Politically Motivated SWFs! Yeah, So What?

Ashby Monk

In the past few months India and Japan have both talked about setting up SWFs for the purpose of resource acquisitions overseas. And a recent report by the CIC (not that one, this one) suggests that the China Investment Corporation’s investments in Canada are all part of a political and development policy based on securing natural resources abroad. So, here’s my question: Does it matter if a SWF makes a strategic (i.e. politically motivated) investment in another country’s resource sector? Obviously, the Santiago Principles, which attempt to define the generally accepted principles and practices of SWF investment behavior, have a clear stance against this practice. But why?

I can see how a target country might be concerned if, say, a foreign country’s SWF was to take a controlling stake in some domestic firm, thereby giving it the power to redirect resources to the SWF’s sponsoring country or sell these resources at a discounted rate. The firm would be made worse off, which would have knock on effects for the local community. But that’s a worst case scenario and, if we’re honest, a straw man argument. The local authorities could ensure this never happens in a variety of ways (see Potash). Moreover, if the investment was a minority stake, would it have any geopolitical significance at all?

I’m not sure. In fact, it may serve the interests of the target country to have a politically motivated SWF investing in its firms and industries. After all, a politically motivated SWF will ascribe a higher value to the firm than it might otherwise do if it was using only cash flows for the valuation.

Anyway, this discussion was inspired by a report (“The Dragon Returns: Canada in China’s Question for Energy Security”) written by Wenran Jiang and published by the Canadian International Council. It’s really quite intriguing, as it implicitly accepts that China’s investments are politically motivated and considers ways in which Canada can still work with the Chinese (instead of over-reacting and shutting them out of the Canadian market completely).

In effect, Jiang suggests that China’s investments in the resource sector are part of a politically motivated “going out” strategy tied to a development model based on maximizing exports, discouraging imports, and enriching the state:

“…China’s “miracle” GDP growth has come with a heavy price tag, including the growing hunger for more and more energy and natural resources, leading to massive extractive activities both inside China and around the world…Accompanying this heavy industrial structure is a tremendous waste of energy…to generate every 10,000 yuan of GDP (C$1,519), China uses as much as three times the energy as the global average.”

“…one major structural requirement for China’s continuous industrialization drive is to enter energy and resource rich countries to secure supplies. Given Canada’s rich endowment of energy, minerals and other key resources, it is only natural that Chinese enterprises see the country as a major frontier to satisfy China’s need. ”

That’s right. Canada has the second largest proven oil reserves behind Saudi Arabia. And it wouldn’t come as a shock if the CIC were investing according to a “double bottom line” (for profit and the nation). After all, back in 2010 Sheng Songcheng, a representative of the People’s Bank of China, said China should use its forex reserves to acquire strategic assets around the world, such as oil.

The real question is whether this motivation should be a source of concern. GAPP 19 would suggest that, yes, it is a concern. But, again, I’m not so sure. Here is my question: Should we treat an SWF with a double bottom line (returns and national development) any differently than we currently treat pension funds with double bottom lines (returns and community development)? In fact, some pension funds are trying to implement triple bottom lines — people, planet, and profit — that are pushing the boundaries of what qualifies as a ‘profit motive’.

Anyway, I don’t have the answer. But I can say that it seems reasonable that a sovereign fund might make investments that serve both the interests of the fund and the nation. And if that is the case, more discussion and engagement between the authorities representing the buyers and sellers may be needed, but it doesn’t warrant protectionism. (After all, nobody seems too concerned with the investment activities of Mubadala.) Moreover, in a certain manner of thinking, every investment a SWF makes has a political motivation: to make money for the sovereign.

11 Responses to “Politically Motivated SWFs! Yeah, So What?”

  1. 1 Sven January 6, 2011 at 2:21 am

    Hi Ashby,
    Great post, as always!
    Some thoughts following up on your questions. Yes, GAPP 19 states that SWFs’ investment decisions should aim to maximize risk-adjusted returns, based on economic and financial ground. But GAPP 19.1 Subprinciple makes an important exception. It requests SWFs to publicly disclose other considerations driving their investment policies, should this be indeed the case. It appears to me that the IWG’s, i.e. the (self-)regulator’s intention was to express rather a preference for transparency of motivation than providing an absolute benchmark. A good number of SWFs, most prominently the Norwegian GPFG, are very transparent about ethical considerations driving certain aspects of their investment decisions. So it appears to me that GAPP 19 does not per se exclude political, ethical or other motivations driving decisions, but requests SWFs to be transparent about them.
    Now over to the CIC. The declared mission of the CIC is to make long-term investments that maximize risk adjusted financial returns for the benefit of its shareholder. It also declares to be driven by a strict commercial orientation, economic and financial interests. So far so good. What would be troubling for GAAP 19.1 Subrinciple is if CIC’s investment behaviour did not correspond with its declared objectives. And your post, Ashby, and the report you highlight suggest that it does not, since it is disproportionally exposed to the resources sector. So, something is not in line. If this is indeed the case, GAPP 19 suggests two options for CIC: Either to realign investment behavior with declared objectives, or to declare that its moves are also informed by China’s broader natural resource investment strategy. In that case, I would not see a violation of GAPP 19. Whether this openness would make recipient economies less worried is an open question.

  2. 2 Ashby Monk January 6, 2011 at 10:28 am

    Hey Sven, Thanks for the comment. Yeah, fair point on the 19.1 sub-principle. In this sense, Mubadala is very transparent about its strategic objectives, which would fit with GAPP. On the CIC, I take your point completely…though I’m doubtful that the CIC would go either of the two routes you suggest. We shall see!

