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Laurance and Louise Armitstead
Funds backed by foreign states could have $12,000 billion to invest by 2012. The financial muscle of these vehicles, their lack of transparency and their uknown motives are now causing alarm in the West
Alistair Darling chose his words carefully: he was scrupulously careful to maintain the pro-free trade line of his predecessor. As finance ministers and central bankers milled around at the meeting of G7 countries in Washington last weekend, the chancellor declared: “We believe in liberal trade . . . The reason London is the world’s No 1 financial centre is because we have a very open economy.”
But, he made clear, his adherence to the free-trade mantra is not going to blind Britain to the threat of the huge and increasing power being wielded by sovereign wealth funds – investment vehicles backed by governments in the Middle East, China, Russia and elsewhere. These funds, he said, “need to play by the rules”.
The subtext was clear: sovereign funds – and, indeed, other investment groups controlled by foreign states – are not going to have completely free rein.
Darling said: “When a company is not acting in a commercial way or we have reason to believe it is going to make an investment where there is an issue of national security, then we have powers to take action.”
Behind the scenes, his advisers were rather more explicit: if Russia’s Gazprom has ambitions to take over Centrica, the parent of British Gas, then it can think again. No deal.
Sovereign funds have been around since 1953, when the Kuwait Investment Authority (KIA) was established to benefit future generations of Kuwaitis when the oil stopped flowing.
But it is only since the turn of the millennium that the power of sovereign funds has mushroomed. The rising price of oil and gas has prompted Middle East countries to look for new ways to invest their piles of cash. Russia has money to spare as energy prices have soared. At the same time, funds in Singapore, and more particularly China, have been boosted by income from huge trade surpluses.
Darling is not alone in raising questions about the way this money will be deployed. Other western governments have been squaring up to the issue. As the G7 meeting was getting under way, French president Nicolas Sarkozy said: “We have decided not to let ourselves be sold down the river by speculative funds, by unscrupulous attitudes that do not meet the transparency criteria one is entitled to expect in a civilised world. It’s unacceptable and we have decided not to accept it.”
In Germany, the government is expected to propose legislation before the end of the year which would give the power for the state to vet foreign investments. German chancellor Angela Merkel has called for the problem of investment by state-backed funds to be tackled “with some urgency”. The European Commission is examining the funds’ effect on Europe’s capital markets.
And in America, protectionist rhetoric is proving popular in Congress in the run-up to election year. There are dozens of bills floating around – most aimed at China. There is a mood of anxiety – a feeling that can only be reinforced by this month’s news that China is putting $1 billion (£490m) into Bear Stearns. A sign of American jitters about foreign state ownership of key assets came last year, when congressional pressure forced Dubai Ports World to sell five American terminals acquired as part of the takeover of P&O.
US treasury secretary Hank Paulson has asked the International Monetary Fund (IMF) and World Bank to draw up guidelines for investments by government-run funds. SO are sovereign funds to be feared or welcomed?
For investment banks, they form an important market to be tapped. Guy Cornelius, a managing director at Lehman Brothers in London, said: “Sover-eign-related investment entities are not a new client base for us; they have always been very important. However, the breadth of their investment activities has been increasing over the past couple of years and we had to respond to that.
“One size does not fit all. Sovereign wealth funds vary greatly in size, transparency, risk appetite and asset diversification and need a bespoke approach that will in part be dependent on what percentage of their assets they choose to directly manage or outsource to third-party managers. The one thing they have in common is a high degree of sophistication.”
Their growing size offers an opportunity for asset managers. But for governments, it represents a challenge.
Simon Israel, chief operating officer at Temasek in Singapore, said: “The world, and particularly western governments, have only recently woken up to the wealth of sovereign funds – mostly because the advent of the Chinese funds has changed the order of magnitude of the wealth. There’s a sudden realisation that this wealth is heading towards the international financial and capital markets. I don’t think many governments have had time to think about what this means.”
The key economic force behind these funds’ growth is the imbalance in world trade; some countries are running huge surpluses. The pool of money in nonwestern hands – held as foreign-exchange reserves or sovereign wealth funds – grew by $1,200 billion in 2006 alone. But America, the European Union and Britain – the three main issuers of safe, highly liquid official securities – sold only $461 billion in government paper last year. Simple arithmetic means the Chinese, Arab and Russian holders of dollars, euros and sterling have sought other vehicles through which to invest all this spare cash; sovereign funds are one of those vehicles.
