| The trouble with money is that it is inert. It does not beget more of itself if it is not worked or spun to do so. Cash per se has no hey presto factor; it yearns to turn into investment of one sort or another. Keep your money liquid and sure, you will not lose it in a credit crunch or a sub-prime meltdown, or the smoke and mirrors of overweening and overwrought derivative products which crack and dissolve into insolvency when the going gets tough. Keep your account current and you will keep the quantity of money you put in as long as the bank stays solvent, but it will lose value by dint of the inflationary push built into the global financial and economic system. “Have money, must invest” is the motto of the rich – be they individuals, institutions, or sovereign states.
So money is like blood in our bodies which flows, circulates, and feeds the vital organs. Money is invested and it grows one way or another for the lucky and plucky few, even in an economy falling into recession. To use another analogy, world capital is like water on the move – it flows, yes, but it also gathers into pools and lakes, builds into seas and vast oceans beyond the control of central banks and nations.
Seas forming
In the case of Sovereign Wealth Funds (“SWFs”) we are witnessing the pools of liquid funds growing into seas in certain parts of the world where massive foreign exchange surpluses are being amassed. For some years these young leviathans have been content to feed on near-cash investments like US Treasury bonds – thus countries like China, Saudi Arabia and Japan, who have invested hundreds of billions of dollars in US bonds, have kept the bankrupt economy of the USA afloat – but the yields from these comparatively safe and unexciting investments are no longer attractive. SWFs are on the move, like a tidal wave looking for more exciting destinations, such as private equity, real estate, hedge funds, and commodities which provide the main source of income for more than half of the 25 largest sovereign wealth funds and as a hedge against the weak US dollar.
A new sea is being created which challenges the status quo of international financial power bases. So how large is the mass of money? The picture is changing rapidly and we can only talk in terms of estimates since most of these funds are secretive and are not subject to the same level of regulation as bank funds. However, some experts place the figure at around USD 3 trillion – with the total assets owned by the UAE, Singapore, Saudi Arabia, Kuwait, China, Libya, Algeria, and Qatar approximately amounting to a staggering USD 2.2 trillion – rising to USD 5 trillion by 2010 and growing, so that by 2015 the figure is estimated to grow to approximately USD 10 trillion.
The biggest player amongst the SWFs is the Abu Dhabi Investment Authority (“ADIA”), which was set up in 1976 to invest funds earned from oil trade surpluses, with an estimated total of USD 875 billion. Amongst the other big players are Norway’s Government Pension Fund with USD 380 billion made from country’s North Sea oil riches; Kuwait Investment Authority is responsible for USD 250 billion; Saudi Arabia’s funds, which are not as yet organised formally as a SWF, are likely to dwarf the ADIA’s assets; Singapore has two SWFs jointly worth almost USD 500 billion which puts them amongst the 10 largest SWFs; Russia sports around USD 127 billion in its Oil Stabilisation Fund and, of course, the great emerging economy of China controls the China Investment Corporation, which is responsible for circa USD 200 billion of assets and growing. China’s foreign exchange reserves grew by 43 per cent in 2007, amounting to USD 1.5 trillion, of which it appears the Chinese government aims to hold USD 1 trillion in traditional government securities.
Whilst these figures are very large we should keep them in perspective. Conventional SWFs may be bigger than hedge funds and private equity combined but they are still small when compared to the USD 75 trillion making up institutional investment funds consisting of pension funds, mutual funds, and insurance investments or with the
USD 165 trillion global value of traded securities.
However, as long as oil prices remain buoyant and commodity prices are strong, the SWFs are growing at a faster rate than their giant cousins. On top of the SWFs we should take account of quasi-SWFs owned by ruling families, highly-placed individuals and their associates which probably total another USD 2 trillion. Some of these people, such as the Saudi Prince Waleed bin Talal, the Chelsea Football Club owner, Roman Abramovich, Indian tycoons such as the Tatas and the Mittals vie with some SWFs in the size of their wealth.
Previously, SWFs were regarded with suspicion by the target countries and companies, their motivations were suspect, they are foreigners coming into the territory. The colonials were turning into colonialists.
Cause for alarm?
