Guest Blog: Can SWFs really be troubled firms white knights?

Stefano Lugo

Here we go again. After the massive capital injection in western financial institutions between 2007 and 2008 and the bail-out of Dubai World in 2009, the idea of SWFs being ‘investors of last resort’ has come back to the fore, as Qatari Prime Minister has recently announced the Qatar Investment Authority (QIA) will invest as much as €300 million in recapitalizing Spanish banks, which according to some estimation could suffer a €120 billion capital shortfall; this came just one week after he discussed with UK Prime Minister David Cameron the possibility of buying from the British government part of their stakes in Lloyds and Royal Bank of Scotland.

As announcements of this kind have appeared regularly in the last four years, it seems financial markets have started to systematically identify SWFs as distressed firms rescuers: in a recent working paper, co-authored with Fabio Bertoni, we show that SWFs investments drive a significant reduction in firms perceived credit risk even when there is no new capital injection. SWFs are somehow expected to protect invested firms against capital shortages, just like sheiks (who are incidentally the same seating in some SWFs Board of Directors) are expected to recapitalize their football clubs when needed.

The most often cited reason why SWFs may be behaving like this is to achieve ‘political goodwill’, as underlined by Regan Dorethy and Dnesh Nair in their article about QIA’s recent investment activity. But can Sovereign Wealth Funds really afford to keep – let alone increase – their stakes in troubled firms with the idea that these will eventually turn out to be good investments (either financially or politically) in the long run? The answer should probably be: it depends on the SWF.

While differences among SWFs in terms of goals, transparency, governance and independence from the Government have been already stressed in this blog, SWFs are as well characterized by very different levels of ‘financial power’, an aspect that can concur along with the others in answering our question.  I think there are at least two key elements in assessing the SWF ability to certify firms economic viability.

The first is the credit risk: the likelihood a fund can face an unpredicted call for liquidity is, other things being equal, lower if the investment would account for an high proportion of its portfolio. Indeed, we find in our study a positive correlation between SWFs wealth and credit risk reduction. Related to this aspect, the level of wealth under direct management and its percentage invested in the money market are also to be considered, as they can proxy the amount of capital ready to be discretionally allocated.

The second is the capital flow policy: funds receiving new wealth to manage on a regular basis, and those that are shielded from withdrawals, can more easily afford to keep their long-term perspective. This could explain why Temasek Holdings, which differently from GIC cannot rely on new capital to invest, decided to realize a big loss selling its stake in Merrill Lynch/Bank of America after just one year, while the other Singaporean SWF has kept its stake in struggling UBS. Also, funds that have decided to recur to debt capital by issuing bonds or sukuk – such as Temasek, Mubadala and Khazanah Nasional – are necessarily forced to keep in mind their interest coverage ratio.

Unfortunately, there still is a lack of information about these aspects; I believe this is detrimental for both SWFs, which could otherwise better exploit their comparative advantage as countercyclical investors, and target firms, which would know to what extent they can actually rely on SWFs as long-term shareholders.

Stefano Lugo is a PhD candidate in Applied Economics at Politecnico di Milano

1 Response to “Guest Blog: Can SWFs really be troubled firms white knights?”

  1. 1 Restructering Firm September 1, 2011 at 8:35 am

    With current economic standards SWFs really need to be aware of their capital flow policies to be able to maintain their long-term perspectives

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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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