monitor swf report final

Assessing the RisksTHE BEHAVIORS OF SOVEREIGN WEALTH

FUNDS IN THE GLOBAL ECONOMY

monitor groupmonitor group

William Miracky Davis Dyer Drosten Fisher Tony Goldner Loic Lagarde Vicente Piedrahita

June 2008

Founded in 1983, Monitor Group is a global fi rm that serves clients through a range of professional services — strategic advisory, capability building and capital services — and integrates these services in a customized way for each client.

Monitor Group has approximately 1500 employees worldwide and is focused on helping clients grow in ways that are most important to them. To that end, we offer a portfolio of services to our clients who seek to stay competitive in their global markets. The fi rm employs or collaborates with some of the world’s foremost business experts and thought leaders to develop and deliver specialized capabilities in areas including competitive strategy, marketing and pricing strategy, innovation, national and regional economic competitiveness, organizational design and capability building.

FOR MORE INFORMATION PLEASE CONTACT:

William [email protected]+1.617.252.2352

Drosten Fisherdrosten_fi [email protected]+1.617.252.2397

Executive Summary ..........................................................2

Introduction ........................................................................6

The Storm over SWFs ......................................................10

SWFs and the Global Financial System .......................20

SWF Behavior: The Evidence of Public Transactions ...32

Categorizing SWFs by Behavior ................................... 48

Scenarios for the Next Five Years .................................54

Implications, Conclusions, and Questions ...................62

Appendix .......................................................................... 75PROFILES OF SELECTED SWFs ....................................................75

SOURCES AND BIBLIOGRAPHY ................................................... 86

ENDNOTES .............................................................................87

Assessing the RisksTHE BEHAVIORS OF SOVEREIGN WEALTH

FUNDS IN THE GLOBAL ECONOMY

Appendix

Most attempts to defi ne it focus on basic characteristics such as

ownership, governance, funding sources,

investment strategy, and purposes or uses.

Executive Summary

ASSESSING THE RISKS 3 Executive Summary

© MONITOR COMPANY GROUP, L.P. 2008

THE RECENT, RAPID RISE of sovereign wealth funds (SWFs) has ignited controversy in many parts of the world. In OECD countries, many observers worry that SWFs could be instruments of state policy posing as investment vehicles. On the other side, representatives of nations with SWFs protest that their motives are purely fi nancial and that they wish to participate responsibly in the global fi nancial system.

Although SWFs have been the subject of much public attention and recent research reports, most commentary and analysis considers the funds at an aggregated level and reaches similar observations and conclusions: that SWFs are targeting invest-ments in OECD countries; that they wish to invest in politically sensitive sectors; that they prefer to acquire minority stakes; and that they are moving from conservative to higher-risk investments.

In our view, such conclusions — and the current debate itself — are not well informed by perspective on the actual behaviors of SWFs. Accordingly, Monitor Group launched an investigation into the funds, focusing on their behaviors and the responses of major constituencies around them.

This report is based on analysis of more than 1,100 pub-licly-reported SWF equity transactions between 1975 and March 2008, representing approximately $250 billion in value. Monitor researchers also interviewed a cross-section of fund managers, policy makers, investment professionals, and expert commentators and analysts.

WALL STREET, NEW YORK CITYLast year, funds from Asia and the Gulf were active investors in U.S. equities.

Although SWFs have been the subject of much public attention and recent research reports, most commentary and analysis considers the funds at an aggregated level.

4 ASSESSING THE RISKS Executive Summary


How does the conventional wisdom stack up in light of the facts? Not well. Rath-er than a narrow focus on the OECD, SWFs show a keen interest in domestic and emerging markets. Rather than posing a potential threat to national security, SWFs avoid sensitive sectors and industries. And rather than only acquiring minor-

ity shares, SWFs often take controlling stakes in their deals. One commonly-held belief appears to be true: SWFs are in fact moving increasingly towards higher-risk investments.

This report is aimed at three main audiences: the funds themselves, fi nancial institutions, and policymakers in

government. We aim to provide each with specifi c, targeted information to allow them better to understand concerns about SWFs and make better decisions.

The main fi ndings are:

SWFs invest heavily in domestic and emerging markets. A majority of SWF investments by value occur in OECD markets, although the proportion is magnifi ed by recent large investments during the credit crunch of 2007-2008. More than half of all transactions by number have occurred in domestic and emerging markets.

Recent SWF investments in U.S. and European fi nancial services fi rms are atypical and opportunistic, refl ecting the credit crunch of 2007-2008. Most SWF investments have occurred in fi nancial services, real estate, and industrial companies, with most publicity focused on fi nancial services. Controlling for the effects of the recent credit crunch, the apparent appetite for investment in this sector drops markedly, though it remains signifi cant.

SWFs do not appear to be investing for political motives. Some funds are making strate-gic investments to hasten economic development in their home country, but they do not appear to be active in ways that threaten the economic or national security of foreign countries where they invest.

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Rather than only acquiring minority shares, SWFs

often take controlling stakes in their deals.

ASSESSING THE RISKS 5 Executive Summary


SWFs are willing to take controlling stakes in companies. In contrast to prevailing views, since 2000, SWFs have acquired controlling stakes in half of their transactions for which stake data are available. By far most of these deals occurred in emerg-ing markets and in sectors not generally deemed politically sensitive.

SWFs are taking more fi nancial risk with their investments. Most SWFs are adjusting their portfolios to combine conservative and relatively liquid asset classes, such as government bonds, with higher-risk, illiquid assets such as equities, real estate, and alternative instruments.

Each fund has a distinctive investment pattern. Attempts to categorize SWFs by age, size, region, purpose, form of their sovereign government owners, or stage of economic development of their home country obscure important differences between them.

These funds can be grouped along two dimensions of risk: fi nancial risk and sovereign own-ership risk (the risk posed by the sovereign government owner to other nations in which its SWF may invest). At present, the behaviors of the funds indicate moderate levels on these risk dimensions. The worst fears of concerned observ-ers have not materialized and there is no evidence that they will.

While helpful along a number of dimensions, increased transparency of SWFs will not mitigate concerns about politically-motivated investing. Greater transparency will facilitate a better understanding of SWF fi nancial objectives and performance and help inform the markets, but it will not put to rest the underlying political concerns in some nations about investments made by funds owned by particular foreign governments.

Coordinated, multilateral regulation of SWFs is unlikely. Based on scenario analysis, it is probable that the evolution of the funds and their reception in global markets will continue in ways already apparent, peacefully and in piecemeal fashion. It is unlikely that SWF activity will aggravate international tensions leading to a political backlash.

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Introduction

© MONITOR COMPANY GROUP, L.P. 2008© MONITOR COMPANY GROUP, L.P. 2008

ASSESSING THE RISKS 7 Introduction

SOVEREIGN WEALTH FUNDS (SWFs) are increasingly visible and active in global fi nancial markets. In 2007, the funds invested $92 billion in publicly-recorded equity transactions, compared with just $3 billion in 2000. This trend appears to be accelerating. SWF investments during the fi rst quarter of 2008 ($58 billion) surpassed their combined total for the years 2000–2005 (approximately $50 billion).

The recent, rapid rise of SWFs has drawn attention and triggered controversy around the world, surfacing fre-quently in public inquiries, discussion, and the media.1 In OECD countries, the loudest voices are critical, concerned that SWFs will pur-sue the political objectives of their sovereign government owners. Critics ask: are SWFs instruments of state policy posing as investment funds? Are they a threat to national security? Are they a sign of a shifting balance of economic and fi nancial power from the OECD to emerging nations? Do they portend a new economic model of state capitalism?

On the other side, among nations with SWFs, supporters of the funds protest that their motives are purely fi nancial. They want to increase national wealth to address domestic social and economic priorities as well as to participate responsibly in the global fi nancial system.

It is too early to say whether SWFs constitute a threat to the existing world order or signify a new order to come. There is a pressing need, however, to understand SWFs better. Most current commentary focuses on the funds at an aggregated level

MAP OF ANCIENT BABYLONIA, CA. 550 BC.Historically, the Middle East and Asia have been leading global centers of trade and investment.

In 2007, the funds invested $92 billion in publicly-recorded equity transactions, compared with just $3 billion in 2000.


8 ASSESSING THE RISKS Introduction

and does not penetrate into their actual behaviors, which are the best available indi-cators of likely future intentions and actions in global fi nancial markets.

Late in 2007, Monitor Group formed a research team to investigate SWFs. We started from the proposition that investment activity provides a window into the in-tentions and behaviors of the funds. We reviewed public information about SWFs

and their transactions and interviewed more than twenty representatives of constituencies involved. In partnership with Grail Research (a unit of Monitor Group), we also built a database of more than 1,100 publicly-recorded SWF transactions between 1975 and March 2008.

Our data likely represent the tip of the iceberg, since most fund activity is private and unreported. That said, we can only comment on what we see, and what we see chal-lenges some widespread beliefs about SWFs while qualifying and confi rming others:

SWFs invest heavily in domestic and emerging markets. Although their foreign transactions by value are concentrated in OECD countries, opportunistic transactions during the credit crunch of 2007–2008 account for a signifi cant portion of this activity. When measured by number of deals, a majority occur in domestic and emerging markets;

Most SWFs appear to be purely fi nancial investors, though a few, such as those based in Singapore and several in the UAE, have pur-sued transactions to accelerate economic development in their home country. The vast majority of SWF investment has avoided sectors in which foreign government ownership may seem threatening to national security in the recipient country;

Contrary to the conventional wisdom that SWFs are passive inves-tors that do not seek control of companies in which they acquire stakes, half of the transactions since 2000 where we have stake data

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What we see challenges some widespread beliefs

about SWFs while qualifying and confi rming others.


ASSESSING THE RISKS 9 Introduction

(211 of 420) identifi ed in our database involve the purchase of equity stakes higher than 50 percent. However, controlling-stake deals in sensitive sectors in OECD countries account for only 2 percent of these by number and 4 percent by value;

SWFs are becoming more aggressive investors, seeking higher risk-adjusted returns in equities and other fi nancial instruments and asset classes;

The current debate about whether to increase transparency of SWFs will, if successful, result in better understanding of the fi nancial char-acteristics of the funds, but will not allay the political concerns of some governments about receiving SWF investments originating in particular foreign nations.

This report presents our key fi ndings. It is aimed at three main audiences: the funds themselves, fi nancial institutions, and policymakers in government. We aim to pro-vide each with specifi c, targeted information to allow them better to understand concerns about SWFs and make better decisions. It is organized in six sections fol-lowing this introduction:

An overview of the SWF phenomenon, including a discussion of the essential features and behaviors of the funds;

An overview of the impact of SWFs on the global fi nancial system, including the major constituencies affected by their rise and activity;

An examination of SWF behavior based on the evidence of 1,181 equity transactions involving SWFs between 1975 and 2008;

A discussion of the fi nancial and nonfi nancial risks posed by SWFs and a mapping of particular funds according to these factors;

Near-term scenarios for the continuing evolution of SWFs and the global fi nancial system;

Conclusions and implications for the major constituencies involved with SWFs.

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The Storm over SWFs


CURIOUSLY, GIVEN ALL THE BUZZ, there is no generally accepted defi nition of a sovereign wealth fund. Most attempts at defi nition focus on basic characteristics such as ownership, governance, funding sources, investment strat-egy, and purposes or uses. From there, commentators have compiled lists of funds that more or less fi t the selected characteristics.2 The resulting lists typically include between 20 and 40 funds but feature oddities such as funds owned by governments that are not sovereign, at least one fund that claims to be owned privately,3 funds long ago ac-cepted without controversy by the international community, and funds that do little foreign investing.

This lack of clarity prompts another look at the essential characteristics of SWFs. The criteria presented here constitute a distinctive set based on potential behaviors of concern in the current discussion. For our purposes, a SWF is a government investment vehicle that meets three criteria:4

It is owned by a sovereign government (because of the concern that funds may act as instruments of national policy);

It is managed separately from funds administered by the sovereign government’s central bank, ministry of fi nance, or treasury (because if it isn’t, then other constituencies need not consider it as some-thing different from the traditional fi nancial agencies of state);

It invests in a portfolio of fi nancial assets of different classes and risk profi les, including bonds, stocks, property, and alternative in-struments, with a signifi cant portion of assets under management

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SAND STORM IN WESTERN AUSTRALIAControversy over large, rapidly growing pools of investment capital owned by governments—especially governments of emerging nations and rising geopolitical powers—continues to mount.

This lack of clarity prompts another look at the essential characteristics of SWFs.

SOVEREIGN WEALTH FUNDS 11 The Storm over SWFs


invested in higher-risk asset classes in foreign countries (because of the concern about the combination of higher appetite for fi -nancial risk and investing outside the home country — no one cares if a fund invests exclusively in government bonds, nor should anyone care if a fund is invested purely domestically).

These criteria not only describe many funds that have sprung into existence in the past decade, but also enable the reclassifi cation of older government investment vehicles that were previously categorized as special funds (such as for economic stabilization or to offset the depletion of natural resource endowments), govern-ment holding companies or investment companies, and even a few pension funds that have become more willing to pursue higher risk-adjusted returns and foreign investments. The criteria also enable us to fi lter existing lists of SWFs and remove funds that do not fi t. The result is our list in Table 1, with funds highlighted in bold of particular interest because we have been able to track at least some of their pub-lic investment transactions.5

Table 1: Sovereign Wealth Funds as of December 2007

COUNTRY FUND NAME

ASSETS UNDER MANAGEMENT (USD BN)

FOUNDING DATE

UAE Abu Dhabi Investment Authority 875 1976Singapore Government of Singapore Investment

Corporation 330 1981

Norway Government Pension Fund - Global 322 1990Kuwait Kuwait Investment Authority 250 1953China China Investment Company Ltd. 200 2007Russia Stabilization Fund of the Russian

Federation127 2003

Singapore Temasek Holdings 108 1974Australia Future Fund 50 2004Sources: Deutsche Bank Research; Peterson Institute for International Economics; Monitor Group.Note: Bold type denotes funds included in the Monitor SWF Transaction Database

12 SOVEREIGN WEALTH FUNDS The Storm over SWFs


SOVEREIGN WEALTH FUNDS 13 The Storm over SWFs

COUNTRY FUND NAME

ASSETS UNDER MANAGEMENT (USD BN)

FOUNDING DATE

Libya Reserve Fund 50 NAQatar Qatar Investment Authority 40 2005Brunei Brunei Investment Agency 35 1983Ireland National Pensions Reserve Fund 29 2001Algeria Reserve Fund 25 NASouth Korea Korea Investment Corporation 20 2006Malaysia Khazanah Nasional BHD 18 1993Kazakhstan Kazakhstan National Fund 18 2000Taiwan Taiwan National Stabilization Fund 15 2000Iran Foreign Exchange Reserve Fund 15 1999UAE Istithmar 12 2003Nigeria Excess Crude Account 11 2004UAE Mubadala Development Company 10 2002New Zealand New Zealand Superannuation Fund 10 2003Oman State General Stabilization Fund 8.2 1980Chile Economic and Social Stabilization Fund 6 2007Botswana Pula Fund 4.7 1993Norway Government Petroleum Insurance Fund 2.6 1986Azerbaijan State Oil Fund 1.5 1999East Timor Timor-Leste Petroleum Fund 1.2 2005Venezuela Investment Fund for Macroeconomic

Stabilization0.8 1998

Kiribati Revenue Equalization Reserve Fund 0.6 1956Chile Chile Pension Reserves Fund 0.6 2007Uganda Poverty Action Fund 0.4 1998Papua New Guinea

Mineral Resources Stabilization Fund 0.2 1974

Mauritania National Fund for Hydrocarbon Reserves NA 2006UAE Dubai International Financial Centre

Investments NA 2006

Angola Reserve Fund for Oil NA 2007Sources: Deutsche Bank Research; Peterson Institute for International Economics; Monitor Group.Note: Bold type denotes funds included in the Monitor SWF Transaction Database


14 ASSESSING THE RISKS The Storm over SWFs

We think of SWFs as part of a continuum of sovereign government investment vehicles that runs along a spectrum of fi nancial risk from central banks as the most conservative and risk-averse, to traditional pension funds, to special government funds, to SWFs, and fi nally to state-owned enterprises, which are the least liquid and highest-risk investments.6 (See Figure 1.)

