Archive for May, 2010

Euro Watchers Fixing Gaze on…China?

Ashby Monk

I should know better than to check my email during vacation. But, alas, I did. And, to my wife’s chagrin, my SWF curiosity — which was quite literally on a beach — was piqued by a friend’s note:

“I notice that both KIA and CIC have been forced to deny that they are not going to dump their European government debt, in the wake of the crisis. I think there’s something interesting to be written about how SWFs have become market leaders and a test of confidence. Stocks have rallied and the Euro has stabilised today…”

Interesting indeed! Apparently, what China and other sovereign funds have to say about the euro is more important than what Europe (or perhaps anyone else) has to say about the euro. Have a look at the raft of news reports over the past few days highlighting China’s ongoing commitment to the Euro area and its impact on euro confidence.

Why? Well, China originally set up their SWFs to diversify their reserves away from dollar denominated Treasuries and into other assets and currencies, such as the euro. So, it would be a huge blow to the euro if the CIC or SAFE decided that it would discount or drop euro assets.

But, as CIC President and CIO Gao Xiquing said in Paris yesterday, “…we were debating whether to underweight Europe, but our conclusion probably is not to underweight it.” On the news, financial markets raced ahead and crude oil surged $3 bucks. And it wasn’t even that strong of  a statement! “Probably”…?

Anyway, back to it…

Guest Blog: Paul Rose

We’ve invited Paul Rose to contribute a guest post for the blog, as Ashby is taking a few days vacation. Paul teaches Business Associations, Comparative Corporate Law, Corporate Finance and Securities Regulation at the Ohio State University’s Moritz College of Law. His scholarship focuses on issues relating to sovereign wealth funds, corporate governance and securities regulation. Without further ado, over to Paul!

Thanks very much to Ashby for inviting me to post a few thoughts. I tend to approach SWF issues by considering the transactional and corporate governance issues presented by SWF investment, so I was very interested to see on Wednesday a Financial Times report that the Qatar Investment Authority had expressed interest in purchasing a portion of the U.S. Treasury’s 27% stake in Citigroup. The FT’s sources warn, however, that “any deal would depend on the price, market conditions and the government’s willingness to sell Citi shares to a sovereign wealth fund at a discount.”

A potential deal between the Treasury and the QIA would be very interesting for many reasons, but I’d like to focus on just two issues in the deal that would be particularly compelling:

  1. The first issue is that the potential deal is not a primary market transaction like Citi’s sales of stock to other SWFS, including the KIA, GIC and ADIA. Here we have a secondary transaction between two sovereign entities, which raises a second layer of the kind of political issues that have hung over primary SWF transactions. So, instead of simply wondering whether we should expect a smooth Committee on Foreign Investment in the Unites States (CFIUS) review of a QIA investment in Citi, we might also wonder how it is that Treasury is going to deal with another sovereign entity, and how Treasury, seated at the head of the CFIUS table, is going to manage a review of a transaction in which it is a participant. To at least partially address these concerns, a senior Treasury official states that “We have to outsource the process to Morgan Stanley so the sale isn’t tainted.” That is probably the best Treasury can do in such a situation, although Treasury (and by extension, the Obama Administration) will likely come under criticism no matter how the deal comes out; it is no simple thing to please political constituents, market counterparties, and foreign governments at once.
  2. A second interesting aspect to the transaction is that the sale would involve the Treasury’s common stock holdings, rather than the sale of its preferred securities. With the SWF investments in US financial firms in late 2007 and early 2008, SWFs typically invested through purchases of preferred securities rather than common stock. SWFs and the banks had a number of good reasons for transacting through preferred stock. Primarily, investments through non-voting preferred stock helped alleviate the concern that SWFs would use share voting power to influence the banks for political or other non-economic purposes. From a governance perspective, this reduces risk for the bank and its other shareholders and stakeholders. The passivity commitment created by the preferred stock investment also helps focus the SWF on economic concerns, and so may also insulate the SWF from domestic pressures. An investment in common stock, on the other hand, may increase transaction costs by inviting more stringent CFIUS review, and potentially increases firm and SWF governance risks that would otherwise be mitigated in a preferred stock investment.

