Sovereign Wealth Funds Say No on Transparency

It’s sad to watch America operate in the illusion that it can exercise much influence over the trajectory of its decline. Mind you, that slippage isn’t inevitable if we were willing to course correct and endure an unpleasant period of low to negative growth as we lowered consumption and increased savings.

But since that program is too unpalatable, we instead are trying to continue to take funds from high savings countries to keep our debt habit going. The problem is that those nations are no longer willing to buy cheap Treasuries; they now want to make some high return investments too, and the amount they will wind up buying is so large as to tip the economic balance of power in a very visible way (mind you, it was shifting regardless, but the man in the street isn’t aware of how large China’s and the Gulf States’ Treasury and agency holdings are).

So politicians and policy experts are trying to find ways to make this buy-up seem a bit less threatening. One plan has been to have the prime actors, the sovereign wealth funds, be more “transparent.” What that means in practical terms isn’t all that clear, but presumably the funds would disclose things like target returns, allocation strategies, and other investment objectives. Of course, that means the funds will have to say they have strictly financial (as opposed to political or mercantilist) objectives, which would simply be obligatory boilerplate.

But the SWF have not interest in this charade. Amusingly, they cite the precedent of the US refusal to require hedge funds to provide more disclosure.

Brad Setser, in “SWFs to IMF: mind your own business, not ours …,” goes through these issues in more depth. There is only one bit where he hits a wrong note. He says that the SWF haven’t used their investments in hedge funds to push for more transparency.

Huh? The main reason for wanting hedge fund transparency was to look at aggregate behavior: flows in and out of sectors, the use of leverage. Investing in some specific funds does not give you sufficient influence over an entire industry to force disclosure. As as far as individual funds are concerned, a professional investor ought to get a good deal of disclosure before putting any money down. It’s called due diligence.

From Setser:

It doesn’t seem like the IMF’s code of conduct for sovereign wealth funds is going anywhere. The power brokers in today’s global financial system argue that they are already commercially-motivated, so there is no need for them to promise to make only commercially-driven investments. And big sovereign funds don’t see the need for much (more) transparency either.

The difficulties agreeing on a code likely reflect the enormous differences among different sovereign funds — differences that reflect the differences in the countries that gave rise to the funds. Steven Weisman of the New York Times:

A week ago, Lou Jiwei, head of China’s $200 billion fund, said at a talk at the World Bank that the I.M.F.’s effort had run into disagreement over the meaning of transparency and political motivation: “It seems there wasn’t any agreement on that, because nobody wants to accept the fact that anybody’s better than themselves,” Mr. Lou said.

Apart from having lots of cash, Norway, Singapore and Abu Dhabi have relatively little in common – and no tradition of working together. Getting agreement among the G-7 is hard; getting agreement among the SWF-3 (or SWF-7) is probably close to impossible.

One contrast between today’s subprime crisis and the Asian crisis: in 1997 and 1998, the US — which then acted as creditor in the global financial system — used its leverage to increase the transparency of key actors. The US, notably, pushed for central banks to disclose far more frequent and accurate information about their reserves. The idea was to keep centrals banks from secretly mortgaging their reserves in a vain effort to defend currencies pegs — as Thailand had done.

Those efforts had a real impact….The increase in transparency didn’t come without the exercise of a bit of leverage: the US made reserve disclosure a de facto requirement for borrowing from the IMF. One result: Countries that managed to avoid turning to the IMF back in the 1990s are systematically less transparent than countries that had to turn to the IMF.

Today, of course, the US is the borrower not the lender. And the big creditors today aren’t using their leverage to push for more transparency — but rather to resist such efforts.

The argument that SWFs shouldn’t increase their transparency now because the US resisted efforts to require more disclosure from hedge funds back in the 1990s strikes me as a red herring. If McKinsey’s report on “The new power brokers” is right, the big SWFs themselves already have large investments in a range of hedge funds and private equity firms. So far, they haven’t used their financial leverage to push for more hedge fund transparency.