Among SWFs, there also is a continuum along the spectrum of fi nancial risk, from those with a conservative investment philosophy like a pension fund, to those that behave more like a university endowment with investments in equities, to those more aggressive still and willing to invest signifi cantly in alternative asset classes

such as real estate, private equity, or hedge funds. Many SWFs also delegate large portions of their portfolios to external fi nancial managers.7

Many SWFs also delegate large portions of their portfolios to external

fi nancial managers.


ASSESSING THE RISKS 15The Storm over SWFs

Figure 1: Continuum of Government Investment Vehicles

Official Reserves/ Central Bank

Pension Funds

Domestic Sovereign Funds

SOVEREIGN FUNDS

Sovereign Wealth Funds

State Owned Enterprises

External assets for directly financing internationalpaymentimbalances

Highly liquid, often OECD government bonds

Investment vehicles to meet government’s future pension obligations

Funded and denominated in local currency

Investment vehicles funded by foreign exchange assets

Managed separately from official reserves

Typically have a higher tolerance for risk

Companies where the state has significant control

May make investments in foreign assets

Investment vehicles to encourage domestic economic development

Funded and denominated in local currency

Federal Reserve (US)

Bank of England (UK)

SAMA (Saudi Arabia)

Government Pension Fund (Norway)

GIC (Singapore)

ADIA, Mubadala (Abu Dhabi)

Temasek, GIC (Singapore)

Istithmar, DIFC (Dubai)

CIC (China)

SAMA (Saudi Arabia)

CNOOC (China)

Gazprom (Russia)

SABIC (Saudi Arabia)

Khazanah Nasional (Malaysia)

EXAMPLES

Source: Adapted from Kimmitt (2008).

At present, 36 funds, originating in 30 nations, meet our criteria for SWFs. About half of the funds were established in the last decade, with two-thirds of these since 2003. As highlighted in Figure 2, SWFs have emerged in several waves over the past half century. The oldest (in Kuwait and what is now Kiribati) were set up in the 1950s to manage surplus foreign reserves and offset the eventual decline of natural resource endowments. These funds initially were conservative investors. Although Kuwait In-vestment Authority (KIA) has long held foreign equities — it has owned a stake in Daimler since 1972 — it has not been notably active in this asset class, typically par-ticipating in only one or two publicly-reported equity transactions per year.



Figure 2: Founding Dates of Major SWFs

1953 1956 1974 1976 1980 1981 1983 1986 1990 1993 1998 1999

KuwaitInvestmentAuthority,Kuwait

RevenueEqualizationReserve Fund, Kiribati

Abu Dhabi InvestmentAuthority,Abu Dhabi

TemasekHoldings,Singapore

MineralResourcesStabilizationFund, Papua New Guinea

StateGeneralStabilizationFund, Oman

Brunei Investment Agency, Brunei

GovernmentPension Fund– Global, Norway

InvestmentFund for Macroeconomic Stabilization,VenezuelaPoverty Action Fund, Uganda

KhazanahNasional, MalaysiaPula Fund, Botswana

GovernmentPetroleum Insurance Fund, Norway

Governmentof Singapore InvestmentCorporation, Singapore

Foreign ExchangeReserve Fund, IranState Oil Fund,AzerbaijanPoverty Action Fund, Uganda

Source: Deutsche Bank; Standard Chartered

Another wave in the 1970s and 1980s refl ected a spike in energy prices and the rise of the Asian tiger economies. Large funds were established in these decades in Abu Dhabi (the fi rst of several in the UAE), Norway (which later converted into a pension fund), and Singapore (Temasek Holdings [1974] and Government In-vestment Corporation [GIC, 1981]). Another wave in the 1990s brought smaller funds in Asia, Africa, and the Middle East.

The major wave, starting in 2000, has led to the formation of nearly 20 funds, most of which are funded by capital infl ows based either on high energy prices (especially in the Middle East but also in Russia) or continued large trade surpluses (e.g., in China). Thus the most recent group includes not only funds originating in small, wealthy nations but also in major geopolitical powers — circumstances that heighten concerns about the potential misuse of SWFs.


ASSESSING THE RISKS 17 The Storm over SWFs

2000 2001 2002 2003 2004 2005 2006 2007

Taiwan National StabilizationFund, TaiwanKazakhstanNational Fund, Kazakhstan

NationalPensions Reserve Fund, Ireland

New Zealand Superannuation Fund, New ZealandIstithmar, DubaiStabilization Fund of the Russian Federation, Russia

MubadalaDevelopmentCompany, Abu Dhabi

Korean Investment Corp, KoreaNational Fund for Hydrocarbon Reserves, MauritaniaDubai International Financial Center Investments, Dubai

China Investment Company, ChinaEconomic and Social Stabilization Fund, ChilePension Reserves Fund, ChileReserve Fund for Oil, Angola

Timor Leste Petroleum Fund,East Timor

AustralianGovernmentFuture Fund, AustraliaExcess Crude Account, Nigeria

Qatar Investment Authority, Qatar

Today, the biggest concentrations of SWFs by dollar volume are in the Middle East and East Asia. Many of the newer funds are inspired by the examples of KIA, ADIA, Temasek, and GIC and resemble university endowments in their investment behavior. They are wealth management vehicles that seek high risk-adjusted returns and are willing to invest across a range of asset classes and prospect actively around the world for attractive opportunities.

Treated as a distinct investor group, SWFs are relatively small compared with other global fi nancial asset classes such as pension funds, mutual funds, in-surance funds, and bank assets. However, as individual institutions, SWFs are large and growing fast.8 They range in size from a few hundred million dollars under management to seven with portfolios valued at more than $100 billion. As points of reference, the largest are much bigger than private equity funds (Carlyle Group, one of the biggest in the United States, has some $80 billion under management) and comparable to the biggest pension funds in the OECD



(California Public Employees’ Retirement System — CalPERS, one of the larg-est U.S. pension funds, manages about $250 billion).

Today, estimates peg the aggregate value of SWFs as between $1.9 trillion and $2.9 trillion, with the limited transparency of many funds and defi nitional issues account-ing for the range. Based on bullish forecasts of continuing high oil prices and trade surpluses in the Far East, it could comfortably surpass $10 trillion by middle of the next decade.9 This growth is equally impressive in relative terms. Today, SWFs ac-count for less than two percent of global fi nancial assets, but the total could surpass 5 percent by 2015. By any measure, SWFs are big enough to cause ripples in the global fi nancial system, and they are likely to become signifi cantly bigger as more nations establish funds and nations that already have them set up more.

Unsurprisingly, the combination of sovereign ownership, large size and impressive growth prospects, appetite for risk, and lack of transparency constitutes a perfect storm for political controversy. Much of the controversy originates in the fact that most new SWFs come from emerging countries outside the OECD. This raises the possibility of new alignments in global affairs between the established powers that became dominant after World War II versus those now emerging.

Given all the publicity about SWFs and investiga-tions of them, it is striking how little we know about them. What we do know is that though each fund has unique characteristics, in combination they are large and growing, and that more new funds are likely to appear in the near term.

The combination of sovereign ownership, large size and impressive growth prospects, appetite for risk,

and lack of transparency constitutes a perfect storm

for political controversy.


ASSESSING THE RISKS 19 The Storm over SWFs

U.S. SENATOR HILLARY RODHAM CLINTON

“…when you have private investors who are basically disciplined by the market, that’s a different kind of investment than if you have sovereign wealth funds that are basically an arm of a government. There are different strategic and national interests at work there.”10

FRENCH PRESIDENT NICOLAS SARKOZY:

“I believe...in globalization but I don’t accept that certain sovereign wealth funds can buy anything here and our own capitalists can’t buy anything in their countries. I demand reciprocity before we open Europe’s barriers.”11

SWFs and the Global Financial System


ASSESSING THE RISKS 21 SWFs and the Global Financial System

SWFS ARE BECOMING IMPORTANT ACTORS in the global fi nancial system, which is already adapting to their presence. It may be helpful to consider the impact of SWFs in terms of the major constituencies involved: 1) the funds themselves; 2) their sovereign owners; 3) recipient countries for SWF investments; 4) multilateral regulatory and oversight institutions; 5) other fi nancial institutions; and 6) companies that receive SWF investments. Based on our analysis and inter-views with representatives across these groups, each has interests and concerns that will have to be weighed and balanced for a stable equilibrium to be reached. Currently, there is tension between several of these constituencies over issues such as transparency and regulation of SWFs. (See Figure 3 for a summary of these in-terests and concerns.)

1. The SWFs

Although each SWF is distinctive, with a particular history and mandate, some com-monalities of interest and concern span the funds. SWFs like to portray themselves as similar to large, privately-owned funds or to older public investment vehicles such as pension funds. That is, they aspire to make money and grow, to have access to the best deals, talent, and ideas, wherever these occur, and to compete without disadvantage against other suppliers of fi nancial capital. They seek to preserve their autonomy, and like their privacy. Most wish to maintain a low profi le, avoiding po-litical controversies and calls for increased transparency or regulation. Jesse Wang, the chief risk offi cer of China’s CIC, for example, claims that his fund is similar to other foreign public pension funds or college pension funds, adopting a diversifi ed, long-term and passive investment strategy.12

SKYLINE OF SHANGHAI, CHINAShanghai’s dynamism refl ects the strength of the Chinese economy, which could soon host the world’s fi rst trillion-dollar SWF.


22 ASSESSING THE RISKS SWFs and the Global Financial System

Age and sophistication of individual SWFs are important variables infl uencing their concerns. New funds from countries still integrating into the global economy, such as Libya or the central Asian republics, tend to be concerned with basic questions about the best way to govern and organize themselves while catching up as mature, sophisticated investors. Older and widely represented SWFs such as KIA, ADIA,

and Temasek serve as models to younger, less estab-lished funds. Given their experience and institutional maturity, the “old hands” among SWFs are concerned about performance, market positioning, and managing external constituencies.

Older and widely represented SWFs such as

KIA, ADIA, and Temasek serve as models to younger,

less established funds.

YOUSEF AL OTAIBA, DIRECTOR OF INTERNATIONAL AFFAIRS, ABU DHABI:

“It is important to be absolutely clear that the Abu Dhabi government has never and will never use its investment organizations or individual investments as a foreign policy tool.”13



Figure 3: Constituencies, Interests and Concerns about SWFs

Interests• Preserve equal access to

opportunities and talent worldwide

• Achieve and sustain highest level of professionalism

• Preserve autonomy

• Maintain low profile

Concerns• Avoiding regulation, calls for

increased transparency

• Avoiding political firestorms when investing abroad

Interests• Capture benefits of this

form of investing (diversification, higher returns, flexibility)

• Increase long-term national wealth

• Increase influence in global financial affairs

• Increase clout in global financial system

Concerns• Avoiding regulation,

calls for increased transparency

• Avoiding protectionist backlash that might hurt broader trade interests

Interests• Enact desire to work with SWFs

as partners, co-investors, clients

• Maintain open access to all SWFs

• Maintain access to opportunities in new geographies

Concerns• Fearing that SWFs will have

unfair advantages (lower cost of capital, privileged access to information and deal flow)

• Worrying about effect on market dynamics (asset pricing, risk premiums)

Interests• Gain access to foreign sources

of capital

• Welcome long-term passive investors

• Gain access to opportunities in new geographies

Concerns• Avoiding potential PR firestorms

• Preserving freedom to operate in certain countries or sectors

• Minimizing foreign political interference in decision making

Interests• Maintain free flow of

capital globally

• Preserve level playing field for all investors

• Preserve systemic stability

Concerns• Monitoring funds that

are not transparent

• Limiting potential for nonfinancial behaviors

• Guarding against corruption

• Protecting against poor risk management

Interests• Welcome responsible

foreign investors

• Protect vital economic and national security assets

• Ensure reciprocity in trade, investing

Concerns• Monitoring SWFs owned by unfriendly

governments

• Limiting potential for nonfinancial behaviors

• Fearing SWFs may be Trojan horses

• Monitoring funds that are not transparent

• In OECD countries, fearing potential loss of economic and political power

SovereignGovernment

Owners

RecipientCountry

Governments

Multilateral Regulatory and

Oversight Institutions

Companies Considering

SWFInvestments

SWFs

OtherFinancial

Institutions



2. Sovereign Government Owners

The interests of the sovereign government owners of SWFs begin with capturing the benefi ts of this form of investment as compared to other government invest-ment vehicles. SWFs enable nations to diversify their wealth beyond traditional economic assets. SWFs also hold the promise of achieving high risk-adjusted fi nancial returns over time. Greater national wealth means more resources to ap-ply to national priorities as well as a buffer against short-term economic shocks and a resource to apply to long-term challenges. Finally, greater national wealth elevates the standing of a nation in foreign affairs and strengthens its voice in multilateral institutions.

Anything that might jeopardize these benefi ts is a source of concern. Sovereign gov-ernment owners want outsiders to welcome the funds as responsible fi nancial actors. Thus most governments have set up their SWFs to be administered by authorities independent of traditional central government agencies and managed according to professional investment standards, though most also so far have resisted calls for increased transparency. Meanwhile, the sovereign government owners, like the man-

FORMER SINGAPORE PRIME MINISTER LEE KWAN YEW

“ We are passive investors, if we are ca-pable, we would be running a merger or an acquisition. But we are not, we haven’t got that vast talent pool so we say, look, I’ll join you, you make the money for me and I’ll just watch you and see how you do it, and I’ll be learning over time.”14

GAO XIQING, PRESIDENT OF CIC, ON CALLS FOR INCREASING TRANSPARENCY OF SWFS

“ Why do you need a law like that? That law will only hurt feelings. It’s — it’s not economic. It doesn’t make sense. Politi-cally it’s stupid.”15



agers of their funds, are often concerned with some basic questions: Whether to set up a single fund or a family of funds; how to apply best practices in governance, administration, and risk management; how to provide prudent political oversight without creating a perception of political interference; how to exploit foreign invest-ment opportunities without igniting cross-border political controversies.

