20071105241195]. [73] China has also created a “qualified foreign institutional investors” (QFIIs) program that allows foreigners to invest in Chinese companies via funds offered by the QFIIs. In May 2007, China pledged to increase the limit on QFIIs to $30 billion during the Strategic Economic Dialogue (SED) held in Washington, but did not officially raise the limit until just before the SED held in Beijing in December 2007. [74] “China’s CIC Wins $5 Bln Investment Quota - Paper,” Reuters, December 17, 2007. [75] Ibid. [76] “China Investment Corp Warns Western Governments Against Protectionism,” AFX News Limited, December 10, 2007. [77] Ibid. [78] Fu Jing, “US Policies May Deter Investors from China,” China Daily, December 12, 2007. [79] Ibid. [80] “China Wealth Fund Aims for Stability, Openness,” China Daily, October 16, 2007. [81] Xin Zhiming, “CIC Aims for Overseas,” China Daily, November 30, 2007. [82] “CIC to be Stable Force in Global Financial Market,” Xinhua, December 11, 2007. [83] “China Investment Co to Invest a Third of its 200 Bln USD ‘Cautiously’ — Official,”AFX News Limited, November 7, 2007. [84] “Sterilization” is a process by which a government absorbs excess foreign exchange in circulation. One common method is by issuing government debt instruments in exchange for the foreign exchange. [85] For more information on China’s accumulation of U.S. debt, see CRS Report RL34314, China’s Holdings of U.S. Securities: Implications for the U.S. Economy, by Wayne Morrison. [86] The name of China’s currency is the “renminbi,” or “people’s currency.” It is denominated in units called “yuan.” On October 10, 2007, the exchange rate between the renminbi and the U.S. dollar was 7.51188 yuan = $1. [87] For example, on January 1, 2007, the exchange rate was 1 yuan of RMB = 12.82 cents of U.S. dollars. If China had invested 100 billion yuan in one-year U.S. treasury bills on January 2, 2007, it would have been offered a return of 5.0%. After

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[88] [89] [90] [91] [92] [93] [94] [95]

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[96] [97] [98] [99]

39

conversion into U.S. dollars, China would have invested $12.82 billion. At the end of the year, China would have been paid $13.46 1 billion by the U.S. Treasury for its investment. However, the exchange rate at the end of 2007 was 1 yuan = 13.59 cents. So, after converting the U.S. dollars back into RMB, China would have received the equivalent of 99.051 billion yuan for its investment — a loss of 949 million yuan, or a -0.9% return on its investment. For an analysis of the potential impact of a shift in foreign holdings of U.S. debt on the U.S. economy, see CRS Report RL32462, Foreign Investment in U.S. Securities, by James K. Jackson. Liz Moyer, “Cornering the Bond Market?,” Forbes, September 28, 2006. For more information on China’s exchange rate policy, see CRS Report RL32165, China’s Currency: Economic Issues and Options for U.S. Trade Policy, by Wayne M. Morrison and Marc Labonte. Mao Jilun and Li Weitao, “City of London Woos China Investment Corp,” China Daily, October 26, 2007. Carol Chung and Carrie Chan, “Stock Scheme on Agenda at Tsang Chat with PBOC,” The Hong Kong Standard, November 22, 2007. “Shares Rally on Signs of US Retail Strength,” Reuters, November 27, 2007. “China Investment Denies Involvement in Alleged Rio Tinto Bid,” CNN, November 26, 2007; “China Investment Denies Rio Tinto Bid,” Xinhua, November 27, 2007. “Government Wakes Up after China Floats $200 Bn Fund,” The Economic Times, November 22, 2007. Michael Richardson, “Barriers to Trust: Sovereign Wealth Funds Must Become More Transparent to Avoid Causing Alarm,”South China Morning Post, December 29, 2007. Ibid. Francis, op. cit, and Lynch, op. cit. Truman, op. cit.

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In: Sovereign Wealth Funds Editors: T. N. Carson, W. P. Litmann

ISBN: 978-1-60692-319-1 © 2009 Nova Science Publishers, Inc.

Chapter 3

STATE CAPITALISM: THE RISE OF SOVEREIGN WEALTH FUNDS Gerard Lyons Chief economist and group Head of Global Research at Standard Chartered, Economic Advisor to the Board, USA

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13th November 2007 Sovereign Wealth Funds (SWFs) have existed since 1953 and are here to stay. Their size and influence is set to grow. Already valued around $2.2 trillion, on current trends they could even reach $13.4 trillion in a decade. Here I provide a comprehensive and up to date analysis of SWFs, detailing the largest 22, what drives them and their likely future impact. 1 2

3 a

The Super Seven: There are already seven big SWFs that have over $100 billion in assets. These are the funds that dominate and include Abu Dhabi, GIC of Singapore, Norway, Kuwait, China, Russia and Temasek. The Secret Funds: Whilst one way of looking at these funds is their size, another is to analyse their investment approach and philosophy. A number of funds are not so transparent and include the UAE funds, China, Qatar, Brunei, Venezuela, Taiwan, Oman and Kuwait. Three Crucial Implications: The influence of SWFs on financial markets is set to grow. Expect these government controlled funds to: take bigger financial stakes in equity and bond markets across emerging economies; to feed more money into alternative investments such as hedge funds and private equity; to boost strategic links with countries that have not shared fully in globalisation or which have been shunned by the West; and to take more strategic stakes in sensitive areas within developed countries. It is these last two areas, which I call State Capitalism, that is the most problematic aspect of sovereign wealth funds.

Gerard Lyons

42 b

c

There is a serious likelihood of Western governments and SWFs clashing over what they can buy and where. A protectionist backlash against strategic investments would be damaging for global trade. There is a huge difference between what is needed and what is likely to happen. There is a strong case for SWFs to adopt the best practice of open funds like Norway. But many governments will argue that it is their money and why should they be so transparent when other areas of financial markets are not. In addition, there is a strong case to be made to encourage the opening up of markets from which SWFs emanate (the so-called level playing field). But this will take time and we are more likely to see Western governments seeking to protect national champions and strategic sectors, as is their right. The aim should be to improve governance and transparency and promote an investment framework that is fair and commercially driven. The rise of SWFs should be seen as a further sign of a shift in the world economy and Western countries should seize this as an opportunity to work with emerging economies such as China and Russia and others to find common ground rules and a code of practice. Although multilateral groups like the IMF and World Bank or even the World Trade Organisation may be best placed to decide a code of practice the danger is that they will be ineffective. In fact more SWFs may invest strategically in order to position their economies on the world stage! Yet, as long as investments by SWFs are made for commercial reasons, and not for political purposes, then these funds should be accepted.

1. THE IMPACT AND IMPLICATIONS Copyright © 2008. Nova Science Publishers, Incorporated. All rights reserved.

1a. Introduction This Report focuses on a major global issue - the rise of sovereign wealth funds (SWFs). We have been at the forefront of this debate, although we have talked about it in terms of State Capitalism - as it is this, rather than all aspects of SWFs, that is the crux of the issue. State Capitalism is the use of government controlled funds to acquire strategic stakes around the world. The growth of SWFs and the location of the countries from which they originate provides another example of how the balance of economic and financial power is shifting. SWFs are not new. In fact some of them have a long history, with the first being established as long ago as 1953. Of the twenty two largest SWFs that are examined in this report, seven were in existence before 1990, six started in the 90s and nine since the millennium. A number of smaller funds have started in recent years and, as existing funds prove successful, this may well encourage other countries to establish their own. Given how long SWFs have been in existence, it is remarkable how focus on them has only recently become a big issue, particularly in policy circles. Why is this? The change seems to be occurring on both sides. On the SWF side, the difference is that now the number of countries pursuing such a strategy of having their own fund has soared and the amounts at their disposal are huge. Although many SWFs are keen to ensure high

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State Capitalism: The Rise of Sovereign Wealth Funds

43

investment returns, there is now added concern about where and what they could buy. China's fund is just the latest example. Meanwhile, in terms of countries into which this money is flowing, there now seems to be far more awareness of the existence of SWFs. In particular, three broad issues stand out as bringing this to wider attention. One, is the potential for these funds to make more strategic investments - hence the term State Capitalism. Second, is the surge in size of these funds and the likelihood that they will continue to grow. Third, is the increased concern about the lack of transparency of some of these funds. All this has focused attention on the fact that, as the consequences of State Capitalism are not clear, there are no ground rules regarding how SWFs should behave and thus no rules as to what they can buy. This, in turn, has added to concerns about future protectionism. In many respects, SWFs are their own worst enemy. Their air of secrecy, including for some a lack of transparency has, in recent years, led to some concern. Although the funds may argue that there are others within the financial markets that are equally secretive, it is the suspicion about their intentions that makes this a more problematic area. This need not be the case. Some SWFs are very open - Norway is perhaps the best example of a fully transparent fund. There are many challenges with SWFs: a major one being their opaqueness, an additional challenge being how one defines a SWF. Allowing for certain exceptions, their main characteristics are: ownership by a sovereign nation state rather than a regional or local state entity; not national pension funds and not central banks or authorities that perform roles typical of a central bank. This is a credible set of qualifying assumptions. It does, however, exclude the likes of Saudi Arabia's Monetary Authority (SAMA), which has reserves of $251 billion, and which also acts as a conduit for the investment of Saudi government funds totalling $116 billion. The biggest is the Abu Dhabi Investment Authority (ADIA), but as it not a transparent fund, the estimate of $625 billion may not be spot on. The uncertainty about some funds is highlighted by some of the wide guesstimates that exist. Take Kuwait as an example. The figure of $213 billion cited in this Report is based on a reply to a Parliamentary question and seems to be more reliable than most other estimates, which vary widely. If any of these figures are not spot on it is a reflection of the secrecy of the SWFs themselves! Overall, it is calculated that the estimated size of the top 22 SWFs is $2.2 trillion. If you add in recent smaller funds, such as Azerbaijan, Trinidad & Tobago, Ecuador, Nigeria and others, $2.3 trillion is the likely scale.

1b. Scale - the Super Seven This Report shows that within the major SWFs there is a Super Seven. These are the seven funds already with over $100 billion in assets. The Super Seven are: • • • • •

Abu Dhabi, Singapore - GIC, Norway, Kuwait, China,

Gerard Lyons

44 • •

Singapore - Temasek, and Russia.

In fact, three of these are also among the five largest if one uses a different benchmark, such as the size of funds as a proportion of GDP. So, in relation to GDP, the five big funds are: • • • • •

Abu Dhabi, Brunei, Kuwait, Qatar, and Singapore - GIC.

1c. Rapid Growth Rates and Future Size Given the scale of these funds now, an important issue is their likely future size. There are a number of driving forces behind these funds. 1

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2

3

4

The movement in oil and other commodity prices: petrodollars and revenues generated by the recent boom in commodity prices have been particularly important for the growth in SWFs. Sixteen of the largest twenty two funds have commodities as their main source of income. The growth in foreign exchange (FX) reserves. The importance of reserves as a key driver behind SWFs should not be overlooked. Total global FX reserves are $5.75 trillion, with Asia accounting for $3.66 trillion. Reserves are rising sharply. For instance, a decade ago, Asian central banks accounted for one-third of global currency reserves, now they account for two-thirds. The investment performance and returns achieved by the fund, which will clearly be influenced by many factors, including the macroeconomic and financial climate and the fund's own strategy. There are, in essence, two parts to SWFs: one, is a fund management, asset allocation investment; the second is a strategic investment. Discretionary factors. Among the six of the largest twenty two that do not rely on commodity prices, the financing varies. Some, like China, may rely on transfers from FX reserves. Others, like Malaysia's Khazanah Nasional (number twelve in size) may be partly financed by debt. A key factor will be how governments wish to finance these funds and the amount that they wish to funnel to them.

Some of these funds have recently enjoyed rapid growth. Growth rates were estimated last year for twelve funds, ranging from zero to 100%. Given such a wide spread, it is clear that it is hard to say anything definite about potential growth rates. Taking out the extremes, and looking at this in relation to other data, a good guide to average annual performance is just under 20%.

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45

Asia Fx Reserves, USD bns Philippines

Dec-97

latest

Thailand Hong Kong India Taiwan China 0

200

400

600

800

1000

1200

1400

Source: Standard Chartered.

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Chart 1. Asia Fx Reserves, USD bns.

If this growth rate was repeated over the next decade the funds would reach $13.4 trillion. But, of course, the last few years have been spectacular for the world economy and for financial markets. Whilst that may suggest caution about the future growth rate, many of the funds may continue to be fed by growing FX reserves. Even if we just assumed that there were no additions to these funds and that they experienced only a modest return over the next ten years, matching an average of the annualised returns seen on US and emerging equities over the last decade then the size of these funds would grow to $5.2 trillion, in itself a large number. Furthermore, the aims of SWFs vary and whilst some may seek to maximise returns, the strategic element sometimes works against that principle. This makes it hard to gauge their likely future size, although it will be fair to assume they will be large and their influence will grow. There is every likelihood that the SWFs that countries in the West are most concerned about will continue to grow significantly. Take China, for instance. China’s new SWF, the China Investment Corporation (CIC), will have an initial capital of around $200 billion and will absorb an earlier fund, established in 2003, the Huijin Investment Company. There is no ideal level of FX reserves, despite many academic studies attempting to determine some magical formula. Yet China's behaviour appears to suggest that they believe FX reserves have reached a significant level to allow China to cope with any external shock. That level would appear to be around $1.1 trillion. Reserves have continued to rise, to around $1.4 trillion, coinciding with the establishment of its $200 billion fund. The amount allocated to this fund looks set to grow. With China committed to a gradualist appreciation of the CNY, its currency reserves look set to keep rising, reaching $2 trillion in early 2009. As reserves grow, it would be no surprise if additional amounts were used in stages to swell the size of China's SWF to, say, $600 billion within two years! Recent developments within China have put a lot of emphasis on this new fund being performance dependent, particularly as behind the scenes not everyone appears happy with its remit. This, in turn, could encourage The State Administration of Foreign Exchange (SAFE) to become more aggressive in its managing of remaining FX reserves, to lessen the argument for more funds going into the new SWF. Furthermore, the new CIC fund, will also use some of its funds to help restructure the financial sector.

