By Sebastian Vos
Head of Competition Practice
Hill & Knowlton Brussels

High finance, high politics…
With Sovereign Wealth Funds (SWF) estimated to be worth around $3.5 trillion, almost twice the size of the hedge fund segment, it is to be expected that they receive their fair share of attention. But despite the fact that some SWF have been around for over 50 years, it is only recently that have begun dominating the headlines. The fascination with SWF is partly because they have become much more visible and partly because they are seen both as an opportunity and a threat. SWF combine high finance with high politics and raise key questions about shifts in economic and political power around the globe.

Increasingly deep pockets
Sovereign Wealth Funds – or state investment funds – are financial vehicles owned by states which hold, manage or administer public funds and invest them in a wider range of assets. While its exact size is unknown, Abu Dhabi’s SWF (set up in 1976) has an estimated $800-900 billion of assets and is considered to be the largest in the world. “New players” are not far behind with the Chinese government recently setting aside $200 billion and the corresponding Russian fund already worth $158 billion. According to investment bank Morgan Stanley, SWF from the Gulf States, China and Russia are currently worth about $2.5 trillion. They expect this figure to rise to about $25 trillion by 2020.

Past behaviour is no guarantee for the future
Even a year ago few people would have been familiar with SWF. Now there are few people in political and financial circles who are not. This has to do not only with the money SWF have to spend, but also how they are spending it and questions as to what they might expect in return.

SWF have an increasing appetite for investing in high profile targets. Following the highly publicised US rejection of the “Dubai Ports deal” in 2006, May 2007 brought the $ 3 billion Chinese investment in Private Equity group Blackstone. In June, Delta Two (owned by the Kingdom of Qatar) acquired an additional $ 1.5 billion worth of shares in J Sainsbury PLC increasing its stake to 25%. M&A activity and the credit crunch brought further investment opportunities and lead to SWF buying substantial stakes in Barclays, Credit Suisse, Merrill Lynch and Citigroup.

Many of the older SWF have been considered ideal investors as they took long term, minority interests and did not demand active influence in the company. It is unclear whether the “new kids on the block” such as China and Russia will behave in the same way. Newer players such as the Qatar Investment Authority (set up in 2000) are already demonstrating more aggressive strategies by purchasing strategic stakes, acquiring target companies outright and not being prepared to assume the passive role of their forerunners. Past behaviour may therefore not give a reliable indication of the future investment behaviour of (some) SWF.

All those in favour…
Despite some concerns about SWF, the current financial situation has helped to underpin their potential benefits. They have vast sums of capital to commit and are (generally) patient long term investors who do not shift their assets around quickly in times of stress. They can be a great source of FDI, act as a stabilising force in times of financial turmoil and can spur investment, growth and job creation. As such, there is a wide acceptance of the positive role they can play in the world economy.

All those against…
But concerns about, inter alia, the geostrategic importance of the source countries, investment motives, transparency and reciprocity have led to strong reactions among some policymakers and other stakeholders. Detractors worry that the aim of SWF investment in certain sectors is not to maximise returns but to gain expertise or political influence. Concerns include the “non-economic” incentives of Russian firms keen to exert control over EU energy supplies or “State sponsored industrial espionage” by Chinese funds owning western technology.

How should regulators proceed?
In an attempt to improve the framework for SWF investments, international organisations and policymakers in the EU, US and elsewhere have been busy trying to formulate an appropriate policy response. In their efforts to address the issue, the European Commission issued a Communication setting out a number of basic principles for a common EU approach. While they were drafted with the EU in mind, they can act as useful guidelines for all regulators. The Commission’s principles include:

• Commitment to an open investment environment.
• Supporting the multilateral work of international organisations such as the IMF (developing a voluntary code of conduct for SWF) and OECD (investment frameworks for the recipient countries).
• Using existing instruments to formulate appropriate responses (thereby avoiding, if possible, a patchwork of new legislation).
• Respect for EU treaty obligations and international commitments.
• Proportionality and transparency i.e. measures taken for public interest reasons (such as national security) should not go beyond what is necessary to achieve the justified goal.

How should SWF proceed?
SWF would be well advised to adopt some basic principles of their own. A crucial part of these principles has to do with communicating to their respective audiences, be they regulators, financial institutions, target companies, trade unions or other stakeholders. While some SWF (such as Norway or Singapore’s Temasek) are already fairly well understood and transparent, others (such as Russia) clearly have room for improvement.

The key issues most stakeholders seem to be worried about revolve around governance and transparency. Governance issues include having a clearly defined investment policy, operational autonomy and risk management policies. The transparency issues relate to providing oversight on the SWF’s activities and whether or not they deviate from their stated objectives. Annual disclosure of investment positions, the exercising of ownership rights and the size and source of an entities resources constitute important elements.

Issues are most likely to arise on a case by case basis, depending on the sensitivity of the investment and the perceived motivation of the SWF in question. By engaging with their stakeholders before a deal enters its crucial phase SWF can minimise the risk of becoming the target of “protectionist” scaremongering by politicians, trade unions or others opposed to the deal. The more successfully an SWF is able to communicate its policies, thereby perhaps differentiating itself from less transparent SWF, the less resistance it is likely to encounter when wanting to make investments.

Conclusion
In conclusion, this situation demonstrates how powerful a role communications plays even in the complex world of international finance. Both SWF and recipient countries should aim to inform each other, not fear each other. SWF should strive to communicate what efforts they are making towards transparency and good governance. Recipient countries should make it clear that investment is generally welcome and outline what the justifiable “public interest” parameters on SWF investment are. SWF clearly have the potential to be a very positive force in the world economy. If the SWF, and the world’s policymakers, can ensure that the rules of the game, and the players, are well understood both have a great deal to gain.