Some sovereign government owners believe that calling for increased scrutiny of SWF investment is inherently unfair. One senior offi cial commented, “For decades, the West has told us that we had to open our borders. We let Western multinationals into our economy, and they have been running the show. But now, when we try and do the same thing, we are told it poses a ‘security risk.’ It’s just hypocritical.”

3. Recipient Country Governments

In countries that receive SWF investments, much discussion focuses on the political risks of doing so. On the one hand, it is in the recipient country’s interest that for-eigners view it as open for business and that its companies have access to foreign sources of capital when available on attractive terms. In the long term, interlocking, cross-bor-der economic interests contribute to international peace and stability. As Robert Kimmitt, U.S. Deputy Secretary of Treasury puts it, “Sovereign wealth funds have been around since the 1950s and thus far their track record is very strong and positive. They are patient long-term investors and we have no evidence that any of their decisions have been made for political and not commercial reasons.”16 As if to confi rm the point, in March 2008 the U.S. Depart-ment of the Treasury reached a voluntary agreement with SWFs based in Abu Dhabi and Singapore in which the funds pledged to invest for purely fi nancial rea-sons when considering opportunities in the United States.

Some sovereign government owners believe that calling for increased scrutiny of SWF investment is inherently unfair.



On the other hand, permitting foreign states to acquire even partial ownership of domestic companies raises fears that such investments will be abused — as a cover for espionage (political or industrial) or as an instrument of the sover-

eign government owner’s geo-strategic interests. In the United States and Europe, there is nervousness about the rise of nations outside the “club” that has dominated international fi nance since World War II and the potential corresponding loss of power and infl uence, especially to new actors who may not share a common set of beliefs and values about interna-tional trade and investment.

The increased appetite for risk of some of these funds causes some concern, espe-cially when the investment comes from infl uential countries like China. The funds sometimes feed the concern by using colorful language. “We mainly do farming, but occasionally we go hunting,” says CIC’s Jesse Wang, adding, “we don’t rule out the possibility of making a few other investments if good opportunities come up.” Wang’s boss continues the analogy, noting of CIC’s $5 billion investment in Morgan Stanley, “If there is a big fat rabbit, we will shoot it.”17

Unfortunately, debate in the recipient countries pays much less attention to the benefi ts of SWF investments and the constructive role that SWFs can play. Their investments normally are made by experienced investment managers, often in part-nership with local fi nancial fi rms and institutions, and outside of sensitive economic sectors. During the credit crunch of 2007-2008, SWFs have provided needed li-quidity to the global fi nancial system. By investing in the United States and other OECD nations, SWFs are preserving jobs and tax revenues and enabling struggling companies to regain their footing.

Unfortunately, debate in the recipient countries

pays much less attention to the benefi ts of SWF

investments and the constructive role that

SWFs can play.



4. Multilateral Regulatory and Oversight Institutions

Multinational regulatory and oversight institutions such as the IMF and World Bank are interested in the global free fl ow of capital according to rules that are equitable for all parties, including banks, insurance funds, pension funds, hedge funds, private equity fi rms, and SWFs.

SWFs pose concern to this constituency as they have the potential to tilt the playing fi eld. State-owned funds may have a lower cost of capital than private sector com-petitors, or they may have access to asymmetric information and intelligence, perhaps through other state agencies. These concerns have raised the notion that new rules will need to be written specifi cally for SWFs to defi ne standards of transparency, set controls around investments they can make, and include sanctions against violators.

At present, several initiatives affecting SWF activity are under consideration. Led by the United States and France, the G7 is pressuring the World Bank, the IMF, and the OECD to draft a new code of conduct for SWFs. Independently, the World Bank and IMF are collaborating with SWFs to develop a voluntary code of conduct by later in 2008. The OECD, meanwhile, is working on best practices for recipient countries, with a draft document ready for review by the fall of 2008.18

SIMON JOHNSON, DIRECTOR OF RESEARCH, IMF

“What should the IMF do about this situation? There’s certainly no need for dramatic action. For one thing, the situation involves sensitive issues of national sovereignty. For another, at their current level of $3 trillion, sovereign funds aren’t a pressing issue. But as the level creeps closer to $10 trillion — although even $10 trillion isn’t a huge amount of money — the phenomenon will likely attract greater attention.”19



5. Other Financial Institutions

Other fi nancial institutions — fi nancial services fi rms, various types of funds, and private institutional investors — view the rise of SWFs through the lens of their own interest. SWFs may be competitors, but also potential partners, co-investors,

or clients. Indeed, other fi nancial institutions view SWFs primarily as a source of opportunity rather than a threat.

The concerns of this constituency refl ect the multiple roles SWFs can play. As competitors, other fi nancial institutions worry that SWFs have unfair advantages re-sulting from their state ownership. The growing size of

the SWFs is another concern. The dynamics of supply and demand suggests that a fl ood of new money may drive up asset prices and drive down risk premiums. The small size of SWFs relative to other fi nancial asset classes in the global economy mitigates this effect, though it may be pronounced in some geographies and sectors. Some representatives of this constituency believe that management talent is lacking in some newer SWFs and thus could result in mistakes that reverberate through fi nancial markets. Over time, this concern will diminish as more SWFs become more sophis-ticated and experienced investors — but that prospect also raises its own competitive concerns, as there will be intensifying rivalry for talent and deal fl ow.

As potential partners or co-investors, other fi nancial institutions are keen to learn more about SWFs, how they think and where they are looking to invest, by sector, geography, and level of economic development. “In the future,” says David Ru-benstein, founder of the Carlyle Group, “sovereign wealth funds and private equity fi rms are likely to pursue large investment opportunities through joint ventures.”20

Finally, other fi nancial institutions are eager to provide management services, re-search and analytical support, joint prospecting for deals, and consulting advice to

As potential partners or co-investors, other fi nancial

institutions are keen to learn more about SWFs,

how they think and where they are looking to invest.



the SWFs. Several large fi nancial services fi rms in the United States and Europe have already established client relationship management teams focused on SWFs.

6. Companies Considering Investments by SWFs

Companies considering investments by SWFs likewise have multiple interests that could be aligned with the funds — or at odds with them. Management generally welcomes long-term, passive investors who are unlikely to become involved in cor-porate strategy or to disinvest. As Howard Socol, CEO of Barney’s, put it after Dubai’s Istithmar acquired the company in 2007, “This transaction further enhanc-es our ability to develop our brand and grow our business.”21 Having a SWF as an investor may also be advantageous in entering some foreign markets, either in terms of facilitating access or smoothing regulatory approval and shortening delays.

Each of these interests has a fl ip side, however. Other owners with shorter invest-ment horizons may have a different view and prefer co-owners willing to set and enforce high standards for management performance. It also is conceivable that SWF investment in a company may handicap market entry in countries with dif-fi cult relations with the sovereign government owner.

Further, a stake held by a SWF may restrict a company’s opportunities to attract investment from certain countries or types of investors. It may also inhibit plans to enter certain politically sensitive sectors or complicate a company’s ability to grow via mergers and acquisitions. Finally, companies recognize the public relations risks and implications of a stake held by a foreign owner, whether a SWF or other gov-ernment investment vehicle.

7. Summarizing the Interests and Concerns

Figure 4 summarizes and portrays the major concerns of the constituencies about SWFs. This matrix has two axes. The fi rst is the fund’s attitude towards fi nancial



risk. This varies from a conservative investment posture, similar to central banks and pension funds, to an aggressive posture, similar to some university endow-ments and private equity fi rms. The second is the degree of sovereign ownership risk, that is, the risk posed by the sovereign government owner to other nations in which its SWF may invest.

Below, we discuss how to measure these dimensions of risk, but for now consider the implications of the matrix. Historically, most government investment vehicles could be placed on the left side of the matrix, often in the lower left quadrant. They took little fi nancial risk, holding their foreign exchange reserves in government bonds of OECD countries. Historically, funds established before the late 1990s were from smaller nations with relatively little infl uence in global affairs. As a result, they tended to have a low level of sovereign ownership risk. However, as major geopolitical powers such as China and Russia establish SWFs, sovereign ownership risk may become an increasing concern to traditional Western powers.

Figure 4: Potential SWF Migration Paths

0

1

2

3

4

5

6

7

1 2 3 4 5 6

2

1

7

FINANCIAL RISK

SOVE

REI

GN

OW

NER

SHIP

RIS

K

Traditional GovernmentInvestment Vehicle Profile



The rise of SWFs raises possibilities of several migration paths away from this traditional situation. Funds from nations which are low on the axis of sovereign ownership risk, but increase the fi nancial risk they are willing to bear, move to the lower right quadrant. This is the current situation of many SWFs, includ-ing most newer ones, which are active investors in foreign equities. Four of the constituencies — the SWFs, their sovereign government owners, other fi nancial institutions, and companies considering SWF investments — generally welcome this movement, though it is not without dangers and surprises, as the govern-ment of Iceland discovered in 2006 when a state-owned Norwegian fund shorted its bonds to realize a short-term fi nancial gain.22 Zone 2 at the lower right corner of the matrix indicates this potential hot spot.

A second potential situation involves a sharp increase in fi nancial risk by a SWF from a country with high sovereign ownership risk. This places the SWF into the upper right quadrant. Much of the recent debate and policy maker concern implicitly refl ects this concern, with worst-case fears embodied in Zone 1 in the upper right corner. Should SWFs migrate into this quadrant, either directly from the lower left or in stages via the lower right, they will risk escalating international tension and triggering more restrictive and interna-tionally coordinated regulatory responses.

This matrix raises several important questions about where particular SWFs cur-rently reside and the direction in which they may be moving. To date, debate on the underlying situation and dynamics has been based on anecdotes and speculation. More detailed investigation of SWF behavior based on publicly-available data sheds light on these important issues and, by doing so, informs the ongoing discussion about how best to accommodate SWFs in global fi nancial markets.

To date, debate on the underlying situation and dynamics has been based on anecdotes and speculation.

SWF Behavior: The Evidence of Public Transactions


ASSESSING THE RISKS 33 SWF Behavior: The Evidence of Public Transactions




LIKE OTHERS WHO HAVE COMMENTED on the emergence of SWFs, we have been hindered by the limited availability of public information about them. In the absence of more verifi able public data, the debate over SWFs will remain heated and calls for their regulation will inevitably continue.

While some funds, such as those of Singapore and Norway, provide considerable transparency into their holdings, comparable information for SWFs based in many other nations is not publicly available. We do not know the logic behind their asset allocation decisions, nor do we have a full picture of the assets in their portfolios. (See the Appendix for investment allocation of selected SWFs.) What we do have is public information about certain transactions carried out by SWFs. Such deals are often reported in fi nancial industry databases, in the media, and occasionally on the websites of the SWFs and the com-panies in which they have purchased stakes.

In an effort to contribute fresh insights and perspectives on the debate, we worked with our partner Grail Research to comb through publicly-available sources on SWF activity. Given the limited transparency of many funds and spotty reporting of SWF transactions, we chose to focus our research on direct investment in equities and real estate. We collected data on 1,181 sovereign wealth fund transac-tions involving 25 funds from 1975 through March 2008.23

To understand SWF behavior better, it was necessary to fi lter the data in sever-al ways. At the outset, we decided to exclude Norway’s GPFG from our search

In the absence of more verifi able public data, the debate over SWFs will remain heated and calls for their regulation will inevitably continue.

ICEBERG, ILILUSSAT GREENLANDThe visible portion of SWF investment is relatively small when compared to their total size but it provides the best insight into their intentions and behaviors.


34 ASSESSING THE RISKS SWF Behavior: The Evidence of Public Transactions

because the particular nature of its holdings — more than 3,000 transactions in-volving stakes of 5 percent or less in companies — would overwhelm our sample. Second, we focused on funds owned by sovereign governments only and excluded those owned by sub-national governments such as provinces or U.S. states. As not-ed earlier, we made an exception for funds based in Abu Dhabi and Dubai because we believe that the emirates within the UAE federation possess decision rights comparable to those of a sovereign authority. Thirdly, we attempted to be rigorous in applying a consistent defi nition of a SWF, leaving out those investment vehicles such as Dubai International Capital and Central Huijin Investment Corp, which did not fi t our defi nition.24 Finally, we fi ltered by date, selecting for detailed analysis deals between 2000 and March 2008.

After applying these screens, we were left with 17 funds, with a total of 785 deals, and some $250 billion of investments in equities and real estate.25 The bulk of the deals originated in two regions, the Middle East and Asia.26

In sum, our research picked up the largest and most public SWF transactions over an eight-year period and sheds much needed light on actual SWF investment be-havior. Although our data inform only a portion of total SWF activity, it permits deeper and more contextualized exploration of many claims and counter-claims made about SWFs. Our data also provide insight into the different investment strat-egies carried out by particular SWFs.

Conventional Wisdom: How Does It Stack Up?

Much current discussion of SWFs relies on a small number of highly-publicized investments, and controversial cases such as the 2005 bid by Dubai Ports World27 for the U.S. port operations of the British company P&O, or the 2007–2008 at-

We were left with 17 funds, with a total of 785 deals, and some $250 billion of

investments in equities and real estate.



tempt by China’s Huawei Technologies to purchase a stake in 3Com. These cases did not involve SWFs but are held to illustrate the potential dangers of investments by funds owned by foreign governments.

The public discussion of SWFs makes many assertions. SWFs are focused on the OECD; invest in politically sen-sitive sectors; prefer to acquire minority stakes and are moving from conservative to higher-risk investments.

How does the conventional wisdom stack up in light of the facts? Not well. Rather than a narrow focus on the OECD, SWFs have shown a keen interest in emerging markets. Rather than investing in po-tentially sensitive sectors, SWFs have avoided sensitive sectors and industries. And rather than only acquiring minority stakes, SWFs have taken controlling stakes in half the deals for which we have stake data.

However, we did fi nd one area where the commonly held beliefs seem to be based in reality: SWFs do indeed appear to be moving increasingly towards higher-risk investments.

1. Geography: SWFs Do Not Focus Exclusively on OECD Markets

The publicity surrounding the large fi nancial services deals in the past two years contributes to the perception that SWFs are, and will continue to be, focused on OECD markets. Some analysts suggest that SWFs will prefer highly liquid markets as they diversify across asset classes, with the implication that the majority of their investments will remain in the United States and other OECD countries.28

Our data show that SWFs do not act as a group and there are signifi cant differences in investment strategy between funds that make it diffi cult to generalize about them.

Our data show that SWFs do not act as a group and there are signifi cant differences in investment strategy between funds that make it diffi cult to generalize about them.



