The Emergence of Sovereign Wealth Funds and U.S. Investment

1. The Emergence of Sovereign Wealth Funds and U.S. Investment ITRN 603 Dr. Stuart Malawer December 2nd, 2009 Catrina Ciobanu Mark DeMicoli Ericka Floyd

2. What are they? The U.S. Department of the Treasury defines a sovereign wealth fund as a “government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from the official reserves of the monetary authorities.” • Two categories: • Commodity SWF - financed by surplus foreign exchange earnings from commodity exports owned or taxed by the government. • Assets of SWFs originating from commodities exports reached over $2.5 trillion at the end of 2008. • Non-commodity SWF - financed through excess foreign exchange assets accumulated as a consequence of running persistent current account surpluses. • $1.4 trillion foreign exchange reserves were held in SWFs in 2008.

3. SWF Overview • When a nation has excess money, it uses a sovereign wealth fund as a way to funnel it into investments rather than simply keeping it in the central bank or channeling it back into the economy. • Estimated value of all SWFs is estimated at $3 trillion. • Emergence of SWF represent a growing stock of government-controlled assets. • SWFs are important players in global financial markets. • Attract substantial attention by policy makers, market participants and the international community.

4. Largest SWFs

5. Why do countries establish sovereign wealth funds? • Protect domestic currencies and banks from crisis. • Promote intergenerational savings. • Diversify revenue streams. • Increase the return on assets held in central bank reserves.

6. U.S. Legislation U.S. Committee on Foreign Investments in the United States (CFIUS) 1975 - an inter-agency committee authorized to review transactions that could result in control of a U.S. business by a foreign person in order to determine the effect of such transactions on the national security of the United States. • Exon-Florio Amendment (1988) • Byrd Amendment (Continued Dumping and Subsidy Offset Act of 2000) • Foreign Investment and National Security Act of 2007 (FINSA)

7. International Legislation Best Practices Initiatives: • International Working Group of Sovereign Wealth Funds • "Santiago principles“ • Generally Accepted Principles and Practices (GAPP) - framework of generally accepted principles and practices that properly reflect appropriate governance and accountability arrangements as well as the conduct of investment practices by SWFs on a prudent and sound basis. • Organization for Economic Co-operation and Development • Freedom of Investment - launched at the OECD in 2006, helps governments to reconcile the need to preserve and expand an open international investment environment with their duty to safeguard the essential security interests of their people.

8. Main Issues • Sovereign funds control about $3 trillion in assets up from $500 million in 1990, and they are expected to grow to $10 trillion by 2012. (IMF) • Most of them are based in the Middle East and Asia. • Because of their growing size SWFs have become a major focus of national and international economic and financial policy with issues such as: • their lack of transparency • their potential to disrupt financial markets and to compete unfairly with private investors • the risk that political objectives might influence their management.

9. Transparency and Accountability • The lack of transparency of most of the SWFs has led to several distinct policy concerns about the effects of SWF investment. • The concern is that SWFs may pursue political objectives or policy goals that are not strictly financial when making their investments.

10. Disrupting of Financial Markets and Protectionism • The concern is that they could cause volatility in markets and disruptions in economies. • There could be a possible protectionist reaction by the investee country government: local government might consider adopting broad protectionist financial market policies that could harm the country’s economy and its foreign relations. • SWFs may be able to use their status as government instruments to compete unfairly with private investors.

11. Exercising Influence as a Shareholder • Given the nature of public markets, shareholders with even seemingly small ownership percentages can exercise influence disproportionate to their shareholding. • The risk is having a SWF exercise influence on decisions in a company as a shareholder. • SWFs may want to use their influence in a company to: • extract technology • protecting their national industries from US competition

12. Financial Tools or Political Power? • Unlike central banks, which usually invest reserves in assets like U.S. Treasury bonds, the SWFs often invest in corporations. • The concern is whether the governments will use the SWFs simply as financial tools or to actually implement political power. • The risk is that political objectives might influence their management • Use funds to create artificial monopolies. • Transfer of strategic US assets: • Key industries and technologies • Trade & state secrets • Natural resources

13. The Issue: National Security

14. National Security Risk • Lack of transparency • Disguised political objectives • Transfer of strategic U.S. assets • Strategic Industries • Key Technologies • Trade and State Secrets

15. Source: Washington Post March 27,2008

16. Measuring Transparency & Political Objectives

17. Transfer of US Strategic Assets • Dubai Ports World Deal • Unocal and China National Offshore Oil Corporation (CNOOC) • AES and China Investment Corporation (CIC) • Citigroup and Abu Dhabi • Wal-Mart and Norwegian SWF

18. Policy Proposals International • U.S. Support Code of Conduct Best Practices • Santiago Principles Domestic • Current Policy Reform • U.S. Committee on Foreign Investments in the United States (CFIUS) • Foreign Investment and National Security Act of 2007 (FINSA)

19. Policy Proposal • Fair and non-discriminatory review of foreign investments, specifically SWFs • Encourage transparency, disclosure, governance and accountability • Limit protectionist barriers against foreign investment • Restrictions on voting rights of SWFs and other government-owned investments in U.S. public companies.

20. Questions?

21. Sources Guha, Krishna. Sovereign funds sign up to code of conduct. Financial Times, UK. September 4 2009. http://www.ft.com/cms/s/0/fda301e0-7a19-11dd-bb93-000077b07658.html?nclick_check=1 Department of Treasury. CFIUS Reform: The Foreign Investment & National Security Act of 2007 (FINSA) http://www.treas.gov/offices/international-affairs/cfius/docs/Summary-FINSA.pdf “IMF Executive Board Discusses a Work Agenda on Sovereign Wealth Funds,” Public Information Notice (PIN) No. 08/41 . 2008 (Washington). www.imf.org/external/np/sec/pn/2008/pn0841.htm International Working Group of Sovereign Wealth Funds. Santiago Principles - Generally Accepted Principles and Practices. October 2008. http://www.iwg-swf.org/pubs/eng/santiagoprinciples.pdf Investopedia. Sovereign Wealth Fund – SWF. 2009. http://www.investopedia.com/terms/s/sovereign_wealth_fund.asp OECD. SOVEREIGN WEALTH FUNDS AND RECIPIENT COUNTRIES. 2008. http://www.oecd.org/dataoecd/0/23/41456730.pdf Teslik, Lee Hudson. Sovereign Wealth Funds. Council on Foreign Relations. January 2009. http://www.cfr.org/publication/15251/ The Washington Post, Chinese Company to buy a Stake in AES; Arlington firm seeks money for new projects, ties to Asia, November 7, 2009 Peterson Institute for International Economicshttp://www.iie.com/publications/pb/pb07-6.pdf International Monetary Fundhttps://www.imf.org/external/pubs/ft/fandd/2007/09/straight.htm Wikipediahttp://en.wikipedia.org/wiki/Committee_on_Foreign_Investment_in_the_United_Stateshttp://en.wikipedia.org/wiki/Dubai_World_Ports http://en.wikipedia.org/wiki/CNOOC http://en.wikipedia.org/wiki/Abu_Dhabi_Investment_Authority Sovereign Wealth Fund Institutehttp://www.swfinstitute.org/ Testimony before the U.S.-China Economic and Security Review Commission: Implications of Sovereign Wealth Fund Investment for U.S. National Security, Daniella Markheim; February 7, 2008 Norwegian Government Pension Fund Dumps Wal-Mart and Freeport on Ethical Exclusions, June 16, 2006 http://www.socialfunds.com/news/article.cgi/2034.html The World Next Week; Oxford Analytica, October 2007