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46

Gerard Lyons

Over time, in general and not necessarily in every country, it seems likely that SWFs will grow at a faster pace than the rise in FX reserves. The funds will not only be fed by the growth in reserves but are likely to enjoy gains on their investment, swelling their size further. Of course, currency policy itself has a big bearing. The appreciating currencies are, by and large, likely to be those enjoying current account surpluses. The lesson of Asia over the last decade is testimony to how this could continue to play out over the next ten years. As intervention takes place to stem the pace of appreciation, this not only leads to currency reserves rising further, but keeps the currency competitive, underpinning its current account. But at some stage, possibly even in coming years and certainly over the next decade, Asia itself will move from being export driven to relying much more on domestic demand. In which case, current account surpluses will shrink and the growth in currency reserves may slow. Although this in itself may remove one of the drivers of the rise in SWFs it will be replaced by another driver - namely the growth in Asian domestic demand will go hand in hand with the deepening of Asian financial markets. And, if SWFs invest in these markets at an early stage (as they already appear to be) then they are likely to enjoy rapid investment returns, as the capitalisation of these asset markets grow. The size of SWFs may also grow relative to other types of investment. According to figures quoted from McKinsey, the world has $167 trillion of financial assets. Thus SWFs constitute 1.3% of this total. But this is likely to rise, particularly as the four constituent parts (i) to (iv) outlined above look set to grow. The current $2.2 trillion in SWFs compares with figures of $1-1.5 trillion for hedge funds and between $0.7 trillion to $1.1 trillion for private equity. Yet the growth in SWFs itself is likely to feed both of these areas, as the investment allocation of SWFs may see more funds directed into alternative investments such as hedge funds and private equity. The growth of SWFs, alongside that of hedge funds, private equity, government pension funds and of currency reserves is a clear indication of the shift underway in parts of the financial markets. The IMF's Global Financial Stability Report from this spring also highlighted the shift underway in markets, although in their analysis the IMF groups the rise in FX reserves and in SWFs together, "Tentative estimates of foreign assets held by sovereigns include $5.6 trillion of international reserves and between $1.9 trillion and $2.9 trillion in types of sovereign wealth fund (SWF) arrangements. These amount to about 10 times less than the assets under management of mature market institutional investors ($53 trillion) and modestly higher than those managed by hedge funds ($1 trillion to $1.5 trillion) (Financial Stability Forum, 2007). Current IMF projections are that sovereigns (predominantly emerging markets) will continue to accumulate international assets at the rate of $800 billion to $900 billion per year, which could bring the aggregate foreign assets under sovereign management to about $12 trillion by 2012." But, as we mention above, not only are SWFs likely to grow at a faster pace than the increase in FX reserves, but they could exceed such FX reserves in total size in a number of years. Not only are FX reserves different to SWFs, but so too are sovereign pension funds. Again these funds are sizeable, whether they are in Chile, Ireland or Saudi Arabia. Collectively, one could argue that all of these (SWFs, FX reserves and sovereign pension funds) are a sign of the increasing might of emerging economies and they reflect another sign of the changing balance of power in the world economy.

State Capitalism: The Rise of Sovereign Wealth Funds

47

1d. Secrecy and Accountability But it is not the age or the size of these funds that has recently prompted attention; it is the opaqueness or secrecy of the fund, and in particular concern about the strategic intention of some funds. Some funds are very transparent. These include: • • • • • •

Norway, Singapore's Temasek, US (Alaska), Malaysia, Canada (Alberta), and Azerbaijan.

These funds provide detailed information on their size, returns achieved and their portfolio composition. And many companies have seen these as investors without any apparent issues to date. In contrast, some funds have very low levels of transparency including

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• • • • • • • •

UAE funds, Kuwait, China, Qatar, Brunei, Venezuela, Taiwan, and Oman.

A simple way to picture this is two axes: on the horizontal axis one measures a fund's transparency, from low (or opaque) on the left to high on the right. Meanwhile, on the vertical axis, funds can be measured on how their investment decisions are made, namely conventional (say, asset allocation) to strategic. On this basis, one could construct four boxes: • • • •

Bottom left being low transparency but conventional investment strategy; Bottom right high transparency and conventional strategy; Top right being high transparency and strategic; Top left being low transparency and strategic.

Chart 2 would imply that the SWFs in the bottom right pose little concern, as they are not strategic and are transparent. The other three boxes all prompt questions, with the biggest area of concern relating to the top left segment. The four SWFs here being both strategic in their investment and also having relatively low transparency. Once again this graph demonstrates the difficulty of generalising about such funds, as a number have very different characteristics. The most secretive funds are on the extreme left of the chart. Whilst secrecy in itself does not mean that a fund will be a bad investor, in a global financial environment where transparency and accountability are seen as important positives, such opaqueness should not be encouraged.

Gerard Lyons

48

One of the surprising aspects of this chart is the position of Russia - seen as relatively transparent and also less strategic than other funds. Allthough both of these characteristics may change when, as of next year, the Russian fund begins to invest partially in more risky assets (so far it does not invest in global equities), this nonetheless might genuinely raise questions as to why there appears to be such apprehension about their intentions. That the situation is likely to change is perhaps the concern amongst some countries. But if there is change it can be two- way. For instance, in my view the increased US dialogue with China, particularly in areas such as the Strategic Economic Dialogue, plus China's desire to ensure high returns form their fund may account for their decision to allocate some of their new money to be managed by international investment managers. That, of course, leads on to what is best practice for SWFs? The bottom right of this chart highlights a number of funds that may be seen as adopting best practice.

1e. Implications - Strategic Behaviour What then are the implications of SWFs? One can look at this in many different ways, in terms of their impact on economies and markets around the world, how the funds themselves might evolve, the likelihood that they will feed protectionist sentiment in the West, and indeed whether governments and funds can work together to ensure some common ground rules. Overview of Investment Approach and Transparency Strategic Commodity Fund Non- Commodity Fund Malaysia

UAE (Dubai) - Istithmar Qatar China

Investment Approach

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UAE (Dubai) - DIC

Singapore - Temasek Singapore - GIC Libya South Korea

UAE (Abu Dhabi) - ADIA Brunei Oman Kuwait Taiwan Venezuela - NDF

Algeria Kazakhstan Russia

USA (Alaska) Chile Canada (Alberta)

Norway

Conventional Low

Level of Transparency

Source: Standard Chartered and Oxford Analytica. Chart 2. The Top 22 Sovereign Wealth Funds.

High

State Capitalism: The Rise of Sovereign Wealth Funds

49

The performance aspect of SWFs and the need to ensure high returns is likely to encourage them to take bigger financial stakes in equity and bond markets across emerging economies as well as to feed more money into alternative investments such as hedge funds and private equity. But consider some aspects of their strategic behaviour first.

Strategic Stakes Are Bought Making investments for purely commercial reasons are one thing, but when they involve government owned funds and the stake is potentially strategic it is clearly another thing. The big worry is that these funds see an opportunity to acquire strategic stakes in key industries around the globe, whether it be:

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• • • • •

Telecommunications, Energy, The media The financial sector, Or even to secure intellectual property rights in other fields.

The difficulty is that many of the more strategic funds are not so transparent and thus it is hard to measure such stakes. Nonetheless, the economic rationale behind such strategic acquisitions is clear. Some countries may seen this as a way to move up the value curve quickly, as they acquire intellectual property and access to research, design and development that it may take years to develop at home. For instance, the expertise of emerging economies, such as China, in low cost manufacturing could quickly be added to by the acquisition of high tech firms overseas. Of course that raises questions, such as should China be able to secure intellectual property rights overseas, at a time when it cannot guarantee to safeguard such rights for foreign firms in their market? Buying into overseas financial firms (whether through SWFs or other arms of a government) makes longterm strategic sense for many emerging economies, particularly if it allows them to transfer such financial skills back home to help develop and deepen domestic financial markets.

Resource Nationalism This means an attempt to buy access to strategic commodities and resources around the world. This is linked into the fundamental shift in the demand for commodities. China stands out here given its insatiable appetite for all types of commodities, and not just energy. For instance between 2004 and 2006, China moved from accounting for 21 % to 26% of total global demand for six industrial commodities (by last year accounting for 30% of zinc demand, 32% tin, 19% nickel, 27% lead, 23% copper and 26% of global demand for aluminium). In softer commodities it also accounts for a significant proportion of demand (16% wheat, 19% maize, 21% soybean and 31 % rice). There is also the buying of overseas strategic assets linked to energy. And here attention is sometimes focused on what happens in the home country from which a SWF originates as much as on what happens abroad. For instance, Russia, and other oil producers, are also in a powerful position as national oil companies become bigger and in the process edge out western multinationals from their oil reserves. And a wider concern linked in here is how will the owners of these stakes behave in the future.

50

Gerard Lyons

The Role of SWFs in Enhancing a Country's Strategic Agenda Should Not Be Overlooked Although in reality there are many ways that a country can seek to provide funds to another country. China's strategic ambitions should not be doubted, as its relationship with Africa highlights. This relationship has changed over the years. After initial enthusiasm a few years ago about Chinese investment in Africa there was then a backlash, as concerns were raised in Africa about both China's intentions and about whether its investment was in the Continent's best interests. Given China's strong incentive to purchase access now to future supplies, the Chinese responded by courting African policy makers. Nearly 50 African leaders were hosted in Beijing last autumn, whilst the annual African Development Bank took place this May in Shanghai, during which the Chinese announced the availability of further funds to be invested in African projects. This could yet evolve further. How will the market and trading companies cope with direct government to government deals on commodity flows, or even with buying of the mining companies themselves?

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1f. Implications - Protectionist Stance Protectionist Backlash There is a need to take seriously the likelihood of Western governments and SWFs being on a future collision course over what they can buy, and where. A protectionist backlash against strategic investments is very real and threatens global trade. As we have seen from recent years, not all countries that are on the receiving end of these flows like this idea. The Thai authorities did not like Temasek of Singapore's purchase of a telecommunications stake in their country, whilst Dubai Ports World had to abandon their attempt to buy P&O's US ports after it prompted a national security debate in the US Congress. China's CNOOC bid for Unocal was also blocked in the US. Future political reactions could be far worse. It is not only governments that should be concerned; markets need to take note of the consequences. The desire of some governments to protect their strategic assets from the clutches of SWFs is coinciding with a rising anti-globalisation sentiment in some countries. If governments attempted to protect strategic industries or important companies, this poses the question of how one defines a strategic industry? One linked to defence is understandable hence in the UK the government has a golden share in British Aerospace that allows it to veto foreign control. But in other areas it is more difficult to say. Yet it is possible to conceive of a number of areas where there are legitimate reasons for a cautious or even protectionist stance on behalf of the recipient country. Such examples might be if the outcome would damage domestic competition; if the outcome was detrimental to national security which is already a key issue in the US whether or not it is a SWF or any other investor that wishes to buy; and perhaps such a response is legitimate if a SWF is secretive and its intentions are strategic.

State Capitalism: The Rise of Sovereign Wealth Funds

51

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Before We Get to this Situation There Is a Need for Ground Rules to Be Established on SWFs These could be imposed at the country or regional levels, but that is a second-best outcome. Far better for a credible global body to seek to establish some ground rules, providing the views of emerging countries were fully reflected. Of course, this risks an ineffective outcome. Many factors have contributed to the recent economic boom, including the opening up of world trade and global financial flows. But the transition to a more global economy can be painful - whilst there are winners (especially in the emerging world), there are also losers (including low skilled workers in developed countries who may not receive large wage gains). It is in response to this that protectionist sentiment may gain a strong footing and the rest of the world is observing this situation in the US. Yet the European stance is equally important - especially as European-Asian trade has now overtaken US-Asian trade. In recent EU bilateral trade negotiations, they UK’s desire to insert social or sustainability clauses in order to protect not just areas of national security but also areas of national sensitivity led to much confusion and highlighted how complex this area is and in my mind provided another example of the need for widely agreed ground rules in such trade negotiations. In some respects it picks up the present mood in Western Europe, which appears to be leaning towards more protection. According to the Centre for European Reform, "Several EU Governments have become alarmed about SWFs. Germany, for example, is thinking of preventing such funds from buying local companies in sensitive sectors. The European Commission is considering how it should respond: should it outlaw such defences or establish them at EU level? the EU needs to ensure that any measures taken in response to SWFs do not threaten the openness of its single market."

1g. Implications - Market Impact Money Goes Elsewhere For instance, if the US Congress becomes more protectionist, blocking state inflows from, say, China, would the money just go elsewhere? Indeed this already appears to be happening in terms of flows from the Middle East that in the past predominantly went to the US. Whilst the US is still the main recipient, a report earlier this year from the Institute of International Finance, using estimates from the United Nations, suggests that there has been a shift away from the US, and that between 2002-2006 20% of investment from Gulf States went to Europe, 11% to the Middle East/North African and 11% to Asia. It is likely that SWFs could divert their attention from markets in the West to focus on nascent equity and bond markets in emerging economies. In fact such a strategy makes sense anyway, as whether one is cautious or optimistic about the global economy, emerging economies are likely to see stronger rates of growth than OECD countries, and offer better longer-term investment opportunities.