The deal activity of large players such as ADIA (Abu Dhabi), KIA (Kuwait), CIC (China), and GIC (Singapore) indicates a focus on OECD markets and perhaps validates the argument that SWFs prefer OECD markets. For these funds, OECD investments make up 80 percent or more of their publicly disclosed transactions by value, with the United States being the main destination.29

Other funds, however, have taken a different approach. Singapore’s Temasek, one of the most sophisticated funds, has 60 percent of its publicly disclosed investments

by value outside the OECD. The majority of these non-OECD deals are either domestic (45 percent of non-OECD deal value), focused on China (37 percent), or in neighboring economies like Thailand (6 percent) and Indonesia (5 percent).

Temasek’s willingness to diversify geographically re-fl ects its experience and understanding of regional economies. Other SWFs appear to be pursuing attrac-

tive deals wherever they occur. The Dubai fund Istithmar, for example, has invested some $6 billion outside of the OECD, a signifi cant share of the $21 billion it has invested since its founding in 2003. Istithmar has focused primarily on real estate, including signifi cant tourism-based property assets such as the Victoria & Alfred Waterfront in South Africa.

In sum, the deal data present a mixed picture of the geography of investment (see Figure 5). On the one hand, measured by number of transactions, only a third of SWF deals have occurred in OECD countries, though by value these deals represent 61 percent of the total. This suggests that SWFs are keen to invest in non-OECD countries, but that they place smaller sums at risk in such transactions. This may be due to a perception of greater country political risk when investing outside the OECD or to the larger size of deal opportunities — bigger companies in which

The Dubai fund Istithmar, for example, has invested some $6 billion outside of

the OECD, a signifi cant share of the $21 billion

it has invested since its founding in 2003.



to invest — there. This pattern may change in the future if risk-adjusted returns improve in emerging markets or OECD countries adopt regulations deemed re-strictive by sovereign government owners.

Figure 5: Geographical Destination of SWF Investments: OECD, BRIC, and Non-OECD

Number of Deals by Region (785 deals)

Value of Deals by Region ($250 bn)

OECD31%

Non-OECD(excluding BRIC)

50%

BRIC19%

OECD61%

Non-OECD(excluding BRIC)

25%

BRIC14%

Source: Monitor SWF Transaction Database

It is important to note that most SWFs invest signifi cant amounts in their home countries, typically in small tranches. Several large funds including Khazanah Na-sional BHD in Malaysia invest primarily at home. Across our sample, domestic transactions represent one-third of the deals by number and 15 percent by value.

The following maps (Figure 6 and Figure 7) illustrate the fl ow of SWF investments from particular regions. Since 2000, funds based in the Middle East and North Africa (MENA) invested some $100 billion and carried out 205 deals. The bulk of this investment, $72 billion, has gone to North America and Europe. However, fewer than half the deals by number occurred in North America and Europe, with the majority elsewhere. 69 deals representing $19 billion in value were made in the MENA region.

Since 2000, funds based in the Middle East and North Africa (MENA) invested some $100 billion and carried out 205 deals.



Over the same period, Asian SWFs invested $150 billion and carried out 573 deals. These funds invest more heavily in their home region than do the MENA funds. Half of total investment, $75 billion, and over 80 percent by number took place in Asia. Europe and North America accounted for most remaining investment, with $74 billion and 94 deals.

2. Sectors: SWFs Avoid Sensitive Sectors and Industries

Many concerns about SWFs stem from the perception that they wish to invest in sectors of strategic importance to their sovereign government owners, driven by motives that are not necessarily or primarily fi nancial. Some funds do seek to acquire intellectual property, technology, and capabilities to help upgrade their do-mestic economy. Whether recipient country governments perceive such investing

Figure 6: Publicly available data for MENA SWF equity deals, 2000-Q1 2008

MENA toNorth America:

$41 bn (32 deals)

MENA toSouth America:

(3 deals)

MENA toEurope: $31 bn(61 deals)

MENA toAsia Pacific: $4 bn (25 deals)within MENA

$19 bn (69 deals)

MENA toSub-Saharan Africa:

$6 bn (15 deals)




as an economic, competitive, or national security threat, however, depends on their own assessments and objectives.

Our database sheds light on the sector preferences of SWFs. As seen in Figure 8, in terms of value, nearly half the investments involved fi nancial services, with a further 19 percent in real estate and 11 percent in energy and utilities. In terms of number of deals, activity is more evenly distributed, with a quarter in fi nancial services, 18 percent in real estate, 15 percent in industrials, 10 percent in IT and 10 percent in consumer goods.

The disproportionate emphasis on fi nancial services — 22 percent of transactions by number and 46 percent by value — refl ects both strategy and opportunism. As we shall see, there are good reasons for SWFs to invest in this sector and interest

Figure 7: Publicly available data for Asia/Pacifi c SWF equity & real estate deals, 2000-Q1 2008

Asia-Pacific toNorth America:

$29 bn (42 deals)

Asia-Pacific toCentral/South America:

(3 deals)

Asia-Pacific toEurope: $46 bn(52 deals)

within Asia-Pacific $75 bn (473deals)Asia-Pacific to

MENA: (3 deals)




spans both OECD markets (66 percent by value) and emerging markets (34 percent by value). Note that the total value of transactions in this sector as well as the share in the OECD are skewed by the recent large investments in U.S. and European banks and fi nancial institutions during 2007-2008.30

Financial services appeals to SWFs for many reasons. First, banks and fi nancial institutions are attractive investment targets for global investors generally. Notwith-standing recent market concerns about exposure to the global credit crisis, banks

are well-regulated assets perceived to be marquee in-vestments for balanced portfolios, providing investors with stable risk-adjusted return opportunities.

Second, many funds investing in this sector are par-ticipating in businesses they know well. Singapore and Dubai serve as global fi nancial hubs and their leaders

are familiar with the world’s leading fi nancial institutions. Unsurprisingly, SWFs from those economies have strong relationships with global fi nancial institutions — draw-ing on their products and services and, in some cases, recruiting away their talent.

Figure 8: Summary of SWF Transactions in Sectors by Number and Value

NUMBER OF DEALS BY SECTOR (785 DEALS) VALUE OF DEALS BY SECTOR ($250 BN)

Financials22%

Financials46%

Real Estate18%

Real Estate19%

Industrials15%

Industrials8%

Consumer10%

Consumer3 %

Telecom 6%Telecom 2%

Healthcare 4% Healthcare 2%Transport 4%

Other 3% Other 8%

IT10%

IT 1%Energy

8%

Energy11%


The disproportionate emphasis on fi nancial services — 22 percent of transactions by number and 46

percent by value — refl ects both strategy and opportunism.



Third, investing in fi nancial institutions provides younger SWFs with opportunities to buy preferential access into a pipeline of high quality investment opportunities more broadly and leverage the industry, product, and deal-making expertise that resides in those fi nancial institutions. This has been highlighted by recent SWF in-vestments in private equity and hedge fund players like Blackstone, Carlyle Group, J.C. Flowers, Och-Ziff, and GLG Partners. Such investments also enable SWFs to access skills and experience that are particularly relevant to countries seeking to establish themselves as global fi nancial hubs. Dubai’s DIFC, for example, has ac-quired stakes in stock exchanges in the United Kingdom, Sweden, and France. In addition to fi nancial returns, DIFC is able to access skills and knowledge to boost Dubai’s competitive position as a regional fi nancial center.

Fourth, the current global credit crisis and its impact on fi nancial services stock prices has created an opportunity for SWFs to secure stakes on attractive terms in brand-name global stocks. While the recent wave of opportunistic buying of fi nancial services stocks has heightened political concerns about SWF motivations, in our view, these fears are overblown. The deals have involved small minority stakes and were made without any certainty that the credit crisis has bottomed out, reinforcing SWF claims that they are investing for the long term. Without sug-gesting that SWFs have been investing for altruistic reasons, it is also worth noting these transactions have helped to buttress the global bank-ing system at a time of considerable market anxiety about the breadth and depth of the credit crisis.

Close relationships with leading fi nancial institutions also help SWFs enhance their own portfolio management strat-egies and risk management procedures. This is particularly important for newer SWFs. Exposure to banking industry best practice, particularly in relation to risk management, can play an important role in strengthening the op-erational integrity of SWFs as fi nancial entities. It also aids their integration into the

Investments in transportation, defense and aerospace, and high technology make up less than one percent of the value of deals in our database.



regulatory and oversight protocols critical to the effi cient and transparent operation of national and global fi nancial markets.

Beyond fi nancial services, the transaction database does not lend compelling sup-port to the notion that SWFs target politically-sensitive industries. Investments in transportation, defense and aerospace, and high technology make up less than one percent of the value of deals in our database.

Individual SWFs, however, are making strategic investments in industries that some other nations may regard as strategic and sensitive:

Temasek has made signifi cant investments in ports and shipping com-panies in Asia, but it is likely that this preference refl ects knowledge of, and comfort with, investments in these assets as a result of Singa-pore’s position as the world’s largest port for container shipping.

Investments in energy account for approximately 11 percent of transaction value, the majority of these originating among Asian and Middle Eastern funds.31 As with the Singaporean investments in shipping, these investments can be seen as an outgrowth of already strong local sectors.

Telecommunications accounts for only two percent of the value in our transaction database. The Singaporean funds are leading investors in part because they seek to build a strategic presence in this industry in Southeast Asia.32

The Abu Dhabi fund Mubadala has targeted high technology and aviation-related services as important to the emirate’s long-term future.

•

•

•

•



3. Ownership and Control: SWFs Take Majority Stakes, at Home and Abroad

Several commentators suggest that SWFs are unlikely to take controlling stakes in foreign corporations. One frequently cited explanation is that SWFs lack suffi cient skilled professional investment personnel or the expertise to represent their inter-ests in the boardroom.

Information in the Monitor SWF Transaction Database, however, suggests a different picture. As indicated in Figure 9, for deals where we have stake data, half of equity transactions involve controlling stakes. However, inside OECD countries, these con-trolling-stake deals are not made in sensitive sectors such as IT, telecommunications, energy and utilities, transportation, and aerospace. Indeed, controlling-stake deals in sensitive sectors in OECD countries account for 2 percent by number and 4 percent by value. Controlling-stake deals are much more com-mon in emerging and domestic markets. Singapore’s Temasek Holdings, for example, has acquired controlling interests in many companies in Southeast Asia. Examples of controlling-stake deals in OECD countries include Dubai’s DIFC, which bought the U.K. software fi rm SmartStream Technologies; Istithmar, which purchased the upscale U.S. retailer Barneys New York; and QIA, which acquired the U.K. healthcare fi rm Four Seasons.

These examples suggest willingness to buy controlling stakes in relatively uncontro-versial sectors such as consumer products and services and industrials, as opposed to in politically sensitive sectors inside OECD countries. Indeed, while more than 20 percent of the transactions in the consumer and industrial sectors resulted in a SWF owning a controlling stake, that result occurred in fewer than 20 percent of transactions in IT (17 percent), telecommunications (13 percent), transportation and aerospace (1 percent) or infrastructure and government (1 percent).

The Abu Dhabi fund Mubadala has targeted high technology and aviation-related services as important to the emirate’s long-term future.



CASE STUDIES: AMD/MUBADALA AND 3COM/HUWAEI

Attempts by organizations linked to foreign governments to acquire shares in strategical-ly important U.S. companies would set off a political fi restorm, or so we believe. This certainly was the case in the controversy over the acquisition of P&O’s U.S. hold-ings by Dubai Ports World. And political tensions also seem to have been behind the Chinese National Offshore Oil Corporation (CNOOC)’s decision to withdraw its bid for the U.S. oil company Unocal.

Political tensions also seem to have been behind the decision by 3Com, a U.S. network equipment maker, to postpone selling a minority stake in the company to China’s Huwaei Technologies. CFIUS, the U.S. government body that reviews foreign acquisition of American companies, inti-mated that national security concerns may block the deal.

So it would appear that organizations linked to governments in China or the Middle East would have great diffi culty buying stakes in strategic companies. But in December 2007, Mubadala, a government investment company from Abu Dhabi, in-vested $622 million for an 8 percent stake

in U.S. semiconductor company Advanced Micro Devices (AMD).

The deal provoked little controversy, and went through relatively unnoticed. How did this happen?

Mubadala tried to keep a low profi le, keeping its stake under 10 percent and not seeking a seat on the AMD board. It also paid close attention to the U.S. domestic political process, sounding out key sena-tors and congressmen informally as part of a larger diplomatic effort by the UAE. It cannot have hurt that, as a result of the deal, AMD is reportedly more likely to consider building a new chip fabrication facility in Malta, New York.

And, according to press reports, it is precisely this lack of attention to domestic U.S. politics that scuppered the 3Com deal. Rather than quietly lobbying and infl uenc-ing, Huwaei, and their U.S. partners Bain Capital, appeared to assume that any politi-cal concerns would not be a deal-breaker.

The lesson appears clear. If you want to make an acquisition in a strategic company in the United States, check informally fi rst for political concerns. Oh, and increasing the likelihood of building new factories in the United States doesn’t appear to hurt.



Figure 9: Stake Acquired by SWFs across all deals and foreign deals

ALL DEALS FOREIGN DEALS ONLY

10-50% Stake 37% 10-50% Stake

40%

50-100% Stake 50%

50-100% Stake 43%

<5% Stake 5%

<5% Stake 7%

5-9% Stake 10%

5-9% Stake 8%


Further insight into the appetite for controlling stakes can be seen when consider-ing geography. In OECD markets, over 50 percent of services and real estate but only 4 percent of fi nancial services transactions resulted in controlling stakes. Apart from Temasek, which made four controlling investments in energy and utilities (one in Australia, two in South Korea and one in the United Kingdom), we have not seen evidence of other SWFs taking controlling stakes in sectors that could be considered politically sensitive.

4. Asset Allocation: SWFs Are Investing in Higher-Risk Asset Classes

Only a few SWFs disclose the composition of their portfolios by asset class, and those that do often list these classes in broad categories such as bonds, equities, and “other.” As a result, it is diffi cult to estimate the relative share of publicly-traded equities in a given fund’s portfolio or how the fund’s investment philosophy may be evolving.



There is clear evidence in our database that SWF appetite for equities has increased notably since 2000 (see Figure 10). Before then, only a few older funds such as Temas-ek actively made signifi cant direct investments. Since then, some 17 have done so. Nor is the appetite for higher-risk asset classes confi ned to stocks: several funds also invest in real estate and some have recently participated in leveraged private equity deals.

Evidence of growing SWF interest in equities is reinforced by the funds’ investments in fi nancial institutions such as U.S. and European banks and private equity fi rms. These moves give SWFs increased exposure to deal opportunities, including through debt-fi nanced capital structures designed and funded by investment bank and private equity partners. While these types of investments are no doubt attractive because of the superior returns they have often generated, they raise legitimate concerns given the role leveraged investment vehicles have played in the 2007-2008 global credit crisis.

Figure 10: SWF Transactions by Number and Value since 2000 33

0

30

60

90

120

150

2000

5363 60

47

90

137129

146

42

3 4 3 6 8

28

49

92

58

2001

Number

2002 2003 2004 2005 2006 2007 2008 (Q1)

Value ($bn)




CASE STUDIES: BARNEY’S/ISTITHMAR AND SAINSBURY’S/QIA

Much reporting about SWFs, especially those from the Middle East, portrays them as on a petrodollar-fueled rampage to acquire assets in OECD countries. And if those assets are premium brands, so much the better.

