Thick Skin and CIC’s Funding Soap Opera

Ashby Monk

I’ve developed a thick skin over the past decade. It’s a necessity in this business. So when I heard/read via email that Z-Ben thought some aspects of my post from Tuesday were “patent nonsense”, it didn’t phase me too much. They point out some good and valid criticisms. Originally, I had raised an idea (which was initially raised by a series of academics in China) that the CIC’s high hurdle rate may have contributed to the rejection of their request for $200 billion. According to Z-Ben, that’s “patent nonsense”. Why?

  • “Any funds that CIC would acquire are already denominated in USD and are, for the most part, invested in ultra-low-yielding, short-term government bonds.
  • Local asset comparisons are useless as the money is locked in non-Rmb currencies.
  • CIC is neither strictly in the hurdle nor the paper profit business: it exists to turn a real long term profit while diversifying a portion of the sterilized reserves into assets capable of outperforming government bonds, regardless of moves in the currency.
  • The pressure generated by the growing pile of reserves is, in our view, the motivating factor for both the absolute size of CIC’s likely 2010 bequest.”

These points, I admit, look eminently sensible. As always, I have a lot of respect for the work Z-Ben does; they are on the ground and in the field and I’m sitting in an ivory tower.

That said, I’m still not totally sure that the “hurdle” issue is as “patent” as they say (at least to this simpleton). If memory serves, the initial disbursement to CIC was funded through RMB bond sales (~1.5 trillion). The RMB that was raised from these sales were then converted into foreign exchange over time to fund different aspects of the CIC. As Brad Setser noted in a paper back in 2008:

“Given the RMB’s ongoing appreciation, the Ministry of Finance has every incentive to only buy foreign exchange when it [the CIC] actually needs the money.”

His point seems to suggest—and maybe I’m wrong here—that the MoF was concerned about (…dare I say the words again…) a hurdle rate!

Now, the story isn’t over. Back in August, the CIC came to an agreement with the MoF to change the way it pays its funding costs. At the time, the CIC reportedly had to pay around $10 billion per annum back to the MoF in interest on this debt. The new agreement, however, changed the structure between the CIC and the MoF from an interest payment to a dividend. This gave the CIC a bit more flexibility, as it had already postponed interest payments due to poor financial returns.

So, where does that leave us? Well, I guess Z-Ben assumes that the CIC’s next allocation of capital will not be done in the same way as the first allocation of capital. And I think they are probably right! There is plenty of cash sitting in USD reserves that could be transferred over. So the “hurdle rate” issue really only applies to the initial disbursement of capital and would not be a factor for the next disbursement. Good to know…

5 Responses to “Thick Skin and CIC’s Funding Soap Opera”

  1. 1 MMcC April 1, 2010 at 6:35 pm

    Ouch! And as the legendary bumper sticker says: “Come back to Miami – we weren’t shooting at you!” Apologies to Ashby and anyone else who ran quotes from the EO. We weren’t gentle and we could have been. Yesterday (and late Wednesday night) we fielded a high number of calls asking about hurdle rates for CIC and were heartily sick of the subject by the time the client note was written. Clearly, we’re no loss to our home nations’ diplomatic services.

    By way of atonement, some meat to add to the news bones. My first instinct, unsupported by time for analysis or the chance to go digging for more information, is that the smaller size of CIC’s grant this year is probably going to skew its investments in two directions, both at the expense of vanilla third-party mandates. I think they’ll try to find non-resource ways to play the China growth story, which suggests looking for companies that either: benefit from growing exports, supply China with higher-IP or higher-manufacturing-quality goods than are available domestically, or are based in neighboring countries where CIC thinks a spillover effect from China’s growth is certain. I also think it means a higher proportion of this year’s spend will go to alts, PE, property and hedge (especially overlay hedges) as CIC puts the finishing touches on its starter portfolio.

    I also think the USD100bn will be confirmed at record speed.

    Ashby – we owe you a night on the town the next time you’re in Shanghai…

    • 2 rien huizer April 2, 2010 at 12:18 am

      It is a peculiar situation. CIC is more or less fully invested (although a lot is liquid). If one assumes that the Huijin component (if in equity and hence in CNY!) has risen in value through CNY/USD appreciation and SOE bank earnings (Huijin accounts for its share on an equity basis), from at least USD 70bn (the probable bookvalue of Huijin when transferred to CIC from SAFE)to, say 90. In addition, “a third” of the original USD200 bn was supposed to be injected/spent on SOE banks and similar starte-controlled institutions not already in Huijin. What has become of the third is unknown (at least to me) but international investments by CIC point in the direction of the 70 bn not having been spent as intended. To what extent that displeases groups within the State/Party structure is hard to guess, but (1) it looks funny that CIC (in contrast to SAFE’s complete lack of publicity) and with the apparent lack of enthusiasm of the PBoC rep on its board) announces that the MoF is applying for USD 200 more from the State Council and (2) that a while later the MoF announces that it is applying again, but now for a smaller amount. Someone seems to have been embarrassed a bit. Usually that has meaning.

      Back to the hurdle: would that be in USD on the foreign (USD denominated) portfolio? In RMB on the foreign portfolio? In RMB of the value of all or part of CIC in the books the MoF keeps for the State Council? Etc. One would guess that Huijin’s assets, being all denominated in RMB, are not a USD exposure! And a share in the profits of the SOE banks over a year of enormous expansion without a commensurate capital increase should easily get over this hurdle. It is incomprehensible or poorly communicated.
      On the CIC’s

    • 3 Ashby Monk April 2, 2010 at 10:50 am

      No worries, Mike! Thanks for adding “meat to the bone”. Very interesting stuff…

      • 4 Ashby Monk April 2, 2010 at 10:56 am

        Rien: Interesting points. The subtle nuances of the internal political debates are beyond me…that China Stakes article you sent me was very enlightening in this regard (; if a bit old, it still offers a great summary of the CIC’s origins, which also offer insights into the funding saga. Cheers.

  1. 1 The CIC Funding Saga Continues « Oxford SWF Project Trackback on January 17, 2011 at 9:16 am

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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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