Sunday, July 01, 2007
State-backed giants who want to buy the world
Government-controlled funds from China and elsewhere are snapping up Western companies, writes
Oliver Morgan. Should we be worried?
Sunday July 1, 2007
Protectionism is making a comeback. At least, that is the fear of many influential figures - from senior officials at finance ministries to politicians and independent economists. These experts are, generally speaking, pointing their fingers from West to East, from the US and Europe to China, Russia and the Gulf, and they are being specific about the threat.
A new breed of global investment behemoths, the so-called 'sovereign wealth' funds (SWFs) - effectively state-controlled investment funds bankrolled by huge foreign exchange surpluses or petrodollars - want to buy up, among other things, western companies. This could provoke protectionist calls from populist politicians.
Last week, for example, the German government was reported to be setting up an agency to examine acquisitions by these investment colossi, concerned that they could pose a threat to national security, particularly if they bought a major bank. A day later, the IMF joined calls for greater scrutiny of what it calls 'black boxes' through which increasing financial flows are funnelled.
There are also questions about whether it is desirable for companies in the UK, say, to be owned by foreign governments whose commitment to capitalism and democracy may be shaky. A week ago, a US Treasury official, Clay Lowery, stated baldly that there was a risk that 'the size, investment policies, and/or operating methods of these funds fuel financial protectionism'.
The UK is concerned too - senior officials from the Treasury and the Foreign Office are meeting the head of China's fund to indicate that, while Britain is open for business, it would be nice to know a bit more about the fund's management and intentions.
As these fears were pouring out, China announced that its state-run foreign exchange corporation would raise £200bn via a bond issue. Even before this capitalisation, China had been active on the international stage, buying a $3bn stake in private equity group Blackstone earlier this year, making investments in Africa and unveiling offers for US companies such as oil giant Unocal.
Meanwhile, officials in Dubai, which operates a hyperactive global investment fund as part of the Maktoum family-controlled Dubai World group - which bought P&O last year - indicated that it was prepared to collaborate with China on future projects and could get involved in asset swaps.
Gerard Lyons, chief economist at Standard Chartered bank, says: 'It is possible that this could lead us down a protectionist route. We have already seen signs of how some countries respond. The problem is that there are few ground rules for how these funds operate.'Lyons points to reaction in the US Congress to China's approach for Unocal and its demand that Dubai Ports World divest US ports on national security grounds as a condition for US clearance of its bid for P&O. But he also points out that sovereign funds have been around a long time. For example, the Singapore Investment Corporation and Kuwait Investment Office have existed since the Eighties. So what has changed?
The US view seems to be that things are getting serious because they are getting big. Lowery said: 'What is new is the number of sovereign wealth funds and their sheer current and projected sizes.'The numbers are indeed dizzying. According to Morgan Stanley and figures quoted by Lowery, SWFs hold some 2.5 per cent of all the world's financial assets. In 10 years' time, says Morgan Stanley,this could rise to 9 per cent.
The reason is the swelling of foreign currency reserves and the increased appetite for risk since the effects of the financial crises in Russia and Asian countries in the late Nineties have receded into history.
In the past five years, global foreign currency reserves have increased at a massive 20 per cent annually to stand at some $5.6 trillion. Much of the increase is accounted for by Asian countries building up reserves following the 1997-98 crisis. In the meantime, the high oil price has boosted foreign exchange earnings for Russia and the Middle East.
With post-crisis safety in mind, the repository for much of these reserves has been government bonds, particularly US treasuries, of which China alone holds about $ 1trillion. Now, however, the limits of prudence have been reached, and countries in surplus are looking to target higher-risk, higher-return assets - such as western companies.
Such is the weight of money behind these funds that analysts at Morgan Stanley estimate that as SWFs grow toward controlling 9 per cent of global wealth in the next decade, global bond yields will rise some 30 basis points in response. In short, the world could become a riskier place as these major investors switch away from safe old government bonds.
The fear is that risk will mean instability and that moving from holding debt to owning companies will make SWFs much more intrusive. The problem is that as things stand little is known about these bodies - from Dubai World to China's State Foreign Exchange Investment Corporation, to Russia's oil stabilisation funds. This only increases the risks that ownership by such bodies poses. Although China's bond issue gives a $200bn clue it is unclear if this is the extent of its finance, and
similar queries exist over the scope of the other players. Meanwhile, such things as investment principles and management discipline are unknown.
This, believes Lowery, could lead to protectionism. 'There will likely be much public attention to whether SWFs exercise the voting rights of their equity shares and if so how. If SWFs obtain operational control of the companies in which they invest, the fact that they are government entities may invite additional scrutiny.'
Lyons says: 'This is all evidence of a major change in the global economy.' He points to the forecast growth in Asia over the next 13 years - by 2020, a third of global trade could be accounted for by Asia compared with a seventh for the US, with the need to create some 750 million jobs on the continent by then.
His view is that it is vital to ensure a 'level playing field' for trade throughout this period of change, rather than the current higgledy-piggledy relationships. 'The US and Germany do have a more protectionist feel about them today,' he says. But this might be down to concerns over reciprocity: if China is able to buy companies in the US and Germany, and gain access to intellectual property, could it happen the other way around? It certainly looks more difficult.
However, as Lyons argues: 'If China opens up its markets, the Germans might become less protectionist.'
He believes a multinational, multilateral approach is needed to establish ground rules governing the operation of state-controlled funds. The question is, which organisation to use. The IMF (or the World Bank) may not cut it in Beijing.
Vincent Cable, Liberal Democrat Treasury spokesman, says: 'The World Trade Organisation should pick it up. China is a member and should be compliant with any conclusions. And this would be a good example of the importance of having Russia as a member of the organisation.'
The difficulty is that there are reservations over Russia's membership - its conduct on trade and economic issues, particularly over 'resource nationalism', is seen as getting worse, not better. There clearly is a will for reciprocity. While Lowery has made his fears clear, another official said last week that the US welcomed investment and would like to see China channelling its dollar reserves back into the US. Whether the need for a share of investment from the new capitalist bloc overcomes the fear of economic takeover by former communist state-owned monoliths may well determine whether the world enters a new era of protectionism.
What they own
2007 China State Foreign Exchange Corporation: Blackstone Group stake worth $3bn (£1.5bn)
2007 Delta Two, controlled by Qatari Royal family: 25 per cent of Sainsbury's
2006 Dubai Ports World (Part of Dubai World, investment vehicle of Maktoum family): P&O group $6.8bn
2006 Temasek (controlled by Singapore government): acquisition of Shin Corp, Thai
1988 Kuwait Investment Office: 22 per cent stake in BP