An earlier version of this op-ed incorrectly referred to DP World as Dubai Ports World. It has been corrected in this version.
SWFs ISO Good Investments
Friday, December 7, 2007; 6:19 PM
The injection of $7.5 billion worth of Arab government funds into troubled Citigroup, which boosted bank shares around the world last week, is a further sign that not all the scare stories about sovereign wealth funds (SWFs) should be believed. Many analysts have seen these massive new state-controlled funds, originating mainly in developing countries, as a new beast of prey, stalking the open global economy for weak victims. Such fears are often exaggerated and based on false premises.
The concern of some American and European policymakers is that as sovereign wealth funds gain traction, political rather than financial motivations will begin to guide international investment decisions and the internal affairs of domestic companies, provoking a protectionist backlash in targeted markets. The rapid growth of sovereign-controlled funds, such as the Abu Dhabi Investment Authority (ADIA), which bought into Citigroup, clashes with traditional economic orthodoxy. In market-based economies, the private sector is meant to own and control wealth, leaving the provision of public services to the state. With SWFs, however, some states now own enough wealth to move world markets.
SWFs are booming, thanks largely to huge increases in oil revenue. Between 2000 and 2005, they doubled from 20 to 40, with estimated combined assets of $2.5 to $2.9 trillion, according to Morgan Stanley. Topping the list are the ADIA, based in the United Arab Emirates ($875 billion), Singapore ($330 billion), Saudi Arabia ($300 billion), Norway ($300 billion), and China ($300 billion). By 2015 the pooled wealth of the funds could reach $12 trillion to $15 trillion.
Central banks, traditionally responsible for investing state reserves, adopt a circumspect approach focused on low-risk, often low-yield ventures. SWF fund managers, however, frequently seek out high-risk, high-return investments. They can avoid significant credit costs because they do not borrow money from banks. Moreover, the size of SWFs allows them to compete viably in an arena dominated by private equity and hedge fund firms.
Apprehension about SWFs is steadily rising in many national capitals. What might be the effect on national security when foreign governments take control of strategically important sectors? Will SWFs be used to exert foreign political influence on domestic markets?
In response to the perceived threat, a transatlantic defense is gradually mounting. In August 2007, the European Commission launched a probe into the role of SWFs in the European Union (EU). The investigation came after German chancellor Angela Merkel urged the EU to start screening foreign-controlled investments.
In a more tempered approach, the U.S. Department of Treasury has asked World Bank and International Monetary Fund experts to develop a set of "best practices" to guide states operating sovereign funds. In November 2007, David McCormick, under secretary for international affairs, told the Senate Committee on Banking, Housing and Urban Affairs, "These [best practices] would provide guidance to new funds on how to structure themselves, reduce any potential systemic risk, and help demonstrate to critics that sovereign wealth funds can be responsible, constructive participants in the international financial system."
U.S. concerns about national security first dramatically surfaced in 2006 when DP World, a subsidiary of the UAE's holding company DP World, acquired the London-based maritime company P&O but, due to Congressional intervention, ceded management of six major U.S. ports. As a result, the Committee on Foreign Investment in the U.S. (CFIUS) now requires a 45-day screening investigation of transactions involving foreign state-owned investors wishing to purchase U.S. businesses.
Before surrendering to anxiety and protectionism, policymakers on both sides of the Atlantic should consider the fact that sovereign funds did not suddenly appear on the radar screen. They date back to the early 1950s when the Kuwait Investment Authority (KIA) was established to manage what would eventually become massive oil revenues. The relatively benign experience of KIA, with a $70 billion global portfolio, suggests that SWFs need not be a Machiavellian attempt by developing countries to take the global market economy hostage.
On the contrary, as the Abu Dhabi investment in Citigroup shows, SWFs could provide a much-needed source of funds to bail out Western financial institutions hit by today's credit crunch. The new wealth of developing countries can also help to boost world economic demand at a time when the United States, the traditional locomotive of international growth, may be facing recession.
What's more, it is the spread of globalization, based on U.S.-backed market principles that has generated the incentives for SWFs and made their operations possible. Kuwait, for instance, would not need a sovereign growth fund merely to invest in its own economy. Foreign direct investment is a critical element in sustaining both American and European economies -- it supports employment, increases productivity, enhances research and development, and bolsters domestic capital.
What matters most is how the systemic changes in the economic role of the state are identified, defined and regulated. The lack of public information on SWFs is a serious concern and should be addressed. These funds fall into a category dubbed by former secretary of defense Donald Rumsfeld as "known, unknowns." Lack of transparency fuels speculation, particularly over the possible national security consequences of foreign investment. Equally worrying could be the consequences of a foreign government's sudden decision to pull out its money.
The Group of Seven leading industrial countries has concluded that SWFs should be more accountable and transparent. That is a move in the right direction. Policymakers should urge for public disclosure of SWF investment strategies and accurate accounts of asset holdings.
If common ground can be reached, everyone will benefit.
The writer is a senior adviser to CSIS and president of the center's Hills Program on Governance.