The recent acquisition of Barney’s of New York, an upscale U.S. fashion retailer, by Istithmar, an investment arm of the Dubai government, certainly fi ts this story. In June 2007, Istithmar bid $825 million for Barney’s. While the deal was being fi nalized, Fast Retailing, a Japanese retail group, sub-mitted an unsolicited bid for $900 million.

Fighting back, Istithmar raised its bid to $940 million, which was ultimately ac-cepted. David Jackson, CEO of Istithmar, stated “We still see value in the price that we ultimately paid. We are comfortable that the price we paid will yield attractive returns.”34

So Gulf-based SWFs will pay any price to snap up western brands, right? Wrong. The Qatar Investment Authority (QIA)’s aborted bid for Sainsbury’s, a U.K. super-market chain, tells a different story.

Founded in 2005, QIA appears to have an aggressive mandate for overseas invest-ment. In the fall of 2006, QIA bid $18 billion for Thames Water, a U.K. utilities company, but ultimately lost to Macquarie, an Australian bank. In September 2007, QIA began to explore a $20 billion bid to acquire Sainsbury’s.

QIA progressed with due diligence through October, fi nding that the cost of the deal was higher than originally thought, by some $1 billion. Finally, in November QIA withdrew its offer, though it maintains a minority stake. One person involved in the bid said “Qatar’s reputation as a credible investor of international assets has been se-riously damaged and it will be a while before another British public company enters into exclusive negotiations with them again. We used to think private equity’s behavior could be low, but what Qatar has done is lower than a snake’s belly.”35

In the end, both aggressive bidding and indecision point to one factor — inexpe-rience. It remains to be seen whether the younger SWFs will learn from their mis-takes. But one thing is certain: they will be major players in the fi nancial markets for many years to come.

Appendix




Categorizing SWFs by Behavior


ASSESSING THE RISKS 49 Categorizing SWFs by Behaviour

SEVERAL TIMES IN THIS REPORT we have noted the diffi culties of generalizing about SWFs as a class. That said, there have been several attempts to segment them according to different variables. In a recent report, analysts at an investment bank, for example, positioned the 20-largest SWFs on a 2x2 matrix of investment objective (passive to strategic) and transparency (low to high).36 The resulting image makes the point that individual SWFs differ markedly from each other on these dimensions and that several (in the UAE, Qatar, and China) pos-sess the worrying combination of being strategic investors with low transparency. The implication is that such funds should be watched carefully for signs of politically-moti-vated investing.

Such analysis addresses the common concern among re-cipient country governments and multilateral regulatory and oversight institutions about the potential abuse of SWFs by their sovereign government owners. In our view, however, this analytical framework is prob-lematic for several reasons. First, the report did not provide descriptions of the underlying research, metrics, or methodologies. Given the lack of transparency of many funds, how can one know based on the data presented whether they are passive or strategic investors? Second, transparency applies to the fund, but as we’ve argued here, the real issue for some external constituencies is the un-derlying objective and behavior of the sovereign government owner. For these constituencies, a highly transparent fund from a country viewed as a strategic rival is no less worrisome because it is transparent.

A highly transparent fund from a country viewed as a strategic rival is no less worrisome because it is transparent.

SKYLINE OF DUBAI, UNITED ARAB EMIRATESFuelled by massive capital infl ows, Dubai is using its SWFs in a bid to become one of the world’s leading fi nancial centers.


50 ASSESSING THE RISKS Categorizing SWFs by Behaviour

As noted in Section 3, a better way to understand the motivations of SWFs is to examine actual behavior as revealed by their appetite for fi nancial risk and the behavior of their sovereign government owner as a member of the international

community. The resulting dimensions of fi nancial risk and sovereign ownership risk can be measured.

To estimate fi nancial risk we relied on public in-formation about the funds and the Monitor SWF Transaction Database. We graded each fund on four dimensions on a 0-3 scale (0 being conservative and 3 very aggressive):

Appetite for equity deals. A heavy reliance on equity deals shows a strong desire to invest in riskier portfolios than traditional govern-ment management of surplus reserves via central banks.

Appetite for controlling stakes. An appetite for acquiring control-ling stakes indicates objectives closer to private equity fi rms than to traditional pension funds.

Appetite for real estate deals. Real estate investments are less liq-uid than other asset classes such as bonds and treasury bills.

Appetite for foreign, especially non-OECD deals. Trading foreign stocks or real estate, especially in non-OECD countries, reveals a more aggressive investment behavior.

Each dimension is equally weighted to generate a 12 point-scale index of fi nancial risk.

Measuring sovereign ownership risk posed a comparable though different challenge. The Peterson Institute for International Economics has published an embryonic transparency ranking for prominent SWFs.37 As we have argued, however, greater

•

•

•

•

A better way to understand the motivations of SWFs is to examine actual behavior

as revealed by their appetite for fi nancial risk and the

behavior of their sovereign government owner.



transparency is helpful but will not address the underlying concerns about SWFs among many constituencies. Allaying these concerns is best done by combining information about transparency with additional information about the behavior of sovereign government owners.

The index of sovereign ownership risk is a 7-point-scale composite that captures both dimensions. The fund’s actual behavior is factored in by using the Peterson Institute index. The risk represented by the sovereign government owner is calcu-lated using a combination of Transparency International’s Corruption Index and various World Economic Forum indices selected specifi cally because they indicate the concerns that animate the SWF debate — for example, access to know-how and respect for intellectual property rights; divergences in governance practices, e.g. level of corruption, effi ciency and effectiveness of the legal system; and openness of markets, e.g. rules on FDI and prevalence of trade barriers.

Although transparency seems to generate the most attention, recent cases that made headlines such as Dubai Ports World or 3Com emphasize that the national provenance of an investment matters more than its type or structure. To refl ect this point of contention, the index of sovereign ownership risk weights the ratings of the sover-eign government owner more heavily than the fund itself.

The resulting matrix appears in Figure 11. The size of the bubbles indicates the amount of funds under management. In the bottom left quadrant are SWFs from Norway and New Zealand. These funds have a low appetite for fi nancial risk, and both originate in countries with low levels of sovereign ownership risk. The Gulf and Singaporean funds are all at a similar level regarding sovereign own-ership risk . However, these funds differ greatly from their counterparts Norway and New Zealand in their appetites for Financial Risk. ADIA, KIA and GIC are

Recent cases that made headlines such as Dubai Ports World or 3Com emphasize that the national provenance of an investment matters more than its type or structure.


52 ASSESSING THE RISKS Categorizing SWFs by Behaviour

more similar to university endowments, in that they accept more risk than some pension funds, but are on the whole relatively conservative investors. The greatest difference in terms of investment philosophy is shown by Temasek, Mubadala and Istithmar. Given their tendencies to take controlling stakes in individual companies, they at times behave more like private equity investors.

Figure 11: Selected SWFs and the Dimensions of Risk

0

1

2

3

4

5

1 2 3 4 5 6 7 8 9 10

NZ Superannuation FundNorway Pension Fund

TemasekHoldings

KIC

Kazanah

Istithmar

Mubadala

Qatar InvestmentAuthority

Central Huijin Investment Company

FINANCIAL RISK

SOVE

REI

GN

OW

NER

SHIP

RIS

K

GIC

KIA

ADIA

On the dimension of sovereign ownership risk, the most interesting case is Chi-na, which here is represented by Central Hujin Investment Company, a fund that invests primarily in China (its new parent fund CIC was formed too recently to pro-vide a meaningful track record in our database). China elicits more concerns about internal governance and intellectual property protection than any other country with SWFs. Its attitude towards fi nancial risk appears to be evolving and refl ective of a conservative investment posture but also one exhibiting a growing appetite for risk in the form of private equity deals.38

Today, the bulk of SWF value is in the middle of this chart, in funds with moder-ate sovereign ownership and fi nancial risk. The potential for this mass to migrate towards the top right quadrant commands attention in every debate. Yet we be-lieve the potential horizontal migration outward along the index of fi nancial risk



is the more likely trajectory for most SWFs in the short to medium term and that exposure to undue fi nancial risk is a greater concern than politically-motivated investing. The 2006 incident noted above involving the Norwegian fund and the Icelandic government illustrates the point. Managers of the Norwegian fund an-ticipated the market by playing short on debt securities of the then-booming Icelandic bank. Although such trading is routine for so-phisticated investors, complaints ensuing from the prime minister of Iceland indicate that even prudent fi nancial investing carries political dangers.

China elicits more concerns about internal governance and intellectual property protection than any other country with SWFs.

Scenarios for the Next Five Years

Illustration by Julia Frenkle


ASSESSING THE RISKS 55 Scenarios for the Next Five Years

IN ATTEMPTING TO SKETCH THE LANDSCAPE in which SWFs will participate in future global fi nancial markets, we distinguish between observable trends and critical uncertainties. We believe that three key trends will play out over the next fi ve years.

SWFs will become fi xtures in global fi nancial markets and more funds will be established in the short to medium term, either by states establishing their fi rst fund or those with existing funds adding more.

SWF appetite for higher risk-adjusted returns has increased in recent years and will continue to do so.

Legislators and policy makers in major capitals will, for better or worse, con-tinue to push for some form of regulatory response to the increasing promi-nence of SWFs.

Two critical uncertainties, however, will play vital roles in defi ning the future partici-pation of SWFs in global fi nancial markets. Perhaps more importantly, they could have potentially signifi cant spill-over implications for national economies and cor-porations as recipients of investment capital, as well as for other providers of capital and fi nancial market intermediaries, including pension fund managers, private eq-uity fi rms, hedge funds and investment banks. These critical uncertainties are:

The extent to which SWFs pursue fi nancial ends as opposed to geo-strategic ends sought by their sovereign government owners; and

The extent to which regulations affecting SWF activities occurs at the nation-state level or is coordinated globally.

1.

2.

3.

1.

2.


56 ASSESSING THE RISKS Scenarios for the Next Five Years

Combining these two critical uncertainties generates four possible futures for SWFs in the year 2013 (see Figure 12 and Figure 13).

Figure 12: Four Scenarios for SWFs in 2013

FROM HUNTERS TO FARMERS

MACHIAVELLI’SNEW TOY

LIFEGOES ON

ROGUESRUN WILD

Geo-StrategicallyMotivated

Purely FinanciallyMotivated

Coordinated MultilateralRegulatory Response

Fragmented NationalRegulatory Response

Financial vs. Geo-Strategic Motivation

SWFs are becoming more aggressive investors, moving away from their traditional investments in currency reserves and bonds into higher-risk asset classes, including equities in OECD and emerging markets. Like other fi nancial investors, SWFs are using more sophisticated investment strategies to secure higher returns. We expect this trend to continue in the future.

Our analysis of SWF deals indicates that national governments are not using these funds as tools of foreign policy. While some SWF investments, such as those in U.S. and European fi nancial services companies, have been criticized as politically motivated, we see no evidence to confi rm such a view. Rather, these investments appear to be motivated by fi nancial interest in the prospect of gain and/or ensuring the stability of the fi nancial system. Some funds, such as Mubadala in Abu Dhabi, have a clear mandate to invest to develop their domestic economy. But its activities are far from meddling in the internal affairs of other countries.



Once it makes an investment in a foreign company, a SWF has “bought in” to the existing system, and has a clear fi nancial interest in playing by the rules. This makes it diffi cult, though not impossible, to imagine a sovereign government leader at-tempting to use a SWF to achieve foreign policy goals.

What might inspire a SWF to invest for political motives? First, a serious dislocation of interest among two or more of the major global powers — the United States, China, Russia and the European Union — preventing all of them from coming together in extreme circumstances to deal with what would clearly be a common threat to their individual national interests;

Second, a widespread mutiny in the multilateral trading system and a breakdown in the normal channels of diplomacy and dispute resolution.

Meanwhile, the severity of the threat also would depend on the aggressiveness and sophistication of a fund’s in-vestment strategy and the relative size of its investment positions in global markets. Some possible futures are set out in Figure 13.

Another scenario, less debated but more likely, is that a SWF could introduce an unacceptable degree of fi nancial risk into another country’s markets through an overly aggressive investment strat-egy. The collapse of Long-Term Capital Management in 1998 and the recent crisis at Bear Stearns, show the risks of investing in complex fi nancial instruments and excessive use of leverage. The possibility for nations and multilateral institutions to consider, in this case, is that of a sovereign hedge fund, highly leveraged, that bets wrongly and collapses.

Once it makes an investment in a foreign company, a SWF has “bought in” to the existing system, and has a clear fi nancial interest in playing by the rules.



Figure 13: Possible Future Scenarios for SWFs

FROM HUNTERS TO FARMERS MACHIAVELLI’S NEW TOY

LIFE GOES ON ROGUES RUN WILD

Sovereign Wealth Funds are allowed to participate as global investors and while no evidence has emerged to suggest that they are anything other than driven by financial self interest, recipient governments continue to receive foreign SWF funds cautiously. Consistent with the 1990s failure to negotiate a Multilateral Investment Agreement, efforts by the OECD, IMF, and World Bank in 2008 to develop global standards for SWF disclosure and investment approval failed to gain traction. Consequently, governments have relied instead on national powers to legislate and regulate. Most OECD countries as well as many others in Asia, Africa and Latin America have passed SWF-inspired amendments to national foreign investment rules that typically require additional review and due diligence of proposed investments in strategic sectors of the economy by foreign government-owned investment vehicles.

Bitter and angry after the imposition of U.S. sanctions, an oil-producing country’s president vowed to send the U.S. economy back into recession by using his nation’s Sovereign Hedge Fund to provoke volatility on Wall Street. Having secured long term oil and gas contracts with other customers, the president has calculated that the country can absorb the pain of U.S. countermeasures such as further economic sanctions.

As a result of global guidelines being successfully negotiated in early 2009 by a special multilateral conference hosted by the IMF and co-chaired by senior Chinese, European, and American officials, much of the anxiety surrounding SWF investments has died down. As a consequence the number of SWFs has doubled – some from new states and some from states with multiple funds - as has the total dollar value of assets under their management. Annual IMF auditing of SWF disclosure statements has provided both recipient governments and other market participants with a high degree of confidence in the transparency of SWF intent and market activity. As they did during the 2007-08 global credit crisis, SWFs have continued to play a valuable role in providing global markets with liquidity and have done so in a manner consistent with their financial self interest in achieving attractive long run returns.

While the global regulatory mechanisms successfully negotiated in 2009 initially appeared to have achieved their goal of enhancing transparency of SWF intent and investment activity, the April 2010 Financial Times exposé of a major country’s manipulation of global commodity markets through one of its SWFs came as a rude awakening to those who had believed in the possibility that the funds would be purely financial actors firewalled from the geo-strategic agenda of their political masters. By employing a complex web of holding companies, foreign intelligence assets, and hedge fund traders in offshore banking centers in the Atlantic and Pacific, the country’s“Sovereign Hedge Fund” had managed by January 2012 to extract profits estimated at $100-125 billion from the short selling of oil futures. Despite pressure from OECD nations to strengthen global oversight mechanisms and introduce retaliatory sanctions for states found in breach of global rules, such efforts have been systematically frustrated and it is now widely considered in official policy and intelligence circles that other states routinely use their SWFs to engage in manipulation of currency and commodity markets.