I look forward to seeing how this all plays out. A Treasury-QIA deal would undoubtedly provide valuable lessons on secondary market transactions between sovereign investors.

SWF Bankers Wanted

Ashby Monk

Help Wanted: Investment banking deal-maker with extensive ties to Sovereign Wealth Funds. The ideal individual will understand the sensitivities involved with these government entities and be adept at navigating the political landscape of the sponsoring countries. Ideal candidates will combine the best characteristics of a diplomat, financial analyst, and educator. In addition, the individual should be enthusiastic about spending extended periods of time on the road to forge relationships with SWFs and secure new business. The ideal candidate will have a remarkable pedigree (Ivy League / Oxbridge) that will impress and carry weight with SWFs. However, there is actually no need to speak Chinese, Arabic, or any other language (except perhaps for English) for this job. The idea that SWFs will only do business with “their own” is a myth that too many asset managers and investment banks fall prey to. In fact, many SWFs explicitly seek out foreign (…read expert…) advisors and service providers. Please send applications to Wile E. Coyote at ACME Investment Banking…

If this job advert (…which is fake by the way…) peaks your interest, then you’ll enjoy reading Paul Clarke’s short article in eFinancialCareers this morning. He suggests that investment banks are continuing their hiring spree around the world to woo SWFs’ business. Why?

“Part of the reason for this could be a need to mount some competition against the small number of investment banks currently courting favour with SWFs…According to Thomson Reuters figures, Morgan Stanley and Goldman Sachs have worked on 20 and 24 SWF M&A deals respectively, worth a combined $33.8bn, since 2005. Their nearest competitors – Citi and HSBC – have worked on 11 and nine, respectively. JPMorgan, Lazard, Bank of America Merrill Lynch and Credit Suisse all featured sporadically in the rankings.”

It sounds to me as if there will be plenty of new jobs in this area. So, if the job advert above describes you, then you’ve probably got a good chance of landing something. SWFs are undoubtedly the ‘growth area’ of the institutional investment business…

Will Western SWF Protectionism Create Eastern Opportunities?

Ashby Monk

This post is coming to you live from a Boston-NYC Acela Amtrak train. I have to say, I’m happy to see that Amtrak has finally installed wireless Internet on their trains (albeit with an overly strict filter that blocks many good news sources in the developing world). In my view, this officially makes train travel on the Eastern sea board preferable to air travel. The convenience is simply unbeatable.

Anyway, enough about trains and planes; I have some interesting SWF news to report this morning. The UAE central bank governor Sultan Bin Nasser Al Suwaidi gave (what sounds like) a pretty candid speech about Abu Dhabi’s SWFs at the MENASA Forum at the Dubai International Financial Centre last night.

In his view, SWFs in the MENASA region (i.e Middle East, North Africa and South Asia), will take an increasingly passive investment approach in Western markets and redirect their active and strategic investment strategies to emerging markets and, in particular, nearby regions.

Why? In part, this redirection will be based on the desire to maintain social order, peace and stability in the region. However, Al Suwaidi also suggests that this new policy will be driven by increasingly protectionist behavior in the West:

“Another reason that makes me think that SWFs from our region might change the flow of their direct investments is that once we see the proposed regulations regarding sovereign wealth funds in the industrialized advanced economies start being implemented, more questions will be asked and more forms will become necessary to fill and more disclosure and transparency will be demanded. This behavior will signal that there is no strong need for foreign capital in the West, and that the political mood has changed…Therefore, we might see gradual tightening of the scrutiny on capital flows from SWF countries at one stage, especially funds that are destined for direct investment in certain companies…Faced with all this nonsense, SWFs will certainly come to the conclusion that it is time to change strategy. This could make SWFs avoid direct investment in certain companies, or even avoid direct investment in all companies, and become more of passive investment vehicles in the West.”