The new stance being taken by SWFs have not been entirely welcome in Western economies for various reasons, including fears over national security. Thus, the USA resisted the acquisition of the UK company P&O by DP World because it would have meant that some ports in the USA would be managed by an Arab country which the US administration considers as a possible threat to the country’s security – not much love lost between the Americans and their Gulf allies then! Therefore, Dubai Ports was obliged to sell the US assets made up of five port terminals as part of the deal for taking over P&O. Dubai is a major current in the SWF sea, for example, Borse Dubai is in the process of paying USD 4 billion to take over the Nordic Stock exchange market operator OMX which manages bourses in Stockholm, Helsinki, Copenhagen, Riga, Tallinn, and Vilnius. The deal is still awaiting regulatory and political approval from the USA.
This complex deal will mean that through a tangled web of interlocking deals, Dubai obtains a 20% share in Nasdaq and in turn it will gain Nasdaq’s 28% stake in the LSE. Nasdaq will have an option to take a 33% stake in Dubai International Financial Exchange which would be renamed Nasdaq DIFX. Dubai International Capital already has a major stake in HSBC, and Dubai Group with Qatar Investment Authority both own stakes in the LSE; Dubai owns an important chunk of Deutsche Bank through DIFC. Abu Dhabi, the much richer but understated neighbour of Dubai, owns, through ADIA, a USD 7.5 billion holding in Citigroup.
However, it is not only the GCC countries who are playing a new role in global finance by buying up assets in Western economies. China is a major player and surprised many when it invested USD 3 billion in Blackstone’s IPO. Singapore, through Temasek, has taken 2.1% stake in Barclays in conjunction with China Development Bank’s 3.1% which was supposed to improve the bank’s bidding power for ABN Amro. Even though it failed on the Amro front, by its involvement with both Singapore and China, Barclays appears to have extended its global reach, especially in the far East. Just before Christmas last year Temasek played Santa to Merrill Lynch by investing USD 4.4 billion in that company with an option to buy another USD 600 million later.
The government of Singapore also invested in Switzerland’s UBS to the tune of SFr 11 billion in company with a private Saudi investor who put in a further SFr 2 billion. Morgan Stanley, in turn, raised USD 5 billion from China Investment Authority. The end of last year saw a flurry of SWF activity in shoring up western banks and institutions suffering from the effects of the sub-prime meltdown. However, most of these investments were held at or below the 10% level, although Citigroup and Merrill have indicated that they would accept further investments from the Kuwait Investment Authority. So the band is prepared to play and the music goes on, and having SWFs on the share register is no longer such a cause for alarm, indeed it gives comfort in many quarters.
| Many have recognised that SWFs are less sensitive to market conditions than private equity or hedge fund investors, they have longer-term goals and as analysts at Citigroup have pointed out, they are able to close deals with less leverage which insulates their investments from equity and credit market volatility.
Previously, SWFs were regarded with suspicion by the target countries and companies, their motivations were suspect, they are foreigners coming into the territory, and these foreigners have hitherto been regarded by the developed world as targets for investment and subsequent exploitation themselves. The colonials were turning into colonialists. However, now with the credit crunch which has stalled the global debt market and inter-bank lending, and with the sub-prime contagion hitting bank liquidity and indeed solvency for some, SWFs are being regarded by many as saviours, especially by those banks and companies that need to bolster their depleted balance sheets and restore their stretched capital solvency ratios.
With the credit crunch, SWFs are being regarded by many as saviours, especially by those banks and companies that need to bolster their depleted balance sheets and restore their stretched capital solvency ratios.
Recycling American debt
The American billionaire investor, Warren Buffet, as is his custom, was brutally frank in his analysis of the situation. He points out that the invasion of SWFs into several Wall Street banks and private equity groups is the result of the US trade deficit, national debt, and weak currency; he argues that sovereign funds are recycling debt issued by the US. He said: “Our trade equation guarantees massive foreign investments in the US. When we force-feed USD 2 billion daily to the rest of the world they must invest in something here. Why should we complain when they choose stocks over bonds?” As far as Buffet was concerned, too many companies had inflated short-term earnings by over-estimating the expected returns on their pension funds, and he castigated financial institutions for their role in the current credit crunch which was exacerbated by the fall in US house prices which had exposed, in his words, “…a huge amount of financial folly”. He added with colourful severity, “You only learn who has been swimming naked when the tide goes out – and what we are witnessing at some of our largest financial institutions is an ugly sight.”