52

Gerard Lyons

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Financial Markets Government intervention through state funds could cause distortions particularly if the funds become active in regional markets across parts of Asia, Africa and Latin America that are smaller, less liquid and lacking maturity. There the impact of foreign state funds could be huge. In recent times there have sometimes been concerns in financial markets of what could happen to US Treasury yields if Asian central banks sold, but in this context for emerging markets the impact of SWFs is likely to be seen in a positive light - provided the markets are big enough and have the capacity to absorb such inflows. Pro-Cyclical Market Impact The impact of larger SWFs on markets could be pro-cyclical, reinforcing trends that are coming into place. Indeed it is possible to see the impact of FX diversification away from the dollar and of SWF investment in smaller and faster growing emerging markets as resulting in a strong impact, adding to dollar weakness and emerging market equity strength. Furthermore, as the funds become bigger they could shift to more risk- seeking behaviour, feeding alternative investments such as hedge funds and private equity, as mentioned above, as well as enhancing the attraction of emerging markets. There is a risk that the presence of SWFs in riskier asset markets could lead to a moral hazard problem, especially if the SWFs have strategic and not just profit maximising objectives. The attraction of emerging markets could go hand in hand with a further shift in global FX reserves away from the dollar. Although the bulk of global reserves are in dollars, its share is declining, albeit slowly. It is not in Asian countries' interests to actively sell the dollar now, but we believe that passive diversification is already underway, as Asian central banks put less of new reserves into dollars. Of course, if they were to actively sell the dollar then the impact - both direct and more particularly indirect - would be significant. For instance, if Asian central banks were to switch reserves to match countries with whom they trade, they would need to offload $1.39 trillion, or a quarter of the world's total reserves. Greater Equity Purchases in Mature Markets Yet even in the mature established markets there could be consequences. The desire to increase returns could see greater equity purchases by state funds, raising the question of how they will behave if they are equity holders when hostile takeovers take place? Would one really want a fund run by the Russian authorities, say, deciding on the fate of a hostile banking takeover?

1h. Implications - Need for Ground Rules Level Playing Fields This is often referred to in terms of reciprocity. Whilst the fear is a protectionist response the West should use the growth of state capitalism to force change for good. For instance, in the UK's financial sector, the aim will be to continue to embrace the Wimbledon effect - better to have the best financial market in London, even if most of the key players are foreign owned. But at Wimbledon the playing field is flat. Chinese banks may buy, own and exert full control over British banks, but could the reverse happen? If the West accepts that Chinese firms can buy freely overseas using state reserves then this should lead

State Capitalism: The Rise of Sovereign Wealth Funds

53

to pressure for China to open its domestic markets further. And the same pressure should be applied to other countries with large state funds that invest overseas.

Best Practice SWFs need to adopt the best practice of the open funds such as Norway. Appropriate regulation of all aspects of the financial sector is needed, and sovereign funds should not be immune, particularly as their importance grows. Whether it is possible to have a code of conduct for SWFs remains to be seen, the likelihood being that many countries will view it as their money, and they may not view it as relevant what Norway, or indeed other countries do. This is in all likelihood what would happen. Avoiding Collision There are some crucial steps that need to be taken to prevent a collision between SWFs and host nations into which they invest. Yet the preconditions for such a collision seem to be already falling into place: • •

•

SWFs are growing significantly and the need for resources, as well as a desire to acquire expertise is resulting in a significant strategic element in many SWFs. This growth mirrors structural shifts in the world economy, where emerging markets are outperforming and assets in these markets look set to exhibit steady and even rapid growth (albeit allowing for near-term cyclical challenges as the pace of global growth slows in the next two years). The challenges of globalisation, plus below trend growth in the US in 2008 and 2009, feed a protectionist stance in the US and in some Western European countries.

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How this might play out is hard to say, but it is unlikely to be pleasant.

Non-Voting Stakes In trying to establish workable ground rules for SWFs, one issue is that of non-voting shares. If SWFs behave as institutional investors that own minority stakes then there may be few grounds for objection, or cause for concern. But if the SWFs begin to acquire large stakes this may lead to valid questions being asked. In particular, one concern is that direct influence by government controlled stakes may lead to capital misallocation and inefficiency. Another is that fear of political interference in business decisions and strategies. One possible solution is to limit SWFs to non-voting shares, although the challenge here is the ability to discriminate between different types of investors. As there is a strong case for more openness and best practice in terms of governance. The growth of newer SWFs has prompted much discussion about whether they will be able to attract the talent to manage such funds. But, in reality, this is no different to others in the rapidly growing financial sector across emerging markets. It may, of course, encourage such funds as they grow to allocate money to third party fund managers. Although that may ease concerns about their transparency it does not remove the need for more openness. Code of Conduct Western countries may need to accept the rise of SWFs as a further sign of a shift in the world economy and should seize this as an opportunity to work with economies such as

Gerard Lyons

54

China, Russia, countries in the Middle East and others to find common ground rules and a code of practice. Although multilateral groups like the IMF and World Bank or even the World Trade Organisation may be best placed to decide a code of practice the danger is that they will be ineffective. State capitalism and resource nationalism are already a major economic phenomenon. Across Asia, Russia and the Middle East governments look set to use their country's currency reserves and savings to acquire overseas assets. Whether it is China, Korea, Qatar or Abu Dhabi or a host of others their funds appear intent on improving returns, building up long-term assets and acquiring strategic stakes around the globe. The shopping list is long!

Force for Good The mood towards SWFs in many emerging countries appears to be to view them as a potential force for good. I have either heard such views directly, or heard them relayed to me from colleagues. In some respects this is a reflection of the SWFs being seen as a further shift in the balance of economic and financial power, and also reflecting the increasing confidence seen in regions such as Asia and the Middle East. Furthermore, there is the expectation that such SWFs will be a source of liquidity and of investment flows into emerging markets.

SECTION 2: THE LARGEST SOVEREIGN WEALTH FUNDS

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2a. Selection Criteria The following analysis has been carried out with the support of Oxford Analytica. One of the many challenges with SWFs is how one defines them. In this analysis the SWFs that we have included fulfil the following criteria: •

•

•

Owned by a sovereign nation state, rather than a regional or local state entity. As exceptions to this rule, we have included five subnational-level funds that are financed by foreign exchange assets resulting from commodities exports, and that are large enough to rank within our top 22: ADIA (Abu Dhabi), Istithmar (Dubai), Dubai International Capital, Alberta Heritage Savings Trust Fund (Canada) and Alaska's Permanent Reserve Fund. Not national pension funds, unless these are financed directly by foreign exchange assets generated by commodity exports. This excludes, for example, Australia's Future Fund, Thailand's Government Pension Fund and Chile's Pension Guarantee Fund, while permitting the inclusion of Norway's Government Pension Fund Global. Not central banks or authorities that perform roles typical of a central bank (eg supervision or currency issuance), even if these organisations also manage foreign exchange assets. This excludes organisations such as the Saudi Arabia Monetary Authority (SAMA), which has foreign reserves of 251 billion US dollars. In addition, SAMA acts as a conduit for the foreign investments of Saudi government funds, including the General Organization for Social Insurance and the Retirement

State Capitalism: The Rise of Sovereign Wealth Funds

•

55

Pensions Agency, which together have total assets of 116 billion US dollars. However, SAMA is the country's central bank, performing roles such as currency issuance, so we have not included it. Investment funds rather than producers of goods or services (although they may invest in productive companies). This excludes state-owned energy companies and state development banks.

2b. Methodology The methodology for gathering data has centred on a search of publicly available data, particularly: • • •

SWF websites, if these exist. Media reports on the activities of SWFs. Research reports by other financial institutions on SWFs.

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For several of the least transparent SWFs, information was also requested by e-mail. The Appendix to this report provides data on some additional funds, which we analysed, but which did not make the top 22 by being excluded using the above criteria (funds i-iii in the appendix) or on grounds of size (funds iv-ix). Many other significant global funds do not meet the above criteria, so the appendix is not an exhaustive list. In addition, many other small funds are currently being launched or have existed for some time, for instance in Ecuador or Nigeria, but either their small size and/or a lack of clarity about their functions means that we did not gather sufficient data to warrant their inclusion in the appendix.

2c. Summary of Findings The 22 SWFs identified by the study manage assets worth an estimated total of over two trillion dollars. The following analysis highlights the differences between the funds in seven main areas: age, source of funds, scale, aim, governance, investment activity, and growth rate. Table 1. Estimated size of largest Sovereign Wealth Funds (Billion US Dollars) UAE (Abu Dhabi)

ADIA

1976

625.0

520.7%

Norway

Government Pension Fund - Global

1990

322.0

102.6%

Singapore

GIC

1981

215.0

169.0%

Kuwait

Kuwait Investment Authority

1953

213.0

268.7 %

China

China Investment Corporation

2007

200.0

8.0%

Russia

Stabilization Fund

2004

127.5

14.2%

Gerard Lyons

56

Table 1. (Continued). Singapore

Temasek

1974

108.0

84.9%

Qatar

Qatar Investment Authority

2005

60.0

185.3%

Algeria

Revenue Regulation Fund

2000

44.4

49%

US (Alaska)

Permanent Reserve Fund

1976

40.2

0.3%

Libya

Libyan Investment Authority

2007

40

117%

Brunei

Brunei Investment Authority

1983

30.0

309.4%

Malaysia

Khazanah Nasional BHD

1993

26.1

12.3%

Korea

KIC (Korea Investment Corporation)

2005

20.0

2.2%

UAE (Abu Dhabi)

ADIA

1976

625.0

520.7%

Norway

Government Pension Fund - Global

1990

322.0

102.6%

Venezuela

National Development Fund (Fonden) 2005

17.5

10.5%

Canada (Alberta)

Alberta Heritage Savings Trust Fund

1976

16.3

1.3%

Taiwan

National Stabilization Fund

2001

15.2

4.0%

Kazakhstan

National Fund

2000

14.9

15.6%

Chile

Economic and Social Stabilization Fund

2007

11.2

8.7%

UAE (Dubai)

Istith mar

2003

8.0

6.7%

UAE (Dubai)

DIC

2004

6.0

4.0%

Oman

State General RF

1980

6.0

16.0%

Total

2,158

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2d. Age Sovereign wealth funds are far from being a new phenomenon. A number of oil exporters were among the earliest. This includes not only Gulf State funds such as the Kuwait Investment Authority (established in 1953) but also funds in the United States (Alaskan Permanent Reserve Fund, established 1976) and Canada (Alberta Heritage Savings Trust, 1976). Table 2. Launch Year Launch year

Top 22 SWFs

2000-2007

China, Russia, Qatar, South Korea, Kazakhstan, Chile, UAE (Dubai) Istithmar, UAE (Dubai) - DIC, Taiwan, Libya, Algeria

1990-1999

Norway, Malaysia, Venezuela

Pre-1990

UAE (Abu Dhabi) - ADIA, Singapore (GIC and Temasek), Kuwait, United States (Alaska), Brunei, Canada, Oman

State Capitalism: The Rise of Sovereign Wealth Funds

57

2e. Source of Funds The large majority of SWFs are financed by the export of commodities. Most noncommodity funds are recent, including China (2007), South Korea (2005) and Taiwan (2001). The two Singaporean funds (launched 1974 and 1981) are the only well-established, large non-commodity SWFs. Table 3. Source of funds Source of funds

Top 22 SWFs

Commodities

UAE (Abu Dhabi) - ADIA, Kuwait, US (Alaska), Brunei, Canada, Chile, Oman, Norway, Venezuela, Russia, Kazakhstan, UAE (Dubai) - Isithmar, UAE (Dubai) – DIC, Libya, Algeria Singapore (GIC and Temasek), China, Taiwan, South Korea, Malaysia

Non-commodities

2f. Scale

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In section 1b I talked of the SWFs in terms of the Super Seven. Once can also try and gauge their scale in other ways. The two charts below illustrate the scale of SWFs, respectively, compared to the size of major stock exchanges, and compared to the sizes of leading asset managers and pension funds. These comparisons make it clear that SWFs have, and will continue to have, an extremely significant impact on global financial markets.

Sovereign Wealth Funds, Nova Science Publishers, Incorporated, 2008. ProQuest Ebook Central,

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58

NYSE

15,421

Tokyo SE

4,614

Nasdaq

3,865

London SE

3,794

Euronext

3,708

Total Sovereign Wealth Funds

2,158

Hong Kong Exchanges

1,715

TSX Group

1,701

Deutsche Börse

1,638

Shanghai SE

918

Korea Exchange

834

Bombay SE

819

Sao Paulo SE

710

Taiwan SE

595

Singapore Exchange

384

Mexican Exchange

348 236

Bursa Malaysia Istanbul SE

162

Warsaw SE

149

Cairo & Alexandria SEs

93 -

2,000

4,000

6,000

8,000

10,000

12,000

US$bn

Sources: Oxford Analytica, World Federation of Exchanges. Chart 3. Size of Sovereign Wealth Funds compared to the market capitalisation of selected stock exchanges.

14,000

16,000

18,000

Sovereign Wealth Funds, Nova Science Publishers, Incorporated, 2008. ProQuest Ebook Central,

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59

UBS

2,016

Barclays Global Investors

1,513

Allianz Group

1,493

State Street Global

1,441 1,422

Fidelity Investments 1,260

AXA Group Capital Group

1,166

Credit Suisse

1,128

Deutsche Bank

1,027

Vanguard Group

958

UAE(ADIA)

625

Norway (GPF Global)

Sovereign Wealth Funds

322

Japan Government Pension

Asset managers

291

Singapore (GIC)

Pension funds

215

Kuwait Investment Authority

213

China (Investment Corporation)

200

ABP

142

California Public Employees

129

Russia

128

Japan-Local Government Officials

101

Federal Retirement Thrift

96 -

500

1,000

1,500 US$bn

Sources: Oxford Analytica, Watson Wyatt. Figures for asset managers refer to end 2005. Chart 4. AUM (US$BN) of selected Sovereign Wealth Funds, Asset Managers and Pension Funds

2,000

2,500

Gerard Lyons

60

2g. Aim Although the strategic investment component of the SWFs is now a concern, the tables below on the funds show that they were typically established with a primary focus on one or more of the following aims: 1 2 3 4

Macroeconomic stabilisation. Countries that are highly dependent on commodity exports are exposed to swings in global prices. The primary aim of the fund in these cases can be to smooth short- and medium-term fluctuations. Higher returns. Countries that have surplus funds are increasingly seeking to maximise returns. This is motivated by the opportunity cost associated with funds being invested in risk free assets. Future generations. Several funds were created with the objective to create a reserve of wealth for the future, when natural resources will have been depleted. Domestic industries. Some of the funds have also been used to restructure and encourage domestic industries.

