Archive for February, 2010

Weekend Reading: USCC Testimony

Ashby Monk

The U.S.-China Economic and Security Review Commission held a hearing yesterday on “U.S. Debt to China: Implications and Repercussions.” Commissioner Michael R. Wessel framed the discussion as follows, “…we’ll find out whose problem it is when the U.S. owes China – our banker – as much as $1.5 trillion.” Readers of this blog will recognize that this is a topic I’m interested in; i.e. what the current “symbiotic” US-China economic relationship means for global economic geography and geopolitics.

As such, I’m going to spend the weekend reading testimony from Mr. Clyde V. Prestowitz, Dr. Simon Johnson, Dr. Derek Scissors, Mr. Leo Hindery, Jr., Dr. Eswar Prasad and Dr. Daniel W. Drezner. From a quick scan of the speeches, I can see that that latter three talk (a bit) about China’s SWFs (in case that’s your only interest here).

In addition, since this ‘weekend reading’ is focused on China, I’m going to spend some time staring at this lovely map.

Have a nice weekend.

SWFs Bringing Liquidity to the Illiquid

Ashby Monk

I was very interested to see Temasek’s sizeable investment in SecondMarket, which is a market maker and broker for illiquid assets. SecondMarket facilitates the trade of such assets as LP interests, CDOs, MBS, and even private corporate stock among other things. In my view, SecondMarket has a bright future, as there is a growing appetite for these types of secondary market transactions.

On the one hand, we’ve just come through a liquidity crisis, which means that many investors have been desperate to sell their illiquid assets. For example, Second Life has apparently seen its inventory of assets spike from around $100 million in 2007 to close to $25 billion today. Remember Stanford University’s problems in this regard?

On the other hand, over the past decade we have seen the entry of SWFs onto the scene; these are perhaps the longest-term investors in the world. SWFs are thus actively looking for investments that offer “illiquidity premiums” to match their long-term investment horizon. SWFs’ appetite for PE came through quite clearly in our survey of SWFs’ own asset managers. See the recent CIC / Apax deal as a potential example of the appetite for secondary market demand of PE LP interests.

As an economic geographer (…someone who is interested in mapping new economic activities and spaces…), I find the rise of these innovative market makers / brokers fascinating; they are facilitating markets and trade that might not have otherwise occurred. Before I started this SWF project, I did a separate research project on the growing world of “patent brokers”, which offer similar services for a similarly illiquid, and increasingly traded, asset class. What I said about patent brokers seems to apply to SecondMarket as well:

“These intermediaries form the heart of a new innovation infrastructure that is tailored to the needs of firms competing in the knowledge economy. Intermediaries facilitate the growth of this new space by overcoming certain coordination problems.”

Though, in this situation, I would replace “firms competing in the knowledge economy” with “long-term investors”. In any case, the SecondMarket investment is an interesting development. Apparently, the firm rebuffed numerous offers of financing over the years until now, which suggests that they view the Asian investors as an opportunity to expand overseas:

“Until now, the six-year-old company has run trading platforms only for U.S. assets, but the investment by Li and Singapore’s sovereign wealth fund Temasek Holdings will likely create new exchanges for illiquid assets in Hong Kong and elsewhere. That should increase the number of potential buyers and sellers for SecondMarket’s existing inventory. Even more importantly, it could provide additional liquidity in China’s private companies and red-hot real estate market.”

Watch this space…

And The Award For Best Commodity Fund Goes To…São Tomé and Príncipe?

Ashby Monk

Why does the possession of natural resources all too often lead to economic and political trouble? Well, there are plenty of reasons, and the Kennedy School’s Jeffrey A. Frankel has decided to put many of them down in a new primer on the natural resource curse. In it, he outlines the various determinants of the curse and also talks a lot about possible solutions.

Drawing on the work of Acemoglu, Easterly, Hall, Levine, Jones, Rodrik, Subramanian, Trebbi and others, Frankel makes the argument that institutions are the all important factors that determine whether a country will overcome the curse. One of these institutions is the commodity fund, a type of SWF. However, Frankel recognizes that the mere creation of a SWF is not enough; sound governance is the all important factor preventing sovereign funds from turning into political slush funds.

So, Frankel sets his gaze on the world’s commodity funds in an attempt to determine which one offers the best model for resource rich, developing countries. In an unexpected turn, he viewed the much vaunted ‘Norwegian model’ as inappropriate for developing countries due to the politicized nature of investments decisions:

“…the fund is managed with political objectives that go unnoticed when held up as an example for developing countries to emulate.”

He’s right; the GPF-G has an explicit mission to include ethical criteria in its investment policies, which can result in the politicization of its operations.

Accordingly, Frankel sought out a different “model SWF”. Surprisingly, he fell on the commodity fund of São Tomé and Príncipe, which, in Frankel’s words, has “extensive restrictions guiding how the oil revenues are to be saved, invested, or spent.”

I have to say, this is the first time I’ve heard of the São Tomé and Príncipe National Oil Account (a fund that isn’t even tracked by the SWF Institute) being held up as the exemplar for other developing countries. What’s the deal? I had to get a bit more information: Dr. J. Peter Pham had the best description of this fund I could find:

“…the Santomean National Assembly unanimously passed and President de Menezes signed in late 2004 a landmark oil revenue law that was drafted with the help of a team of experts from Columbia University’s Earth Institute and after fifty-five town hall meetings throughout the country. The law creates a single National Oil Account which will receive all hydrocarbon revenues due to São Tomé and Príncipe. The account will be held at the U.S. Federal Reserve and there will be but one annual transfer from it to the budget as approved by the National Assembly and requiring the signatures of four separate officials. The maximum amount of the transfer is determined according to a fixed formula indexed to stages of oil exploration and actual production, while everything else is put into a sub-account, the Permanent Fund, that cannot be expended but which would form a “national endowment.