In Britain, the huge power of sovereign wealth funds has become manifest. The London Stock Exchange has found itself at the centre of an extraordinary tussle for dominance by two of the Middle East’s most powerful state investors. Despite some hiccups late last week, J Sainsbury is likely to fall into the arms of Qatar. Only last week, the Korea National Oil Company – not strictly a sovereign fund, but still state-controlled – signalled that it would be prepared to bid £1.7 billion for Britain’s Burren Energy.
The clout of sovereign funds can only increase. Stephen Jen, chief currency economist at Morgan Stanley, estimates that even if China tries to rein in its current-account surplus, the country’s sovereign fund could grow by $200 billion a year, becoming the world’s largest within a few years. As Russia capitalises on the rising price for oil and gas exports, its fund could grow by $40 billion a year. The IMF estimates that total investments by sovereign funds have reached $2,000 billion and could hit $12,000 billion by 2012.
Kuwait’s KIA has long beena conspicuous investor. In 1974, it snapped up St Martins Property Corporation. Then, in 1983, it bought Autobar, one of Europe’s largest drinks and food-vending business. And in 1987, in the aftermath of the disastrous privatisation of BP, the Kuwaitis took a 22% stake in the British oil company. Today, Kuwait is reckoned to own about 2.5% of BP.
Other states in the Middle East have followed in the KIA’s footsteps. The Abu Dhabi Investment Authority (Adia), founded in 1977, is the next oldest sovereign fund. It is also one of the most opaque; estimates of its funds vary between $250 billion and $1,000 billion.
Whatever the exact figure, there is no doubting that it is huge – and Adia has shown an increasing willingness to throw its weight around. In June this year, it took a 10% stake in Apollo, the American private-equity group. Last month, it emerged Adia was to buy Canada’s PrimeWest Energy Trust for US$5 billion.
Qatar, Kuwait and Abu Dhabi have the Gulf’s biggest sovereign funds. Saudi Arabia has two funds that invest externally. But the big Saudi money is in the hands of family concerns, such as Olayan Group and holding companies, the best known of which is Prince Al-Waleed’s Kingdom Holdings.
The pattern of Middle Eastern states recycling their income into overseas investments is therefore well established. But the arrival of newcomers such as Russia and China has proved more controversial.
The China Investment Corporation (CIC) was launched only this year with an initial $200 billion at its disposal. But with the fund’s first high-profile investment – putting $3 billion into the flotation of the American private-equity group Blackstone, the comrades in Beijing soon learnt the lesson that shares can go down as well as up: the value of the investment tumbled by 30%.
China has also discovered that by investing overseas it can provoke suspicion and opposition. In 2005, its state oil company CNOOC was forced to scrap an $18.5 billion takeover of Unocal in the face of political pressure. NOT everyone is worried. One banker said: “There’s some noise about foreigners coming in and concern about Arabs and so on. But the reality is, over the past couple of years, the worst of the arguments over economic patriotism have been fought and won.”
And remarkably, some sovereign funds have managed to press ahead with investments that, at first glance, appear highly sensitive: Dubai owns 3% of EADS, which makes the Eurofighter; a further 5% is held by a state-owned Russian bank.
But the lack of transparency of many sovereign funds worries western governments that might otherwise welcome long-term overseas investment. On the face of it, having investors who hold stakes in companies rather than government bonds should mean less risk of volatility; bonds and cash are the ultimate liquid assets that can be bought and sold in an instant. However, for governments, the concern is that they cannot always be sure of the true objectives of sovereign wealth funds – or even what other assets they hold.
Certainly, many large funds are opaque. It is actually against Kuwaiti law for the KIA to reveal what it owns. Outsiders can only guess at the value of investments held by the world’s largest fund, the Abu Dhabi Investment Authority.
And this lack of transparency adds to the anxiety that sovereign funds are interested in more than simply making money for their citizens; they are also trying to make strategic purchases to exert power.
One example is the tussle between the Qatari Investment Authority and the Bourse Dubai over the London Stock Exchange; it is scarcely conceivable that the prices paid for LSE shares could be justified purely on the grounds of fruitful investment. The price of shares in Scandinavia’s OMX exchange were also pushed to astronomical levels as the Gulf states vied for position.
