Sovereign wealth to who’s rescue? (Again)

Rachel Ziemba
17 Jan 08

The second round of sovereign wealth injections to financial institutions began today with GIC/KIA/KIC buying into Merrill and GIC/KIA buying into Citi. Other investors included Mizuho for Merrill (marking the first such investment since Japan’s crisis). key Citi investors like Saudi prince Alwaleed also added money to maintain their stakes. Today’s news that Citi and Merrill Lynch would receive massive capital injections (led by sovereign investors) was highly anticipated. Merrill has been seeking new funds almost since it announced the previous injection Dec 24 and it has seemed a done deal since the big WSJ piece last week detailing likely capital injections. The scope of these injections might mean that we are on track to exceed the almost $30b sovereign funds invested in financial institutions in Q4 (see here for more or a nice chart here).

But how far will the sovereign wealth ATM last? the available assets do depend on what share of oil revenue is spoken for elsewhere, the persistence of large surpluses in Asian countries. but aside from that, will there come a point when sovereign investors will feel over extended in the financial sector. Does this second round mean that we are at the bottom or just in the middle? At what point will sovereign funds worry about their implied losses. Even long-term investors could be forced to sell unpopular losses. Or are these banks now undervalued and good purchases?

These deals are fairly similar in structure to those from Q4. They involve preferred shares that may convert to stakes in perhaps two years time. However, the FT noted that Citi’s new shares did more to protect these new investors from the downsides than those of late November. That is the banks are guaranteeing an even higher upside even if share prices stay low. Again, investors stressed the passivity of their investments, their unwillingness to take on a management role and their long-term horizon.

Another interesting addition to previous such deals, Citi will offer convertible shares to the public also. Previous private investors complained that the good terms on the convertible shares were not available to others. The WSJ noted the purchasing power of sovereign investors thus – in explaining the investment of the New Jersey investment dept alongside the state funds: At the same time, buying alongside deep-pocketed partners helped New Jersey get attractive terms.

“Whatever pricing power is, these people have it,” says the source, referring to the overseas investors. The article also suggests that adding some US investors might have been part of a plan to ease regulators concerns.

As I suggested today (among other musings on SWFs) on CNN International (link not yet available) and yesterday on CNBC the fact that these investors are abdicating their voting rights might not be the panacea some hope. While this is unclear, there is another risk, that too many investors will give up their voting rights thus degrading the rights of other stock holders. Other sovereign funds include DIC and Temasek have history of installing good independent directors in some cases. Although giving up rights was intended to ease regulatory concerns, it may raise others.

Though sovereign funds might also get a bit concerned that the recipients want it both ways – they want funds, but they also want to know the asset allocation. In fact KIA is on record wondering what bar governments will set – do they want it announced before one makes the investment?

We are clearly seeing more interdependence between financial institutions and sovereign funds. It is a real evolution. Many of these funds had entrusted high levels of funds to some of the banks, financial institutions over the years. More on the interdependence of key asset managers and sovereign funds in an upcoming post.

As rumored, the Kuwait Investment Authority emerged as one of the larger investors in these deals – taking stakes of around $4b in Merrill and an undisclosed amount in Citi. Over $5 billion in total. A recent article by Henny Sender, seemed to indicate that Kuwait was waiting for the right opportunity to buy up distressed US financial assets – and that it had learned that speed was necessary to catch up – a bit of envy perhaps. So Kuwait’s investment didn’t come as a shock. KIA officials cited the opportunity to snap up good assets at cheap prices – and stressed the passivity of their investment. But if they wanted to make a splash, buying into two big financial institutions is probably a good way to do it.

Singapore’s GIC which previously took a stake in UBS in December stepped up for $6.88b – apparently making up the shortfall for anticipated investment from the China Development Bank.


The combined total of over $15 billion probably indicates that they manage a lot more than the “over $100 billion” that they disclose publicly – probably over $200 billion – top i-bank estimates have reached $330 billion but that doesn’t seem to square with the portfolio investment reported in Singapore’s International Investment Position.

Temasek also invested in Merrill last month.

Like ADIA, both of these funds have a history of being largely portfolio investors, tending to take smaller stakes, tending not to disclose their stakes – KIA did take some large stakes in the 80s and 90s in Spain, some of which it had to sell at a loss and in Daimler and BP. But since then it has tended to be a more passive investor. In fact, until a portfolio shift a few years ago, US treasuries were thought to dominate. But it has upped holdings in EM, hedge funds and private equity , investing with rather than competing with the funds though. But perhaps with the exception of Norway (and maybe Kazakhstan) pure portfolio investment may be on the way out for sovereign funds. After all, even Korea is getting in on the action. Next we’ll have to watch Russia.

Speaking of Korea, the Korea Investment Corp is another unknown quantity. It has been slower to get off the ground since being launched in 2006. It took quite a while for it to place its initial $20b in capital, perhaps because it was quite restricted in where the capital could go. Emerging markets were out as were equities. It was not until this fall that KIC announced it had placed most (around $17b of its capital). At that point it also received another $10b and the right to invest in foreign equities, citing university endowments as its new model. WSJ’s Deal blog reports that the investment in Merrill is the first such deployment of this new $10b. Is it also the start of a new approach for KIC? I wonder how popular or unpopular such a decision will be in democratic Korea. However, domestic press has been quite insistent that Korea has been slow to get higher returns on its large reserve stockpile.

Perhaps the biggest story is who wasn’t there – China. Yesterday, it was highly rumored that China’s CDB would take a $2b stake in Citi, until reports surfaced that the Chinese government would block the purchase as it reportedly ultimately did.

Has the Chinese government decided it has enough exposure in the US financial system?


Is it afraid of more losses particularly those of the state banks recently recapitalized?


Caijing suggested that CDB had been too quick off the mark in buying into Barclays last summer – not accounting for its liabilities.


Or as Tan Wei suggested, will CIC now move away from financial sector assets or is this a reflection of issues between the different managers of China’s foreign portfolio. Brad Setser has a great new paper out on Chinese foreign asset management and underlying political tensions. He writes:

The consensus that China had enough liquid reserves, however, doesn’t seem to be matched by a comparable consensus on how China should manage its rapidly growing external portfolio. The precise mandate of the institutions – like the CIC – that have been created to manage China’s foreign assets has yet to be established. Existing institutions – whether the State Administration of Foreign Exchange (SAFE) or the state banks – are under pressure to increase the returns on their foreign investment.

Or is Citi not well placed for pending domestic asset management and financial sector development as other purchases have.

The other interesting absence – the smaller funds from the gulf. DIC did announce a series of purchases in November, including Sony. But the others have been relatively quiet. Perhaps they are merely waiting for new opportunities to come along at cheap prices. But it seems not coincidental that the sovereign funds that relied most heavily on leverage are absent in a time of higher credit costs, which discouraged deals with a lot of debt. However, several funds pointed to the opportunities inherent in the current climate. Though they may be more interested in other sectors

One possible headwind to this second round of capital injections (and possible third and fourth rounds that some analysts have suggested) is rising political concerns. Regulators are starting to worry lest sovereign investors act in concert – with several 4-5% stakes turning into 15-20%. Rhetoric (and plans) from politicians in France (Sarkozy whilst in the gulf selling French nuclear technology), Germany (plans for a new takeover law after the old one barred some intra EU investments) and the US (Senate banking committee is calling for a closer look at SWFs and a GAO study). After all it with sovereign funds as the new go to capital source, it seems harder to push them to be more transparent – especially as many of them seem to be waiting to be given credit for their investments.

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