Archive for March, 2010

Wasting Wealth in Ireland

Ashby Monk

Pension Reserve Funds can be a source of controversy; the political nature of retirement systems mean that these funds are vulnerable to political interference. For example, in the late 1990s the Clinton Administration considered investing the U.S. Social Security Trust Fund in equities. However, the proposal was torpedoed due to fears that politicians would have influence over the investments, intrude on the Trust Fund’s operations, and engage in ‘stock picking’ so as to use Social Security assets for personal or political gain. The end result would be wasted wealth.

For those of us that think the US missed an opportunity in the 1990s; that pension reserve funds are actually quite a good idea (if properly structured); that they can help shore up underfunded retirement systems; the news coming out of Ireland today is quite depressing.

According to Dara Doyle and Colm Heatley of Bloomberg, Ireland’s banks need $43 billion (!) in new capital. If they don’t get it, they could face collapse / nationalization. As FM Brian Lenihan said,

“Our worst fears have been surpassed…Irish banking made appalling lending decisions that will cost the taxpayer dearly for years to come.”

It’s not just his worst fears; it’s all of our worst fears about how the assets in pension reserve funds can be misappropriated, misused and, ultimately, wasted (albeit this is from the strict perspective of the pension system). Indeed, in this case  it’s not just the banking system that will suffer. In 2009, the Irish Government directed the National Pension Reserve Fund to invest in failing Irish banks for recapitalization. However, given the need for another large recapitalization today, the NPRF’s investment will likely end up being wasted.

At the time, Lenihan defended his decision to use pension assets in this manner by saying he wants

“to keep jobs going, to keep people in their homes, to allow people to buy motor cars and to do all the other things that we need to do in our economy.”

Laudable but misguided, in my opinion. The original legitimacy of the NPRF was based on the fact that this fund would not be touched (at all) through to 2025. It was set aside to mute the looming impact of a pension crisis…not to mute the impact of the financial crisis. I recognize that Ireland tapped the NPRF out of pure desperation — Iceland had just gone down and people were beginning to speculate that Ireland would follow suit. But I’m frustrated to see directed investing (once again) come back to cost pensioners and taxpayers so much money.

In my view, when a government sets up a pension reserve fund, it needs to place sufficient constraints over political interference to avoid this type of directed investing. I’ve said this before, but I think the Canada Pension Plan Investment Board has the right model. The political requirements for changing the CPPIB mandate are even greater than for changing the Canadian constitution! Canadian legislation ties politicians’ hands with respect to the CPPIB; there is almost no possibility of being tempted to use the money for other purposes than pensions. This is a necessary political condition for the CPPIB’s existence.

So, while some of Irish Banks may manage (just) to avoid nationalization, you can be sure that the NPRF’s investments will be diluted and discounted to keep these banks running. In other words, a political move cost the pension system money; this is pretty much exactly what US politicians feared back in the 1990s.

(Photo by geoffreyrockwell)

Council Rejects CIC’s Request for $200bil

Ashby Monk

There was a widespread assumption among practitioners and academics that the China Investment Corporation would receive  $200 billion in the early part of 2010 from the State Council to fund ongoing overseas investments. Indeed, the CIC invested almost all of its international portfolio in 2009, leaving it very little cash to work with. If granted, the CIC would become the biggest SWF in the world!

But, as so often occurs, assumptions are just that…and this one was wrong. It turns out that the CIC’s request for $200 billion was flat out rejected by the State Council. But since the CIC is almost out of capital, it quickly submitted a new proposal to the State Council, paring down the amount to $100 billion.

This proposal is currently under consideration. As is the request from the CIC’s subsidiary Central Huijin for roughly $28 billion to bolster under-capitalized domestic banks (and avoid dilution of state interests).

According to an article in China Stakes,

“The proposals from CIC and Huijin are making their way through the approval procedure, and have stirred debate among the related departments inside the State Council. CIC before tried to get US$200 billion more from the Ministry of Finance but failed.”

What’s going on here? I thought China was desperate to invest and diversify its $2.4 trillion in foreign reserves (which, by the way, represents roughly 30% of the world’s total). Isn’t the CIC just the vehicle to achieve this diversification? So, why did the CIC get turned down for the $200 billion? And why is the $100 billion such a problem?