But it makes perfect sense from the Gulf perspective. As one commentator said: “This is not about how much is a Scandinavian exchange worth, or how much the LSE is worth. This is about a race to be the biggest financial centre in the Gulf – a key to which is having a global stock exchange. There’s only room for one between London and Japan, and any amount of cash is worth paying to get it.” Willem Buiter, former chief economist for the European Bank for Reconstruction and Development, declared that “most of these funds are transparent as mud”. He added: “As agents of the state, these funds are always potential instruments of foreign policy. Since the Russian state has already chalked up quite a record for using Gazprom as an instrument of Russian foreign policy, the Russian Oil Stability Fund can never be trusted to act as a normal, profit-driven investor.”
And lack of transparency will play into the hands of protectionists. Gerard Lyons, chief economist at Standard Chartered, said: “There is a serious likelihood of western governments and sovereign wealth funds clashing over what they can buy and where. A protectionist backlash against strategic investments is real and threatens global trade.”
Bob Wigley, chairman of Merrill Lynch for Europe, the Middle East and Africa, said: “Since international investment by these funds will be crucial to an orderly unwinding of global imbalances, they must focus on transparency and governance, and politicians must choose their protection methods in a thoughtful way that achieves national interest protection without risking the wide economic benefits.”
Jeffrey Garten, professor of international trade and finance at the Yale School of Management, believes wariness about sovereign funds’ motives is fully justified. “No western government has had the courage to admit that dealing with sovereign wealth funds may require departures from orthodoxy on investment flows,” he said.
He favours limiting government-owned stakes in foreign companies to 20% and imposing an obligation for greater transparency. Some sovereign wealth funds are showing that they are alert to the risk. Singapore’s Temasek is transparent in that it publishes full accounts. It also tries to argue that it operates independently of the Singaporean government and therefore can remain aloof from government policy.
On this point, it is a hard case to sustain: the fund’s chief executive, Ho Ching, is the wife of Singapore’s prime minister, and the Temasek board is adorned with people from the Singapore establishment.
The fund announced in July that it was putting $2 billion into Barclays to bolster the bank’s bid for ABN Amro (it failed in the end). Temasek also holds 17.2% of Standard Chartered.
Temasek’s Simon Israel said: “Now is a formative time for the sovereign wealth investors, which in turn has prompted questions about their objectives, accountability, transparency and impact on global financial systems. Are they looking for influence beyond private-capital investment, are they seeking influence, political or otherwise, and will they have a destabilising impact?
“Personally, I believe the world should welcome us. The advent of sovereign wealth funds signals the willingness of governments to take responsibility and manage their wealth, which is positive.
“Generally, these funds are looking for long-term investments, which have a stabilising element in financial markets that are being increasingly dominated by investors with short-term horizons – from private equity to hedge funds. So this capital should allow companies to make decisions for the long-term good.”
Of course, sovereign wealth funds are not the only way in which countries’ accumulated foreign-exchange reserves can be recycled. State-owned enterprises can also be used to channel money overseas.
China illustrates the point. The CIC is only now getting into its stride, but the Beijing government has already encouraged other state firms to expand abroad.
Look at the financial sector alone. Last week saw news that Industrial and Commercial Bank of China is putting $5.5 billion into Standard Bank, Africa’s biggest lender. The China Development Bank bought a 3.1% stake in Barclays in July; had Barclays’ bid for ABN Amro succeeded, the Chinese could have invested a further $11 billion. And in August, China Construction Bank agreed to buy Bank of America’s Hong Kong and Macao operations for $1.2 billion.
China is promising up to $8.5 billion of investment in the Democratic Republic of Congo in exchange for a slice of its mineral assets. Last year, China signed a $1.6 billion deal with Angola to develop an oilfield in the African state.
The money may not be coming directly through sovereign funds. But from the point of view of target companies and countries, the investment is no less real for that.
Investors already holding equities should welcome the arrival of a new wall of money.
One banker said: “The sovereign funds arriving on the scene meant suddenly here was real cash that had the ability not just to fill the vacuum left by hamstrung private-eq-uity deals, but drive the market forward in a way never seen before.
“Investment banks, which have in recent years slowly been building up teams to deal with the petrodollars, are now gearing up their activities. Sovereign wealth departments have sprung up just as fast as leveraged-debt departments have been closed down.”
