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State-backed investors seeking higher returns on their capital are using sovereign wealth funds (SWFs) to buy western company shares, but the move has provoked a mixture of anger, mistrust and protectionism.
A new report issued by Standard Chartered, the UK-listed emerging markets bank, predicts that the greatest controversy will be created by the most secretive funds, which include those from the Gulf and China.
Gerard Lyons, chief economist at Standard Chartered, says that: “Western countries may need to accept the rise of SWFs as a further sign of a shift in the world economy and should seize this as an opportunity to work with emerging economies such as China and Russia, countries in the Middle East and others to find common ground rules and a code of practice.”
So should SWFs in emerging economies become more transparent, given that many other areas of financial markets are not? Should they work to establish a code of practice to avert a protectionist backlash in western countries? And what effect will SWFs have on the global markets and the interaction of the developed and developing worlds? Mr Lyons answers your questions in a live debate.
Would the G3/G7 importance be diluted, as a direct consequence of the SWF’s and instead a much wider G20(?) emerge? If the answer is yes, wouldn’t that result in slow decision making process and more disagreements than agreements? If the answer is no, would that result in widening economic divisions between the developed and developing world?
Dipak Khot, London
Gerard Lyons: The danger with the present set-up is that the voice of emerging economies is not being heard. The recent Doha trade round gives some insight into your question. Instead of a multilateral deal we have had a second best outcome, with bilateral trade deals being agreed to. That may help those individual countries, but it is not the ideal solution. I would not call it G7 being diluted, as you do in your question - if there is an issue then we need a solution, and for the right solution we need all the key players involved in getting the answer. That has to include the likes of China, India and others. How would it play out? Well the UN gives some insight - the decision making process can water things down and take a long time. The SWF debate is a case in point - and perhaps patience is the outcome.
There are huge differences between what is needed and what is likely to happen. There is a strong case for SWFs to adopt the best practice of funds such as Norway, being open and transparent, but many governments will argue that it is not only their money but also there are many other players in the financial markets that are not open and take stances that not everyone would agree with. Perhaps the ideal outcome is a level playing field, encouraging the countries from which the SWFs come to open up their markets to players from the west.
Coming back to your question, as you correctly point out, it is not easy. Many emerging countries, for instance, see SWFs as a force for good. That is why getting the debate started is key - and that is what I hope the G7 can do on this subject here in Washington this weekend.
It appears that the indebted countries especially the US does not want to pay the full price for its excesses? What difference will all this make for the ordinary citizen?
John Fernandes, Brazil
Gerard Lyons: There are two issues - first, the broader issue you touch on; second, SWFs themselves. In terms of the first the way to think about it is that the US consumer needs to spend less, save more, and get his or her balance sheet back into shape. Much in the way in which the US corporate sector had to get its balance sheet back into shape in 2001, which then led to the US downturn. In terms of what this means now, it implies at best a period of weak, below trend growth for the US, in which its savings rise, and at worst a deep recession. Hence the reason the Fed is cutting rates. How then do SWFs come into this. The wealth built up in SWFs over the years is a sign of strong economies in the rest of the world. What it means for ordinary citizens is that in time we should expect to see greater market influence from investors in the Middle East and Asia and - provided we avoid protectionist backlash - expect to see more of what has been evident recently with companies in the West being purchased by those in the East. The three words the ordinary citizen has seen most in recent years is Made In China perhaps the three future words could be Owned by China!
What do you think the real significances of SWFs are? The funds appear enormous in dollar terms but are tiny in the overall markets. Is the FT’s Martin Wolf right in saying that the real significance is that they symbolise the transfer of money and power to undemocratic nations?
Gerard Lyons: Stepping back and looking at this subject, one of the most important issues is that this is a further sign of how the world economy is changing. It is a further sign of a shift in the balance of economic power from the west to the east. It is not happening overnight. But it is happening gradually. What that also means is that the rules by which markets are run may need to evolve. In fact it can be seen in terms of the need for global policy fora to change to accommodate the growing influence of the BRICs and of other emerging economies. Thus, in terms of SWFs there is a need for common ground rules but the west cannot just tell the SWFs how to run themselves - it is after all their money. The democracy issue is not going to be addressed overnight, but what one can say is that good economics is normally good politics, if SWFs can be used, for instance, to invest in economies in the Middle East, say, then this will help them to diversify and generate jobs.
In your opinion, to what extent are the emerging markets SWFs politically motivated? Is the threat as serious as Washington believes?
Martin Vaivods, Riga Latvia
Gerard Lyons: There is a political aspect to some but not to all of the funds. And thus it is important to appreciate that there are large differences across the spectrum of SWFs. In the report that Standard Chartered released this week with Oxford Analytical’s input we looked at SWFs from many different aspects. One of those was size. Another was to look at their investment strategy - and this took into account how open and transparent some of the funds were - and also looking at them in terms of whether their investment decisions were strategic or driven by commerical considerations. In answer to your question there is clearly a strategic aspect to some of these funds. The big worry is that these funds see this as an opportunity to buy strategic assets in key industries, whether it be telecoms, energy, media, financial or even to secure intellectual property rights in other fields. And it is this strategic element that is seen as political.
