Archive for January, 2010

Russia’s Wealth: Weapon of Economic Destruction?

Ashby Monk

Bloomberg has an astounding article out today that, if true, suggests that Russia was plotting “economic disruptions” against the US in 2008. According to the article, which I have to admit is a bit confusing, former Treasury Secretary Henry Paulson discovered a plot by the Russian government to convince the Chinese to sell US agency debt en masse to force a major US government bailout. The plot was discovered by Paulson during his trip to the 2008 Olympics:

“Russia urged China to dump its Fannie Mae and Freddie Mac bonds in 2008 in a bid to force a bailout of the largest U.S. mortgage-finance companies…The Russians made a ‘top-level approach’ to the Chinese ‘that together they might sell big chunks of their GSE holdings to force the U.S. to use its emergency authorities to prop up these companies’…”

The Chinese rejected the idea, and the Russians are, obviously, denying that any of this occurred. Still, Paulson’s report is pretty amazing. If true, it would appear that Russia was plotting economic warfare against the US during the summer of 2008; I don’t really know what else to call it. Their intention was to use their sovereign wealth to purposely weaken and damage the US economy. The fact that all this apparently occurred around the same time that Russia was engaged in a traditional war with Georgia, a US ally, lends some credibility to the idea.

This revelation–while unconfirmed–will not comfort those in the West that fear SWFs; it doesn’t help anybody if these funds are seen to be potential weapons of economic destruction…

Game Theory: SWFs and Cleantech

Ashby Monk

If you watched the US State of the Union Address last night, you no doubt remarked on the President’s interest in clean energy technology (cleantech). As I see it, the Obama Administration is interested in this developing market for three reasons: 1) It offers a way to create skilled jobs in the USA; 2) It fits with his environmental agenda; and 3) It is a way to achieve energy independence. Indeed, according to the White House:

“The President’s vision includes investments in important technologies to diversify our energy sources and reduce our dependence on foreign oil…”

Given that the Recovery Act allocated $80 billion to creating ‘clean energy jobs’, the US is quite obviously serious about this endeavor. I wonder what the commodity rich countries—those pesky sellers of foreign oil—think about this; how should they react to this ongoing push in America to stop buying their primary export? I think this topic could be a great subject for a game theory paper.

One option, which I highlighted a few months back, is for these resource rich countries to invest in clean tech themselves. As I said in a previous post:

“…I think cleantech would be a great investment for commodity based SWFs. Since sponsors of such funds typically rely on resources that will lose-out if the cleantech revolution succeeds, these investments would offer a very nice hedge over a long-term time horizon (~30 years). Indeed, getting in on the ground floor of cleantech would attenuate any loss of revenues associated with a technological advance that reduces our dependence on hydrocarbons.”

As such, it would be a great way to diversify the country’s long-term revenue stream. Interestingly, according to a Reuters article this morning, there are other reasons for SWFs to be interested:

“Since two-thirds of their wealth comes from oil and gas interests, the funds set up by nations from Norway to the Middle East and China would be burnishing their image by helping finance clean energy projects… Moving into more socially responsible areas is a way to diversify portfolios into alternative assets that can deliver returns uncorrelated to such traditional classes as stocks and bonds…”

Still, I can also think of some good reasons for these funds NOT to get involved as well. For example, if we are living in a capital starved world (which we have been), I can see how commodity SWFs would NOT want to provide their capital to a firm that would then work to end the world’s reliance on their country’s primary export! In fact, it may be that the cleantech firm will go out of business without the SWF’s investment. Of course, this only holds true if there are no other investors that would step in to take the SWF’s place, but it is something to consider.

In addition, SWFs are not in the business of giving out subsidies; they have a mandate to make a profit. So, for this industry to attract SWF investments, they need to show that they can generate returns. Ironically, in the short term, it may be state subsidies and regulations that help this industry turn a profit!

So there is a lot to consider. And since my brain hurts thinking about it, I leave this to the game theoreticians and their backward inductions…

Is The CIC Motivated By Profits And Politics?

Ashby Monk

According to Katrin Bennhood of the New York Times, over 50 Chinese officials and executives — including the President of the China Investment Corporation, Gao Xiqing — are descending on Davos this week to rub shoulders and, in effect, “go shopping” for new investment opportunities. It seems China’s state investment vehicles are set for another busy year.

As if on cue,  Bloomberg reported this morning that the CIC is considering a new round of resource related investments. I find this remarkable, as the CIC already invested $10 billion in the sector in the last six months alone! You’d think the fund’s unblinking focus on resources would raise suspicions of politically motivated investing at some point.

It has; this suspicion was voiced by Larry Catá Backer in a (fascinating) blog post over the weekend:

“A review of [the CIC’s] activities during the last six months suggests the way in which state policy, political objectives for economic activity can be harmoniously mixed with profit maximization to deepen a new form of investing that is neither entirely private (as conventionally understood) or wholly public… The Chinese sovereign wealth fund moves over the course of the last six months suggests not merely power within global private markets, but also the mechanics of an operation that are neither entirely public nor private.”

To date, however, the fund has avoided such concerns by using inflation as its justification for this wave of resource investments; as Gordon and I argued in our recent article in Foreign Policy:

“…due to expansionary monetary policies in the West, the CIC has been able to invest in resource and commodity firms without drawing geopolitical attention. Indeed, inflation is now the major concern among institutional investors, and real assets offer a good hedge; the CIC has clearly been taking advantage of this. In a sense, the recession provided the CIC with cover to invest in a way that met both the fund’s commercial needs and China’s strategic goals.”

So, is the CIC motivated by both profit and politics? It’s very difficult to tell, but there is a growing awareness of this possibility. As Backer says, this may “require close scrutiny as it develops over the next half decade.”