For investment banks, new funds being channelled back to the west may be welcome. Others – Alistair Darling included – remain apprehensive.
– $138.9 billion: the total value of sovereign wealth fund investments in the last two years
– 127 individual deals were done in the last two years
– 37 were worth $1 billion or more
Wall of money flows out of the Gulf
The Qatar Investment Authority (QIA) is not the biggest sovereign wealth fund but it is the one that is making the most noise in London.
In April, the QIA snapped up Chelsea Barracks in London for £900m, some £300m more than was expected. Next it bid for J Sainsbury, swooping in with a 600p-a-share offer that CVC, the private-equity giant, was unable to reach. More recently it snapped up 20% of the London Stock Exchange plus 10% of OMX, the Scandinavian exchange, in one evening.
All three deals seem to point to the power and wealth of the new players. Even better, since Qatar has the world’s third-biggest reserves of natural gas and a small population of fewer than 1m, the supply of money looks almost limitless.
But last week the excitement was dampened when the Sainsbury deal was postponed. It emerged that Delta Two, the QIA-backed bid vehicle, needed to ask Doha for another £500m to fund the deal.
One trader said: “There was a realisation that nobody really knows the QIA. They haven’t done a deal like this before – are they for real?”
Sainsbury aside, there is no doubting the wall of money coming from the Gulf. It is estimated that the rising oil price is generating an extra $1 billion (£487m) a day of surplus cash.
Abu Dhabi, having a population of 1.8m, is also a favourite with investment banks in London. Its main fund, Adia, set up in 1977, has $875 billion under management. The newer Mubadala fund, set up in 2002, invests smaller amounts, but has caused a stir with investments such as a 5% stake in Ferrari, the carmaker.
The smallest fund in the region is Oman’s State General Reserve, set up in 1980, and managing $10 billion.
Recent big investments by Sovereign Wealth Funds include:
Abu Dhabi Investment Authority PrimeWest Energy Trust of Canada ($5 billion)
GIC (Singapore) Half share in WestQuay shopping centre, Southampton ($600m) Chapterhouse Holdings, owner of Merrill Lynch Financial Centre ($960m) Half share of Westfield Parramatta, Australian property company ($584m)
KIA (Kuwait) 7.2% stake in Daimler ($8.1 billion)
China Investment Co 10% of US investment fund Blackstone ($3 billion)
Temasek (Singapore) Almost $2 billion in Barclays 12% stake in ABC Learning Centres of Australia 24% of China Eastern Airlines – acquired jointly with Singapore Airlines
Alaska Permanent Reserve Fund (US) Stakes in GE, Exxon, Microsoft, Google, Procter & Gamble
Norwegian Pension Giant
It is the money of the Gulf states, China and Russia that has caught the headlines as the financial world wakes up to the significance of the burgeoning might of sovereign funds.
But for 17 years, Norway has been quietly building up enormous holdings in bonds and equities through its government pension fund. This is now the second-largest sovereign fund on the planet.
About four-fifths of the Oslo government’s revenues from oil licences and oil taxes go straight into the fund.
By the spring of this year, its value was reckoned to have hit $322 billion (£157 billion) – more than an entire year’s Norwegian gross domestic product and equivalent to $70,000 for every single person in the country.
The fund’s value is projected to hit $500 billion by 2009. The annual cost of managing the assets is remarkably low – less than 0.1%.
The fund has remained a resolutely low-profile investor. Equities account for only 40% of the money under management – although Norway intends that this should rise to 60%. And investments are spread thinly: the fund holds shares in about 3,500 companies, with stakes typically being kept below 1%.
Far smaller, but adopting a similar approach, is Canada’s Alberta Heritage Savings Trust Fund. Its aim is to manage savings accumulated from Alberta’s nonrenewable resources; income is transferred to the province’s budget.
The Canadian fund’s value grew by 22% last year to reach US$16.4 billion.
The fund aims to have 29% of its money in fixed-income investments, with most of the rest in domestic and overseas equities.
In Australia, the country’s Future Fund handles money from accumulated government surpluses. By May this year its value stood at US$42 billion.
The fund was set up last year to pay for the future pensions of public servants. The full liability should be underwritten by 2020, by which time the fund is expected to have grown to US$103 billion.
It is managed by the Northern Trust Corporation, an American investment management group.