An article in the Economic Observer might offer some insights. According to some academics in China, the hurdle rate for the SWF was simply too high:

“Given its registered capital was raised by the issuance of special treasury bonds at a fixed interest rate of 4.5 percent per annum, the CIC now faces huge pressure to pay back the capital…considering the bonds’ high annual interest rate and an 8 percent appreciation rate of the Renminbi per year, CIC had to keep its rate of annual return at above 13 percent; otherwise, the MoF would face financial losses.”

This is an incredibly high (!) hurdle rate. I too would be skeptical about giving any investor capital if they needed to return above 13% before I made money. Nonetheless, the CIC has been pretty savvy over the past two years, so perhaps even this high hurdle rate is achievable.

Sheikh Ahmed bin Zayed Al Nahyan

Ashby Monk

You may already be aware that Abu Dhabi Investment Authority Managing Director Sheikh Ahmed bin Zayed Al Nahyan went missing on Friday when his glider crashed into a lake in Morocco.

Our thoughts go out to his family and to ADIA. Everybody is impatient for news as to his whereabouts.

Despite a request for “analysis” of the implications for ADIA, I’m reserving judgment of any kind until we have more information. Let’s just hope he is found safe and sound and is soon back to work.

UPDATE: Moroccan authorities have confirmed the unhappy news that they have located the Sheik’s body…

Weekend Reading

Ashby Monk

I just came across quite an interesting paper by G. Andrew Karolyi and Rose C. Liao. It’s called, “What is Different about Government-Controlled Acquirers in Cross-Border Acquisitions?”

The authors offer a comprehensive survey of government-led, cross-border acquisitions extending back two decades. Their objective is to understand the motives for and consequences of 5,317 failed and completed cross-border acquisitions by government controlled acquirers.

The paper has some interesting insights about SWFs:

“Among those deals involving government-controlled acquirers, we do find important differences involving sovereign wealth funds (SWFs). SWF-led acquisitions are less likely to fail, they are more likely to pursue acquirers that are larger in total assets and with fewer financial constraints, and the market reactions to SWF-led acquisitions, while positive, are statistically and economically much smaller.”

Get it here or here.

Mauritius Seeks Inner Peace Through SWF – Sort Of

Ashby Monk

Feeling stressed? Feeling like you’re living in a world that is totally out of control? Try this: picture yourself on a gorgeous beach, take a deep breath, and repeat after me, “Calm blue ocean…” Breath. “Calm blue ocean…” Now open your eyes. You’re feeling better right?

Wrong. Especially if you live in a tiny island nation that depends almost entirely on tourism revenue and export-oriented sectors (e.g. textiles and sugarcane). In fact, thinking about a calm blue ocean (like the one encircling your country) probably leaves you feeling pretty vulnerable to global forces. Put simply, your economic and social wellbeing is based on the willingness of foreigners visiting your country and buying your products.

What to do? How do you manage the stress and uncertainty of this precarious position? Increasingly, “inner peace” is achieved by setting up a sovereign wealth fund, which serves to bolster domestic plans and institutions in an uncertain–and increasingly globalized–world. We’ve seen several Island nations take this route; Singapore and Bahrain jump to mind. Significantly, Mauritius now wants to do the same. Villen Anganan of Bloomberg has the scoop:

“Mauritius is considering setting up a sovereign fund to help reduce currency fluctuations….Industry Minister Dharambeer Gokhool said, ‘There is a need for greater stability and predictability of the exchange rate.’”

Over the past two years, the Mauritian rupee has experienced a great deal of volatility vis-à-vis the dollar; down over 11 percent in 2008 and then up nearly 5 percent in 2009. This has made long-term budget planning very difficult. As such, the new SWF is meant to help smooth exchange rates (ostensibly by facilitating central bank operatations and sterilization) so the government can be more certain about the country’s long-term economic plans.

Now. Picture yourself on a gorgeous beach and repeat after me, “sovereign wealth fund…sovereign wealth fund…”

(Photo by subzi73)

The 中央汇金投资有限责任公司 Needs Cash!

Ashby Monk

If you can read the title above (which I cannot), you’ll know that the Central Huijin Investment Ltd needs cash! According to “unnamed CIC sources” and “semi-official state newspapers”, Central Huijin may need as much as $50 billion. Why you ask? Because it is the majority shareholder of China’s four largest commercial banks, and they are in desperate need of recapitalization.

While it is a subsidiary of the CIC, Central Huijin’s investments are almost exclusively in domestic financial services firms. In addition, Huijin’s Board of Directors and Board of Supervisors are all appointed by (and remain directly accountable to) the State Council. As such, Central Huijin is, in effect, the tool through which the State Council exercises influence over domestic banking (see picture below).