New SWFs for 2010

Ashby Monk

Given the rapid growth in the number of SWFs we saw in 2009, it isn’t all that surprising to see the trend continue into 2010. Today, it was announced that both Ghana and Iran are considering setting up new SWFs.

For its part, Ghana wants a SWF to sequester a portion of their new oil revenues, which are set to start when their Jubilee energy field commences operations later this year. According to Ghana’s Finance Minister Kwabena Duffuor:

“We have held a couple of meetings already … it’s something we’re seriously working towards and we hope to put the proposals before cabinet in about a month.”

So Ghana joins Nigeria, Angola and Tunisia as African countries that are currently considering SWFs as a way to manage oil rents. However, according to a Reuters article by Natsuko Waki, these countries face a different set of constraints than SWF sponsors outside of Africa:

“…the challenges posed by such plans are significant: on the one hand is the need for a vehicle to invest windfall surpluses for future generations and ring-fence today’s wealth from greedy leaders…[also] investing offshore — as do the sovereign funds of major developed and emerging economies — would be political dynamite in Africa. In many African countries, badly in need of infrastructure and poverty reduction, the funds would be more likely to be deployed at home.”

These are some serious governance challenges. But for the new SWFs to be successful, they’ll absolutely need to overcome them. Indeed, we have seen situations where SWFs have, in effect, failed due to governance deficiencies brought on through corruption or greed.

This appears to be the case in Iran, where the government is now considering creating a new SWF to replace the one the country set up in 2000. The current SWF, known as the Oil Stabilisation Fund, is a contingency fund that has been so secretive that little is known about it. The OSF was given the lowest transparency rating by the SWF Institute and was deemed 0% GAPP compliant in recent academic research. Reports suggest that the fund topped $20 billion in 2008, but critics suggest that the government has squandered much of these windfall oil revenues.

Today, the government wants to close the current contingent fund so as to set up a new fund focused on development. While laudable, it appears that the new SWF would still be directly accountable to the ruling elite.

“Its board of trustees would include the president, the vice president in charge of planning, the oil minister, the economy minister, the central bank governor and two other ministers picked by the president.”

A new SWF for politicians’ pet projects? It’s hard to see how the outcome for the new SWF will be any different from the old SWF.

Democracy and SWF Governance

Ashby Monk

Is there a link between a SWF sponsoring government’s level of democratization and the internal governance of the SWF? Sven Behrendt of the Carnegie Endowment for International Peace thinks so; he shows the extent to which a SWF’s compliance with the Santiago Principles corresponds to the country’s democratization:

It’s a fascinating chart with some interesting implications. It is telling to see how far most countries are from being “GAPP compliant.” Only the New Zealand Superannuation Fund even comes close to full compliance. Most of the funds only manage 40-60% compliance, while the SWF from Iran has the dubious honor of 0% compliance. These observations clearly fit with Sven’s correlation of political freedom and SWF governance. Indeed, if the SWF takes its cues from the sponsoring government, and most do, these results shouldn’t be all that surprising.

However, in a paper for New Political Economy, I looked at a similar issue: how governance can help a SWF overcome the taint of a sponsoring government that scores low on the democratization table. In talking about the China Investment Corporation, I noted:

“…in the absence of ‘good governance’, the CIC is tainted by China’s broader principles (as perceived in the United States). However, with the application of good governance, the CIC would be evaluated on its own merits and could potentially be viewed as ‘legitimate’ and ‘trustworthy’.”

Unfortunately, while I still believe the above, Sven’s research seems to suggest that my point is moot.  As such, Sven concludes that:

“Any meaningful progress on the compliance of SWFs in emerging economies, particularly in the Arab world, is likely to be closely associated with broader democratic reforms.”

Good luck with that…

Weekend Reading

Ashby Monk

Gordon and I published a commentary over at Foreign Policy this week. Entitled Singing in the Rain, it’s on the China Investment Corporation and how it prospered through the financial crisis:

“…rather than stemming the CIC’s growth, the global financial crisis has had a profoundly positive effect on China’s SWF. Although the fund struggled to overcome a series of managerial, financial, and geopolitical hurdles upon its creation, the financial crisis set the stage for a remarkable transformation. Now, the fund has matured into perhaps the world’s largest and most influential strategic investor.”

Get it here.

Enjoy your weekend!

Have SWFs Re-Gained Their Confidence?

Ashby Monk

The second half of 2009 saw an up-tick in SWF activity. According to a new report by the Monitor Group and Eni Enrico Mattei, SWF transactions more than doubled in number from 11 in Q2 2009 (worth $3.5 billion) to 25 in Q3 2009 (worth $25.3 billion).   According to the report’s authors:

“…the most recent quarter represents the largest quarterly deal value since Q1 2008 and the greatest number of publicly reported transactions since Q3 2008.”

The report suggest that this reflects a “re-gained confidence” among SWFs.

While I hope the authors are correct, I think we need to put things in perspective. Consider this: Q1 of 2008 saw 175 equity transactions by SWFs valued at $128 billion. So while Q3 2009 saw an increase in activity, it still had SWFs operating at about 14% of where they were a year and a half earlier. Is that encouraging?

Additionally, it looks as though three SWFs were responsible for almost all of 3Q 2009 activity. Investments by the China Investment Corporation ($3.8 billion), Abu Dhabi’s International Petroleum Investment Company ($6.7 billion) and the Qatar Investment Authority ($11.7 billion) accounted for 88% of the 3Q 2009 transactional value.

To me this raises some pressing questions: What were the other 30 SWFs in the Monitor FEEM data doing in 3Q 2009? When will these SWFs re-gain their confidence?


This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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