The Emergence of Sovereign Wealth Funds and U.S. Investment

1
The Emergence of Sovereign Wealth Funds and U.S.
Investment
ITRN 603 Dr. Stuart Malawer December 2nd, 2009
Catrina Ciobanu Mark DeMicoli Ericka Floyd
2
What are they?

• The U.S. Department of the Treasury defines a
  sovereign wealth fund 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.
• Two categories
• Commodity SWF - financed by surplus foreign
  exchange earnings from commodity exports owned or
  taxed by the government.
• Assets of SWFs originating from commodities
  exports reached over 2.5 trillion at the end of
  2008.
• Non-commodity SWF - financed through excess
  foreign exchange assets accumulated as a
  consequence of running persistent current account
  surpluses.
• 1.4 trillion foreign exchange reserves were held
  in SWFs in 2008.

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SWF Overview

• When a nation has excess money, it uses a
  sovereign wealth fund as a way to funnel it into
  investments rather than simply keeping it in the
  central bank or channeling it back into the
  economy.
• Estimated value of all SWFs is estimated at 3
  trillion.
• Emergence of SWF represent a growing stock of
  government-controlled assets.
• SWFs are important players in global financial
  markets.
• Attract substantial attention by policy makers,
  market participants and the international
  community.

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Largest SWFs
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Why do countries establish sovereign wealth funds?

• Protect domestic currencies and banks from
  crisis.
• Promote intergenerational savings.
• Diversify revenue streams.
• Increase the return on assets held in central
  bank reserves.

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U.S. Legislation

• U.S. Committee on Foreign Investments in the
  United States (CFIUS) 1975 - an inter-agency
  committee authorized to review transactions that
  could result in control of a U.S. business by a
  foreign person in order to determine the effect
  of such transactions on the national security of
  the United States.
• Exon-Florio Amendment (1988)
• Byrd Amendment (Continued Dumping and Subsidy
  Offset Act of 2000)
• Foreign Investment and National Security Act of
  2007 (FINSA)

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International Legislation

• Best Practices Initiatives
• International Working Group of Sovereign Wealth
  Funds
• "Santiago principles
• Generally Accepted Principles and Practices
  (GAPP) - framework of generally accepted
  principles and practices that properly reflect
  appropriate governance and accountability
  arrangements as well as the conduct of investment
  practices by SWFs on a prudent and sound basis.
• Organization for Economic Co-operation and
  Development
• Freedom of Investment - launched at the OECD in
  2006, helps governments to reconcile the need to
  preserve and expand an open international
  investment environment with their duty to
  safeguard the essential security interests of
  their people.

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Main Issues

• Sovereign funds control about 3 trillion in
  assets up from 500 million in 1990, and they are
  expected to grow to 10 trillion by 2012. (IMF)
• Most of them are based in the Middle East and
  Asia.
• Because of their growing size SWFs have become a
  major focus of national and international
  economic and financial policy with issues such
  as
• their lack of transparency
• their potential to disrupt financial markets and
  to compete unfairly with private investors
• the risk that political objectives might
  influence their management.

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Transparency and Accountability

• The lack of transparency of most of the SWFs has
  led to several distinct policy concerns about the
  effects of SWF investment.
• The concern is that SWFs may pursue political
  objectives or policy goals that are not strictly
  financial when making their investments.

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Disrupting of Financial Markets and Protectionism

• The concern is that they could cause volatility
  in markets and disruptions in economies.
• There could be a possible protectionist reaction
  by the investee country government local
  government might consider adopting broad
  protectionist financial market policies that
  could harm the countrys economy and its foreign
  relations.
• SWFs may be able to use their status as
  government instruments to compete unfairly with
  private investors.

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Exercising Influence as a Shareholder

• Given the nature of public markets, shareholders
  with even seemingly small ownership percentages
  can exercise influence disproportionate to their
  shareholding.
• The risk is having a SWF exercise influence on
  decisions in a company as a shareholder.
• SWFs may want to use their influence in a company
  to
• extract technology
• protecting their national industries from US
  competition

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Financial Tools or Political Power?