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2h. Governance Management responsibility for SWFs varies widely, from Ministries of Finance and central banks through to separate entities that often have executive boards to make decisions. External money managers are typically contracted to manage funds on the basis of policies set by the board. A limited number of funds, including the Norwegian fund, provide detailed information on their operations and performance. Among newer funds, there is a divergence between those that have sought to adopt best practice, and those where arrangements seem to have emerged on an almost ad hoc basis and where little is known of formal codes. Most obviously in the latter category is the new Chinese fund, and this is partly why China's SWF investments are raising most concern in recipient markets.

2i. Investment Activity The flurry of SWF activity in established stock markets this year has been striking. Investment policies vary, but tend to do so according to the SWF's primary aim and governance. •

•

'Future generations' funds with high levels of transparency, such as the SWFs in Norway, Alberta and Alaska, have a high level of diversification and hold only small stakes. Norway's fund owns shares in about 3,500 companies, and it holds stakes that are typically below 1%. Stabilisation funds such as Russia's, for example, are tasked with delivering stable and low-risk returns, and so are limited to investment in AAA-rated sovereign bonds, with a given currency composition to manage currency risk.

State Capitalism: The Rise of Sovereign Wealth Funds • •

61

Low-transparency funds such as the Abu Dhabi Investment Authority (ADIA) usually prefer investing in small stakes to avoid disclosure requirements. A number of funds have acquired significant stakes in foreign companies. These include the China Investment Corporation, GIC, Temasek, the Kuwait Investment Authority, the Qatar Investment Authority, and Dubai's Istithmar and DIC.

Russia

96%

Kazakhstan

36%

Singapore - Temasek

35%

Kuwait

30%

Norway

28%

Malaysia

23%

Canada (Alberta)

22%

US (Alaska)

18% 14%

Algeria UAE (Abu Dhabi)

10%

Singapore - GIC

9.5%

Brunei

0% 0%

20%

40%

60%

80%

100%

120%

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Source: Oxford Analytica. Chart 5. Estimated growth rates of a selection of SWFs.

2k. Growth Rates Growth rates could be estimated for only twelve funds (see chart 5). For several funds direct information on growth rates in 2006 is not available, and the estimates are based on secondary sources or proxies for growth, such as returns over longer periods of time or estimates of returns or transfers to the fund.

Gerard Lyons

62

TOP 22 SOVEREIGN WEALTH FUNDS

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1. Abu Dhabi Investment Authority (UAE) Launch Year

1976

Fund Value (US dollars)

Estimates vary significantly -- from 250 billion to 1 trillion.[1] Our analysis says 625 billion.

Fund Value as % of GDP

521%

Growth Rate

10% p.a.[2]

Financing

Oil

Objectie

Diversify investment of foreign currency reserves from oil exports.

Ownership

100% owned by Government of Abu Dhabi.

Management

Sheikh Khalifa, president of the UAE, is the Chairman.

Investment Policy and Asset Allocation

No investments in commodities and Middle East stock markets. Stakes in financial institutions in the region include Banque de Tunisie et des Emirats (39%), Arab Banking Corporation in Bahrain (27%), Arab International Bank in Egypt (25%), and the Joint Arab Investment Corporation (23%). Until 2006, investments only in foreign assets. ADIA’s asset allocation: 50-60% in equities, 20-25% in fixed income, 5-8% in real estate, 5-10% in private equity and 5-10% in alternatives. Usually investments are limited to less than 4.5% to avoid disclosure. In 2006, a new institution was set up, the Abu Dhabi Investment Council, with the goal of investing both within and outside Abu Dhabi.

Outlook/Trends

The United Arab Emirates are expected to run annual current account surpluses of 3540 billion US dollars over the medium term if oil prices remain at about the current level. ADIA could potentially be allocated a large part of these funds.

Launch Year

1976

Transparency

T ran sp aren c y is v e ry lo w. In th e 3 0 ye a r s s in ce it wa s established, it has never publicly declared the value of assets it has under management. There is a lack of clarity about how much cooperation and competition there is between ADIA and ADIC.[3] In May 2007 ADIA acquired 8% of EFG-Hermes, an Egyptian investment bank. In July 2007 purchased a small stake in Apollo Management, a US private equity company. In September 2007 ADIA announced a takeover of PrimeWest Energy Trust (Canada) for 5 billion dollars, according to press reports.

Recent investments

2. Government Pension Fund - Global (Norway) Launch Year

1990

Fund Value (US dollars)

322 billion (March 2007).[4]

Fund Value as % of GDP

93%

Growth Rate

28% (2006)[5]

Financing

Receipts from oil licenses, oil taxes. About 80% of the government’s oilrelated revenues are transferred into the GPF.

Objective

The assets are to be used to meet the country’s growing pensions bill after 2015.

Ownership

Norwegian Government (Ministry of Finance).

State Capitalism: The Rise of Sovereign Wealth Funds Launch Year

1990

Management

Operational activities are delegated to Norges Bank Investment Management (NBIM), which is part of the Norwegian Central Bank. Most of the GPF is managed internally by the Norwegian central bank, but there are 50 external bond and equity managers running about 28% of the total.

Investment Policy and Asset Allocation

- Bonds represent 60% (over half of them AAA-rated) of the portfolio and equities 40%. - Asset allocation broadly reflects the structure of Norway's imports but with over-emphasis given to the liquid US markets. - The benchmark is for over 50% to be placed in European currencies and 35% in North American. - Asia accounts for less than 10% of asset allocation. The GPF’s investments in emerging markets is growing. - It has an ethical screening process to exclude companies with "unacceptable violations of fundamental ethical norms".

Outlook/Trends

NBIM forecasts the fund will reach 500 billion US dollars by 2009.

Transparency

High. Annual and quarterly reports publicly available.

Recent Investments

The fund owns shares in about 3,500 companies, and it holds small stakes, typically below 1%.

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3. Government of Singapore Investment Corporation Launch Year

1981. A restructuring in 1999 led to the creation of three operating units: the Public Markets Group, investing in equities, fixed income, and money market instruments; Government of Singapore Investment Corporation (GIC) Real Estate, investing in real estate-related assets; and GIC Special Investments, investing in venture capital and private equity funds, as well as direct investments in private companies.

Fund Value (US dollars)

100-330 billion (2007).[6] Our analysis says 215 billion.

Fund Value as % of GDP

169%

Growth Rate

GIC's annual return has averaged 9.5% in US dollar terms over the 25 years to March 2006, since its launch in 1981. In real terms, the annual rate of return averaged 5.3%.

Objective

To preserve and enhance the international purchasing power of Singapore’s reserves, by achieving a real rate of return above the G3 inflation rate by a specified amount over a specified long-term horizon. For medium-term performance monitoring, to outperform an appropriate composite of recognised market indices, through optimal allocation among and within asset classes.

Ownership

Private company wholly owned by the Government of Singapore.

Management

Lee Kuan Yew, Chairman; Dr Tony Tan, Deputy Chairman & Executive Director. Lim Siong Guan Group Managing Director (as of September 22, 2007).

Investment Policy and Asset Allocation

Invests in 40 markets, with a long-term focus through systematic diversification across equities, fixed income, foreign exchange, commodities, money markets, alternative investments, real estate and private equity.

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(Continued). Outlook/Trends

Increased holdings in emerging markets are likely.

Transparency

Medium. Information about structure and investments, but no detailed financial reports on website.

Recent Investments

July 2007: Part of consortium in 895 million US dollar acquisition of Myer Melbourne site for redevelopment. July 2007: Acquisition of a 50% in WestQuay Shopping Centre, UK, for 600 million US dollars. June 2007: Purchase of Chapterhouse Holdings Ltd., whose primary asset is the Merrill Lynch Financial Centre, for 960 million US dollars. May 2007: Formation of joint venture with Sumitomo Corporation to invest 1.3 billion US dollars over two years in Japanese retail properties. April 2007: Acquisition of 50% of for Westfield Parramatta (Australian real estate company) for 584 million US dollars.

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4. Kuwait Investment Authority Launch Year

1953

Fund Value (US dollars)

213 billion (March 2007), of which 174 billion invested in the Future Generations Fund and 39 billion in the Public Reserve Fund.[7]

Fund Value as % of GDP

265%

Growth Rate

30% (2006)[8]

Financing

Oil. Each year, 10% of state revenues are transferred to the Kuwait Investment Authority’s (KIA’s) Future Generations Fund (FGF). Assets cannot be withdrawn from the FGF. The KIA also manages the Public Reserve Fund, the main treasurer for the government.

Objective

To achieve a long term return in order to provide an a l t e r n a t i v e t o o i l r e s e r v e s f o r K u w a i t ’ s fu t u r e generations.

Ownership

Ministry of Finance

Management

Its board includes the oil minister, a representative of the central bank and of the finance ministry. Management of the FGF is outsourced to third-party managers.

Investment Policy and Asset Allocation

The FGF invests outside Kuwait. Its portfolio includes investments in private equity, hedge funds and real estate.

Outlook/Trends

The FGF is shifting from a very conservative strategy, aimed at preserving capital, towards a more risk-taking approach, focused on growth.

Transparency

Low. Disclosure to the public of any information related to KIA's work is prohibited by law.

Recent Investments

The KIA holds significant stakes in Daimler Benz and in the engineering group GEA.

State Capitalism: The Rise of Sovereign Wealth Funds

65

5. China Investment Corporation Launch Year

2007. Official launch in September, although investment activities started earlier.

Fund Value (US dollars)

200 billion of foreign exchange reserves is currently being transferred to China Investment Corporation (CIC). An additional 200 billion may be added if Central Huijin Company, a People’s Bank of China-dominated investment entity that controls three of China’s ‘big four’ state banks, is folded into CIC as expected. At current market value, Huijin’s shareholdings of the Bank of China, China Construction Bank and Commercial Bank of China are worth over 200 billion US dollars.[9]

Fund Value as % of GDP

8%

Growth Rate

The fund’s initial capital is still being transferred.

Financing

Transfers from foreign exchange reserves.

Objective

To increase the return on assets. Chinese officials have suggested that the objective will include social and political returns. Chinese government.

Ownership Management

Deputy Secretary-General of the State Council Lou Jiwei, is likely to be appointed as the president of the new company. This will make it a ministerial-level organisation answering directly to the State Council. The names of the core management team have yet to be announced. The general manager will possibly come from the central bank or State Administration of Foreign Exchange. CIC is likely to delegate a substantial portion of management to foreign portfolio managers; however, there is likely to be a long selection process.

Launch Year

2007. Official launch in September, although investment activities started earlier.

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Investment Policy and Asset Intended to manage a wide array of assets, not just shares from a few major financial Allocation institutions (as had been the case with Central Huijin Company). Outlook/Trends

The fund may be required to aim for annual returns above 10%, in order to cover management costs and probable renminbi appreciation.

Transparency

Low.

Recent Investments

CIC in May this year invested three billion US dollars to acquire almost 10% of the initial public stock offering of US investment fund Blackstone Group LP. The People’s Bank of China bought a 0.46% stake in BG Group plc in June and July this year for 250 million US dollars. This purchase is rumoured to have been on behalf of the CIC.

6. Stabilization Fund (Russia) Launch Year

2004

Fund Value (US dollars)

127.5 billion US dollars (March 2007).[10]

Growth Rate

96% (September 2006 to August 2007).

Financing

Export duty on oil and petroleum products and taxes on mineral resources. The base price of oil is set at 20 US dollars per barrel, above which revenues start accumulating in the fund. The government has the right to withdraw money if oil prices fall below the base level.

Objective

Absorb volatility of commodity prices. The fund is currently used to finance the pension fund and to repay foreign debt. The government can tap amounts above the base threshold of 500 billion roubles (18 billion US dollars) for expenditures outside the official budget.

Ownership

Ministry of Finance.

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66

(Continued). Launch Year

2004

Management

The fund is managed by the Ministry of Finance. Some asset management functions are delegated to the central bank.

Investment Policy and Asset Allocation

Securities must be issued by governments of US and selected EU countries. Further restrictions on minimum amount and structure of the issue (eg AAA rated, no options, fixed coupon).Current currency composition: US dollars 45 %; euros - 45 %; pounds sterling - 10 %.

Outlook/Trends

In 2008, the fund will be divided into a reserve fund, which will continue to be invested conservatively and used when oil and gas incomes fall; a more aggressive fund, which will invest in higher risk assets; and federal budgetary spending. The more aggressive fund may be allocated only 19 billion dollars initially.[11]

Transparency

The Ministry of Finance publishes a monthly public report on the fund’s accumulation, spending and balance. Details on investments are reported quarterly to the Russian Parliament.

Recent Investments

The fund has not yet started to invest in global equities.

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7. Temasek Holdings (Singapore) Launch Year

1974

Fund Value (US dollars)

108 billion (March 2007).[12]

Fund Value as % of GDP

85%

Growth Rate

The value of Temasek’s portfolio grew 35% over the year ending on March 31, 2007. Total shareholder return for the year was 27%.[13]

Financing

Reserves from high savings rate and reinvested profits.

Objective

Active shareholder and investor. Aims to create and maximise sustainable value for owner. An ‘exempt private company’ with Minister of Finance as shareholder.

Ownership Management Investment Policy and Asset Allocation

S Dhanabalan, Chairman. Ho Ching, CEO. Operates as an autonomous and professional investment house, guided by an independent board. Operates under commercial principles to maximise long-term returns. Temasek’s geographical asset mix in March 2007 was: Singapore (38%); rest of Asia (excluding Japan) 40%; OECD economies (excluding South Korea): 20%; others 2%.

Outlook/Trends

Since 2002, Temasek has raised its focus on Asia (except Singapore and Japan). Over the 12 months to March 2007, exposure to Singapore declined from 44% to 38% and exposure to the rest of Asia (excluding Japan) rose from 34% to 40%. 61% of the portfolio is in the financial services, telecoms and media sectors.