Can you foresee limits to the size to which sovereign wealth funds can grow? Surely they cannot grow for ever. What factors will limit their size - presumably there is some downside to countries running big current account surpluses? Isn’t it good to have investors with money wherever they are from?
Gerard Lyons: To answer this one needs to look at the factors contributing to the growth in the SWFs now. There are four factors driving their current growth. These include a) high oil and commodity prices; b) the growth in FX reserves; c) the investment performance that they achieve; d) discretionary factors, such as how much governments want to put into them. Of the top 20 funds, 14 receive their money from oil and commodities. If current trend growths continues these funds could rise from around $2,200bn now to over $13,000bn in a decade. It is hard to quantify and one should say in qualitative terms - they are going to be big. Also one needs to look at the context in which, say, the current account shrinks. If for instance, current accounts shrink that might remove one impetus behind these funds - but the environment in which they are shrinking might well be one in which domestic demand and domestic financial markets in Asia, the Middle East are growing and in that respect SWFs are likely to be gaining from their investments in these markets.
How can the sovereign wealth funds be used to provide the stock exchange traded companies with required capital efficiently? How can the SWFs lead to the redistribution of the global capital flows?
Viktor O. Ledenyov Ukraine
Gerard Lyons: The second part of your question is key. SWFs should be seen as another example of how the world economy is changing, shifting from the west to the east. From an investment and from a strategic perspective one should expect in the future more of the funds to be allocated to the emerging markets. One of the big problems in the world economy is the so-called Asian savings glut. One way this can be addressed is to ensure that more Asian savings are directed into domestic consumption and even domestic investment. For this to happen, financial markets need to deepen and a shift of funds into these markets over time can help that. SWFs could be a force for change in this area. And indeed within the Middle East as well, where there is a desire to deepen financial markets as well. Not sure I fully understand the first part of the question. But as I read it, SWFs are a new and growing type of player in the financial markets and like many other investors they will seek to ensure that the firms they invest in are adopting best practice in all areas.
SWFs are a double edged sword. On the good side, they add tremendous liquidity to the markets they invest in. Additionally, they can generate higher returns on their capital instead of just sitting on their fixed income investments. On the other hand, do we really want any government (including your own) using businesses for politically strategic purposes? I think not. So why doesn’t every country agree to not let SWFs take controlling stakes in any entity? This isn’t protectionism, it simply save the market from even more political intervention. Has there been anything like this proposed?
Ben Thypin, New York
Gerard Lyons: With so many people just switching their attention to SWFs there is much uncertainty as to what their impact will be. In many respects they will be a force for good for emerging economies. As you touch on in your question, emerging economies are already in a position where they are better able to cope with external shocks. Compared with a decade ago, and the 1997 economic and financial crisis emerging economies are already better able to cope - high FX reserves, and solid current accounts (with the exception of east Europe), relatively low inflation and credible macro policies. Where SWFs could make a difference, particularly in Asia, is in helping economies deepen their domestic financial markets. This is a must for the world economy to become more balanced, as deeper financial markets will help build stronger domestic demand. Over time I would expect more of the investment focused money of SWFs to be attracted to emerging economies. Some already is going there. But many of these markets do not yet have the absorptive capacity - or indeed the products - to cope with large inflows. But as the SWFs money goes in, this will help the markets develop.
As for the West, there is a concern about the strategic issues that you mention. That highlights the need for ground rules on this - and that includes the right of recipient countries to define what they see as a national champion or a strategic industry. The danger is that without common ground rules being ironed out then the actions of one country to protect a certain industry could quickly lead to similar actions elsewhere - feeding the very protectionism that policy makers fear. At this weekend’s IMF meeting - and I am here in Washington now - SWFs are seen as one of the current hot topics, with a desire for some rules as to how countries should proceed. I do not expect anything to come out this weekend in terms of policy - that would be premature - but the debate is likely to move on with greater awareness of the issues, and a realisation that SWFs can be a force for good.
The current investment strategy of the newly formed Chinese SWF is quite opaque. In your view, what kind of investments can the EU-27 expect?
Tomas Cifra Brussels, Belgium
Gerard Lyons: The new Chinese fund is attracting much attention - but it is very much in its formative stages and there is still much debate about it within China. The person running the fund, Lou Jiwei, is an impressive character, as indeed are many of the policy guys in China, and he clearly wants to make the fund a success. But he will need to prove himself in terms of running this. Early signs are that the fund has been given a remit to maximise returns, with an emphais on commerical considerations to begin with, rather than strategic objectives. Additionally, possibly to ensure this, and also perhaps to alleviate US concerns, a chunk of the money is being given to international investment managers. This suggests that the fund could resemble other investment type vehicles in its initial strategy, perhaps with a more aggressive stance, As for the EU 27, the currency angle also comes into play, given the euro looks firmer than the dollar. That suggests to me a mixture of equity and fixed income, but also the Chinese clearly will allocate funds to alternative types of investments such as private equity and even hedge funds. The M&A and strategic plays will come later. With China’s FX reserves set to rise significantly, the early commerical success of the fund is important for it to secure a steady flow of those future FX reserves into it.