I don’t think I would call increasing transparency and disclosure requirements “nonsense”. But, whatever your views on the subject, it is clear that Al Suwaidi is pessimistic about Western markets’ willingness to accept SWF investments without some new restrictions or increased regulation.

Interestingly, Al Suwaidi doesn’t seem to be all that broken up about this. In fact, it sounds to me like he sees this as a possible boon for the MENASA region:

“…restrictions put in place in many countries, including the G7 countries, might open a window of opportunity for countries in our region or the wider area.”

This reminds me of something my dad would say: ‘There are no problems, there are only opportunities.’ And, to a certain extent, Al Suwaidi is correct in thinking this way. To be sure, Western protectionism will undoubtedly create new opportunities in other jurisdictions (including his own).

However, that doesn’t mean that these new investment opportunities will offer SWFs similar or better risk adjusted returns. The investment climates in MENASA can be challenging. Moreover, SWFs are in many instances designed to prevent Dutch disease, which presumes that the assets will not be invested domestically. If SWFs redirect their capital towards local markets, this will mute SWFs’ impact on this phenomenon.

Anyway, my opinion is that Al Suwaidi is being overly optimistic here; Western protectionism may indeed create new Eastern opportunities, but these new opportunities will have plenty of problems of their own. In particular, local or domestic investments typically require rigorously sound governance procedures to ensure that money is not wasted on politically oriented investing. And, in my view, this is a problem that could be more difficult to resolve than simply filling out some forms or increasing transparency…

China Implements Loans-for-Oil Program

Ashby Monk

I mentioned last week that China was increasingly using its foreign exchange reserves in innovative ways to secure commodities and resources that meet the country’s strategic needs. Specifically, I talked about China’s new policy of loaning out foreign exchange reserves to resource rich countries in exchange for crude oil imports. As it happens, there is a pretty good article out in Caixing English today that goes into quite a bit more detail on the new policy:

“Major loan-for-oil swaps signed in recent months by China and several other countries marked a coming-out for the new policy…The adjustments are designed to help China diversify its foreign currency assets and provide a channel for some of the US$ 2.4 trillion in reserves held by the central bank…The reforms also expanded SAFE’s responsibilities beyond its traditional role of managing foreign exchange reserves, effectively turning the agency into a foreign currency lender.”

So, it sounds as if the new policy is already in a full implementation phase. Indeed,  China has already signed a series of high-profile loan-for-oil swaps:

“…China has signed loan-for-oil agreements worth more US$ 60 billion in recent months with Russia, Venezuela, Kazakhstan, Turkmenistan and other countries. Altogether, these agreements have given China the rights to import nearly 75 million tons of crude oil every year.”

Roughly speaking, this is enough crude oil to meet China’s import needs for close to four months. Indeed, in all of 2009 China imported 203.79 million tons. So, while this represents a pretty major policy shift for China, it seems to be meeting its objectives…

Can Transparency Be Profitable for SWFs?

Ashby Monk

A while back I had a discussion with a SWF executive who was trying to make the ‘business case’ for transparency. In other words, he wanted some insights and inspiration for how improving transparency might translate into higher returns for his organization. It was an enjoyable discussion, and we actually managed to come up with quite a few commercial reasons to improve transparency.

One point that really seemed to resonate with this individual was the need to get domestic “buy-in” for the SWF’s operations so as to ensure that it would have a “license to operate” in good and bad times. In other words, if the public was made to understand, and hopefully support, the operations of the fund, then the public would (in theory at least) not challenge the legitimacy of the SWF during short- to medium-term downturns in the market. This would ensure that the fund’s investment horizon would remain long-term, and it would never have to sell assets at a discount because domestic stakeholders changed their mind about a certain investment strategy.

