The Rise of Sovereign Wealth Funds (SWFs) in the Age of Uncertainty

The Rise of SWFs

Sovereign Wealth Funds in the Middle East and Asia have accumulated US$2.8 trillion in assets and are multiplying their global acquisitions, according to a study by Morgan Stanley. Merrill Lynch estimates that SWF investments may quadruple to US$7.9 trillion by 2011. Morgan Stanley expects them to reach US$12 trillion by 2015. Mckinsey believes that this large liquidity contributes to global low long-term interest rates.

The Abu Dhabi Investment Authority (ADIA) has a war-chest of US$ 900 billion. It recently acquired 7.5% of Carlyle Group for US$1.35 billion and 5% of Citigroup for US$7.5 billion. It has also bought an undisclosed stake in SONY. This was outdone by the Kuwait Investment Authority (KIA), which took a stake of US$14.5 billion in the Citigroup, along with Saudi Prince Alwaleed bin Talal and Singapore’s Temasek. Dubai Sovereign Funds have snapped up shares in big names such as MGM Mirage casinos, aerospace giant EADS and the Barneys department stores. and Qatar HoldingDubai Borse have bought 24 and 28 % respectively of the London Stock Exchange, vying to take control of the Nordic stock exchange operator OMX. Dubai has formed an alliance with Nasdaq, of which it already owns about 20 %. All these are likely to be dwarfed by Saudi Arabia, which is expected to be setting up soon ‘the mother’ of all sovereign funds.

At the end of 2006, Asian central banks were accounting for $3,100bn of global SWF investments. That was more than double the total assets managed by hedge funds and quadruple those held by global private equity. By the end of 2007, Asian FX reserves were up 20 per cent to $3,700bn. As for petrodollars, McKinsey Global Institute calculates that with oil prices above $70 a barrel, $2bn of new petrodollars will enter global financial markets every day.

The Singapore Investment Corporation (SIC) has been very active. After acquiring a 12% stake for US$ 4 billion to become the largest shareholder of Standard Chartered Bank, it has bought 9% of UBS for US$ 9.75 billion and 10% of cash-strapped Merrill Lynch for US$ 5 billion.

The China Investment Corporation (CIC) has been set up to manage US$200 billion of China's US$1.4 trillion foreign currency reserve. It has acquired a 9.9% stake for US$ 5 billion in Morgan Stanley, following an earlier 10% stake for US$ 3 billion in Blackstone. All of China’s major multinationals are controlled by the state. Their funds and investments are therefore considered in the same category. China’s Industrial and Commercial Bank of China (ICBC), the world’s largest bank by market capitalization, has taken a 20% stake (US$ 5.6 billion) in Standard Bank, the largest bank in South Africa. This was the largest single foreign direct investment in Africa. This followed China Development Bank’s acquisition of a 2.6% stake for US$ 3 billion in Barclays Bank and Citic Securities’ 6.6% stake for US$ 1 billion in Bear Stearns. China has now spent US$ 29.2 billion in acquiring overseas assets.

Objectives of SFSs

By definition, SWFs are not answerable to private shareholders. Because of their size, they are often used as instruments of the state, to invest in strategic industries, to gain relevant business or technological expertise, and to build up the presence of the country owning such funds in their target investment locations. China’s SWFs, for example, are set up for the following reasons:

(a) to look for higher returns for her huge foreign currency reserve;
(b) to reduce her excessive domestic savings and liquidity;
(c) to help redress the global financial imbalance;
(d) to relieve international pressure on the RMB to appreciate too fast;
(e) to facilitate the globalisation of China’s financial services;
(f) to sharpen her international financial expertise; and
(g) to gain international strategic leverage.

SWFs are sometimes regarded as investing in ‘risky assets’ but are generally run according to commercial principles. The ADIA, for example, has teams of world-class financial specialists and professionals. However, as SWFs tend to be controlled by less democratic and less transparent states, there are legitimate concerns with geopolitical undertones about their overseas investments.

In any event, some countries tend to regard some of their national business icons off limits to foreign ownership. For example, France did not want Pepsi Cola to take an equity stake in her yogurt conglomerate Danone. Others, e.g. the US, may be worried about foreign investment in what are regarded as strategic assets by a different political regime such as China. These apprehensions managed to scuttle China National Offshore Oil Corporation (CNOOC)’s bid for UNOCAL earlier. Similar concerns have been raised in the EU, notably Germany and France. Other countries, such as South Africa, may have a more open mind. To vet politically-sensitive SWF investments, the US has an inter-agency ‘Committee on Foreign Investments in the United States’ (CFIUS). Other developed countries have similar mechanisms. Most of these misgivings, however, may be more imagined than real.

