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Sovereign Wealth Funds and the Rise of the "Global South"

What insights does a truly global — not just Western — perspective into these new investment vehicles yield?

August 31, 2007

What insights does a truly global — not just Western — perspective into these new investment vehicles yield?

Have you ever wondered how — maybe three centuries ago and more — the peoples of Asia and the United States might have felt about the commercial activities of “foreign” entities like the East India Company?

That institution lasted 274 years, lay at the heart of the British Empire, was empowered to make war and peace — and created monopolies in key commodities and trading routes.

The results of its business operations included the Boston Tea Party, which triggered the United States’ War of Independence and widespread resentment and violent opposition in India.

If we look back even further to the late 14th and early 15th centuries, we slip into a world that was essentially Sino-centric — not Euro-centric, as we are mostly taught.

Christopher Columbus set sail to find markets and gold in East Asia. Vasco da Gama was trying to get to India — and Magellan wanted to find a westward route to the spice islands of Indonesia.

Asia’s riches and development, in fact, have been argued by historians to have been the basis for the growth and concentration of wealth and trade in Europe, particularly in Venice and Genoa. If you go to these cities even today, the historical connections to Asia and the Middle East are obvious and unmistakable.

In effect then, Southeast Asia was one of the most important, richest and oldest civilized regions in its own right long before the birth of Christ. It linked China, Japan and the Pacific islands and served as a gateway for China’s vigorous commercial, cultural and trading influence.

Istanbul capitalized on trade between India, Africa and central Asia. These regions and empires dominated the global economy between 1400 and 1800.

Europe, and later what was to become the United States of America, were the newly industrializing countries of their time.

Capitalizing on their own metals and gold discoveries in the Americas, they used their wealth, their global wanderers and their wit, of course, to mount an eventually devastating challenge to the established Asian and Middle Eastern economic order, so to speak.

Fast forward to 2007 — and you can see that the boot is on the other foot. There is a growing chorus of unrest that can be heard in the West nowadays about the business activities and influence of foreign institutions that we now call Sovereign Wealth Funds (SWFs), or investment funds into which governments channel financial resources.

In a world dominated by globalization, information technology and capital markets, the role and activities of SWFs have become the focus of attention.

Though they have been around for a while, the announcement earlier this year that China was to set up such an institution and authorize its first investment as a $3 billion allocation to the Blackstone Group generated a considerable brouhaha that has refused to die down.

In mid-July, the German government talked about considering legislation to block foreign state-controlled investments, when Chancellor Angela Merkel voiced concern about SWFs.

A week later, the European Commission had launched an inquiry into whether SWF activities were threatening the single market.

In addition, a senior U.S. Treasury official has warned about these investment vehicles in a major speech, and the Bush Administration has asked the IMF to investigate them.

The new French president, Nicholas Sarkozy, has re-emphasized traditional French hostility to foreign participation in strategic sectors and firms with a deliberate reference to them.

That is a curious reaction. After all, these same countries have been investing for centuries in the strategic industries of many of the same countries now seeking to return that favor.

Is this just a bit of Western pique at the financial muscle of mainly Asian and Middle Eastern financial institutions — now that the tables are turning?

Or does it go beyond this, seeping into political and possibly protectionist nooks and crannies, from where it might be hard to extricate common sense?

Just to be clear, SWFs are not central banks. They are separate state-run institutions that have been established either as stabilization or as future-generation funds.

Stabilization funds — such as those set up by many oil and commodity-exporting countries — accumulate assets to invest for the future. They may be called upon at any time to help support government programs in the event of a sudden or sustained shortfall in commodity export revenues.

Future generation funds have a more explicit long-term raison d’etre, namely, to invest assets for the long-term good of the country’s citizens and their welfare.

Together, these institutions manage about $2.5 trillion in assets, the stock of which may be growing at about 15-18% per year. At present, there are roughly 30 SWFs — about half of which are located in Asia and the Middle East, if one includes not just the central Asian republics that have SWFs, but also Russia.

This half of the SWFs manages about 80% of the assets. They include those held by China, Hong Kong, Singapore, Korea, Malaysia, Russia, United Arab Emirates, Saudi Arabia, Kuwait, Qatar, Dubai and Algeria.

So these are financially well-endowed and powerful institutions that — for the most part (Norway is the exception) — don’t report on their activities or operations. Thus, they remain essentially hidden from view as regards global financial markets.

In this respect, of course, they remain quite different from central bank institutions. Anecdote and history suggest that SWFs tend to be long-term in their outlook and cautious in their asset allocation.

They tend to prefer equity-type investments, including direct stakes in companies, infrastructure, private equity, hedge funds and external managers.

To the extent that they are investing overseas the savings that their countries generate that can’t be invested locally or spent on imports, the economic function played by SWFs is constructive. They help channel — or recycle — capital to countries that need it to make the books balance (e.g., the United States) or just need it (e.g., emerging nations).

So what’s all the fuss about? It’s basically about their lack of transparency, as perceived by the West. If we don’t know what they’re doing — and if there isn’t full and proper governance — they may be courting uncontrollable risks that they might not be aware of.

This didn’t stop us Westerners, mind you, from deregulating financial markets and creating exactly these risks in global credit markets, which — due to recent “subprime” events — are now clear for all to see.

If we don’t know what they’re doing, won’t they end up distorting the free flow of goods and services in our economies? And if we don’t know what they’re doing, how do we know they won’t take stakes in strategic industries like banking, aerospace, defense, nuclear technology and so on?

We could debate this ad nauseam — and there probably is a case that properly functioning capital markets, especially cross-border flows, in a globalized world should be open and transparent. Or at least, where there are restraints or limits, these should be open and internationally agreed upon.

But in the end, doesn’t the fuss just come down to protectionism by another name?

This speaks to an underlying concern that the economic and financial power of the West is on the wane. That is certainly true in relation to East Asia, Russia and the Middle East. We now live in a world characterized by both a secular shift in power towards the Orient and shortages of energy.

Since we Westerners can’t change either of these phenomena and can’t sanction mass protests against SWFs along the lines of those carried out by early Americans and Indians against the East India Company, the best thing surely is to engage.

SWFs may not want to open up, for one reason or another, but that doesn’t mean that we can — or should ignore them or see and treat them as threats. Protectionism in any form is a lose-lose situation.