Attempts by foreign interests to buy large companies at the forefront of a nation’s commercial life often arouse strong protectionist feelings. When the buyer is an overseas government, the resistance may be stronger – especially if the target has strategic significance.
So it is no surprise that the arrival in the US and Europe of state-backed foreign investors with enormous amounts to spend on corporate acquisitions has caused a frisson among politicians and business interests. Countries such as China, with fast-growing foreign exchange reserves, are following the lead of those where savings stem from extracting oil and other commodities in creating sovereign wealth funds to invest in advanced economies.
No longer satisfied with the income from lending their cash to the US and other governments by buying bonds, these funds want to acquire assets that offer better returns. Their actions are stirring up concerns in the countries they target and the feared motivations of some of the sovereign investors are prompting calls for measures to block foreign takeovers of strategic assets.
“There is a distinct risk that foreign funds turning from creditors to owners will trigger reactions from the recipient countries that will undermine globalisation,” says Stephen Jen, a currency analyst at Morgan Stanley.
Sovereign wealth funds themselves have been around for decades. The Kuwait Investment Authority, created in 1960 to invest the emirate’s oil revenues, has accumulated more than $100bn (£49bn, €73bn) of assets, including a recent 3.1 per cent stake in EADS, the aerospace group. The largest sovereign fund is thought to be the Abu Dhabi Investment Authority, which ING, the Dutch banking group, estimates has as much as $500bn under management.
Countries with commodity-based sovereign funds also include Botswana, Brunei, Qatar and Norway. More recently, Russia launched the Stabilisation Fund, which has received every dollar of oil revenue above a certain price since 2004 and is now worth more than $100bn.
A second type of sovereign wealth fund was created by Singapore to invest its foreign exchange reserves for higher returns than the government bonds that are usually held to fend off speculative attacks on currencies. Temasek Holdings, established in 1974, has an $85bn portfolio that includes stakes in Singapore Airlines, India’s ICICI Bank, China Construction Bank and Standard Chartered, the UK emerging markets bank. The Government of Singapore Investment Corporation (GIC), created in 1981, owns overseas equities, bonds and property worth more than $200bn.
Malaysia and South Korea were among those to follow suit – and China recently announced its intention to launch the China Investment Corporation with $200bn to invest. But with many Asian countries accumulating foreign exchange reserves far in excess of what is needed to protect their exchange rates, the amount of money diverted into sovereign wealth funds is forecast to rise sharply. Mr Jen estimates that the money at the disposal of these sovereign funds could rise from $2,500bn today to nearly $12,000bn by 2015.
Overseas investments by sovereign wealth funds have always had the potential to cause alarm in the destination countries. After Kuwait acquired a stake of more than 20 per cent in BP in 1988, the British government forced it to reduce the holding to 9.9 per cent amid concerns over the influence of an oil producer on one of the world’s largest oil companies.
More recently, talk of a bid for Centrica, the UK utility, by Russia’s Gazpromsparked widespread concerns last year in a country known for its openness to foreign bidders. The government was divided over the possibility that an arm of the Russian state could take effective control of the company that distributes gas to much of the British market.
In the US, Dubai Ports World, owned by the Gulf emirate, was forced to sell five port terminals it acquired when it bought P&O in 2006. Congressional opposition to allowing an Arab country to acquire the facilities led Dubai’s ruler to decide on disposal to a US entity after the takeover. In 2005, CNOOC, the Chinese state-controlled oil company, was forced by Congressional opposition to drop its $18.5bn bid for Unocal, the US energy group. Supporters of Chevron, the domestic rival bidder that won Unocal instead, had portrayed CNOOC as a front for Beijing’s strategic energy interests.
The threat that such concerns could disrupt capital flows prompted an overhaul of the vetting system for foreign acquisitions of US assets. Last week, President George W. Bush signed legislation to strengthen scrutiny by the Committee on Foreign Investment in the US that advocates of foreign investment hope will reduce uncertainty in the future. “There has been a complete and thorough debate over the last 18 months,” says Nancy McLernon of the Washington-based Organization for International Investment. “My hope is the processes will be given a chance to work.”
One early sign that this hope may be fulfilled has been the response to China’s $3bn investment in last month’s initial public offering of Blackstone, the US private equity group. Perhaps chastened by previous experiences, the Chinese won an informal nod from the Treasury in advance of taking a 9.9 per cent non-voting stake.