Management of the National Oil Account is entrusted to a committee composed of representatives of the president, the prime minister and cabinet, and the National Assembly, including the political opposition. They are legally limited in the financial decisions they can make, including provisions barring investments in São Tomé and Príncipe itself and against using petroleum resources to secure credit. The committee, in turn, is accountable to an independent public oversight board, the Petroleum Oversight Commission, which includes representatives of civil society and members of the general public. The legislation also includes provisions for enhancing transparency as well as criminal penalties for violations thereof.”

This does sound like a remarkably well-governed fund; it has a clear mandate, direct lines of accountability and steadfast rules dictating the use of assets. It appears that Frankel is right, this SWF — sponsored by an island nation off the coast of Africa — is perhaps a better model for developing countries looking to set up a commodity fund than Norway’s GPF-G.

The Human Rights Obligations of SWFs

Ashby Monk

Larry Catá Backer has just kicked off a new series of articles over at his blog on “Business and Human Rights.” In his most recent article, he examines the different human rights obligations of corporations and the institutions that finance corporate activity.

Apparently, there is a different standard of due diligence for each entity; corporations are held to a higher standard than financial institutions (according to the United Nations Special Representative of the Secretary-General on Business & Human Rights). This logic is based on the notion that financial institutions are ‘one step removed’ from the actual corporate activity they are financing, so they are simply unable to do the on-site due diligence for all the investments they make.

This assumption seems to roil Backer:

“It seems odd to suggest that an industry with such a sophisticated approach to the monitoring and control of borrowers would be incapable of adding another layer of monitoring and review–that centered on human rights–to an already well established list of risk assessment protocols. Indeed, it would seem that banks are in a better position to monitor compliance form their borrowers than companies might be able to monitor the conduct of their down chain supply chain partners.”

So how do SWFs fit into this story? Backer highlights the difficulty of using the above logic for this class of investor. As government-owned entities, they should be held to the highest standards of due diligence in terms of human rights. However, SWFs, in many cases, are working very hard to be seen as “commercial” and “returns driven” entities. So, this begs the question: should SWFs be held to the same human rights standards as private financial institutions (i.e. low) or to the same standards as governments (i.e. high).

Here is Backer’s (abridged) take:

“Where sovereign wealth funds invest primarily in shares of other entities, then, to that extent they ought to be subject to the same scope of responsibility as other funds of the same type. In that case the obligation would be that of a shareholder investor, and to a large extent, remote form the operations of the corporations whose shares are acquired in the market….SWFs that own controlling interests in an enterprise ought to face substantially broader responsibilities. And SWFs that own financial operations–banks and the like–ought to be responsible for their downstream operations like any other enterprise.”

Backer has raised an interesting thought experiment that has some practical ramifications. The above shows the difficultly in reconciling government obligations with private sector demands. Indeed, the legitimacy of these funds is bound up in their ability to act in accordance with government and societal standards of due diligence (think Norway). However, the success if these funds (also in the eyes of the government and society) depends on their ability to compete according to private sector standards.

Needless Worrying About Chinese “Dumping” T-Bills

Ashby Monk

Michael Pettis has a fantastic and in-depth article on the recent drop in Chinese holdings of US Treasury Obligations. Here’s a snippet:

“Fear of Chinese “dumping” of US treasury bonds, even if it were possible, should be a non-issue, but since it plays easily into various geopolitical conspiracies, we seem to love to worry about it needlessly.”

Read it here.

Drop the Script: A Request to SWF Researchers

Ashby Monk

I read many, if not all, of the new SWF research papers published or put online every week; it’s part of my job to keep abreast of what’s out there (and then inform the public here). Since I’m fascinated with SWFs, I think it’s a pretty good gig. But, I have to say, I’ve noticed an annoying trend in many SWF research papers: the first five pages are growing very (!) repetitive. I acknowledge that all papers need a solid introduction, but it seems like SWF papers are increasingly following some form of the same script.

Generally, they kick off with some history (Kuwait 1953). They then move into a discussion of SWFs’ rapid rise (CIC) and the current state of global imbalances (Gieve, Aizenman). This is then followed by a discussion of definitions (Rozanov et al.), which inevitably leads to some talk of assets under management (Jen). Then we move into the international concern and anxiety (Dubai Ports, CIC), which, the paper reminds us, is based on the poor governance and transparency of these funds (Truman, SWF Institute). This is then followed by a discussion of what the international community is doing about it (protectionism, IWG, International Forum). Only after all this, oftentimes five pages into the paper, does the author tell us something new and interesting…

Can’t we spice this up a bit? In 2008 and even 2009, the above script was reasonable; few people knew what these funds were and this basic context was necessary.  In 2010, most people have at least heard the term SWF and, at the very least, there are many, many research papers out there that can be quickly referenced, eliminating the need for this script. In my humble opinion, research papers, as opposed to books, don’t need to recreate the wheel in this manner. As a writer, we all want to get our message out, but, I can tell you, it is very hard to persevere through the “script” to the informative parts of these papers.

Sorry for the rant, I’ll get back to more informative posts on Monday…


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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