Transparency

High. Audited annual financial reports, as well as periodic updates, are provided to the Ministry of Finance. While not required to release financials publicly, group financial highlights have been published since 2004 in the annual Temasek Review.

State Capitalism: The Rise of Sovereign Wealth Funds Launch Year

1974

Recent Investments

Temasek confirmed on July 23 this year that it is investing almost 2 billion US dollars in Barclays plc. Temasek will invest a further 3 billion US dollars in Barclays conditional upon completion of the merger with ABN AMRO. Temasek also holds 17.22% in Standard Chartered Bank[14]. Other overseas investments during the year to March 2007 included new holdings in ABC Learning Centres (Australia, Temasek holds 12%), Intercell AG (Austria, 8.1%), Country Garden and Yingli Green energy (both China), INX Media (India, less than 25%), Mitsui Life (Japan, 4.6%), PIK Group and VTB Bank (both Russia). Temasek in May 2007 increased its stake in STATS ChipPAC to 83%. In late September 2007 press reports noted that Temasek and Singapore Airlines together acquired 24% of China Eastern Airlines Corporation.

Copyright © 2008. Nova Science Publishers, Incorporated. All rights reserved.

8. Qatar Investment Authority Launch Year

June 2005

Fund Value (US dollars)

Estimated value 50 billion to 70 billion (March 2007).[15] Our analysis says 60 billion.

Fund Value as % of GDP

185%

Growth Rate

--

Financing

Gas.

Objective

Involved in the investment of Qatar's surplus financial resources in local and international markets; establishment of companies and projects; economic and energy affairs.

Launch Year

June 2005

Ownership

Qatar government.

Management

Sheikh Tamim Bin Hamad Al Thani, son of the Emir of Qatar, is the Chairman of the authority.

Investment Policy and Asset Allocation Outlook/Trends

--

Transparency

Low. No reports provided.

Recent investments

UK care homes provider Four Seasons Healthcare (100%). Other holdings include 20% (now 24% according to some press reports in late September) of London Stock Exchange Group, 9.98% in Nordic Exchange OMX (Sweden), 5.1% in Lagardere (France), 97.3% of BLC Bank (Lebanon), 20% in the Housing Bank for Trade and Finance (Jordan) and 5% in Raffles Medical Group (Singapore). QIA was a co-investor in Dubai International Capital’s July 2007 purchase of a 3.12% stake in European Aeronautic, Defence & Space Co (EADS). QIA is currently bidding to buy UK retailer Sainsbury, through its Delta Two Fund, which already holds 25% of Sainsbury.

Fund size expected to double by 2010. Qatar Investment Authority (QIA) plans to expand its investments in Asia up to 40% of its portfolio (with the rest in the Americas and Europe), particularly financial institutions and consumer-oriented export industries.

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9. Revenue Regulation Fund (Algeria) Launch Year

2000

Fund Value (US dollars)

44.4 billion (June 2007)[16]

Fund Value as % of GDP

49%

Growth Rate

9% rise in Algerian dinar terms between October 2006 and June 2007.[17]

Financing

Oil revenue recorded in excess of budget law projections. The Fund resources may be supplemented by advances from the Banque d’Algérie.[18] 1) Offset the shortfalls resulting from oil tax revenue below budget law projections. 2) Reduce the external public debt.

Objective Ownership

Algerian government

Management

Bank of Algeria

Investment Policy and Asset Allocation

n.a.

Outlook/Trends

n.a.

Transparency

Low. No reports available, no information on investment policy.

Recent Investments

n.a.

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10. Permanent Reserve Fund (Alaska) Launch Year

1976

Fund Value (US dollars)

40.2 billion[19] (2006).

Fund Value as % of GDP

0.3%

Growth Rate

17% July 2006 to June 2007; 18% July 2005 to June 2006.

Financing

Objective

Oil. Each year, the fund's realised earnings are split between inflationproofing, operating expenses, and the annual Permanent Fund Dividend. Benefit future generations of Alaskans once oil reserves are depleted. Only investment income can be spent by the State legislature. Principal cannot be spent without a vote. Target return: 5% over 10-year period.

Ownership

State of Alaska.

Management

Managed by the Alaska Permanent Fund Corporation (APFC). Part of the portfolio is allocated to several dozen external managers.

Investment Policy and Asset Allocation

Target asset allocation: 34% domestic equities, 19% international equities; 25% domestic fixed income; 4% international fixed income; 10% real estate; 4% private equity; 4% absolute return. Historical return over 10 years is 8.4%.

Outlook/Trends

Expected to reach 46 billion US dollars by 2012.

Transparency

High - public reports.

Recent Investments

The fund invests in several dozen sectors and countries. Top five stockholdings are GE, Exxon, Microsoft, Google and Procter & Gamble.

State Capitalism: The Rise of Sovereign Wealth Funds

11. Libyan Investment Authority Launch Year

2007

Fund Value (US dollars)

40 billion (target)[20]

Fund Value as % of GDP

117%

Growth Rate

--

Financing

Initial funds transferred from central bank. The Libyan Investment Authority will receive an annual portion of the oil revenue surplus.

Objective

Diversify oil revenues into financial assets

Ownership

Libyan government

Management

Libyan Investment Authority. Chairman is Mohamed Layas.

Investment Policy and Asset Allocation

Portfolio investments managed through Western banks and institutions.

Outlook/Trends

The fund plans to purchase real estate worldwide and, when it is more established, also engage in private equity transactions.

Transparency

Low/medium. Data on size and investments made available through the media.

Recent Investments

Set-up an investment fund (total 2 billion US dollar) with the Qatar Investment Authority to invest in Libya, Qatar and Western markets. Other assets: Lafico (real estate, 3 billion US dollars), Libyan African investment portfolio (5 billion US dollars), portfolio investments in capital markets (8 billion US dollars).

Copyright © 2008. Nova Science Publishers, Incorporated. All rights reserved.

12. Brunei Investment Agency Launch Year

1983

Fund Value (US dollars)

30 billion US dollars (March 2007).[21]

Fund Value as % of GDP

309%

Growth Rate

At its peak during the 1990s, it is estimated that the value of the Brunei Investment Agency (BIA) was at least 100 billion US dollars. The value of the fund then declined and seems to have stabilised at about 30 billion US dollars over the last several years.

Financing

BIA manages the country’s foreign exchange reserves.

Objective

To increase the real value of Brunei’s foreign exchange reserves.

Ownership

Part of the Ministry of Finance.

Management

Chairman is Pehin Dato Seri Setia Awe Hj Yahya bin Begawan Mudim Dato Paduka Hj Baker. Awang Haji Ali bin Haji Apong was appointed Acting Managing Director in May 2003.

Investment Guidelines

Holdings in the United States, Japan, ASEAN countries and Western Europe.

Outlook/Trends

Transparency

An ongoing dispute over billions of US dollars, which it is claimed were channelled from the BIA to private bank accounts during the 1990s, now appears close to being resolved. Former Chairman of BIA Prince Jefri Bolkiah has been accused by the Sultan of Brunei (his brother) of Very low.

Recent Investments

BIA last year purchased a stake in Jordan Phosphate Mines Company Ltd.

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13. Khazanah Nasional (Malaysia) Launch Year

1993

Fund Value (US dollars)

26.1 billion (May 31, 2007).[22]

Fund Value as % of GDP

12%

Growth Rate

23% (annual average May 2004-May 2007)[23]

Financing

Non-commodity fund partly financed by debt.

Objective

Part of Khazanah Nasional’s (KN’s) mandate is to make strategic investments abroad, under the overarching objective of ‘nation building’ for Malaysia. Other key themes of the strategic investment mandate include: Creating sustainable value; raising national competitiveness; and cultivating a culture of high performance. Through its investments in Malaysian legacy companies, KN seeks to achieve these aims by promoting restructuring and reorganisation.

Ownership

Ministry of Finance. KN is the investment-holding arm of the government of Malaysia.

Management

The Prime Minister of Malaysia is the Chairman of the Board. The Management team is headed by Managing Director Dato' Azman b. Hj Mokhtar.

Investment Policy and Asset Allocation

KN has investments in over 50 companies, in Malaysia and abroad, within over a dozen different sectors. The major sectors are utilities (23.5% of portfolio in May 2007), media and communications (22.3%), and infrastructure and construction (18.2%).

Launch Year

1993

Outlook/Trends

KN is a leader in innovative Islamic finance. It issued the world’s first exchangeable Sukuk (Sharia-compliant bond) in October 2006, for 750 million US dollars.The proportion of KN’s total portfolio held in foreign investments has risen from 0.2% in May 2004 to 9.2% in May 2007. Over the next three years, KN aims to increase synergies across its investments and to continue to broaden the base of its investments.

Transparency

High. Annual report provides good data.

Recent Investments

KN has investments in 12 Asian countries, Saudi Arabia, the UAE, New Zealand and the UK (Proton, the Malaysian national carmaker). The main destinations of KN’s investment abroad are Indonesia (4.3% of total portfolio), India (1.8%), China (1.6%) and Singapore (1.4%).

14. Korea Investment Corporation Launch Year

2005

Fund Value

Initial capital of 20 billion dollars (2007).[24]

Fund Value as % of GDP

2.2%

Growth Rate

Initial capital is still being invested.

Financing

Of the Korea Investment Corporation’s (KIC’s) initial capital, 17 billion US dollars was transferred from the Bank of Korea’s foreign exchange reserves, and 3 billion dollars from the Ministry of Economy and Finance’s Foreign Exchange Stabilization Fund.[25]

Objective

To achieve a stable and continuous return exceeding the benchmark within an appropriate level of risk, and to foster development of local financial industry and of local talent pool.[26]

State Capitalism: The Rise of Sovereign Wealth Funds Launch Year

2005

Ownership

Government of Korea.

Management

The KIC is designed to be run commercially and independently. It has engaged external fund managers but has not provided further details. The Korean government expects KIC’s external fund managers to transfer global best practices to local Korean managers over time. Serck-Joo Hong was appointed president and CEO in September 2006.

Investment Policy and Asset Allocation

KIC’s asset classes may include securities (including stocks and bonds defined under the KIC Act), foreign currencies and derivatives.

Outlook/Trends

It is the government’s intention to invest the full initial 20 billion US dollars by the beginning of next year, and to begin covering its costs by 2010. A further 90 billion US dollars of existing official reserves could soon be transferred to the KIC.

Transparency

Medium. KIC plans to disclose its financial statements and accounting standards; audit report for financial statements; mid- and long-term investment policies; total value of assets under management and rate of return; composition ratio and rate of return for each asset class. The Steering Committee exercises supervision over KIC’s business, and may, as prescribed under the KIC Act, entrust a private accounting firm to inspect the business.

Recent Investments

KIC’s first investment was made in November 2006. KIC has not provided further details.

Copyright © 2008. Nova Science Publishers, Incorporated. All rights reserved.

15. National Development Fund (Venezuela) Launch Year

2005

Fund Value (US dollars)

17.5 billion (end 2006).[27]

Fund Value as % of GDP

11%

Growth Rate

The value of the fund increased from zero to 17.5 billion US dollars in just over two years.

Financing

Transfers from the international reserves of the Central Bank of Venezuela and from the national oil company Petroleos de Venezuela SA (PDVSA).

Objective

The National Development Fund’s (Fonden’s) official role is to manage and disburse funds for purchasing foreign debt, goods and services in foreign currency, and to maintain a reserve in case of disasters.

Ownership

Government of Venezuela

Management

--

16. Alberta Heritage Savings Trust Fund (Canada) Launch Year

1976

Fund Value (US dollars)

16.4 billion [28]

Fund Value as % of GDP

1.1%

Growth Rate

22% (January to December 2006).

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(Continued). Launch Year

1976

Financing

Oil

Objective

To manage savings from Alberta’s non-renewable resources. The investment income earned by the Heritage Fund is transferred to the province’s budget.

Ownership

Ministry of Finance.

Management

Investment Management Division, within the Ministry of Finance.

Investment Policy and Asset Allocation

Target investment allocation: 29% fixed income; 15% US equity; 15% nonNorth American equities; 15% Canadian equities; 10% real estate; 4% private equity; 12% other.

Outlook/Trends

Forecasted to reach 16.5 billion US dollars in 2009/1 0.

Transparency

High. Quarterly and annual reports and business plans are publicly available.

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17. National Stabilization Fund (Taiwan) Launch Year

2001

Fund Value (US dollars)

15.2 billion (August 2007).[29]

Fund Value as % of GDP

4%

Growth Rate

The value of the National Stabilization Fund (NSF) appears to have declined slightly from 16.1 billion US dollars at its launch.[30]

Launch Year

2001

Financing

The sources of the NSF are a 6.3 billion US dollar collateral- backed loan from local financial institutions and 9.46 billion US dollars in cash from postal savings, postal insurance savings, and pension funds for public sector workers.

Objective

‘Crisis management’ for Taiwan's capital markets, which tend to be dominated by individual investors. The fund’s draft regulations stipulate that it can be used on three conditions: 1) When share prices on the stock market fall significantly over an extended period of time. 2) When massive movements of international capital occur or when foreign speculators attempt to manipulate fluctuations in local financial markets. 3) When major domestic or overseas events threaten market order or national security. However, the draft regulations state that the fund will not be used to intervene in the foreign h k t Ministry of Finance

Ownership Management

A committee chaired by the finance minister is responsible for the fund's management. It consists of seven to nine members, including the governor of the central bank; the minister of transportation and communications; the director-general of the budget, accounting and statistics; the chairman of the Council of Labour Affairs; the director-general of the Central Personnel Administration; and up to three scholars invited by the Ministry of Finance. Investment Policy and Asset -Allocation Outlook/Trends

The NSF has come under considerable media pressure to intervene in order to support Taiwan’s stock market during periods of turbulence this year. It is unclear whether/how much the NSF may have intervened so far.