The Age of Uncertainty

As a source of huge and ready cash, SWFs are becoming increasingly welcome in a world reeling from a global credit crunch coupled with a host of financial and economic uncertainties. Particularly -

(a) the crunch doesn't look as if it is going to peter out any time soon. No one can rule out the possibility of still some more dirt being revealed from under the carpet of more major banks and finance houses;

(b) the global financial imbalance doesn't look any less precarious. The USD continues to appear sickly with the US economy weighed down by sub-prime jitters. Major USD holders including central banks, SWFs and petrodollar owners are likely to further diversify their currency baskets. There is danger of a vicious circle leading to plummeting confidence in the greenback;

(c) the prices of energies and commodities, including minerals and foodstuffs, continue to rise worldwide, fuelling inflation and recession fears;

(d) in the short-term at least, the Fed seems ready to sacrifice inflation safeguards by continuing to lower interest rates to stimulate the economy; yet much of these lower rates do not pass to the final consumer borrowers owing to increased credit risk aversion;

(e) job losses and lowering wages are translating into rising protectionist sentiments on both sides of the Atlantic. This is bad news for international trade.
The above shows that amidst the current global credit crunch, SWFs are increasingly being courted as white knights in shining gold armour for the rescue of banking damsels in distress. This is underpinned by a desire to forge closer links with some of the world’s most dynamic emerging markets.

Conclusion

SWFs command massive financial resources and are becoming increasingly prominent internationally. How they choose to invest or park their money has a significant impact on sectors, industries, economies, and currencies, if not whole countries. Because of their very nature, SWFs tend to be less transparent and are less able to meet full disclosure requirements. They deserve to be closely monitored and regulated. But a balance needs to be struck between suspicion, caution, and genuine commercial considerations, especially if the stake is not large proportionally, if the investment does not carry any voting rights, and if such investment does not compromise national security.

No country even if able to do so should copy the Middle East and East Asia by rushing ahead to establish its own SWF. These funds are usually the product of external circumstances. In the case of the Middle East, they are the product of concentration of oil reserves coupled with an unprecedented rise in oil demand and prices. In the case of China, they have arisen from her export-oriented and fully globalized manufacturing powerhouse and a less developed internal financial investment market.

If not used properly, a SWF may run the risk of weakening private sector competitiveness of the country owning the SWF. Channelled properly, however, they should be welcome as a most potent force for good. They will provide the developing countries concerned with more exposure to international best practices. They will integrate them even more closely with the global trading system. Above all, these mountains of gold in the East could well provide the financial impetus required in partnering with Western green energy and environmental companies to cash in on the benefits of accelerating global responses to Climate Change (See my article ‘China and the Middle East: an Eastern Alchemy for Global Harmony’ under Publications on my website below). This may be a most meaningful way to finance the Bali Roadmap on Climate Change and to turn its international rhetoric and intention into reality.

Andrew K P Leung, SBS, FRSA

www.andrewleunginternationalconsultants.com

The Bali Roadmap and the Geopolitics and Geo-economics of Climate Change

The Bali Roadmap on Climate Change was drawn up in a drama of agony and ecstasy about Planet Earth and North-South responsibilities. Yet the familiar TV images of threatened polar bears and smoke-belching factories hide tectonic shifts in geo-economics and geo-politics that are quietly re-shaping the world.

Though timely, the feeble Bali Roadmap is no guarantee of deliverance from fossil fuel addiction. Notwithstanding recent dramatic strides in renewable energies, the West is likely to rely mainly on fossil fuel to maintain a mobile individualistic lifestyle. Likewise, the newly industrializing and urbanizing countries will continue to depend on it for sufficient manufacturing jobs to maintain economic progress and political stability. China alone has to generate at least 24 million jobs a year to stay even. India, set to overtake China as the world’s most populous country in about four decades, cannot rely on IT services alone to employ her teeming millions.

Unlike previous Industrial Revolutions, populations across the developing world are industrializing all at once. They are rightly wary of restraints on their long-awaited development opportunities. Their Western counterparts are equally unenthusiastic about restrictions of their preferred lifestyle. Until a viable alternative energy source is found on a global scale, there will be increasing concerns about energy security, scrambles for fossil resources and shifts in the world’s economic and geopolitical landscape, set against the background of Climate Change.

There are five drivers at work.