Similarly, they didn’t condition their capital injections into Wall Street banks on more transparent disclose of the banks’ off-balance sheet positions.

Wall Street — I suspect — increasingly thinks it stands to gain far more if from untransparent funds than transparent funds. I strongly suspect — though of course I do not know — that the large untransparent funds generate substantially more fee income than say Norway’s government fund. The government fund tries to maximize returns — given the constraints on its mandate — in part by minimizing costs.

Plus, with the exception of Korea’s investment corporation, the big capital injections into Wall Street Banks have come from untransparent funds. That probably isn’t an accident. Funds that work within a mandate set by a democratically elected government might might need parliamentary approval for such a shift in strategy; at a minimum, they would need to be able to defend their investment in potentially risky institutions on terms that didn’t give them any formal control.

I also increasingly find the debate on “political” v “commercial” investments a bit frustrating as well. It assumes a clean dividing line between “commercial investment” and “political investment” that I am not sure really exists.

All sovereign funds are motivated by returns: none has a mandate to lose money. As a result, most funds are unlikely to make investments that result in large losses (at least intentionally) to produce political gains. Just think of the heat that the CIC has taken on its investment in Blackstone.

At the same time, most sovereign funds seem quite keen to do “deals” that offer the prospect of both strong financial returns and spillovers that benefit their home country. Consider:

— Dubai and Qatar were interested in NASDAQ and OMX because they believed that a stake in these companies would further their own ambitions to emerge as the Gulf’s regional financial center.

— Mubadala’s investment in Ferrari likely played a big role in Ferrari’s decision to build a theme park in Abu Dhabi….

— The game also works both ways. Qatar airlines ordered a lot of A350s in mid-2007, helping Airbus — and thus France and Germany — out. That deal was signed in the presence of French President Sarkozy and Sheikh Hamad bin Khalifa Al-Thani. The QIA, along with DIC, takes a stake in EADS, Airbus’ parent company.

— At least some Gulf funds seem to think that they have done the US as a favor — not just made a good commercial investment — by taking big stakes in troubled US banks. Qatar’s Sheik Hamad Al-Thani: “But after the crisis I think most of the sovereign wealth funds, which have helped in the United States and elsewhere in Europe, this has been welcomed by the government.”

And then there is the vexing set of issues surrounding the CIC.

The overarching motivation for the founding of the CIC wasn’t to make money….At the same time, no one should doubt that China is looking for better returns than it could get from Treasuries and Agencies. If the CIC doesn’t produce better foreign currency returns than SAFE, it is in trouble.

One of Lou Jiwei’s comments in the Weisman article jumped out at me:

Mr. Lou … said concerns about political motivations were unfounded because China’s fund invested mostly in portfolios, or took small positions in companies and did not try to control their policies.

Lou’s argument that the CIC took “small positions” seems at odds with the CIC’s current portfolio, which — best that I can tell — is dominated by large stakes. The CIC has large stakes in four state banks (ICBC, CCB, BoC and CDB), a small stake in China Railways and stakes in Blackstone and Morgan Stanley. It supposedly will be investing with JD Flowers. Its portfolio investments seems dominated by large stakes in the financial sector — see this article.

To me, the big surprise from the CIC has been its — to date — its lack of a conventional diversified portfolio of small stakes in a broad range of companies.

The fact that the CIC holds China’s stake in its state banks indicates it has a mandate that goes beyond simply looking for the best risk-adjusted return. At the same time, it is hard to draw a clean line between the CIC’s non-commercial activities and its commercial activities. The CIC probably has done far better on its China Railways stake (An investment supposedly done for “short-term earnings”) than on its Blackstone stake.

An era of state-capitalism and state-led globalization will inevitably blur a lot of limes. A sovereign fund could well end up doing better on its investments in its own state-banks than on the rest of its portfolio. Does that make such investments commercial?

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