Geo-Strategically

Motivated

Pure

lyFi

nanc

ially

Mot

ivat

ed

Coordinated Multilateral Regulatory Response

Fragmented National Regulatory Response

Another possibility is the emergence of a world in which SWFs are used as ancil-lary tools by national political leaders in the competition among states to secure long-term access to natural resources and perhaps export markets. In this Machia-vellian world, it is not hard to imagine a pattern of behavior emerging in which



SWF states clandestinely use the power of insider information gained through for-eign intelligence assets to arbitrage currency, commodity and futures markets. This would be the fi nancial markets equivalent of espionage — undertaken by everyone despite globally-accepted norms to the contrary and toler-ated by everyone unless and until these activities become so obvious and egregious as to demand public rebuke and international sanction.

In this future scenario, private sector investors would be the biggest losers because of the disadvantage resulting from the information asymmetries created by state-funded foreign intelligence operations. Consequently, widespread market perception of such a world existing could have damaging consequences for the broader operation of an effi cient global fi nancial market. In such a context, SWFs might be perceived by private sector market participants as “market makers,” thereby creating incentives for private equity fund managers, hedge fund traders and day traders to try to “front run” SWF investment activity, thereby creating mar-ket volatility and suboptimal asset pricing.

Globally Coordinated vs. Fragmented Regulatory Response

While the debate continues over whether SWFs present any real cause for concern, political leaders and legislators in OECD capitals from Berlin and Bangkok to Wash-ington and Canberra are already calling for a review of regulations applying to global investment vehicles owned by foreign governments. We believe that, irrespective of the merits of SWF-specifi c regulatory measures, some form of regulatory action by policy makers and legislators is likely in the next two or three years.

Three basic models for possible regulatory response have emerged from the ongo-ing debate:

Irrespective of the merits of SWF-specifi c regulatory measures, some form of regulatory action by policy makers and legislators is likely in the next two or three years.



Voluntary improvements in transparency of objective and investments on the part of the SWFs themselves;

Imposition of national regulations in the form of SWF-specifi c modifi cations to existing foreign investment laws and review procedures;

The development of global regulatory standards and mechanisms by one of the existing inter-governmental organizations with existing oversight for the effi cient conduct of global fi nancial markets. These organizations include the International Monetary Fund, the World Bank and the Financial Stability Forum.

In our view, to the extent that SWF-specifi c regulatory measures are considered necessary, a global approach to regulation and oversight is the preferred approach. The global nature of the investment footprint of SWFs, and indeed other large globally-minded investors, calls for the harmonization of national investment rules. Among other things, global regulatory standards for investment would help to enhance information fl ows and market signalling for all investors. Global standards would also help to mitigate the risk of unduly discriminatory treatment of state-owned investors vis-a-vis private investors and would help minimize the transaction costs on the cross-border fl ow of capital.

Nevertheless, a global solution to SWF concerns is unlikely to emerge. As witnessed by the failed attempt in the 1990s to negotiate a Multilateral Investment Agreement (MIA), little consensus exists on foreign investment rules among OECD nations, let alone the broader international community. Ownership limits, review, approval and appeal pro-cedures and, perhaps most contentious of all, the defi nitional boundaries of “national interest” and “national security” are all hotly contested.

Second, little consensus has emerged in the early months of 2008 about which in-ter-governmental organization is most appropriate to provide oversight of SWFs. The IMF, OECD, World Bank and Financial Stability Forum are all involved in the ongoing investigation of possible multilateral regulatory measures, yet none of these bodies possesses clear jurisdictional authority to oversee and enforce stan-dards relating to government-owned investment vehicles including SWFs.

1.

2.

3.



This highlights a third and potentially stronger barrier to the search for a multilat-eral response: most SWF states do not have a seat at the top table of many of these inter-governmental organizations. One of the least articulated aspects of the ongo-ing SWF debate is the fact that their rapid emergence highlights, far sooner than many expected, the unrepresentative nature of many of the world’s transnational and multilateral organizations today. It is diffi cult to see why SWF states would sign on to any new SWF-specifi c regulations if they had not been granted an ac-tive voice in designing and promulgating the new rules of the game for global investment.

We also see little likelihood of an effective voluntary scheme emerging, despite the pressure on SWFs to develop and adopt a code of conduct encompassing en-hanced disclosure practices. First, many SWF states do not currently see it in their best interest to take the lead on this issue of transparency, not least because most of the concern being expressed in OECD capitals is explicitly or implicitly directed to Chinese, Russian and Middle Eastern SWFs. Second, at a practical level, no obvious mechanism exists for the managers of SWFs to collaborate in drafting a voluntary code of conduct. Finally, even if some form of limited voluntary transparency standards did emerge among SWFs, we doubt it would alleviate the real underlying concerns of Western policy makers. Suspicions about the accuracy and complete-ness of any voluntarily disclosed information would remain.

The Most Likely Scenario

Given the diffi culty of coordinating a multilateral regulatory response, we believe this is unlikely to happen. And given the current investment profi le of the major SWFs and the care they take to avoid sensitive sectors in the OECD, we also be-lieve it is unlikely that SWFs will begin to invest for geo-strategic reasons. The most likely future in our opinion is “Life Goes On,” in which SWFs continue to evolve as fi nancial investors in a relatively unregulated global system.

Most SWF states do not have a seat at the top table of many inter-governmental organizations.

Appendix




Implications, Conclusions, and Questions


ASSESSING THE RISKS 63 Implications, Conclusions, and Questions

THE KEY CONSTITUENCIES in the global fi nancial system obviously can infl uence which scenario plays out. Here are the implications for each of these ac-tors, as well as actions for them to consider — or avoid — in shaping the evolution of the global fi nancial system in ways that address their interests and concerns.

For SWFs

Managers of newer SWFs would do well to learn from their counterparts at older, successful funds like Singapore’s GIC and Temasek, Norway’s GPFG, and Abu Dhabi’s ADIA. Namely, SWFs will benefi t from:

Distancing themselves organizationally and administratively from their sovereign government owners to reinforce perceptions of independence and autonomy;39

Demonstrating to other constituencies that their funds are man-aged by respected professional investment managers;

Having in place risk management systems commen-surate with their growing appetite for higher-risk asset portfolios; and

Building and disclosing a track record illustrating pursuit of fi nancial goals.

When making foreign investments, SWFs would be wise to avoid sensitive sectors or iconic national companies and

•

•

•

•

When making foreign investments, SWFs would be wise to avoid sensitive sectors or iconic national companies and continue to act as long-term, passive investors.

MANDARIN ORIENTAL HOTEL, NEW YORK CITYIn December 2006, Istithmar, a Dubai-based SWF, purchased the Mandarin Oriental Hotel in New York for $594 million.


64 ASSESSING THE RISKS Implications, Conclusions, and Questions

continue to act as long-term, passive investors with relatively small equity stakes in target companies. Exceptions are possible but should be managed carefully because funds that stray from the proven path face signifi cant risks.

Managers of SWFs that score high on the dimensions of sovereign ownership risk and fi nancial risk face particular challenges. Leadership and organizational capa-bilities in corporate diplomacy — gaining a richer, more nuanced understanding of constituencies affected by particular investments as well as tactics and techniques for dealing with their concerns (see sidebar) — are distinguishing features among the most successful funds in their foreign investments.

For Sovereign Government Owners

SWFs offer an unparalleled opportunity to their sovereign government owners to help increase prosperity. Nevertheless, the ultimate test for national governments will be not

how much money they accumulate in the SWF itself, but how the proceeds from SWF investments are productive-ly reinvested back into the domestic economy.

There is a genuine risk that the income stream from SWF investments globally can cushion political lead-ers from the diffi cult and politically dangerous task of

pursuing structural economic and social reforms at home. In this sense, proceeds from SWFs that are distributed to citizens in the form of cash or welfare transfers may yield undisciplined and uncompetitive economies in the future. This has long-term implications not only for citizens of the sovereign government owner but also for other constituencies and the global economy as a whole.

Another risk to sovereign government owners is failing to recognize the impact of their policies and behaviors on how other constituencies view their SWFs. As we’ve

SWFs offer an unparalleled opportunity

to their sovereign government owners to

help increase prosperity.



A NOTE ON CORPORATE DIPLOMACY

In today’s world, it can be diffi cult to discern between opportunities and threats or to identify the true bases of power and infl uence. The best analysis and the most compelling busi-ness case — an investment in a new geography, a cross-border merger or acquisition, a new advertising cam-paign targeted at unfamiliar customers, an effort to preserve a proprietary advantage — can result in nothing if the proposed activity sparks criticism and controversy from stakeholder groups who feel impacted. Billions of dollars in corporate valuations and personal reputations can be at risk. Capabilities and skills in corporate diplomacy are be-coming essential to success, particularly for organizations like SWFs and their investment banking advisers routinely engaged in cross-border activities and managing a global investment footprint.

Corporate diplomacy is the communi-cation and engagement with external stakeholders based on insightful situ-ational awareness of the political, economic, geo-strategic and social contexts within which specifi c com-mercial activity is undertaken. Effective corporate diplomacy helps to identify and pursue signifi cant opportunities, an-ticipate and manage potential problems, avoid embarrassing false starts, and escape or minimize crises. It requires a systemic management approach across a range of corporate functions and activi-ties - from the gathering and synthesis of situational intelligence, to the for-mulation and execution of stakeholder engagement strategies and the training and development of corporate leaders within the organization to undertake these activities and represent the organi-zation’s interests on a global stage.



noted, providing greater transparency of SWF objectives and investment activity is a positive step toward giving other participants in global fi nancial markets bet-ter information but it will not eliminate political concerns. Neither transparency of SWF intent or activity nor the democratic credentials of the parent state will guarantee favorable reception to a SWF investment in a foreign country. The driver of acceptance will be the track record of observable behavior by the SWF’s sover-eign government owner in international affairs more broadly.

This last point bears emphasis. SWFs of countries perceived as aggressive or ir-responsible global citizens will be suspect. In broad terms, we expect that SWFs from nations that support or fail to confront groups engaged in terrorism, drug smuggling, or money laundering will continue to get a cool reception in foreign markets. Similarly, funds based in countries that get low marks for protectionism,

corruption, transparency, and ineffi cient or politicized legal and regulatory systems also will be suspect.

Even so, much is in the eye of the beholder. Many OECD states have sought to link global trade and in-vestment rules to state behavior such as protection of human rights, the natural environment, and intel-lectual property. As witnessed by recent pressure on

U.S. and European corporations and fund managers to divest shares in companies with commercial activities in Sudan, SWFs seeking access to OECD markets can expect increasing scrutiny at the foreign investment screening stage around their parent government’s commitment to social, political, and cultural values cherished in OECD countries.

Other countries, however, place signifi cantly less importance on adherence to such standards. As Professor Steven Weber and others have pointed out, trade and in-vestment fl ows continue to grow between the emerging economies, with many of

Neither transparency of SWF intent or activity nor the

democratic credentials of the parent state will guarantee

favorable reception to a SWF investment in a foreign country.



them possessing the most lucrative greenfi eld natural resources and high-growth investment opportunities in global markets today. Herein lies the rub for OECD policy makers who have become accustomed to presiding over the most attrac-tive investment markets while alleging the moral superiority of progressive liberal values. This world may be vanishing. In Weber et al’s “World Without the West,” SWFs from emerging market nations may simply sidestep investment opportunities in OECD markets because of the political friction and transaction costs involved and focus their at-tention instead on comparably-attractive opportunities in markets less likely to attract political and regulatory scru-tiny. This confl uence of high-growth investment opportunities with lesser concern for social and cultural norms defi ned by Western liberal democracies is a new phe-nomenon in global affairs, one with potentially profound implications.40

For Recipient Country Governments

National security remains an area of acute concern to all governments considering foreign investment proposals, especially when originating with foreign government-owned investment vehicles. Nevertheless, recent public statements by politicians highlight a range of other concerns among recipient nations. French President Nicholas Sarkozy has expressed concerns about an uneven playing fi eld emerging in global cross-border investment. And the German government is reportedly setting up its own version of the Committee on Foreign Investments in the United States (CFIUS), in part in response to the public debate over SWFs.41

As highlighted by these responses, the debate so far has lacked a clarity of purpose and little evidence of any analytical grounding — conditions that do not bode well for a level-headed assessment of the risks and the drafting of appropriate and ef-fective monitoring and oversight mechanisms.

SWFs from emerging market nations may simply sidestep investment opportunities in OECD markets because of the political friction.



We share the view that foreign direct investment is benefi cial both for national economies and international relations. Thus it is not in any nation’s interest to raise impermeable barriers to inward SWF investments. In general, investments by SWFs should be treated on equal terms as other sources of fi nancing and subject to the same oversight and regulations. Additional scrutiny and review should be reserved for transactions likely to impinge on clearly demarcated national security interests. Greater transparency in SWF reporting should be encouraged better to inform market participants. Finally, as with other constituencies, recipient country govern-ments may use the matrix of sovereign ownership risk and fi nancial risk to inform thinking about particular SWF investments.

For Multilateral Regulatory and Oversight Institutions

To date, SWFs have demonstrated themselves to be responsible long-term investors and contributors to the welfare of the global fi nancial system. Any changes to exist-ing multilateral or transnational regulatory frameworks should take care to preserve

the benefi ts SWFs offer and avoid penalizing them for irresponsible behavior that has yet to materialize.

It is in the interests of all constituencies that SWFs not only be treated like other classes of investors but also be watched closely for signs of inappropriate infl u-ence on their investment behavior by political leaders

in their home country. SWFs should enjoy no fi nancial advantages over private investors based on sovereign government ownership.

Increased transparency of SWFs would make the tasks of regulation and oversight easier — though as noted repeatedly in this report — would not remove all SWF investments from suspicion or regulation. In our view, common and effective stan-dards of transparency for SWFs are desirable, whether established voluntarily by the SWFs or instituted by multilateral regulatory organizations.

SWFs should enjoy no fi nancial advantages over

private investors based on sovereign government

ownership.



For Other Financial Institutions

SWFs clearly pose both threats and opportunities to other fi nancial institutions. Once again, the matrix of sovereign ownership risk and fi nancial risk may provide a useful guide for other parties in weighing how investments by a particular SWF in a given country may be perceived. As competitors to SWFs, other fi nancial in-stitutions may glean insights into the likelihood that a SWF will seriously pursue a certain transaction or the reactions that may be generated in local markets. Un-derstanding where and how SWFs prefer to invest is highly valuable competitive intelligence that could support pre-emptive moves or positioning as an alternative, less controversial supplier of capital.