So we have seen some transactions where the SWFs have come in as white knights to save the recipient business from debilitating embarrassment. In November last year ADIA invested USD 7.5 billion in the US bank Citigroup (which has had the Saudi billionaire, Prince al-Waleed bin Talal as a significant shareholder since the early 1990s) as the bank needed the cash transfusion to strengthen its balance sheet. However, the suspicion remains, for good reasons and bad. Legislation and vetting processes are proposed or will be coming into effect which will limit SWF involvement in national economies and make it more difficult for these invading funds to take over flagship and security-sensitive companies and businesses. Resistance is not consistent however, thus France and Germany appear to have accepted the Dubai stake in EADS.
Transparency needed
In order to allay some of the fears of western governments and institutions, SWFs have been urged to become more transparent and use external managers to allocate investments, in line with publicly stated strategies even though already almost half SWF assets are managed by external managers. However, this could fall, as SWFs develop their own expertise. Thus public disclosure of investment management strategies is uneven and remains opaque. The situation is very much in the balance. Right now, the state of the financial markets in the West is weak and SWFs have been seen, albeit reluctantly, by regulators and governments as helping to bolster shaky banking institutions with their investments in these institutions. In the long run, a degree of transparency will become necessary if they are to swim in Western financial waters.
Already there is talk of a SWF considering bringing the disclosure of its investments and practices into line with the a new code of conduct for British private equity groups which will publish regular data about participating funds activities and the companies they own, including the provenance of the funds and details on their investment strategies which presently appear to be benign in that they are not aiming to take over companies but to hold shares as passive shareholdings. Even so, the fact is that SWFs are not philanthropists, they are hard-nosed players in the financial markets and they are becoming more canny and are driving increasingly hard bargains. For that reason they will not easily succumb to EU and USA calls for more transparency and codes of conduct.
We should not exaggerate the chances of codes of conduct being adopted by SWFs in the near future. Already Bader al-Sa’ad, the Managing Director of the massive SWF, the Kuwaiti Investment Authority, has criticized the insistence by Western governments that SWFs be more transparent. He points out that the same principles should apply to hedge funds, pensions funds, private equity funds and so on.
“It is time to call a spade a spade,” Mr Sa’ad said with a certain asperity at a trade conference in Luxembourg. “Recipient countries are placing handcuffs on sovereign wealth funds in the form of regulations termed, in the best tradition of George Orwell’s Newspeak, ‘codes of conduct’ or ‘principles of operation’ or ‘best practices’. These regulations will not solve or prevent any future financial crises.”
Politics are inevitably tangled with the presence of SWFs in western financial institutions; it was clear to Mr. al-Sa’ad that such “handcuffs” would adversely affect capital global flows. He has challenged recipient countries to demonstrate how the declaration of the size of assets under management by the SWFs would enhance the stability of global financial markets in addition to ensuring the security of their domestic markets. In short, Mr. Sa’ad appears to be saying to the crisis-ridden western financial markets: take it or leave it, you are the ones who need our money, the blood is running in your streets, to adapt the famous adage from John. D. Rockefeller – there are other markets that SWFs can invest in and obtain good returns. But such strident tones from SWFs are not likely to allay fears in recipient states about the power and motives of SWFs. Indeed, Germany’s ruling coalition has recently agreed to enact measures to block unwanted investments by foreign sovereign wealth funds.
In the long run, a degree of transparency will become necessary if SWFs are to swim in Western financial waters.
A tough call
It is a tough call and we have to be less strident and more modulated in our attitudes to SWFs and seek to work with them. However, we should continue to press at least for codes of conduct with appropriate disclosure benchmarks, in a way that persuades these funds that the need for codes is not another way of dressing up chauvinistic and racist backlash from recipient countries but that accountability is good for the health of global markets as a whole.
It is going to be a difficult business when such funds are being amassed by non-democratic governments who are not used to being called to account and asked to show their hand. The greater participation of SWFs in the economies of the developed nations brings with it great opportunities and many dangers, both real and perceived. We shall see in the next few years how this particular brand of finance and economics, power and politics resolves itself – whether the new sea is going to be comparatively calm, yielding good catches, or whether it will be a turbulent one in which we shall all suffer.
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