First, rapidly rising energy prices have dramatically boosted the confidence and international influence of countries rich in fossil energy. Some of these countries, such as Russia, Iran and Venezuela, are flexing their energy muscles to gain geopolitical space. Others, especially the petrodollar countries, are making their mighty financial presence felt across the globe. For example, the Abu Dhabi Investment Authority has acquired 7.5% of Carlyle Group for US$1.35 billion and 5% of Citigroup for US$7.5 billion. This was outdone by the Kuwait Investment Authority, which bought a US$14.5 billion stake in the Citigroup, along with Saudi Prince Alwaleed bin Talal and Singapore’s Temasek. Saudi Arabia, a gigantis inter paris amongst the Gulf Cooperation Council (GCC) states, has a domestic investment fund of US$600 billion with projects in the pipeline over 20 years. There are talks of a GCC Monetary Union for 2010. The attitude of OPEC countries on what currencies in which to keep their oil wealth would have a major impact on the US dollar and global financial stability.

Second, we are seeing new energy geopolitics and geo-economics re-defining relationships in Central Asia, as in the case of the Shanghai Cooperation Organization. (See my article of 17 June, 2006‘What the Shanghai Cooperation Organization means for the global order’ under Publications). We are seeing them in Australia, which is fast emerging as a major provider of much sought-after mineral resources, including uranium for the world’s resurging nuclear energy programmes. We are seeing them also in resource-rich countries in South America, such as Venezuela and Brazil. In particular, Brazil is the world’s leading exporter of ethanol, produced from her abundance of sugar cane. As some 65% of Brazil’s cars already use bio-fuels, the Brazilian experience is a well-fitted laboratory for the world’s business-savvy auto giants on cue to revolutionize the world’s future car industry with green energy cars.

Third, insatiable global energy demand has given Africa a new-found dynamism, putting her in the spotlight of global geopolitical attention. At the recent EU/Africa Summit in Lisbon, the cool reaction to the EU’s bilateral economic partnership overtures is a sign of rising African pride, nationalism, and solidarity. This display of African strength reflects an awareness that an energy and resource-hungry world seems to be competing in a new courtship of Africa. China’s pervasive and ideology-free investments are seen in the context of her geopolitical influence in this resource-rich and strife-ridden continent. While the EU is redoubling her efforts to engage Africa, the US is considering relocation of her African strategic command from Frankfurt to Africa.

Fourth, energy security has come up on top of many countries’ political agenda. In his last State of the Union Addresses, President Bush re-emphasized the reduction of gasoline usage by 20% over the next 10 years in order to achieve the target of reducing Middle East oil import by 75%. He set great store on renewable energies and bio-fuels as well as technologies for plug-in and hybrid vehicles. Similar calculations of energy security inform the EU’s energy policy, ever conscious of the long arm of Russia’s energy reach. China is well aware of her own conundrum. Internally, she has to take the pollution together with the world’s outsourced energy-intensive manufacturing. Externally, she has to contend with the world’s competitive energy geopolitics. Accordingly, she has mandated sustainable development together with emission and energy input reduction targets in her 11th Five Year Plan (2006-10). (See my article of 8 August, 2006 ‘Energy Security and Countering Climate Chaos: China’s Approach and Global Impact’ under Publications). That’s why China, along with India, played an enthusiastic and constructive role in the negotiations for the Bali Roadmap.

Last and definitely not least, a recent study by Trausti Valsson (How the world will change with Global Warming, University of Iceland Press, 2006) shows how the momentum of global warming may change the balance of the world’s economic gravity dramatically towards the Artic. We are already witnessing a flurry of active interests (including Russia) in staking territorial claims on the Artic’s cornucopia of oil, gas and mineral deposits. Over the next few decades, the melting of Artic ice is set to open up much shorter shipping lanes connecting the North Pacific with the North Atlantic through the Bering Straits and the Canadian archipelago. The Davis Strait, the Denmark Strait, the passage between Iceland and Norway, and the so-called GIUK (Greenland, Iceland and UK) sea lanes are also likely to gain commercial and geopolitical importance, along with the position of Alaska, the Kamchatka Peninsula, the Sea of Okhotsk, and the Aleutian Islands. In an extreme scenario, if global warming persists at its current pace past 2100, the centre of the world’s economic gravity is projected to shift towards the Northern Hemisphere near the Artic (thought to be virtually ice-free by then) while the world’s current temperate zones may become overheated and the Southern Hemisphere relatively marginalized. Even if this extreme case does not materialize, the on-going geopolitical and geo-economic implications for countries with existing Artic territorial claims such as Russia, Canada, the Nordic countries and the US would demand serious attention. The same goes for the implications for countries such as China and India without direct and ready Artic access.

Needless to say, the above implications are over and above the threatening projections of rising sea-levels, disrupted Gulf Stream flows, methane release by melting permafrost in the Siberian tundra, and other looming ecosystem dislocations.

Before the Bali Roadmap has a chance to re-shape the world’s climatic order, the global geopolitical and geo-economic landscape is poised to change almost beyond recognition in the 21st century.

Andrew K P Leung, SBS, FRSA

www.andrewleunginternationalconsultants.com