State Capitalism: The Rise of Sovereign Wealth Funds Launch Year Transparency

2001 Very low. Managers and others associated with the NSF are subject to imprisonment and fines if found guilty of leaking information about the committee's investment plans.[31]

Recent Investments

--

18. National Fund (Kazakhstan) Launch Year

2000

Fund Value (US dollars)

14.9 billion US dollars (August 2007).[32]

Fund Value as % of GDP

16%

Growth Rate

The value of the National fund (NF) increased by 36% between August 2006 and August 2007.[33]

Financing

The NF was integrated into the budgetary system in July 2006: receipts from all extractive companies are now channelled to the NF.

Objective

Dual function of saving for future generations and stabilising government budget. The NF is also drawn upon to fund public investment.

Ownership

Government of Kazakhstan

Launch Year

2000

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Management

Investment Policy and Asset Allocation

ABN AMRO Mellon Global Securities Services provides custody and income collection; portfolio accounting, including daily valuation; monthly reconciliation; performance measurement; compliance monitoring; and securities lending. Investment management is allocated via a bidding process. External managers for global fixed income are ABN AMRO Asset Management; BNP Paribas Asset Management/FFTW; Deutsche Asset Management; State Street Global Advisors; and Union Bank Privée. External Managers for global indexed equities are Credit Suisse Asset Management and HSBC Asset Management. The NF has two portfolios: a stabilisation portfolio (minimum 20% of the NF) -- to ensure lower volatility of returns; and a savings portfolio -- to ensure higher long-term returns. Benchmarks: Stabilisation portfolio: Merrill Lynch 6-month US Treasury Bill Index. Savings portfolio: 75% Salomon World Government Bonds Index 80% US dollar hedged (SWGB Index 80% hedged); 25% Morgan Stanley Capital International (MSCI) World excluding Energy sector. Investment categories: Government Bonds included in SWGB; corporate bonds with A- credit rating or higher; mortgage backed securities and asset backed securities with credit rating above AA-; stocks included in MSCI World Index; derivatives for tactical asset allocation and hedging.

Transparency

Medium. The NF website provides up-to-date data on revenues and expenditure. However, specific explanations of how the NF’s resources are being used are lacking.

Recent Investments

The NF is fully invested in foreign markets.

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19. Economic and Social Stabilization Fund (Chile) Launch Year

March 2007. The Economic and Social Stabilization Fund (ESSF) absorbed the Copper Stabilization Fund, which was launched in 1985.

Fund Value (US dollars)

11.2 billion, including funds of Copper Stabilization Fund (September 30, 2007).[34]

Fund Value as % of GDP

8.7%

Growth Rate

Annualised internal rate of return of 2.6%.[35]

Financing

Copper-related revenues. Revenues in excess of the 1% structural surplus will be paid into the ESSF, which is designed to finance any fiscal deficits that may occur in periods of economic downturn.

Objective

To smooth government expenditure in social areas (eg education, housing and health).

Ownership

Government of Chile

Management

Managed by the Central Bank. Custodial services provided by JP Morgan Worldwide Securities Services. March 2007. The Economic and Social Stabilization Fund (ESSF) absorbed the Copper Stabilization Fund, which was launched in 1985.

Launch Year Investment Policy and Asset Allocation

The fund can invest domestically and abroad. As of September 2007, the portfolio allocation was as follows: 67.5% sovereign; 2.2% agency; 30.3% bank. Quarterly and monthly reports provide further detail on the currency breakdown (between US dollars, euros and yen) and the terms of the investments. Currently formulating investment strategy to include new asset classes.

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Outlook/Trends Transparency

High. Monthly and quarterly reports are available on the Ministry of Finance website.

Recent Investments

See above for current portfolio allocation.

20. Istithmar (Dubai/UAE) Launch Year

2003

Fund Value (US dollars)

No reported value. Estimated value 8 billion.[36]

Fund Value as % of GDP

7%

Growth Rate

--

Financing

Oil

Objective

Focus on financial returns, but also support Dubai’s status as an international commercial hub.

Ownership

Part of holding company Dubai World, founded by Sheikh Mohammed, Prime Minister of the UAE and Ruler of Dubai.

Management

Sultan Ahmed Bin Sulayem, Chairman of Dubai World, is also Istithmar’s Chairman. CEO is David Jackson, former investment banker at Lehman Brothers. Focus on consumer, financial, real estate and industrial sectors. Detailed asset allocation not available. Appears to invest mainly in equities and real estate.

Investment Policy and Asset Allocation Outlook/Trends

Expected to invest 3-4 billion US dollars annually.

State Capitalism: The Rise of Sovereign Wealth Funds Launch Year

2003

Transparency

Low -- no reports provided. List of investments available.

Recent investments

1.2 billion US dollars in Standard Chartered Bank. 3% stake in hedge fund GLG. Agreement to buy fashion chain Barneys in August 2007 for 942 million US dollars. In September 2007 Istithmar joined MGM Mirage’s joint venture with Kerzner International to build a multi-billion dollar resort in Las Vegas, according to press reports.

21. Dubai International Capital (UAE) Launch Year

2004

Fund Value (US dollars)

No reported value. Estimated value 6 billion.[37]

Fund Value as % of GDP

4%

Growth Rate

--

Financing

Oil

Objective

The purpose of DIC is to create a return for its shareholder, Dubai Holding and its ultimate shareholders, the Ruling Family of the Emirate of Dubai.

Ownership

Part of Dubai Holding, which also includes a number of large- scale infrastructure and investment projects in Dubai. It is not, as commonly thought, an investment arm of the Government of Dubai.

Management

Sameer Al Ansari, Executive Chairman and CEO, former Group Chief Financial Officer for The Executive Office of Sheikh Mohammed. Focus on private equity investments. Operates through three divisions: global buyouts, Middle East/North Africa investments, an d pub lic equit ies (leveraged stakes in large p ublic companies).

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Investment Policy and Asset Allocation Outlook/Trends

Expected to invest 3-4 billion dollars annually.

Transparency

Low. No public reports available, but list of selected investments.

Recent investments

800 million pound sterling acquisition of Tussauds Group. 700 million pound sterling acquisition of Doncasters. 675 million pound sterling secondary buyout of Travelodge. One billion US dollar investment in DaimlerChrysler. DIC purchased ‘substantial stakes’ in HSBC Holdings (May 2007) and in Indian bank ICICI Bank Ltd. (July 2007). It has also invested in EADS (July 2007).

22. State General Reserve Fund (Oman) Launch Year

1980

Fund Value

Not disclosed. Estimates range form 2-10 billion US dollars.[38] Our analysis says 6 billion.

Fund Value as % of GDP

16%

Growth Rate

--

Financing

Oil and gas.

Objective

Fund budget shortfalls.

75

Gerard Lyons

76

(Continued). Launch Year

1980

Ownership

--

Management

--

Investment Policy and Asset Allocation

--

Outlook/Trends

--

Transparency

Very low

Recent investments

Wave Seafront Resort in Oman. Reported to be involved in the development of Heron Tower in London.

APPENDIX I. THE FUTURE FUND (AUSTRALIA) Launch Year

2006

Fund Value (US dollars)

42 billion (May 2007).[39]

Fund Value as % of GDP

6%

Growth Rate

The fund has a target return of 4.5-5.5% above Consumer Price Index inflation (CPI) over the long term. The Board has interpreted this as an objective to provide a return of at least 5% above CPI over rolling 10-year periods. Government surpluses. The fund’s value also includes the value of approximately 2.1 billion shares in Telstra Corporation, most of which are held under escrow until mid-2008.

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Financing

Objective

Established to fully fund the future superannuation payments of public servants, which currently come from the federal budget. The fund aims to fully underwrite the unfunded superannuation liability by 2020.

Ownership

Government of Australia.

Management

In May 2007 a competitive tender to manage the Future Fund was won by US fund management company Northern Trust Corporation. The fund is overseen by an independent Board of Guardians, selected on the basis of expertise in investment management and corporate governance. The Chairman of the Board of Guardians and CEO of the Future Fund Management Agency is David Murray. Paul Costello is the General Manager of the Future Fund Management Agency.

Investment Policy and Asset Invest in a broad, diversified range of assets. The Future Fund Allocation does not intend to publish details of its investment programme. Outlook/Trends

The size of the Future Fund in 2020 may be about 103 billion US dollars[40].

Transparency

Medium. The first annual report is due to be published in September.

Recent Investments

The initial cash contributions to the Fund -- about 33 billion US dollars, have been invested with the Reserve Bank of Australia before being transitioned into a broad range of asset classes. This strategic asset allocation process has started and is likely to take several years to complete. Most of the Telstra shares cannot be traded until November 2008.

State Capitalism: The Rise of Sovereign Wealth Funds

II. GOVERNMENT PENSION FUND (THAILAND) Launch Year

1997

Fund Value (US dollars)

10.9 billion.[41]

Fund Value as % of GDP Growth Rate

The net rate of return to members was 3.44% in 2006 and 6.83% in 2005.[42]

Financing

No less than 20% of annual budget, plus monthly member and employer (government) contributions.

Objective

Management of retirement savings.

Ownership

Government of Thailand

Management

The GPF is supervised and managed by the Government Pension Fund Board. It uses seven fund managers to manage about one-fifth of its portfolio.

Launch Year

1997

Investment Policy and Asset Allocation

Emphasises the safety of the principal fund, coupled with good returns that outperform long-term inflation. As of June 2007, the GPF’s asset allocation was: Thai fixed income 67.77%; Thai equity 11.57%; global equity 12.64%; Alternative investment 4.02%; Property 4.00%.

Outlook/Trends

The GPF has stated this month that it is positioning itself as a global fund manager.[43] Next year it plans to explore investing in global bonds rather than just local bonds.

Transparency

Medium-high. Quarterly financial statements available on website, but little detail about specific investments.

Recent Investments

--

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III. PENSION GUARANTEE FUND (CHILE) Launch Year

December 2006

Fund Value (US dollars)

1.42 billion (September 30, 2007).[44]

Fund Value as % of GDP

1.1%

Growth Rate

Annualised internal rate of return of 2.47%.[45]

Financing

Funded through part of the annual structural surplus.

Objective

Designed to guard against the fiscal impact of an ageing population. Cannot be drawn upon until 2016.

Ownership

Government of Chile.

Management

Managed by the Central Bank. Custodial services provided by JP Morgan Worldwide Securities Services. The fund can invest domestically and abroad. As of September 2007, the portfolio allocation was as follows: 66.2% sovereign; 2.5% agency; 31.3% bank. Quarterly and monthly reports provide further detail on the currency breakdown (between US dollars, euros and yen) and the terms of the investments.

Investment Policy and Asset Allocation

Outlook/Trends

Currently formulating investment strategy to include new asset classes.

Transparency

High. Monthly and quarterly reports are available on the Ministry of Finance website.

Recent Investments

See above for current portfolio allocation.

77

Gerard Lyons

78

IV. BOTSWANA PULA FUND Launch Year Fund Value (US dollars) Fund Value as % of GDP Growth Rate Financing Objective Ownership Launch Year Management Investment Policy and Asset Allocation Outlook/Trends Transparency

1966 4.7 billion (March 2007)[46] 38% -Diamonds --1966 -----

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V. STATE OIL FUND (AZERBAIJAN) Launch Year

1999

Fund Value (US dollars)

1.5 billion[47]

Fund Value as % of GDP

8%

Growth Rate

5% (December 2005 to February 2007)

Financing

Oil

Objective

Assets are used to finance the state budget, new infrastructure projects and social projects.

Ownership

Government of Azerbaijan.

Management

Investment Policy and Asset Allocation

The executive director (Shahmar Movsumov) is appointed directly by the president of Kazakhstan. The Supervisory Board includes several members of the Cabinet. About 8% of the fund’s assets are administered by external managers. About 60% of the fund is invested in cash, the remainder mostly in bonds. Only a marginal portion (0.3%) is invested in equities.

Outlook

--

Transparency

High. Annual reports publicly available.

Recent Investments

--

VI. HERITAGE AND STABILIZATION FUND (TRINIDAD & T OBAGO ) Launch Year

2006

Fund Value (US dollars)

1.4 billion (2006).[48]

Fund Value as % of GDP

9%

Growth Rate

500 million US dollars were transferred to the HSF in 2006.[49]

Financing

60% of excess revenues will be allocated to the Heritage and Stabilization Fund (HSF).[50]

State Capitalism: The Rise of Sovereign Wealth Funds Launch Year

2006

Objective

To insulate fiscal policy and the economy from swings in international oil and gas prices and to accumulate savings from the country’s oil and gas assets for future generations. The main aim is to be able to maintain public expenditure over the long term when oil and gas revenues decline.

Ownership

Government of Trinidad & Tobago

Launch Year

2006

Management

The Central Bank is responsible for the day-to-day management of the HSF, in order to meet investment objectives set by the Board. However, most of this management is being outsourced to external fund managers. The Board is appointed by the President of Trinidad & Tobago, following advice from the Ministry of Finance.

Investment Policy and Asset Allocation

The HSF invests in foreign assets. It has a long-term focus on maximising expected returns within a set of risk constraints. The Board determines the level of risk tolerance (within a range of medium to high) of the HSF and the target portfolio return Transfers out of the fund for the purpose of economic stabilisation will be resisted if the value of the HSF declines to one billion US dollars.

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Outlook/Trends

Transparency

Legislation stipulates quarterly reports by the Central Bank to the Board, and annual reports by the Minister of Finance to parliament. Some or all of these will be made public.

Recent Investments

--

VII. FUND FOR MACROECONOMIC STABILISATION (V ENEZUELA ) Launch Year

2003 (previously the FIEM -- Investment Fund for Macroeconomic Stabilisation). Legislation governing the Fund for Macroeconomic Stabilisation (FEM) was revised in 2005.

Fund Value (US dollars)

793 million (March 2007).[51]

Fund Value as % of GDP

0.5 %

Growth Rate

13% growth over the last four years. 3.3% annual growth to August 2007.[52]

Financing

Transfers of state funds resulting from fiscal surpluses, privatisations and other ad hoc transfers.

Objective

To provide for stability of public expenditure at national, state and municipal levels.

Ownership

Ministry of Finance.

