12 June 2008
How Welcome Is Investment by Sovereign Wealth Funds?
Promoting best practices can reduce mutual misgivings, encourage investment
Washington -- The United States is better off keeping its markets open to investments from large funds owned by foreign governments, despite concerns about those funds’ objectives and management practices, according to several experts.
The fastest growth of large pools of capital controlled by governments -- known as sovereign wealth funds -- has occurred in oil-producing nations and export-driven economies such as China. Those funds worldwide quadrupled their assets to between $2 trillion and $3 trillion from 2003 to 2007, exceeding the total capital managed globally by hedge funds, which are lightly regulated private investment funds.
Many sovereign funds in developing countries are far from transparent. They score below their counterparts in developed nations on the quality of institutional structure and governance, accountability and behavior. These characteristics raised concerns about their impact on global financial stability and the national economies that receive their investments.
Some policymakers and legislators in the United States and Europe worry that foreign governments can use sovereign funds to advance their strategic, economic, political or social interests, rather than their commercial interests.
So far, those fears have proved unfounded.
Nevertheless, due diligence is necessary to ensure that vital national interests are preserved, said Daniella Markheim, a Heritage Foundation scholar, in a 2008 paper.
In the United States, the due diligence process is already in place, says Douglas Rediker, a researcher at the New America Foundation.
“Our country is extraordinarily well protected by existing law and regulations” against any foreign investors driven by non-commercial intents, he told America.gov.
Other experts say more needs to be done to protect U.S. interests.
Peter Navarro, a business professor at the University of California, Irvine, proposed making strategic sectors such as telecommunications, ports, energy infrastructure and defense off limits to sovereign funds. He also proposed ownership caps and strict transparency requirements on their investments. Others called for limiting investment to nonvoting equity shares, suspending voting rights, or restricting funds to reciprocal arrangements.
Rediker himself, in a 2007 paper he co-authored, urged restrictions on control by or voting rights of sovereign wealth funds that invest in U.S. public companies.
But he changed his mind when Congress and the administration moved to make the review process for foreign investments in U.S. companies more predictable and comprehensible.
In 2007, Congress reformed an interagency body that reviews some foreign investment deals. (See “Foreign Investments in U.S. To Get More Transparent Scrutiny.”)
In 2008, the Treasury Department proposed a regulation that would clarify that seeking control of a company would be the primary factor in determining whether a deal sought by a sovereign wealth fund is scrutinized.
Indiana Senator Evan Bayh, who has expressed doubts about sovereign funds, believes Congress must establish standards for transparency and behavior for such entities to prevent “unwarranted interference in our economy by foreign governments.”
Markheim, however, rejects any restrictions that amount to barriers to foreign investment. Those barriers stifle innovation, reduce productivity, undermine economic growth and prevent job creation, she said.
Rediker shares this view. Rather than pursuing more restrictions on sovereign funds, the U.S. government should do even more to make them feel welcome in the United States, he said. For example, it could put together a roadmap to help guide those and other foreign investors through the acquisition process.
Some sovereign fund managers complain that developed countries send contradictory signals. They urge the funds to invest in their economies, but when the funds actually do, those countries’ governments grow suspicious.
Bush administration officials have gone out of their way to reassure sovereign funds that the United States welcomes their investments in U.S. businesses.
“We reject measures that would isolate us from the world economy,” said Treasury Secretary Henry Paulson during his June trip to the Persian Gulf region.
Experts hope internationally accepted best practices for sovereign funds can help to dispel misgivings. The Organization for Economic Cooperation and Development published the first set of such practices earlier in June. The International Monetary Fund (IMF) is expected to issue its own set in the fall.
In March, the United States, Abu Dhabi and Singapore agreed on a set of policy principles they said they hoped would serve as a blueprint for the IMF guidelines.
Paulson said general acceptance of voluntary best practices could “quell calls for restrictions.”
Rediker believes a private-sector approach can work even better. He suggests that experienced managers of large U.S. capital funds engage their counterparts at foreign sovereign funds to share experience and work out solutions to major problems.
“It is one thing for a bunch of politically driven guys to tell other countries what to do, but another to create opportunities for cross-fertilization among market participants,” he said.
More information about sovereign wealth funds can be found on the Web sites of the Board of Governors of the Federal Reserve System, the Council on Foreign Relations and its magazine Foreign Affairs, and the Peterson Institute for International Economics. The texts of Paulson’s remarks and a related news release can be accessed at the U.S. Treasury Web site.
