from Follow the Money

SWFs to IMF: mind your own business, not ours …

February 10, 2008

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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. My own work tracking global reserves hinges on the data many central banks now release (January, incidentally, is shaping up as a huge month for Asia). 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. Abu Dhabi, Inc more or less said as much. The chairman of ALDAR, Ferrari’s theme park partner noted:

Mubadala Development company’s purchase of Ferrari shares earlier this year allowed ALDAR an opportunity to forge a relationship with one of the world’s leading brands. We are delighted that this opportunity has swiftly progressed into an exclusive agreement, which has arisen from the natural synergy of ideologies and objectives between Ferrari and ALDAR.

From Ferrari’s point of view, the backing of Abu Dhabi’s government likely made the theme park a much more attractive investment.

-- 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. Borrowing in RMB and buying dollars, Australian dollars, pounds and euros is a fairly sure-fire way to lose money, at least in the short-run. The CIC’s primary purpose is to provide an alternative sterilization mechanism. Parts of China’s bureaucracy also liked the idea that the CIC would loosen the PBoC’s monopoly on the management of China’s foreign portfolio.

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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