Management

The Treasury Bank (a state institution). The president of the FEM and its four board members are nominated by the president of Venezuela. Investment Policy and Asset -Allocation

79

Gerard Lyons

80

(Continued). Outlook/Trends

The relative importance of the FEM has decreased sharply over the last two to three years as the government has established alternative off-budget funds such as Fonden (see above), which have far larger resources. There is no sign of this trend changing. Basic data on the fund is available on the website of the Central Bank of Venezuela. However, there is no transparency about where the fund is being invested.

Transparency

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VIII. REVENUE EQUALIZATION FUND (KIRIBATI) Launch Year

1956

Fund Value

400 million dollars[53]

Fund Value as % of GDP

526%

Growth Rate

--

Financing

Phosphates

Objective

Possible financing for domestic enterprises.

Ownership

--

Management

Possible financing for domestic enterprises.

Investment Policy and Asset Allocation Outlook/Trends

Prudent management. Was entirely invested in offshore funds in 2001. Designed to maintain real per capita value over time. Financing of budget shortfalls means slower fund growth.

Transparency

--

Recent Investments

--

IX. FOREIGN EXCHANGE RESERVE FUND (IRAN) Launch Year

1999

Fund Value (Us dollars) Fund Value as % of GDP Growth Rate

Press reports from earlier this year suggest that as of January 2007, the Foreign Exchange Reserve Fund (FERF) was empty or even overdrawn.[54] Zero

Financing

The Iranian Central Bank suggested in January 2006 that the value of the FERF would rise to 14-15 billion US dollars by March 2006.[55] Since then, the resources of the FERF appear to have been used up by the government. Revenues related to hydrocarbons exports.

Objective

Provide support to domestic industry and cover fiscal deficits.

Ownership

Government of Iran.

Management

Government of Iran.

Investment Guidelines -Outlook

The FERF appears no longer to be relevant. However, there is a chance that it may be replenished from future privatisation revenues or further hydrocarbons windfalls.

Transparency

Very low.

Recent Investments

In 2004 the FERF committed to disbursing over 8.5 billion US dollars for domestic industrial projects.[56]

State Capitalism: The Rise of Sovereign Wealth Funds

81

REFERENCES [1] [2] [3]

[4] [5] [6] [7] [8] [9] [10]

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[11] [12] [13] [14] [15] [16] [17] [18] [19] [20] [21] [22]

[23]

250 billion (2005, State Street); 250-500 billion (2007, Financial Times); 600-1,000 billion (2007, Financial News); 875 billion (2007, Morgan Stanley). Euromoney. Abu Dhabi has another state-owned diversified investment company, Mubadala Development Company, which recently purchased 7.5% of Carlyle Group. Its links to ADIA and ADIC are unclear. Although its international investments are listed on its website, transparency about the size of this fund is extremely low. Oxford Analytica’s estimate, based on comparing Mubadala’s number of staff (250) with the staff-fund value ratios at ADIA and the Qatar Investment Authority, is that Mubadala’s fund value could be 120 billion US dollars. Norges Bank http://www.norges-bank.no/Pages/Article____42084.aspx Oxford Analytica calculations from Norges Bank data. http://www.norgesbank.no/Pages/Article____41397.aspx ‘Well over 100 billion' (GIC website: http://www.gic.com.sg/aboutus.htm, 2007) to 330 billion (Morgan Stanley, 2007). Arab Times (based on a statement by the Minister of Finance) http://www.mafhoum.com/press10/304E20.htm. Arab Times http://www.mafhoum.com/press10/304E20.htm. Oxford Analytica Daily Brief. Stabilization Fund of the Russian Federation, http://www1.minfin.ru/ stabfond_eng/sobj_eng.htm Financial Times, September 18, 2007: http://www.ft.com/cms/s/0/187ba59a-657f11dc-bf89- 0000779fd2ac.html Temasek Holdings website: http://www.temasekholdings.com.sg/ Temasek Holdings website: http://www.temasekholdings.com.sg/ London Stock Exchange, September 13, 2007. Financial News. El Watan (based on draft budget law for 2008) . http://www.elwatan.com/ spip.php?page=article&id_article=77485 http://www.algerie-dz.com/article6788.html IMF (2005), ‘Algeria: Report on the Observance of Standards and Codes—Fiscal Transparency Module’ http://www.imf.org/external/pubs/ft/scr/2005/cr0568.pdf Alaska Permanent Fund Corporation (2006), annual report. http://www.apfc.org/ Financial Times, http://www.ft.com/cms/s/0/c4bd32be-7cd2-11dc-aee20000779fd2ac.html?ncick_check=1 Morgan Stanley estimate. Khazanah Nasional annual review of June 1, 2007 (using exchange rate of May 31, 2007. Net worth, using the same exchange rate, is 18.3 billion US dollars): http://www.khazanah.com.my/docs/2007%20Annual%20Review%20June%20007. pdf Growth between May 2004 to May 2007 was 87%. Khazanah Nasional annual report: http://www.khazanah.com.my/docs/2007%20Annual%20Review%20June%202007 .pdf

82 [24] [25] [26] [27] [28] [29] [30] [31] [32] [33]

Copyright © 2008. Nova Science Publishers, Incorporated. All rights reserved.

[34] [35] [36] [37] [38] [39] [40] [41] [42] [43] [44] [45] [46] [47] [48] [49] [50] [51] [52] [53] [54] [55] [56]

Gerard Lyons http://www.kic.go.kr/en/?mid=in01 Dow Jones. http://www.kic.go.kr/en/?mid=in01 Unofficial quote by senior member of Central Bank of Venezuela. Alberta Heritage Savings Trust Fund: http://www.finance.gov.ab.ca/business/ ahstf/index.html Taipei Times archive: http://www.taipeitimes.com/News/biz/archives/ 2007/08/18/ 2003374790 Taiwan Journal: http://taiwanjournal.nat.gov.tw/ct.asp?xItem=17763&CtNode=122 Taiwan Journal: http://taiwanjournal.nat.gov.tw/ct.asp?xItem=17763&CtNode=122 National Fund website: http://www.nationalfund.kz Asian Development Bank/National Bank of Kazakhstan: http://www.adb.org/ Documents/Books/ADO/2007/KAZ.asp Ministry of Finance of Chile: http://www.hacienda.cl Ministry of Finance of Chile: http://www.hacienda.cl Euromoney, Financial News. Euromoney, Financial News. Euromoney, Morgan Stanley. http://www.futurefund.gov.au/ Parliament of Australia, Research Note no. 43 2004–05 GPF website: http://www.gpf.or.th/GeneralServlet GPF website: http://www.gpf.or.th/GeneralServlet http://www.thailandoutlook.com/thailandoutlook1/top%20menu/investor%20news/ Daily%20News%2 0Summary?DATEDAILY=Friday,%20August%2010, %202007 Ministry of Finance of Chile: http://www.hacienda.cl Ministry of Finance of Chile: http://www.hacienda.cl Morgan Stanley State Oil Fund http://www.oilfund.az/ Ministry of Finance: http://www.finance.gov.tt/documentlibrary/ downloads/ 10/Enill% 20Media% 20Briefing%20on%20the%2 0Economy% 20current%201.pdf Ministry of Finance: http://www.finance.gov.tt/documentlibrary/ downloads/10/ Enill%20Media%20Briefing%20on%20the%2 0Economy% 20current%201.pdf Bank for International Settlements: http://www.bis.org/review/r070522d.pdf Central Bank of Venezuela Central Bank of Venezuela Morgan Stanley. http://www.rferl.org/featuresarticle/2007/02/12a0ffc6-05c1-4265-a73fa512fb376c12.html http://www.payvand.com/news/06/jan/1027.html http://www.payvand.com/news/04/nov/1062.html

In: Sovereign Wealth Funds Editors: T. N. Carson, W. P. Litmann

ISBN: 978-1-60692-319-1 © 2009 Nova Science Publishers, Inc.

Chapter 4

SOVEREIGN WEALTH FUND ACQUISITIONS AND OTHER FOREIGN GOVERNMENT INVESTMENTS IN THE UNITED STATES: ASSESSING THE ECONOMIC AND NATIONAL SECURITY IMPLICATIONS: TESTIMONY BEFORE THE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, UNITED STATES SENATE, NOVEMBER 14, 2007 Edwin M. Truman Copyright © 2008. Nova Science Publishers, Incorporated. All rights reserved.

Peterson Institute for International Economics, USA Chairman Bayh, ranking member Shelby, and members of the Committee on Banking, Housing, and Urban Affairs, it is a pleasure to appear before you this afternoon to discuss sovereign wealth fund acquisitions and other foreign government investments in the United States and their implications for U.S. economic and national security. In my testimony, I discuss the increasing relative importance of cross-border investments by governments, including by their so-called sovereign wealth funds (SWF), and the forces behind these phenomena. I outline some of the economic, financial, political, and national security issues that they raise. I present the results of a scoreboard on SWF that I have developed with Doug Dowson. Finally, I draw some implications for U.S. economic and financial policy. In brief, I make five points. First, sovereign wealth funds and related vehicles for external or cross-border investments by governments have been around for a long time, are growing in relative importance, and are here to stay. Second, the existence and growing importance of these types of cross-border investment vehicles raise profound questions about the structure and functioning of the international financial system. Third, the continuation of these trends does not currently pose a threat to U.S. national or economic security that cannot be dealt with under existing laws, procedures, and regulations. Fourth, it would be desirable to consider possible improvements in the U.S. statistical information base on foreign-government-related

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84

Edwin M. Truman

investments. Fifth, the U.S. government should continue actively to encourage foreign governments with large cross- border investments to develop and follow a set of best practices with respect to managing those investments in their interests, in our interests, and in the interests of the stability and openness of the international financial system. Our scoreboard provides a starting point for the development of such a set of best practices for sovereign wealth funds. Sovereign wealth funds is the descriptive term applied to separate pools of international assets owned and managed by governments to achieve a variety of economic and financial objectives. They sometimes include domestic assets as well. Those assets may be managed directly by a government entity or may be subcontracted to a private entity inside or outside the country. Their objectives may include the accumulation and management of a tranche of reserve assets, the stabilization of the macroeconomic effects of sudden increases in export earnings, the management of pension assets, or the transfer of national wealth across generations. In practice, they usually involve multiple objectives. Moreover, SWF are only one form of governmental cross-border investment; other forms include foreign exchange reserves, other loosely organized collections of government assets, and government-owned or government- controlled financial or nonfinancial institutions. Sovereign wealth funds are new only as a descriptive term. Previously they may have been described as stabilization funds, nonrenewable resource funds, trust funds, or similar terms. The first such fund was established by the Pacific island nation of Kiribati in 1956 to manage revenues from phosphate deposits. A number were established before 1980 in the context of the build-up of oil export revenues during the 1970s; at least a dozen have been established since 2000. Although most of them derive the major portion of their funding from revenues from natural resources, some countries have used fiscal surpluses, revenues from privatizations, and foreign exchange reserves to fund their SWF. Table 1 attached to this testimony provides a list of 32 SWF of 28 countries along with the dates on which they were established, the principal source of their funding, and estimates of their size. My total is $2.1 trillion. Differences in definitions and timing can lead to different totals. My figures do not include the $142 billion recently added to China’s new SWF, the China Investment Corporation, or Libya’s new $40 billion Investment Authority. They do include, in some cases sizeable, holdings of domestic assets. The growth of SWF and similar governmental activities reflect multiple, interrelated trends in the world economy and financial system: increased global integration, substantial elimination of restrictions on international capital flows, technological innovation, sustained spectacular growth rates in many emerging-market countries, ageing populations and the expansion of pension funds and related pools of assets, recognition that diversification contributes to increased investment returns, loosening of “home bias” in investment decisions, rapid growth in foreign exchange reserves, and enormous wealth transfers from most traditional industrial countries to a number of emerging-market and developing countries as a consequence of the sustained rise in commodity prices in recent years. Most of these trends will not be reversed in the near future. SWF and similar governmental activities are here to stay. What is distinct about these trends is that they involve a dramatic increase in the role of governments in the ownership and management of international assets. This characteristic is unnerving and disquieting. It calls into question our most basic assumptions about the structure and functioning of our economies and the international financial system. In the

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Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments…

85

United States, we favor a limited role for government in our economic and financial systems; we have a market-based economy and financial system; we view central planning as a failed economic framework of the past; and we presume that most cross-border trade and financial transactions involve the private sector on both ends of the transaction. Unfortunately, our orientation is not congruent with certain facts, and we are being called upon to recalibrate our understanding of the world. Table 2 attached to this testimony displays the holdings of foreign exchange reserves (as of June 2007) and the estimated size of the sovereign wealth funds (where relevant) for the 10 countries with the largest reserve holdings, for the 5 other countries with the otherwiselargest sovereign wealth funds, and for Saudi Arabia. Saudi Arabia has small official reserves and no formal SWF, but the Saudi Arabian Monetary Agency reports substantial holdings of international securities on and off its balance sheet (shown in the SWF column). The countries are ranked by the combined size of these holdings shown in the first column, adjusting as best we can for double counting. The combined total for the 16 countries is $6 trillion. More generally, total holdings of foreign exchange reserves and sovereign wealth funds are about $9 trillion: about $6 trillion in foreign exchange reserves, $2 trillion in SWF, and $1 trillion in miscellaneous financial holdings by countries like Saudi Arabia. The $9 trillion represents at least 12 percent of all cross-border assets—a share that has probably doubled over the past five years and can be expected to continue to rise. The 12 percent figure does not include other cross-border investments by government-owned or government-controlled financial and nonfinancial institutions other than SWF. The absolute and relative size of all such government-owned and government-managed cross- border assets is likely to continue to increase driven by the combination of economic and financial forces outlined above. These forces are shifting wealth toward countries with different conceptions of the role of government in their economic and financial systems. These developments, in turn, give rise to a number of risks. First is the risk that governments will mismanage their international investments to their own economic and financial detriment and with negative consequences for the global economic and financial systems. Second is the risk that governments will manage those investments in pursuit of political or economic power objectives—for example, promoting state-owned or state- controlled national champions to global champions. Third is the risk of an outbreak of financial protectionism in host countries, in anticipation of the pursuit of political or economic objectives by the owners of the investments or in response to the actual actions of those governments. Fourth is the risk that in their management of their international assets, governments will contribute to market turmoil and uncertainty. Fifth is the risk of conflicts of interest for government owners of the international assets and the domestic or foreign institutional or individual managers of those assets with an associated potential for corruption. At this point, these risks, with one exception, are largely in the realm of the hypothetical, in particular, with respect to sovereign wealth funds. For example, on the fourth risk, most experienced observers with whom I have spoken do not see SWF posing a threat to financialmarket stability on the basis of the past behavior of the owners and managers of these funds. In my view, the most serious risk is to the economic and financial stability of the countries accumulating these huge stocks of international assets. This accumulation poses enormous