As potential investment partners, other fi nancial institutions may be able to infl uence the choices and terms under which a SWF undertakes investments abroad. Once again, understanding of SWF motives and behaviors is valuable intelligence for those seeking to help a SWF realize its goals and objectives. At the same time, other fi nancial institutions with complementary knowledge in such areas as local funding alternatives and corporate diplomacy can render signifi cant service to SWFs.

For Companies Considering Investments by SWFs

Boards of directors and top executives of companies in which SWFs may invest can also benefi t from understanding the motives and behaviors of SWFs and the risks they pose. The appearance of new suppliers with vast capital resources obvi-ously is inviting, especially because these suppliers appear to be patient, long-term investors who are not likely to interfere in governance or management. Clearly a company evaluating an investment from a SWF should test these appearances and consider circumstances under which they might change.



Accepting an infusion of capital from a SWF need not be controversial if managed well — that is, by fi rst acknowledging, then addressing the concerns of corporate stakeholders, including the media, as well as of other constituencies in the global fi nancial system.

Final Observations and Questions

The current debate over SWFs risks polarizing proponents and opponents into separate and isolated camps. It may be more productive to step back and view the debate as the opening conversation of a larger discussion among nations about the role of emerging nations in the global fi nancial system.

That SWFs, like private equity fi rms and hedge funds, remain largely opaque and unregulated highlights the inability of international regulatory authorities to keep pace with innovation and adaptation in the global fi nancial system. It also highlights the increasingly problematic divide between the states that write the rules on how the global fi nancial system should operate and provide the systems administration function for it, versus the states that focus their atten-tion on how to maximise risk-adjusted returns within the existing rule set. In this light, the rise of SWFs signifi es an important change in the global fi nancial

system, one that increasingly pushes the boundaries of acceptable state behavior as understood by pre-vailing conventions.

Emerging nations clearly believe that they also have the right to write the rules. Speaking recently, Yang Jie-

chi, the Chinese Foreign Minister, said “It’s in everyone’s interest to make good use of sovereign funds in line with international fi nancial rules. But of course, the rules of games should be set up by all involved.”42

The rise of SWFs signifi es an important change in the

global fi nancial system.



As the new cash-rich emerging market states test the prevailing conventions pre-sided over by the victors of World War II, challenges lie ahead in revising the rules on global investment market behavior. While issues have been raised in recent years about the merits of closer regulation of private equity and hedge funds, it is clear that the government-owned nature of SWFs complicates any attempt to limit regulation purely to preserving the stability of the global fi nancial system — an objective around which all states and fi nancial market participants have a collective interest.

Meanwhile, SWFs have important implications for the evolving role of the nation state in the global economy. Some experts have suggested that the funds portend a comeback for the state, offsetting trends toward smaller central governments. We do not fi nd such arguments plausible. A few prominent exceptions notwithstanding, national governments are ceding responsibility for economic production to private enterprise while focusing on policy-setting and reg-ulatory agendas. This transition occurs in many forms and at varying rates, from full privatization (as in electricity grids and airports in many OECD economies), to the outsourcing of management and operating responsibility for government-owned assets (as occurs in the oil and gas industry). This process is neither fast nor easy due to politically-sensitive employment impacts. Despite the challenges, emerging market economies with traditions of strong state involvement in economic produc-tion, including China and India, continue to recognize the superior performance of private commercial actors.

On the other hand, SWFs do represent a reassertion of the state in the global economy. The proliferation of funds is one of several indicators highlighting the determination of many states to preserve ownership rights over sources of national wealth, typically in the form of resource endowments (such as oil) or the accumu-

The government-owned nature of SWFs complicates any attempt to limit regulation purely to preserving the stability of the global fi nancial system.



lated cash proceeds from the prior sale of those commodities. In this regard, SWFs are an outcome of other strategic choices made by national political leaders.

First, controlling access to natural resources matters more than it ever has. The emergence of massive new consumers of energy such as China and India has prompted resource-rich states to pay greater attention to the management of the future value of their resources. Although states such as Russia and Venezuela have made a strategic choice to re-nationalize ownership and control of their energy

resources, other states have demonstrated increasing savvy in negotiations with multinational corporations over access rights.

Second, there are minimal barriers to entry in wealth management and, buoyed by the rapid accumulation

of excess foreign reserves, many states view SWFs as opportunities to become more vocal and active in global economic affairs.

In sum, the rise of SWFs and the reassertion of the state in global economic affairs pose fi ve key questions for policy makers and regulators:

What are the potential risks of SWFs for which regulation is the solution? While prudent risk management needs to rely on the application of the precaution-ary principle, much of the SWF debate so far has been characterized by “what if ” speculation that, as our database of SWF transactions shows, is not well grounded in the reality of fund behaviors to date.

Which fund-related entities should regulation cover? Note two key points. First, non-discriminatory regulation is important to the effi cient and effective function-ing of global fi nancial markets. Do the risks at the core of concerns about SWFs relate only to these funds or also to other types of government-owned global investment vehicles and/or privately-owned global investment vehicles such as private equity and hedge funds?

1.

2.

Many states view SWFs as opportunities to become more vocal and active in global economic affairs.



Second, regulatory responses need to be developed with a holistic view of the global investment system in mind. If SWF-specifi c regulations are introduced they will increase the transaction costs (fi nancial and po-litical) for SWFs and perhaps increase barriers to investment in some sectors deemed to be of national security importance. While this may thwart unwanted direct investment by SWFs, it may also motivate them to adopt investment strategies with lower transaction costs and lower barriers to entry. These might include adopting a “fund of funds” ap-proach in which SWF money is managed by third parties in markets that remain less regulated.

3. Which multilateral authority is the most appropriate to oversee SWFs? The regu-latory architecture of the global fi nancial system is still largely confi gured to oversee market participants that dominated international fi nance in the twentieth century: central banks, commercial banks, insurance com-panies, mutual funds, and pension funds. Despite the debate in recent years, little progress has been made on how to accommodate the emer-gence of signifi cant new types of asset managers such as private equity fi rms, hedge funds, and now SWFs.

This lack of clarity is perhaps best highlighted by the fact that national governments, regional bodies such as the EU and international bodies such as the IMF and the World Bank are each independently crafting recommendations in relation to SWF regulation.

4. What specifi c measures are both appropriate and practical to implement? Financial market evolution and innovation dramatically outpaces the regulatory reactions of the international community. Would specifi c measures be enforceable or would they need to rely on voluntary compliance?



5. Perhaps most important, which nations will get to participate in negotiations over regulation and oversight of SWFs and under what terms? In the near term, ex-isting multilateral institutions seeking oversight of SWFs are listening to nations that are not members or traditionally involved in decision mak-ing. Sooner or later, this will change, and whether the change proceeds smoothly or as the result of struggle and confl ict is a key question for the world in the years ahead.


ASSESSING THE RISKS 75 Appendix

Appendix PROFILES OF SELECTED SWFs

Asia

China Investment Corporation (CHINA)

Government Investment Corporation (SINGAPORE)

Temasek Holdings (SINGAPORE)

Middle East

Abu Dhabi Investment Authority (ABU DHABI, UAE)

Dubai International Financial Center Investments (DUBAI, UAE)

Istithmar World (DUBAI, UAE)

Kuwait Investment Authority (KUWAIT)

Mubadala Development Corporation (ABU DHABI, UAE)

Qatar Investment Authority (QATAR)

EuropeGovernment Pension Fund Global (NORWAY)


76 ASSESSING THE RISKS Appendix

ASSET ALLOCATION

N/A

DEALS, 2000-Q1 2008(9 DEALS, $34BN)

Energy andUtilities 3%

Financials97%

RECENT DEALS

JC Flowers + Co(February 2008, $4bn)

Morgan Stanley (December 2007, $5bn, 9.9 percent stake)

BG Group (September 2007, $250m, 0.46 percent stake)

Blackstone Group (May 2007, $3bn)

•

•

•

•

China Investment Corporation CHINA

KEY INFORMATION

Investment arm of the Chinese Government

Launched in September 2007

CIC’s mandate is to invest a portion of China’s foreign currency reserves

Key People:

Chairman: Lou Jiwei

General Manager: Gao Xiqing

Chairman of the Board of Supervisors: Hu Huaibang

OBJECTIVE AND STRATEGY

According to Li Yong, China’s Vice Minister of Finance, CIC’s investment strategy is:

1/3 of capital is to purchase Central Huijin Investment Co., owner of China’s major state-owned commercial banks

Another 1/3 would be used to replenish the capital of the Agricultural Bank of China and China Development Bank

The remaining 1/3 would be invested in global fi nancial markets

Investment in global fi nancial markets is to be gradual and CIC would not invest in overseas airlines, telecommunications or oil companies

ORGANIZATION CHART

N/A

•

•

•

•

»»»

•

»

»

»

•



KEY INFORMATION

Headquartered in Singapore, and establishedin 1981, GIC is an investment arm of the Singaporean Government

It has some $330bn of assets

Key People:

Chairman: Lee Kwan Yew (Minister Mentor, Singapore)

Deputy Chairman: Lee Hsien Loong (Prime Minister of Singapore)

Executive Director: Tony Tang Kem Yam


GIC’s objectives are:

To preserve and enhance the international purchasing power of Singapore’s reserves, by achieving a real rate of return over and above the G3 infl ation rate over a long-term horizon.

For medium-term performance monitoring, to outperform an appropriate composite of recognised market indices, through optimal allocation among and within asset classes.

ORGANIZATION CHART

Government of Singapore

GIC

Real EstateAssetManagement

SpecialInvestments

•

•

•

»

»

»

•

»

»

ASSET ALLOCATIONBY CLASS, JULY 2006

Equity50%Bonds

30%

Others*20%

DEALS, 2000-Q1 2008(74 DEALS, $56BN)

Financials46%

RealEstate38%

Infrastructure14%

Other2%

RECENT DEALS

UBS (February 2008, $14.4bn, 10 percent stake)

Citigroup (January 2008, $6.8bn, 4 percent stake)

Merrill Lynch Financial Center (July 2007, $953m)

British Airports Authority (May 2006, $2.5bn)

Associated British Ports Holdings (March 2006, $5.1bn)

•

•

•

•

•

Government of Singapore Investment Corporation SINGAPORE



KEY INFORMATION

Headquartered in Singapore, Temasek is an investment arm of the Singaporean government

It was established in 1974, and currently has some 300 employees

Key People:

Chairman: S Dhanabalan

Deputy Chairman: Kwa Chong Seng

Executive Director: Simon Israel

CEO: Ho Ching (Wife of the Prime Minister of Singapore)


Temasek’s investment strategy is to:

Buy shares of foreign businesses to earn dividends

Buy foreign banks as an investment vehicle to raise funds in the respective country

Its main investments are in fi nance, telecommunications, media, IT, transport, real estate, construction, engineering, pharmaceuticals and airlines sectors

75 percent of Temasek’s investments are in Singapore

ORGANIZATION CHART

•

•

•

»»»»

•

»

»

»

•

ASSET ALLOCATIONBY SECTOR, 2005-2007

FinancialServices38%

Telecoms23%

Other6%

Transport12%

Energy6%Infrastructure

6%

Real Estate9%

DEALS, 2000-Q1 2008 (393 DEALS, $52BN)

Financials50%

Telecom 6%

Other 10%

Industrials12%

IT 4%

Energy andUtilities

12%

Consumer 6%

RECENT DEALS

Merrill Lynch (December 2007, $4.4bn, 9.5 percent stake)

TXU Australia (July 2007, $3.7bn, 100 percent)

Barclays (July 2007, $3bn, 2.1 percent)

Bank of China (March 2007, $1.5bn, 5 percent stake)

Standard Chartered PLC (2006, $4bn, 11.5 percent stake)

•

•

•

•

•

Government of Singapore

Temasek

Executive Offi ce

Strategic Development Asia

Strategic Development ASEAN

Strategic Development Global

Capital Resources Management

Private Equity

Fund Management

Temasek Holdings SINGAPORE



Abu Dhabi Investment Authority ABU DHABI, UAE

KEY INFORMATION

Headquartered in Abu Dhabi, Abu Dhabi Investment Authority (ADIA) is an investment vehicle of the Abu Dhabi Government

It was established in 1976 by Sheikh Zayed bin Sultan al Nayhan, and its size is estimated at $875bn

Key People:Chairman: Sheikh Khalifa Bin Zayed Al Nahyan Managing Director: Sheikh Ahmad Bin Zayed Al Nahyan CEO: Hareb Al DarmakiCFO: Salem Rashed Al Muhanadi


ADIA’s mandate is to accumulate wealth for future generations in Abu Dhabi

ADIA invests in various asset classes:Equities » Real EstateFixed income » Alternative assets (PE, hedge funds)

Around 70-80 percent of ADIA’s portfolio is managed by external fund managers

Generally tries to keep equity stakes below 4.5 percent to avoid disclosure

ADIA is separating into two organizations; ADIA and ADIC

ORGANIZATION CHARTGovernment of

Abu Dhabi

Abu Dhabi Investment

Council

Abu Dhabi Investment

Authority (ADIA)

Abu Dhabi Investment Company

AssetManagement

Corporate Finance and Investment

Banking

PrivateEquity

RealEstate

•

•

•»»

»»

•

•»»

•

•

•

ASSET ALLOCATIONFUND ALLOCATION BY ASSET TYPE, 2006

Equities50–60%

FixedIncome20–25%

Private Equity5–10%

Other AlternativeInvestments5–10%

Real Estate5–8%

DEALS, 2000-Q1 2008(15 DEALS, $16BN)

Financials59%

EnergyandUtilities35%

Real Estate6%

RECENT DEALS

Citigroup (November 2007, $7.5bn, 4.9 percent stake)

PrimeWest Energy of Canada(September 2007, $5bn)

MediaSet SpA (August 2007, $220m, 2 percent stake)

Suez Cement Company (January 2007, 7.6 percent stake)

Sturegallerian (May 2006, $580m, 100 percent stake)

•

•

•

•

•



Dubai International Financial Center Investments DUBAI, UAE

KEY INFORMATION

Headquartered in Dubai, Dubai International Financial Center (DIFC) Investments is one of the arms of the Dubai International Financial Center, a fi nancial hub funded by the Dubai government

It was established in April 2006, and employs 15 people

Key People:

Chairman: Omar Mohammed bin Suleiman

Managing Director: Beshir Barazi


DIFC Investments is charged with making investments to support the development of Dubai as a global fi nancial center

Other responsibilities include the management of subsidiaries, and managing strategic alliances

Recent investments seem to indicate DIFC Investments intends to build up a portfolio in global stock exchanges

This is assumed to be with the aim of developing the capability of the Dubai Stock Exchange

ORGANIZATION CHART

DIFCAuthority

DIFCInvestments

Dubai International

Financial Exchange

Four Other Regulatory

Bodies

Governmentof Dubai

Dubai International Financial Center

•

•

•

»»

•

•

•

»

ASSET ALLOCATION

N/A

DEALS, 2000-Q1 2008(11 DEALS, $9BN)

