The challenge of sovereign funds

Are sovereign funds Trojan horses for the strategic interests of mercantilist states such as Russia or China, using large currency reserves to muscle in on free market economies? Or is this just the inevitable evolution of globalisation away from western dominance?

by Financial Times; The Observer
Last Updated: 23 Jul 2013

The arrival in the US and Europe of state-backed foreign investors with huge cash reserves, mainly as a result of rising energy revenues, has caused a ripple of concern in western business and political circles.


China is following in the wake of Gulf states and Russia in using ‘sovereign' or state-controlled funds to buy stakes in western companies. Previously these funds were mainly used to accumulate Treasury bonds, mostly in dollars.


As the dollar has depreciated, China has looked to raise its returns on its huge hard currency reserves ($1.3 trillion). Ever since a Chinese oil company CNOOC made a bid for US oil company, Unacol, in 2005 only to be rebuffed on security grounds by opponents of the deal in Washington, the issue of sovereign funds has slowly crept up the political agenda.


The UK has been more open to sovereign takeovers of stalwarts of UK plc, welcoming the acquisition last year of P&O ports by Dubai Ports World. Following the acquisition, Dubai Ports World had to divest five US ports owned by P&O to assuage US fears over Arab ownership of its strategic assets. Security fears can be read as protection in another guise.


Another argument put against the activity of sovereign funds is that many of them are from countries whose capital markets are not as open as those in which they are fishing. This lack of a quid pro quo has been raised in European discussions of how to respond to sovereign fund takeovers.


The biggest sovereign fund is thought to be Abu Dhabi Investment Authority with around $500 billion, according to Dutch banking group ING. Emerging economies dominate the commodity-based sovereign funds, a typical example being Russia's Stabilisation Fund, worth more than $100 billion, which reinvests earnings from Russia's oil and gas exports.


Another kind of sovereign wealth fund, those mainly from Asian states including China, Singapore, Malaysia and South Korea, invests a country's foreign exchange reserves. As these reserves increase, Morgan Stanley is predicting that sovereign funds will rise in value from a current $2.5 trillion to $12 trillion by 2015. Through these funds China has recently acquired stakes in US private equity group Blackstone, and a Singapore fund, Temasek, has bought a £5 billion stake in UK bank Barclays. The Qatari government is bidding for UK supermarket chain J Sainsbury's.


A model sovereign investment fund could be the Norwegian Government Pension Fund, which invests much of the country's oil riches, and is recognised as having high standards of governance and accountability. Other funds may have to follow the Norwegian model if they want to avoid a protectionist backlash against their buying spree in Europe and the US.


Writing in the Financial Times, Lawrence Summers argues that sovereign funds pose a challenge to market economies in that they threaten to reverse the trend away from state ownership of the last quarter century by bringing state ownership into the financial sector - a kind of financial re-nationalisation.


He urges rule tightening over sovereign funds because, he warns, they are likely to pursue influence, push national champions or seek to extract technology and know-how from the companies which they have bought stakes in, rather than just seek the best risk-balanced returns.


A question for Summers and for western policymakers is how far can they influence the behaviour of sovereign funds as their power increases - or will the choice be one of taking their money or closing the door?


Sovereign funds shake the logic of capitalism
FT, July 30
China takes great leap forward into western markets
The Observer, July 29

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