Sovereign wealth funds seem suddenly to have become the new behemoths bestriding the financial markets, whose financial might could influence economic activity from New York to Sydney. Their investments amounted to a record US$48.5bn in 2007 and US$24.4bn in just the first two months of 2008. Government controlled funds from the Middle East and Asia are now significant investors in Merrill Lynch, UBS, Citigroup and Standard Chartered – to name but a few venerable financial institutions.
By some, sovereign wealth funds are hailed as the providers of much needed liquidity to global markets and as the saviours of those investment banks deeply wounded by the credit crunch. By others, especially some Western governments, they are viewed with caution, aroused by the very size of the funds under management and the potential influence that these could have, a fear accentuated by the funds’ lack of transparency surrounding their activities and objectives.
Sovereign wealth funds are estimated to manage US$2-3 trillion globally, and may reach US$5 trillion in the next two years.
The tripling of oil prices since 2002 has created enormous wealth for oil-producing nations, which havebecome eager to find investments outside their home regions on which to spend their petrodollars. At the same time, Asian central banks are sitting on enormous reserves of foreign exchange, and many are looking to diversify their investments into higher yielding assets than US Treasury bills.
The establishment last year of the China Investment Corporation with its US$200bn created some noise, but several other countries in Asia have their own funds, which they prefer to keep very low profile: the Government of Singapore Investment Corporation, for example, is thought to run US$330bn.
These identified funds, plus a plethora of other government linked investment vehicles: state holding companies like the mighty Dubai Holdings, national pension funds and major state dominated enterprises such as China Life or CNOOC in China that should perhaps be classed together with them, have aroused concerns about their potential to disrupt financial markets. Rumours of investments by one player or another have already been seen to have influence on specific asset classes. Some analysts are warning of the serious market disturbances that could be triggered if funds were abruptly to sell large overseas holdings.
However, it may be easy to overstate the impact of sovereign funds on global markets, which in total represent closer to US$200 trillion. Despite all the attention generated by the international activities of the government funds, they still make up a small percentage of this total. Moreover, as declared long-term investors, they are arguably less likely to add volatility to markets than hedge or private equity funds with shorter time horizons. They also tend to be cautious investors, maintaining minority stakes and not seeking to exercise control over target companies.
Nevertheless, on Capitol Hill and in many OECD countries, serious concerns remain about the motivations of some sovereign funds. The lack of information available about most funds, with asset allocation and investment decisions being kept a close secret, has fuelled the worry that political objectives might influence their decision-making. Investments might not be driven by purely commercial motivations, but may reflect a desire to obtain technology and expertise to benefit domestic strategic interests.
The US, in particular, is troubled by the possibility that sovereign funds from emerging markets might buy stocks in companies considered vital to national security, such as energy, technology and defence. Dubai World’s proposed acquisition of P&O’s business in America, which included ports in New York and New Jersey, was blocked by government concerns about Arab ownership of strategic infrastructure. Similarly, the attempted takeover of 3Com, a US telecommunications equipment maker, by Huawei Technologies was derailed after concerns about possible links between Huawei and the Chinese military. (Such controversies to date have involved state owned companies rather than strictlydefined sovereign wealth funds). In recent months, there have been growing calls from around the world for much greater transparency about the sovereign funds’ investment holdings and their governance structures; and, increasingly sensitive to the preoccupations of Western governments, some of the leading sovereign wealth funds are taking steps to address their concerns.
Last month, the US, Singapore and Abu Dhabi agreed on principles for sovereign wealth funds that emphasise governance and transparency and specify that politics will not influence investment decisions. In return, recipient countries should publish clear investment rules and should not put up protectionist barriers nor discriminate between different sovereign funds. The IMF is also planning to develop best practice guidelines for sovereign wealth funds with the intention of producing a draft in October.
Individual funds have already begun to disclose more about their activities. In July 2007, the Kuwait Investment Authority for the first time revealed that its total holdings were US$213 billion. Temasek in Singapore now publishes an annual report. To the extent that State pension funds are considered to be sovereign funds, some institutions may already be said to have exemplary fiduciary standards. New Zealand’s Superannuation Fund, for example, is held up as standard of good governance, accountable to the Crown but operating strictly at arm’s length and according to its fiduciary duty to invest the fund on a prudent and commercial basis. Norway’s Government Pension Fund Global is another institution regularly commended for its extensive disclosure of information about its investment strategy and results.
While most of the worries of the Americans and others
seem to centre around possible interference by sovereign funds in their local markets, a tangible corporate governance problem arising from their activities might be quite the opposite – a desire to be too accommodating and not to speak out against poor performance by their investee companies. Sovereign funds have appeared as a blessing for investment banks suffering through the subprime debacle: they have deep pockets, are willing to be long term investors, don’t want board seats and have clearly stated that they won’t be activist.However, this non-confrontational and patient attitude could be viewed negatively, as it may mean there will be little pressure for real change at institutions that are arguably in great need of reform.
Meanwhile, with yet more substantial write-downs announced this month by UBS and Deutsche Bank, the subprime crisis is far from over. Recipient countries and institutions are likely to have to continue to balance their concerns about the inner workings of the sovereign funds with their urgent need for investment capital.
Alexandra Tracy is president of Hoi Ping Ventures