SWFs to the Rescue

Over the past six to nine months, it has seemed as if many major American and European financial institutions have been getting government bailouts. Only the governments haven’t been in Washington or Paris. Instead, China invested $5.5 billion in Morgan Stanley and another $1 billion in Bear Stearns (although the later investment was not enough to stave off disaster). Singapore gave $4.4 billion to Merrill Lynch, $9.75 billion to UBS, and $6.9 billion to Citigroup, which raked in another $7.5 from Abu Dhabi. Kuwait has ponied up, as have Korea, and Japan.

Until the flurry of deals hit both continents, few Americans or Europeans paid attention to the government- owned investment vehicles known as sovereign wealth funds (SWFs). But when so many stepped in to purchase large ownership stakes in flailing Western financial companies, the entire concept of state ownership in other countries’ corporations suddenly became too big to ignore. Some estimates peg SWF spending on corporate equities at more than $60 billion last year, compared to just $25 billion the year before. And that is only a fraction of their buying power. Peter Morici, an economist and professor at University of Maryland’s School of Business, estimates that governments in China and the Middle East have enough capital to purchase as much as 20 percent of the U.S. equity market. Although not a prediction, it is one indication that buying by SWFs is here to stay.

So what should Westerners think? There’s no simple answer, if for no other reason than there are two dozen or so major SWFs that have varying motives and degrees of transparency. It seems clear that some, if not most, are likely to behave no differently than any other large institutional investor. In fact, boards at many companies are likely to find them to be a new source of patient capital that is a lot less demanding than activist shareholders. However, because SWFs are government entities, they’re subject to potential political considerations that don’t arise with large pools of capital held by traditional institutional investors. Many of the SWFs are run by government officials, including some in autocratic countries such as China and the Mideast oil kingdoms. Some disclose the magnitude of their holdings and what they buy and sell, while others are as secretive as the Kremlin during Communism.

Government investments in multinational corporations are a new phenomenon that raises thorny questions for market-based economies, and for the boards that must weigh the pros and cons before they decide whether or not to accept such investments. The most difficult problem for Western corporate leaders and politicians is that there may be no way to know if a country plans to wield its SWF as a political or economic weapon—or whether, if large equity purchases are allowed to go forward unimpeded, a future foreign leader will pursue ulterior objectives as the political and economic winds shift.

As a result, the funds’ new visibility has sown confusion across industrialized economies. Conservative leaders like Germany’s Angela Merkel and France’s Nicolas Sarkozy are calling for new laws or other actions to guard against any politicized SWF investment, even as European business groups and European Union (E.U.) officials warn about protectionism.

Similarly, in the United States, some business leaders—especially those receiving SWF infusions or hoping to—endorse them as a welcome source of new investment. But Democratic presidential candidate Hillary Clinton has called for increased scrutiny and possibly regulation of SWFs, while Treasury Secretary Henry M. Paulson, Jr., most likely in an attempt to take the lead from the political wing, has urged international bodies like the International Monetary Fund (IMF) to set up a code of conduct for the funds. Overall, 11 countries have debated or passed laws to restrict foreign investment, according to an upcoming Council of Foreign Relations report by Carlyle Group’s David Marchick and Matthew Slaughter of Dartmouth College. “If the debate [in the United States] gets hot enough, we’ll see legislation regulating SWFs, although personally I don’t think it’s necessary,” says Edwin M. Truman, a Senior Fellow at the Peterson Institute for International Economics in Washington, D.C.

Whatever actions Western countries take, SWFs are likely to become an ever-larger presence in Corporate America and Europe. Indeed, some of the projections for their growth are just short of astounding. Because some SWFs disclose scant public information, no one has a precise estimate of their current size. But most experts think the top 20 or so have assets of more than $2 trillion (see table, pg 35). Last year, Morgan Stanley forecast that SWFs could hit $17.5 trillion in 10 years, while Citigroup Global Markets said they could do so in half that time. Of course, a majority of SWFs stem from natural resources, especially oil, so such spectacular growth is predicated on oil and other commodity prices holding close to their current sky-high levels, which, of course, is no guarantee.