Meanwhile there has been little adverse reaction in the UK to last week’s £5.4bn investment in Barclays, the UK banking group, by the state-owned China Development Bank and Singapore’s Temasek. The money has boosted the Barclays bid for ABN Amro of the Netherlands and will leave the two Asian investors with 9.2 per cent of the enlarged group if the British bank is successful.
However, reaction to a bid to take full control of a leading UK company could be tested by the proposed Qatari offer for J. Sainsbury, the supermarket chain that supplies groceries to Britain’s middle classes. Delta Two, an arm of the Qatar Investment Authority, which controls $40bn of funds, already owns 25 per cent of Sainsbury and has mooted a bid for the rest.
There are signs of deepening concerns elsewhere in Europe, where politicians and business leaders are already more resistant than the British to foreign acquisitions.Angela Merkel, German chancellor, said this month that Berlin was considering legislation to make it harder for sovereign wealth funds to take over German companies.
Germany is attracted by the US approach of vetting potential acquisitions and blocking them in sensitive industries. However, an alternative approach was outlined last week by Peter Mandelson, European Union trade commissioner, who said a vetting process would deter legitimate investors. He suggested instead that the EU could allow governments to use “golden shares” to stop foreign state-controlled funds buying sensitive companies that the buying country protected domestically.
Brussels has opposed golden shares in the past and forced European governments to scrap them other than for sensitive industries such as defence. Mr Mandelson said any system should be regulated at a pan-European level to avoid distorting the single market. “You cannot leave it simply in the hands of a member state that is pursuing its own national interests,” he said. “These shares must reflect the European interest, not the national one.”
But by adding that it would be wrong to exclude sovereign wealth funds altogether, he strengthened the impression among some observers that the real target for European concerns is Russia.
France and Germany, for example, seemed happy to allow Dubai’s ruling family to buy its stake in EADS this month. But with Russian companies such as Gazprom saying they are interested in acquiring energy assets in the EU, there are fears that strategic sectors could fall under Moscow’s control – particularly in the eastern and central European countries that have just broken free from its grip.
It is not clear that the European Commission has the power to regulate international investment, says BusinessEurope, the employers’ organisation formerly known as Unice. “Golden shares would undermine the single market,” argues Adrian van den Hoven, director of international relations. “Our preference would be for a limited review process for the most sensitive cases only, perhaps linked to competition policy so it can be dealt with in a technical way.”
Even a low-key vetting process would, however, be resisted by the British government. Alistair Darling, in his first big speech as chancellor of the exchequer, last week said he opposed vetting corporate acquisitions by foreign state investors. “It would be wrong for any government to step in and say: ‘No, you can’t do this.’”
But he went on to say that government-backed companies needed to operate according to the rules of the market in which they participated, including “high standards of governance and appropriate transparency”.
In the US, a senior Treasury official has also warned that the growth in sovereign wealth funds could create new risks for the international financial system. Clay Lowery, acting under-secretary for international affairs, said little was known about their investment policies, which meant minor comments or rumours would tend to increase volatility in capital markets.
He warned that the funds were rarely subject to market disciplines, being controlled by public servants imperfectly accountable to the citizens for whom they were investing. There were also dangers for those who dealt with them if they assumed that the funds were underwritten by the state that owns them. “With so much money invested across a wider range of asset classes, sovereign wealth funds will need to have strong fiduciary controls and good checks and balances to prevent corruption.”
The International Monetary Fund is working on the issues raised by the growth of sovereign wealth funds, which will be on the agenda of the IMF’s annual meeting in October. Simon Johnson, chief economist, expressed concern last month that financial flows were going increasingly through “black boxes” and could pose risks to global stability.
Officials in developed countries know that one big underlying cause of rapid growth in sovereign wealth funds is the exchange rate policies of countries such as China that run enormous trade surpluses.
By holding down their exchange rates, nations maintain the competitiveness of their exports while building up funds that finance the acquisition of assets in the developed world. Allowing their currencies to appreciate would slow the accumulation of foreign exchange reserves and the growth of their funds.
The officials also know that changes in exchange rate policy are unlikely in the short term, so are concentrating on persuading sovereign wealth funds to be more open and commercial in their operations. The Norwegian Government Pension Fund – which has invested much of the country’s North Sea oil riches and is now worth more than $300bn – is widely acknowledged to offer a model of good governance and accountability.