Anyway, I decided to recount this anecdote because it looks like some similar conversations may have been taking place in other SWFs. In particular, I was interested to read this assessment of the recent investigation into the utility of active management that took place within Norway’s GPF-G:

“Where the fund stumbled, Ang says, was in its failure to clearly communicate the types of active strategies that it was pursuing. ‘The Norwegian parliament and public are sophisticated about these matters. For example, when equity markets fell dramatically in 2008, there was no outcry because the Norwegians understood that equity markets could crash.’…In the case of the more recent discord over losses in the assets under active management, Ang suggests that the Norwegian public should have been made aware of the active investment strategies the fund was pursuing prior to 2008. “They would have understood that such strategies might provide low returns or even losses in the short term, and been steeled to expect the downside,” he says.”

In other words, the government would not have been compelled to launch a complete re-evaluation of the fund’s active management policies if it had been more transparent about what it was doing!

And if that’s not compelling enough for you, there are other commercial reasons to improve transparency.  For example, in my discussions with the SWF executive, we also talked about how transparency can ensure access to markets and industries around the world that might otherwise be off-limits to a non-transparent, foreign, government entity. From the perspective of modern portfolio theory, increasing access to these markets and industries would improve risk adjusted return (i.e. further diversify the portfolio).

So there you have it — that’s two examples of how transparency might make a SWF more profitable. In short, there is value in securing the approval of domestic and foreign constituencies…

Euro Crisis Leading to Trade Tension

Ashby Monk

With the Euro in free fall and stock markets crashing, it’s a good time to start thinking about what the European situation will mean for the global economy. Thankfully, Michael Pettis has already done all the heavy lifting. Indeed, he has a remarkable post on his blog that outlines the global implications stemming from the Euro crisis. It’s not pretty:

“Expect trade tensions to get nastier than ever by the end of this year or the beginning of the next.”

Why you ask? It’s complicated. Nonetheless, I encourage you to take the time to read and understand Pettis’ logic below; it’s very compelling:

“1. I assume that for the foreseeable future the major trade deficit countries in Europe are going to find it very difficult to attract net new financing. At best they will be able, through official help, to refinance part of their existing liabilities.

2. If these countries cannot attract net new capital inflows, their currency account deficits, currently equal to two-thirds that of the US, must automatically contract.

3. If European trade deficits contract, there must be one or both of two automatic consequences. Either the trade surpluses of Germany and other European surplus countries – larger than that of China and just a little larger in sum than the European deficits – must contract by the same amount, or Europe’s overall surplus must expand by the same amount.

4. We will probably get a combination of the two, but a much weaker euro – combined with credit contraction, rising unemployment, and German reluctance to reverse policies that constrain domestic consumption – will mean that a very large share of the adjustment will be forced abroad via an expanding European current account surplus.

5. If Europe’s current account surplus grows, there must be one or both of two automatic consequences. Either the current account surplus of surplus countries like China and Japan must contract by the same amount, or the current account deficits of deficit countries like the US must grow by that amount, or some combination of the two.

6. If the Chinas and Japans of the world lower interest rates, slow credit contraction, and otherwise try to maintain their exports – let alone try to grow them – most of the adjustment burden will be shifted onto countries that do not intervene in trade directly. The most obvious are current account deficit countries like the US.

7. The only way for this not to happen is for the deficit countries to intervene in trade themselves. Since the US cannot use interest rates, wage policies or currency intervention to interfere in trade, it must use tariffs.”

If things play out according to this scenario – and it’s hard to see how they won’t – tensions surrounding trade will undoubtedly increase. This could, in turn, have implications for SWFs’ investment strategies. Moreover, while many seem to think that the Greek crisis and the Euro depreciation have taken the heat off of China for a RMB revaluation, the Pettis’ scenario actually strengthens the argument for RMB adjustment. But will that happen? Probably not. I leave you with Pettis’ depressing conclusion:

“I don’t really see how the numbers are going to work. Europe, China and Japan are all implicitly demanding that the US trade deficit rise to help them through their domestic employment problems. The US has its own domestic employment problems and is determined to bring the trade deficit down. Both sides cannot win and there doesn’t seem to be much serious attempt at global coordination.”


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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