• Unlike central banks, which usually invest
  reserves in assets like U.S. Treasury bonds, the
  SWFs often invest in corporations.
• The concern is whether the governments will use
  the SWFs simply as financial tools or to actually
  implement political power.

• The risk is that political objectives might
  influence their management
• Use funds to create artificial monopolies.
• Transfer of strategic US assets
• Key industries and technologies
• Trade state secrets
• Natural resources

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The Issue National Security
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National Security Risk

• Lack of transparency
• Disguised political objectives
• Transfer of strategic U.S. assets
• Strategic Industries
• Key Technologies
• Trade and State Secrets

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Source Washington Post March 27,2008
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Measuring Transparency Political Objectives
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Transfer of US Strategic Assets

• Dubai Ports World Deal
• Unocal and China National Offshore Oil
  Corporation (CNOOC)
• AES and China Investment Corporation (CIC)
• Citigroup and Abu Dhabi
• Wal-Mart and Norwegian SWF

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Policy Proposals

• International
• U.S. Support Code of Conduct Best Practices
• Santiago Principles
• Domestic
• Current Policy Reform
• U.S. Committee on Foreign Investments in the
  United States (CFIUS)
• Foreign Investment and National Security Act of
  2007 (FINSA)

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Policy Proposal

• Fair and non-discriminatory review of foreign
  investments, specifically SWFs
• Encourage transparency, disclosure, governance
  and accountability
• Limit protectionist barriers against foreign
  investment
• Restrictions on voting rights of SWFs and other
  government-owned investments in U.S. public
  companies.

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Questions?
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Sources

• Guha, Krishna. Sovereign funds sign up to code of
  conduct. Financial Times, UK. September 4 2009.
  http//www.ft.com/cms/s/0/fda301e0-7a19-11dd-bb93-
  000077b07658.html?nclick_check1
• Department of Treasury. CFIUS Reform The Foreign
  Investment National Security Act of 2007
  (FINSA) http//www.treas.gov/offices/international
  -affairs/cfius/docs/Summary-FINSA.pdf
• IMF Executive Board Discusses a Work Agenda on
  Sovereign Wealth Funds, Public Information
  Notice (PIN) No. 08/41 . 2008 (Washington).
  www.imf.org/external/np/sec/pn/2008/pn0841.htm
• International Working Group of Sovereign Wealth
  Funds. Santiago Principles - Generally Accepted
  Principles and Practices. October 2008.
  http//www.iwg-swf.org/pubs/eng/santiagoprinciples
  .pdf
• Investopedia. Sovereign Wealth Fund SWF. 2009.
  http//www.investopedia.com/terms/s/sovereign_weal
  th_fund.asp
• OECD. SOVEREIGN WEALTH FUNDS AND RECIPIENT
  COUNTRIES. 2008. http//www.oecd.org/dataoecd/0/23
  /41456730.pdf
• Teslik, Lee Hudson. Sovereign Wealth Funds.
  Council on Foreign Relations. January 2009.
  http//www.cfr.org/publication/15251/
• The Washington Post, Chinese Company to buy a
  Stake in AES Arlington firm seeks money for new
  projects, ties to Asia, November 7, 2009
• Peterson Institute for International
  Economicshttp//www.iie.com/publications/pb/pb07-
  6.pdf
• International Monetary Fundhttps//www.imf.org/ex
  ternal/pubs/ft/fandd/2007/09/straight.htm
• Wikipediahttp//en.wikipedia.org/wiki/Committee_o
  n_Foreign_Investment_in_the_United_States
  http//en.wikipedia.org/wiki/Dubai_World_Ports
• http//en.wikipedia.org/wiki/CNOOC
• http//en.wikipedia.org/wiki/Abu_Dhabi_Investmen
  t_Authority
• Sovereign Wealth Fund Institutehttp//www.swfinst
  itute.org/
• Testimony before the U.S.-China Economic and
  Security Review Commission Implications of
  Sovereign Wealth Fund Investment for U.S.
  National Security, Daniella Markheim February
  7, 2008
• Norwegian Government Pension Fund Dumps Wal-Mart
  and Freeport on Ethical Exclusions, June 16, 2006
• http//www.socialfunds.com/news/article.cgi/2034
  .html
• The World Next Week Oxford Analytica, October
  2007