The biggest equity owner in Europe, it lists all 3,500 investments on its website and is an activist investor, voting on all resolutions – against poison pill protection from takeovers and for pay linked to future performance. Its stakes are typically small in each company so, far from feeling threatened by its investments, companies often welcome it to their share registers.
Mr Lowery of the US Treasury said he hoped the IMF and World Bank would develop best practices for sovereign wealth funds that would encourage them to become more transparent and maintain openness to international investment.
If the move of foreign funds from creditors to owners is not to trigger protectionist measures in the way feared by Mr Jen of Morgan Stanley, they must be persuaded that transparency is good for them, as well as for the international financial system.
Markets eye the rich new kids on the block
By Joanna Chung
How powerful sovereign wealth funds decide to invest their vast armoury of cash will play a pivotal role in reshaping financial markets in the next decade.
With total holdings estimated to be worth up to $2,500bn (£1,200bn, €1,800bn), the funds are already equivalent in size to about half the gross official reserves of all countries. Aside from their sheer bulk and their rapid rate of growth, they are developing a greater appetite for risk.
Prices of equities, and other riskier assets – such as corporate bonds, hedge funds, private equity, real estate, and commodities – should rise as a result. Safer investments, such as government bonds and the US dollar, should fall. That is the conventional wisdom. But exactly what impact these funds – some of which are very secretively managed – will have on markets remains largely conjecture.
“The full impact on financial markets will manifest itself over multiple years,” says Ramin Toloui, emerging markets portfolio manager at Pimco, one of the world’s largest fixed-income managers.
What is clear is that markets are increasingly sensitive to the activities of the funds, closely watching decisions such as those last week by China Development Bank and Singapore’s Temasek to take stakes in Barclays, the UK bank. What is also clear is they want to increase their returns.
While countries with large foreign exchange reserves invested in bonds are unlikely to want to risk hurting the value of their holdings through heavy sales, a greater proportion of new reserve accumulation is likely to flow into non-bond assets, causing bond prices to fall and yields to rise over time.
“As these investors diversify into credit products, equities and other alternative investments, this would tend to put downward pressure on these types of risk premiums relative to where they otherwise would be,” says Mr Toloui.
As a result of a shifting pattern of demand away from relatively safe assets such as bonds, Morgan Stanley estimates that bond yields will gradually rise by 30-40 basis points during the next 10 years. The equity risk premium – the excess return over the risk-free rate that compensates investors for taking on the higher risk of equities – could fall by 80-110 basis points.
Nicholas Brooks, senior economist at Henderson Global Investors, says of China’s plans to create a State Investment Corporation that, if a primary goal of its asset allocators is to reduce the share of US Treasury bond holdings, yields on those should rise. If the SIC were to invest along the lines of Singapore’s GIC (assuming bond allocation is 25 per cent and 60 per cent of this is in US bonds) and reserves rose at the same pace as in 2006, net new annual buying of government debt would drop from $89bn to about $56bn, he says.
In the absence of any big change in US government net debt issuance, this would imply around a half-point increase in the yields on US 10-year Treasury bonds. But Mr Brooks adds: “It is not in China’s economic, financial or political interests to roil US debt markets or antagonise its smaller neighbours by creating undue upward pressure on their exchange rates and equity markets …[so] asset allocation changes will be gradual and timed to minimise their impact on markets.”
Indeed, the level of risk tolerance of these funds is only likely to become clear over time. Central banks’ asset allocation decisions are made at a “glacial pace”, say ING analysts.
Some market watchers add that SWFs might initially shift allocations within the developed markets – for example, buying more US equities instead of US Treasuries.
Yet even in China’s short career in foreign equity ownership, one of its most high-profile investments has so far proved disappointing. The $3bn stake it took this year in the initial public offering of Blackstone has lost some of its value as shares in the private equity group stand nearly 22 per cent below the offer price.
A shift towards riskier assets does not necessarily spell gloom for bonds. Credit markets, which have been the backbone of many equity market gains this year, are in turmoil. The sharp sell-off of shares last week is meanwhile a reminder that the boom in equity markets will not last forever.
“The rapidly growing savings in emerging markets have to be invested somewhere,” says Pimco’s Mr Toloui. “By far the more important driver of near-term action in bond markets will be economic factors and concerns about subprime and other credit markets.”
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