[Overseasview]Who’s afraid of sovereign wealth funds?When sovereign wealth funds from Asia and the Middle East injected more than $21 billion into Citigroup and Merrill Lynch in January, they began to attract a new level of scrutiny in Washington. Some U.S. lawmakers are now publicly fretting over the potential impact of a new class of foreign investment in politically sensitive U.S. assets.
In 2005, the big story was a bid by a state-owned Chinese energy firm CNOOC to buy an American oil company, Unocal. In 2006, it was a state-owned Arab company, Dubai Ports World, bidding to acquire operating rights to several U.S. ports. The latest foreign investment story raising the political temperature on Capitol Hill comes from state-subsidized foreign investors buying multi-billion dollar stakes in U.S. financial institutions.
Sovereign wealth funds, government-controlled pools of surplus capital produced by high oil prices or an export boom, are not a new phenomenon. They’ve been generating controversy since Margaret Thatcher forced the Kuwait Investment Authority to sell most of a stake it bought in British Petroleum in 1987.
But their financial muscle — and the political anxiety they generate — have grown sharply in recent years. There are now as many as 40 of them, and some estimates suggest they have nearly $3 trillion to invest. They account for about 12 percent of all international investment, double their share of just five years ago. Some credible forecasts suggest their assets could grow to $15 trillion by 2015. Twelve new funds have been established since 2005.
For the moment, the need to bolster U.S. banks in the wake of the subprime mortgage mess limits official hand-wringing over these latest purchases. But a Feb. 7 meeting of the U.S.-China Economic and Security Review Commission, which studies the national security implications of U.S.-Chinese commercial relations, brought some worries to the surface.
The China Investment Corporation, a Chinese sovereign wealth fund, made headlines in December with a $5 billion equity stake in Morgan Stanley.
During the hearing, senators Evan Bayh from Indiana and his fellow Democrat, Jim Webb from Virginia, warned that China and other foreign governments could use sovereign wealth funds to acquire equity stakes and board representation in U.S. firms for political, rather than commercial, purposes. They argued that tougher restrictions on these types of investment might be necessary.
Other witnesses suggested that sovereign wealth fund investments in U.S. companies could provide foreign companies and governments with access to sensitive U.S. technologies, allowing them to spy on U.S. firms and government agencies and to generate financial instability in America for a strategic advantage.
In other words, the fear is that by welcoming an infusion of (sometimes badly needed) cash, U.S. regulators may be opening America’s doors to a Trojan horse that gives Asian and Middle Eastern autocracies valuable political leverage within the country.
It’s true that some sovereign wealth funds are far from transparent. It’s often unclear who manages them. Some of their investments may not be intended to maximize profits but to serve the political interests of the governments they represent. But there are ways for U.S. and other rich world governments to mitigate these risks — while they continue to profit from openness to foreign investment. Certainly, Washington should work with foreign governments to ensure that the sovereign wealth funds they manage operate as transparently as possible.
There are certainly macroeconomic advantages that come with sovereign wealth fund investment. They supply liquidity to markets and help redress global economic imbalances. To the extent that U.S. officials worry about “decoupling,” a global move away from the dollar that reduces the interests of emerging market countries in U.S. economic stability, investments by sovereign wealth funds in U.S. firms amount to a form of “recoupling,” encouraging foreign governments to invest in continued U.S. economic growth.
The more that China, Russia and Persian Gulf states invest in U.S. and European companies, the greater their stake in international stability. In other words, we should worry less that Chinese and Arab funds are buying into U.S. banks than that Russia has so far remained on the sidelines.
Some of the fears associated with sovereign wealth funds are overblown. The worry that sensitive technology will end up in the wrong hands has been around for decades, and it’s not a concern limited to the actions of sovereign investors.
There are plenty of legislative protections already in place to address these issues. The most important of these is reform of the Committee on Foreign Investment in the United States, the multi-agency executive branch committee charged with reviewing and approving proposed foreign investment in U.S. assets to ensure they do not undermine U.S. national security.
Last July, Congress passed the Foreign Investment and National Security Act of 2007, which expanded the number of industries that may be defined as “critical infrastructure” and increased the level of political accountability by requiring committee members to sign off on decisions not to investigate certain transactions. Defense planners I’ve spoken with tell me they worry far more about Russian sales to China of cutting-edge, high-tech weapons systems than over the vulnerability of U.S. technologies to commercial espionage.
Another common complaint: Why should a Chinese government-subsidized fund be allowed to buy stakes in U.S. banks when many Chinese firms are off limits to U.S. and other foreign investors?
Because for the moment, many of those U.S. banks need the money, and the U.S. government isn’t prepared to bail them out. As Deputy Treasury Secretary Robert Kimmitt wrote in the January/February 2008 issue of Foreign Affairs: “It is in the United States’ interest to be open to market-driven instruments — from both private and sovereign entities — even if other countries are not.”
But U.S. officials are missing the biggest threat. It’s not the motives of sovereign wealth funds that should worry us most but legitimate doubts about their managerial competence. In short, some of them may not know what they’re doing. Other state-controlled entities operate in wasteful and inefficient ways. Why should sovereign wealth funds be any different?
Consider the national oil companies that have come to dominate today’s energy markets. Some operate with standards of professionalism that make them competitive with the most successful multinationals. Think Saudi Aramco and Norway’s StatoilHydro — and, to a lesser extent, Malaysia’s Petronas and Brazil’s Petrobras. But many state-owned energy companies are burdened with lousy management.
Consider the case of the energy giant Ptrolios de Venezuela, S.A. and the damage to the country’s oil export capacity — and its economy — that come with the state’s use of that company as a political piggy bank.
*The writer is president of Eurasia Group, a political-risk consultancy. He can be reached via e-mail at email@example.com.
by Ian Bremmer