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86

Edwin M. Truman

political and policy challenges for the authorities. The understandable temptation is to try to use international assets to promote domestic economic development objectives. Doing so is essentially impossible without undermining or reversing the fiscal, monetary, and exchange rate policies that gave rise to the initial accumulations of the external assets. With the possible exception of exchange rate policies, such reversals are likely to boost inflation, create wasteful distortions in domestic economies, and contribute to slower, not faster, growth and development. It is important to remember that a number of countries have established SWF only to squander and liquidate the resources that have been set aside under short-term political pressures. Two examples are Ecuador’s Stabilization Fund and Nigeria’s Petroleum (Special) Trust Fund. Venezuela appears to be following a similar trend with its two SWF. Also recall that, in general, governments are not skilled investors. They are not good at picking winners. Government-owned banks tend not to be the most profitable. I was told recently that preliminary research suggests that recent mergers and acquisitions by Chinese corporations, many of which are government-owned or government- controlled, underperform other cross-border mergers and acquisitions. Notwithstanding my view that the greatest risks are to the countries whose governments have accumulated the large stocks of international assets, authorities in the countries where those assets are invested also have legitimate concerns about how they will be managed. Those concerns focus primarily on acquisition of large or controlling stakes by foreign governments or government-controlled entities in institutions in the host countries, i.e., the United States. In this connection, with respect to sovereign wealth funds, it is important to appreciate that only a few such funds currently follow acquisition strategies. We have reasonably complete information on the investment strategies of 24 of the 28 countries with SWF listed in table 1.1 At present, the SWF of only 8 of the 24 countries follow investment strategies involving the acquisition of significant or controlling stakes in companies: Brunei, Canada, China, Kuwait, Malaysia, Qatar, Singapore, and the United Arab Emirates. Moreover, in the cases of Canada and Malaysia, the companies involved are domestic. Of course, this pattern could change, and foreign government-owned or governmentcontrolled financial and nonfinancial institutions do acquire stakes in companies in other countries, including controlling stakes. The enactment of the Foreign Investment and National Security Act of 2007 revised the framework and procedures of the Committee on Foreign Investment in the United States. With these changes and the existing powers of the Securities and Exchange Commission as well as other U.S. financial regulators, we are well positioned, in my view, to evaluate and, if necessary, to block any U.S. acquisitions by a SWF or other foreign government entity to protect our national security. With respect to economic security concerns, my view is that the greatest risk to the U.S. economy is that we will erect unnecessary barriers to the free flow of capital into our economy and, in the process, contribute to the erection of similar barriers in other countries to the detriment of the health and continued prosperity of the U.S. and global economies. We may not in all cases be comfortable with the consequences of the free flow of finance and investment either internally or across borders, but on balance it promotes competition and efficiency. 1

We lack sufficient information about Algeria, Iran, Oman, and Sudan.

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However, I would identify one area in which those responsible for our financial system should monitor future developments: investments of SWF in private equity firms, hedge funds, and regulated financial institutions. Some observers of private equity and hedge funds have concerns about the implications of their activities for the stability of our economy and financial systems. I do not share most of those concerns though I have long favored increased transparency for large private equity and hedge funds. For those who have deeper concerns about such pools of capital, I note that foreign governments via investments by their SWF or through other channels provide capital to them that subsequently is leveraged. This trend deserves watching. With respect to the acquisition by a SWF, or by a government-owned or government- controlled entity, of a stake in a U.S. financial institution already subject to supervision and regulation, the responsible U.S. authorities should continue to review and monitor such investments to limit the potential for distortions in the allocation of capital and conflicts of interest that are resolved in unhealthy directions. Consideration should also be given to improving our statistical information in this area. The U.S. government collects extensive data on foreign investments in the United States and U.S. investments abroad. I applaud the painstaking efforts by several agencies of the executive branch over the past decade to improve the comprehensiveness and quality of these data. With respect to information on the stocks and flows of investments in the United States by foreign governments, my understanding is that the published data cover foreign official institutions defined as central banks, finance ministries, and other government institutions, including sovereign wealth funds. However, our data collection system does not presently permit the identification of holdings and activities in the United States by sovereign wealth funds separately from holdings and activities of other foreign official institutions. My understanding, as well, is that our data also do not separately distinguish financial and direct investments in the United States by government-owned (or government-controlled) banks and corporations. Published data on U.S. official assets abroad include holdings by the U.S. Treasury, Federal Reserve, and other federal lending agencies, but my understanding is that foreign assets of U.S. government owned or sponsored entities are included among private assets. Finally, my understanding is that we also do not identify separately holdings by government owned or sponsored entities at the state and local level, for example, by the Alaska Permanent Fund or state pension funds such as the California Public Employees’ Retirement System (CalPERS). I do not want to minimize the cost or complexity that would be involved in the collection and publication of more detailed data on U.S. international assets and liabilities on the basis of whether the assets are owned (or, more complex, are controlled) by U.S. or foreign governments at all levels. In addition, the usefulness of such data would depend on whether a large group of other countries were willing to participate in parallel data collection efforts. (Although U.S. data include investments in the United States by SWF such as the Norwegian Government Pension Fund-Global as holdings by foreign official institutions, data published by Norway in its international accounts do not report those assets as official holdings or as subcategories of other types of investments.) The fifth edition of the IMF’s Balance of Payments Manual provides for the reporting of countries’ official holdings of foreign debt and equity securities other than as reserve assets in

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88

Edwin M. Truman

subcategories of holdings of such assets (and liabilities), but few if any countries report their data this way. Moreover, my understanding is that the draft sixth edition of the IMF’s Balance of Payments and International Investment Position Manual contemplates a more complete categorization of international financial data in terms of the general government and other governmental subentities. However, the new manual has not yet been completed and published, nor are all its new features likely to be implemented widely once the manual has been adopted. Nevertheless, it would be instructive for U.S. statistical agencies to prepare information for the Congress on what statistical information is currently available on U.S. assets and liabilities of governments and government owned or controlled entities broken down by the nature of those entities, on the costs and complexities for the United States of expanding the collection of such information, and on prospects for encouraging similar efforts in other countries. What should be done to make the world safer for sovereign wealth funds? They should increase significantly their accountability to the citizens of their countries, to the U.S. citizens and our government as well as to the citizens and governments of other countries, and to participants in international financial markets. The increased size and scope of these funds and related cross-border governmental financial activities coupled with the prospect that their disproportionate expansion will continue has put them on the international radar screen, as their owners and managers know, and it is in their interests to respond appropriately. The most effective way to increase the accountability of these activities is through the establishment of a standard or a set of best practices for international investments, in general, and for sovereign wealth funds, in particular. For sovereign wealth funds, best practices should cover four categories: (1) structure, (2) governance, (3) transparency and accountability, and (4) behavior. To aid in the development of a set of best practices for SWF my colleague Doug Dowson and I have developed a scoreboard for the 32 sovereign wealth funds of 28 countries listed in table 1. It is based on systematic, publicly available information about the 32 SWF. The scoreboard includes 25 elements grouped in the four categories.2 At least one SWF receives a positive score on each element. The construction of the scoreboard is described in more detail in the appendix to my testimony. Table 3 attached to this testimony summarizes our results. (Table 4, also attached, provides the scores for the 32 SWF on each element as well as subtotals for each category.) Out of a possible total of 25 points, the highest score is 24 recorded for New Zealand’s Superannuation Fund, followed closely by Norway’s Government Pension FundGlobal at 23 points.3 The Abu Dhabi Investment Authority (ADIA) and its Investment Corporation (ADIC) in the United Arab Emirates record 0.5 points. The average is 10.27 points. Six of the largest SWF score at or below the average, including two of the three 2

As a point of reference, we also scored the California Public Employees’ Retirement System. CalPERS assets were $244 billion as of August 2007; its 2006 annual report states that 25 percent were foreign. CalPERS scores slightly lower than Norway’s SWF at 21.75, the same as Timor-Leste’s Petroleum Fund. 3 Norway’s SWF has not strictly followed its rules on the use of earnings from its SWF, does not provide the currency breakdown of its investments, and is not subject to a fully independent audit. New Zealand’s SWF has no formal guideline governing the speed of adjustment in its portfolio.

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largest funds at the bottom of the table. One of the two is the Government of Singapore’s Investment Corporation (GIC). At the same time, Singapore’s Temasek Holdings scores considerably above the average. As is displayed in table 3, the 32 funds fall into five groups of 5 to 8 funds each; the first and third groups could be further subdivided as indicated. In the first three categories— structure, governance, and transparency and accountability—scores are correlated, but not perfectly, with overall scores. On balance, the scores are higher (relative to the potential maximum) in the structure category, which covers the clarity of the objectives of the fund, the source of its funding, the use of its principal and earnings, and its integration with the country’s fiscal framework. The scores in the governance category are lower relative to the theoretical maximum. This category covers the respective roles of the government and managers and the existence of corporate governance and ethical guidelines. The relative average score is about the same for the larger transparency and accountability category, which is based on the nature of regular public reporting on the investments and performance of each fund. However, in this category the variance of the scores is the largest. The development of a set of best practices for sovereign wealth funds, and similar understandings covering other cross-border government investments, offers the most promising way to increase the accountability of these activities, which are likely to increase in relative importance over the next decade. The associated increase in transparency, which is a means to the end of greater accountability, would help to reduce the mysteries and misunderstandings surrounding these governmental activities. At the same time, the environment for them would become more stable and predictable. I endorse the efforts of the U.S. Treasury to encourage countries with sovereign wealth funds to act collectively and cooperatively in establishing a set of best practices for those investment vehicles. The G-7 has embraced this approach to reinforcing the global framework governing cross-border investment. The willingness of the IMF, World Bank, and OECD to promote a dialogue on identifying best practices is also positive. In the end, it will be the governments of countries with the sovereign wealth funds and related activities that must decide that it is in their individual and collective self interest to participate in these efforts. It is in our self interest to facilitate this process.

APPENDIX. SCOREBOARD FOR SOVEREIGN WEALTH FUNDS This appendix presents the scoreboard that I have constructed with the assistance of Doug Dowson. It covers four basic categories: (1) structure, (2) governance, (3) transparency and accountability, and (4) behavior. Within each category, we pose a set of yes/no questions. The total number of questions is 25. For two of the categories, we group questions in subcategories. For each of our 25 questions, the answer is yes for at least one SWF. If the answer is an unqualified yes, we score it as “1”. If the answer is no, we score it as “0”. However, for many elements, we allow for partial scores of 0.25, 0.50, and 0.75, indicated by (p) in the descriptions below.

Sovereign Wealth Funds, Nova Science Publishers, Incorporated, 2008. ProQuest Ebook Central,

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90 Table 1. Sovereign Wealth Funds Country

Name

Date Established Source of Funds

522 – 897e

United Arab Emirates Abu Dhabi Investment Authority and Corporation Istithmar (Dubai) Mubadala Development Company (Abu Dhabi)

1976

Natural resources

(500 – 875e)

2003 2002

Natural resources Natural resources

Temasek Holdingsb Government Pension Fund – Global Kuwait Investment Authority Stabilization Fund of the Russian Federation Central Huijin Investment Companyb Qatar Investment Authority Future Fundb Revenue Regulation Fund Alaska Permanent Fundb Brunei Investment Agency Korea Investment Corporation National Oil Fund Khazanah Nasionalb Alberta Heritage Savings Trust Fundb

1981 1974 1990 1960 2004 2007 2005 2006 2000 1976 1983 2005 2000 1993 1976

Foreign exchange reserves Fiscal surpluses Natural resources Natural resources Natural resources Foreign exchange reserves Natural resources Fiscal surpluses Natural resources Natural resources Natural resources Foreign exchange reserves Natural resources Fiscal surpluses Natural resources

National Development Fundc Macroeconomic Stabilization Fund Economic and Social Stabilization Fund Superannuation Fundb State General Reserve Fund Oil Stabilization Fund Pula Fund Oil Income Stabilization Fund State Oil Fund of the Republic of Azerbaijan Heritage and Stabilization Fund Petroleum Fund

2005 1998 2006 2001 1980 2000 1997 2000 2000 2007 2005

Natural resources Natural resources Natural resources Fiscal surpluses Natural resources Natural resources Natural resources Natural resources Natural resources Natural resources Natural resources

(12e) (10e) 208 – 438er (100 – 330er) (108) 329 213 148r 68e 50e 49 43 40 35e 20r 19 18 15 16 (15) (1) 10 10 10e 9e 6 3 2 1 1

Singapore Government of Singapore Investment Norway Kuwait Russia China Qatar Australia Algeria United States Brunei Korea Kazakhstan Malaysia Canada Venezuela

Chile New Zealand Oman Iran Botswana Mexico Azerbaijan Trinidad and Tobago Timor-Leste

Current Sizea (billions of US dollars)

Sovereign Wealth Funds, Nova Science Publishers, Incorporated, 2008. ProQuest Ebook Central,

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91 Country

Name

Date Established Source of Funds

Kiribati São Tomé and Sudan Totald

Revenue Equalization Reserve Fund National Oil Account Oil Revenue Stabilization Account

1956 2004 2002

Natural resources Natural resources Natural resources

Current Sizea (billions of US dollars)