  3. 3 John Nugee January 6, 2011 at 11:16 am


    A very clear statement and I for one entirely agree. In my view a state is entitled, within the framework of agreed international relations, to use all the assets at its disposal in any way it chooses in pursuit of its national aims.

    The qualification “within the framework of agreed international relations” is clearly necessary and, for example, these days rules out by common consent more powerful countries invading or bullying lesser ones. We have moved on from the gunboat diplomacy of the 19th century. And if the international community agrees and so wishes, it can rule out using SWF assets to buy political power or position.

    But this is not a given and not the default position – in fact I would say that the default position is that a state should be entitled to use its SWF assets in any way it chooses, up to and including stockpiling raw materials or buying control of strategic corporate assets. If the international community objects, and can forge a consensus to stop such activities, fine, but in the absence of such an agreement and consensus that would be the default position.

    After all, it’s their money.


  4. 4 Ashby Monk January 6, 2011 at 11:40 am

    Thanks, John. Nice comment.

  5. 5 Sven January 7, 2011 at 1:27 am

    Appears that your blog entry stimulates an interesting conceptual debate about power and legitimacy in international affairs in the 21st century, applied to the world of SWFs, Ashby!
    John, for the time being I do not see the emergence of a framework of agreed international relations that applies to SWFs. SWFs have come out with the Santiago Principles speaking for SWFs; the OECD has come out with their declarations speaking for recipient countries, put in simplistic terms. But though it appears that recipients and investor countries are talking here and there, I do not see a strategic dialogue between recipients and investors that could result in something that could eventually be called agreed framework. Ted Truman eludes to this on the final pages of his recent book, stating “if SWFs are to have a safe future, home and host governments should comprehensively approach broader issues associated with capital flows and international investments by governments.” I advocated that such a process could be anchored with the G20, for lack of a better forum.
    Given that we do not have this framework for the time being, I agree, John and Ashby, that sovereign states should make sovereign decisions about where their money goes. I simply argue, in line with GAPP 19.1 Subprinciple that SWFs should call a spate a spate and say what they are up (see Mubadala, as you mention it, Ashby, and to be fair, there are many others who do exactly that). Of course it is their sovereign decision to implement this Principle. But if some (of the big ones) continue to beat around the bush, they leave it to the international community, not least to this blog, to figure out what it is that they are really about. This in the end, through all sorts of political channels, creates a political and regulatory risk environment that SWFs cannot and are not happy about. I guess much boils down to transparency of motivation consistent with real behaviour as the basis for a healthy relationship.
    Now, I consider it equally legitimate for recipient economies to arrive at a sovereign decision about how to allow access to assets within their jurisdictions. If new regulation would be a beneficial move in this day and age is different question, but nobody would be in the position to call it a foul; we do not have a reference point that would disallow potential sovereign recipients to do so.
    So, what we are left with is something that reminds me of the classic prisoners’ dilemma in which both parties are left with a suboptimal outcome because they are not talking and jointly develop something that you suggest, John. Btw. it appears that it is not only the world of SWFs that is facing this situation. Watch the airline, extractive, automotive, etc. industries. Parag Khanna is just about to publish a book describing that situation as a world of “new medievalism”, in reference to Hedley Bull’s “anarchical society”. Let’s hope that we overcome this state of anarchy.

  6. 7 Rien Huizer January 11, 2011 at 1:00 am

    A self-styled SWF acting as an agent for a state in trying to acquire, for instance, resources in Canada or Sudan, is simply entering the domain of another sovereign in a private capacity. Depending on the local rules for foreign investment by states acting in private capacity or through an agent, that should receive level playing field treatment or not. I think the problem is that outfits like CIC try to impersonate private principals, rather than government agents. The problem arises with virtually every large Chinese firm since there are hardly any without a dominant state interest. I think that one of the reasons for having a SWF charter was, within the framework of international economic governance and its principles,to give a specific type of foreign state financial firm the same status as local private financial investors, provided they would conform to rules that would negate any advantage state sponsorship would entail.

    That (behaving within those rules) would clearly not be the case in a material sense if a state firm (from a country with very large market imperfections and under the rule of a “communist” party) with access to virtually unlimited resources would operate in a foreign “capitalist” environment with primarily the interests of its own state in mind. The host country should have the right to invoke the national interest in cases such as these and discriminate against such a firm.

  7. 8 Rien Huizer January 11, 2011 at 1:14 am

    I should add that most developed resource-rich countries have foreign investment rules where state-controlled actors face stricter scrutiny than purely private ones.
    China does not need a CIC to acquire resources in Namibia: state industrial firms with assistance from China’s development and export-import banks would be sufficient. But precisely in countries like Australia where portfolio investment in resources firms is easy and FDI or complete acquisitions are much harder, having a utility institution that operates under the portfolio investment rules as much as possible can be very practical. And there are lots of mining minors who like to oblige and undercut the grip mining majors have on secure, high quality production around the world. Just look at the frantic attempts by “China” to undermine the de facto iron ore cartel of BHP, Rio and Vale by controlling a large enough minor. If the Chinese state were a centralized,highly coordinated and disciplined operator (which it is not, at present) that could be quite harmful to non-Chinese interests. However, for the time being it all comes across as pretty decentralized and, in fact, looks like real private sector clumsiness…

  8. 9 Ashby Monk January 11, 2011 at 8:30 am

    Thanks, Rien. Interesting as always.

  1. 1 Korea to Expand KIC’s Objectives? « Oxford SWF Project Trackback on January 11, 2011 at 8:50 am
  2. 2 SWFs and Energy Security « Oxford SWF Project Trackback on May 18, 2011 at 10:04 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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