During the financial crisis, the State Council called on the ‘big four’ banks to advance new loans to bolster the economy. The banks obliged; the Bank of China, for example, expanded its credit book by over 50 percent (!) in 2009. And today the government is calling on the banks to expand credit by another 17 percent in 2010.

However, by the end of 2009 the capital adequacy ratio of the Bank of China had dropped to 11.14 percent, which barely breaks the statutory requirement of 11 percent. Accordingly, the Bank of China (and the entire banking industry) is desperate to recapitalize.

The banks are thus launching aggressive fund raising programs in Honk Kong and mainland stock markets. However, the State Council doesn’t want to see its position in the big banks diluted (or so it says). As such, Central Huijin has put in a request for $50 billion to the central government so it can buy-in with the the private investors. (The money would ostensibly come out of foreign reserves.)

An alternative interpretation would be that Central Huijin needs the money because private investors aren’t all that keen on investing in a banking industry that 1) is expanding credit at breakneck pace and 2) is under the thumb of the central government. In my view, that isn’t a recipe for high returns. So perhaps the $50 billion is just another government bailout? We’ll see…

Ghana Petroleum Funds Take Shape

Ashby Monk

I noted earlier this year that Ghana was considering a new SWF to sequester a portion of their imminent oil revenues, which are set to start when their Jubilee energy field commences operations later this year. It is expected that income generated from this project could reach $2 billion a year, which has created a sense of urgency in Ghana to begin planning for the management of these rents.

Accordingly, Ghanas’ Ministry of Finance and Economic Planning has just released a Preliminary Proposal for a new oil revenue and management law. As if on cue after yesterday’s article, a major component of this Proposal is to ensure that Ghana does not suffer the ‘resource curse’:

“In putting together this proposal, we have been keenly aware of the so called “oil curse” that has come to be associated with oil rich, developing countries.”

As I argued at length yesterday, commodity funds are crucial in this regard. They facilitate ‘stabilization, sterilization and savings’.

As such, a key part of this Proposal is to establish two new SWFs. Indeed, Section 13 sets out the basics for the new Ghana Stabilization Fund and Ghana Heritage Fund (the “Ghana Petroleum Funds”). The Ghana Heritage Fund will be used to preserve Ghana’s oil wealth over the long-term, while the Ghana Stabilization Fund will fill short-term budget gaps. The specific objectives of thee funds are as follows:

“(a) Cushion the economy from the impact of unanticipated petroleum revenue shocks and safeguard macroeconomic stability. (b) Cushion the impact on or sustain public expenditure capacity during periods of revenue shortfalls whether caused by a fall in prices of crude oil or natural gas, or through produc-tion changes. (c) Generate alternate stream of income to support public expenditure. (d) Provide a heritage, through the Ghana Heritage Fund for future generations of Ghanaians from savings and investment income derived from petroleum revenue.”

In reading through this document, I couldn’t help but be impressed with the transparent and professional job the Ministry of Finance is doing. From public consultations in all regional capitals to a commitment to transparency and accountability informed by international standards of best-practice, it’s an impressive Proposal. For anybody curious as to how a developing country goes about setting up a SWF, it’s worth reading in its entirety. As best I can tell, it touches all of important points described by Udaibir S. Das, Yinqiu Lu, Christian Mulder, and Amadou Sy in their recent paper. For example, the Proposal strictly defines the transfers, allocation and outflow of oil revenues to and from the various SWFs. It’s pretty thorough.

My only concern then is with the governance of the new funds. As best I can tell, the Minister makes all the investment decisions:

“The Minister shall be responsible to oversee the collection, disbursement and the over-all management of the Ghana Petroleum Reserve Accounts…The Minister shall not make any decisions in relation to the investment strategy or management of the Ghana Petroleum Reserve Accounts without first seeking the advice of the Investment Advisory Board.”

So the Minister only has to consult with the Investment Advisory Board? In addition, it looks to me as of the Advisory Board is itself entirely political. The President can appoint and fire board members almost at will. Ideally, I’d rather see an independent investment committee making investment decisions.

Still, I’m not all that worried in this case because the Proposal rigorously defines the “qualifying instruments” that the fund can invest in. These are internationally denominated government debt instruments and currency deposits. Nothing too aggressive.

Anyway, it is fascinating to watch Ghana’s petroleum funds take shape. they look pretty good on paper, but as a friend of mine says, “the proof of the pudding will be in the eating.”


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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