Financials 93%

Industrial3%

IT 4%

RECENT DEALS

OMX AB (February 2008, $4.7bn, 98.4 percent stake)

London Stock Exchange (August 2007, $1.6bn, 28 percent stake)

Deutsche Bank (May 2007, $1.8bn, 2.2 percent stake)

Euronext of France(February 2007, April 06, $370m, 3.48 percent stake)

•

•

•

•



ASSET ALLOCATIONN/A

DEALS, 2000-Q1 2008 (63 DEALS, $21BN)

Real Estate73%

Financials 6%Other 4%

Consumer 17%

RECENT DEALS

Barneys New York (June 2007, $942m, 100 percent stake)

Time Warner (February 2007, $2bn, 2.39 percent stake)

Standard Chartered (October 2006, $1bn, 2.7 percent stake)

Loehmann’s Holdings (May 2006, $300m)

280 Park Avenue (April 2006, $1.2bn, 100 percent stake)

•

•

•

•

•

Istithmar World DUBAI, UAE

KEY INFORMATION

Headquartered in Dubai, Istithmar World is a member of Dubai World, a holding company owned by the Dubai government

Established in October 2002, employs 35 people and its size is estimated at $12bn

Key People:

Chairman: Sultan Ahmad Bin Sulayem

Vice-Chairman: Adel Abdul Aziz al Shirawi

CEO: David Jackson


Istithmar’s mandate is to obtain superior fi nancial returns through global investment

Private equity investment is in 3 main sectors:Consumer (Retail, Healthcare, Media & Entertainment)

Financial Services (Private Banking/Asset Management, Investment Banking, Islamic Financial Services, Insurance)Industrial (Logistics & Transportation, Utilities & Energy, Manufacturing, Construction, Aerospace)

It also invests in equities and joint ventures

ORGANIZATION CHART

Istithmar World

LimitlessLLC

Some 50Associated Companies

Governmentof Dubai

Dubai World (Holding

Company)

Istithmar World Capital (Private Equity)

Istithmar World

Ventures(Venture Capital)

Istithmar World

Aviation

DP World(formerly Dubai Port Authority)

•

•

•

»»»

•

•»

»

»

•



Kuwait Investment Authority KUWAIT

KEY INFORMATION

Headquartered in Kuwait City, the Kuwait Investment Authority (KIA) is the investment arm of the government of Kuwait

Established in 1953 as the Kuwait Investment Board, and became the KIA in 1982

Employs 270 people, and size estimated at $250 bn

Key People:

Chairman: Mustafa Al Shemali

Managing Director: Bader al Saad


KIA’s mandate is to provide an alternative stream of public fi nance to oil reserves

Strategic sectors include:

Equities » Real Estate

Bonds

In 2006, it reduced its investments in US from 85 percent to 70 percent of its total asset value

The focus shifted to higher-yield bonds, Chinese buildings and Asian PE funds

Their major targets are regions with high economic growth and low levels of institutional investment

ORGANIZATION CHART

KuwaitInvestment

Offi ce

Governmentof Kuwait

Kuwait Investment Authority

General Reserve Fund

Marketable Securities

Alternative Investments

Operations

•

•

•

•

»»

•

•

»»

•

»

•

ASSET ALLOCATIONBY CLASS, NOVEMBER 2007

Equity 57%

Bonds15%

Real Estate,Private Equity andHedge Funds6%

Cash 22%

DEALS, 2000-Q1 2008(13 DEALS, $13BN)

Real Estate7%

Energy & Utilities71%

Financials22%

Kuwait Investment Authority

RECENT DEALS

Halkbank (May 2007, $209m, 2.7%)

Industrial Bank of China (April 2007, $720m)

Cevahir Shopping Center(November 2006, $750m, 100 percent stake)

Merrill Lynch (June 2005, $2bn)

•

•

•

•



KEY INFORMATION

Headquartered in Abu Dhabi, Mubadala Development Company is an investment vehicle of the Abu Dhabi Government

It was established in October 2002 as a Public Joint Stock Company, and employs 250 people

Key People:

Chairman: Sheikh Mohammed, Crown Prince of Abu Dhabi

CEO: Khaldoun Khalifa Ahmad Al Mubarak

CFO: Carlos Obeid

COO: Waleed Al Mokarrab Al Muhairi


Mubadala’s mandate is to invest in a way that will benefi t the economy of Abu Dhabi


Energy » Utilities

Real Estate » Basic Industries

Mubadala is also assumed to have the mandate to build up the aviation and aerospace sector within Abu Dhabi

ORGANIZATION CHARTGovernment of

Abu Dhabi

Mubadala

Finance & Corporate Affairs Group

Operations Group

Acquisitions Aerospace & Technology

Energy & Industry Healthcare

Infrastructure & Services

Properties Development

•

•

•

»

»»»

•

•

»»

•

ASSET ALLOCATIONN/A

DEALS, 2000-Q1 2008 (34 DEALS, $20BN)

Industrials44%

Transport andAerospace 10%

Energy &Utilities30%

Consumer 7%

Real Estate6%

Other3%

RECENT DEALS

Advanced Micro Devices (November 2007, $622m, 8.1 percent stake)

Ferrari (June 2007, $137m, 5 percent stake)

Piaggio Aero of Italy (April 2006, 35 percent stake)

SR Technics of Switzerland (March 2006, $1.3bn, 40 percent stake)

Carlyle Group (July 2005, $1.35bn, 7.5 percent stake)

•

•

•

•

•

Mubadala Development Corporation (ABU DHABI, UAE)



Qatar Investment Authority QATAR

KEY INFORMATION

Headquartered in Qatar, Qatar Investment Authority (QIA) is the international investment arm of the Government of Qatar

It was established in 2005, employs 92 people and its size is estimated at $40 billion

Previously known as the Supreme Council for Economic Affairs and Investment

Key People:

Chairman & CEO: Tamim Bin Hamad Al Thani

Vice-Chairman: Hamad Bin Jassem Bin Jabr Al Thani, Deputy Prime Minister

Head of PE: Ken Shen


QIA’s mandate is to invest in a way that diversifi es the economy of Qatar away from energy


Real Estate

Private Equity

Investment Funds

Also invests in strategic sectors within Qatar

Was involved in an abortive bid in 2007 to buy Sainsbury’s, a British supermarket chain, for $21 billion

ORGANIZATION CHART

•

•

•

•

»»

»

•

•

»»»

•

•

ASSET ALLOCATIONN/A

DEALS, 2000-Q1 2008 (22 DEALS, $12BN)

Healthcare27%

Other 3%

Financials38%

RealEstate 24%

Infra andGovernment

8%

RECENT DEALS

Credit Suisse (February 2008)

London Stock Exchange (September 2007, 20 percent stake)

Chelsea Barracks, UK (June 2007, $1.9bn)

OMX of Sweden (April 2007, 14 percent stake)

Four Seasons Healthcare (September 2006, $2.6bn, 100 percent stake)

•

•

•

•

•

QatarHoldings

LLC

DeltaCommercial Properties

Delta Two Delta Three

Government of Qatar

Qatar Investment Authority



KEY INFORMATION

Headquartered in Oslo, the Government Pension Fund — Global (GFPG) was set up in 1990

The fund is run by Norges Bank Investment Management, but makes extensive use of external fund managers

Key People:

Governor, Norges Bank: Svein Gjedrem

Deputy Governor, Norges Bank: Jan Qvigstad

Executive Director, NBIM: Yngve Slyngstad


The objective of the GFPG is to create a future strategic stream of income to replace income from natural resources

The ‘strategic benchmark portfolio’ is:

Fixed income instruments (60 percent share) — Europe (60 percent), America/Africa (35 percent) and Asia/Oceania (5 percent)

Equities (40 percent share) — Europe (50 percent), America/Africa (35 percent) and Asia/Oceania (15 percent)

The fund has interest in over 3,000 equities, 1,000 fi xed income securities and 2,000 foreign exchange reserves as of Dec 31, 2006.

ORGANIZATION CHART

Governmentof Norway

Norges Bank

FinancialStability

InvestmentManagement

Staff andGroup

Services

MonetaryPolicy

•

•

•

»»»

•

•

»

»

•

ASSET ALLOCATIONPERCENTAGE OF INVESTMENTS BY VALUE, 2007

Fixed IncomePortfolio 55%

EquityPortfolio 45%

DEALS, 2000-Q1 2008

N/A

RECENT DEALS

N/A

Government Pension Fund - Global NORWAY



Sources and Bibliography

Laura Badian and Gregory Harrington, “The Politics of Sovereign Wealth,” The International Economy, January 2008

Blundell-Wignall, Adrian, Yu-Wei Hu, and Juan Yermo, “Sovereign Wealth and Pension Fund Issues,” OECD Financial Market Trends, 2008

“Briefi ng: Sovereign-wealth Funds,” The Economist, January 19, 2008

Citigroup Global Banking, “Sovereign Wealth Funds: A Growing Global Force,” October 18, 2007

Deutsche Bank Research, “Sovereign Wealth Funds: State Investments on the Rise,” September 10, 2007

Global Insight, Sovereign Wealth Fund Tracker, April 2008

Jen, Stephen L., “How Big Could Sovereign Wealth Funds Be by 2015?” Morgan Stanley Global Research, May 3, 2007

“Sovereign Wealth Funds: A New and Growing Class of Funds,” Investment Management Journal, December 2007

Johnson, Simon, “The Rise of Sovereign Wealth Funds,” Finance & Development, September 2007.

JP Morgan Research “Sovereign Wealth Funds: A Bottom-up Primer,” May 2008

Kimmitt, Robert M., “Public Footprints in Private Markets: Sovereign Wealth Funds and the World Economy,” Foreign Affairs (January-February 2008)

Lyons, Gerard, “State Capitalism: The Rise of Sovereign Wealth Funds,” Standard Chartered Bank, October 15, 2007

McKinsey Global Institute, The New Power Brokers: How Oil, Asia, Hedge Funds, and Private Equity Are Shaping Global Capital Markets (October 2007).

Merrill Lynch Global Economics, “The Overfl owing Bathtub, the Running Tap, and SWFs,” October 5, 2007.



Setser, Brad W., and Rachel Ziemba, “Understanding the New Financial Super-powers — The Management of GCC Offi cial Foreign Assets,” RGE Monitor, December 2007.

Truman, Edwin M., “A Blueprint for Sovereign Wealth Fund Best Practices,” Peterson Institute for International Economics, April 2008.

“A Scoreboard for Sovereign Wealth Funds,” Peterson Institute for Interna-tional Economics, October 19, 2007.

“Sovereign Wealth Funds: The Need for Greater Transparency and Ac-countability,” Peterson Institute for International Economics, August 2007.

Weber, Steven, Naazneed Barma, and Ely Ratner,” A World Without the West,” The National Interest, July-August 2007.

www.swfi nstitute.org

www.swfradar.com

Endnotes

1 Two websites that provide frequent news updates and commentary are: www.swfradar.com and www.swfi nstitute.org. See Sources and Bibliography for additional references.

2 See, for example, Truman (August 2007), Deutsche Bank Research (2007), and Lyons (2007). 3 Dubai International Capital (DIC) appears on some lists of SWFs but its managers insist that it is based on the private

wealth of the ruling emir. Dubai has two other SWFs that qualify: Istithmar and Dubai International Financial Centre. See also, Setser and Ziemba, December 2007.

4 Most descriptions of SWFs include a point about their funding sources, noting that these consist heavily of surplus foreign exchange reserves derived either from commodity sales (especially oil and gas) or trade surpluses. In our view, the source of funding provides little insight into the behaviors of the funds, though of course it explains why so many funds have been founded since 2000 and why, given current trade patterns and projections of energy prices, existing SWFs may grow much larger and more SWFs may yet appear.

5 Two points about the list in Table 1. First, it is not exhaustive. We began by aggregating lists published in the literature and did not look for additional funds except as new funds were created and announced. Further research undoubtedly will result in changes to the list. For example, state pension funds of The Netherlands and Canada invest in alternative asset classes and foreign equities and may qualify. Second, SWFs are moving targets. New funds or older funds that alter their behaviors to fi t our criteria may show up on future lists; alternatively, some existing SWFs may disappear if their ownership or behaviors change.

6 Kimmitt, (2008). Even so, some defi nitional problems remain. The Saudi Arabian Monetary Authority is a central bank that invests some of its portfolio of foreign reserves like a SWF. See Setser and Ziemba , December 2007.

7 According to a recent study, more than 40 percent of SWF assets are managed by third parties. See http://www.pion-line.com/apps/pbcs.dll/article?AID=/20080307/DAILY/762550071.

8 Information in this paragraph and the next is drawn from Morgan Stanley Research Global (Stephen Jen), Deutsche Bank Research, Standard Chartered (Gerard Lyons); Citigroup Global Banking; McKinsey Global Institute, and Merrill Lynch Global Economics.

9 Jen, “How Big?” 10 Interview with Bloomberg television, January 16, 2008.



11 Reuters, “Sarkozy attacks wealth funds on eve of Mid East trip,” January 12, 2008. 12 “CIC Dispels Fund Concerns,” The Standard, March 10, 2008. 13 “Our Sovereign Wealth Plans,” Wall Street Journal, March 19, 2008. 14 Speech to the Global Competitiveness Forum, Riyadh, Saudi Arabia, January 22, 2008. 15 Interview with “60 Minutes,” April 6, 2008. 16 “Kimmitt: Sovereign funds a positive force to date,” Reuters, March 11, 2008. 17 “China’s CIC on the Prowl for Direct Stakes,” Reuters, March 3, 2008. 18 Badian and Harrington, January 2008; Ziemba, November 2007. 19 Johnson, “The Rise of Sovereign Wealth Funds.” 20 Presentation, Munich, February 27, 2008. 21 AME Info, June 23, 2007. 22 “Briefi ng: Sovereign-wealth Funds,” The Economist, January 19, 2008. 23 ADIA; Alaska ; Alberta Heritage; Australia Future; Azerbaijan; BIA; Central Huijin; CIC; DIC; DIFC; GIC; Hong Kong; Iran;

Ireland; Istithmar; Kazakhstan; Kaznanah BHD; KIC; KIA; Libya; Mubadala; New Mexico; New Zealand; QIA; Temasek. 24 DIC is privately owned by the ruler of Dubai and, as of 2007, Central Huijin is now a part of CIC. Historically, Central Huijin

rarely invested outside of China. 25 ADIA; Azerbaijan; BIA; CIC; DIFC; GIC; Iran; Ireland; Istithmar; Kaznanah BHD; KIC; KIA; Libya; Mubadala; New

Zealand; QIA; Temasek. 26 Singapore’s Temasek Holdings accounts for a signifi cant share of the Asian deals. To control for its effect, we tested our

conclusions by checking them with and without Temasek included. We are confi dent that the conclusions reported here are sound. It is worth noting, moreover, that Temasek is one of the most highly regarded SWFs and is a model for younger funds. Thus its behavior is important to note.

27 Dubai Ports World is a government-owned operating company that is part of a larger group, including the SWF Istithmar 28 Jen, “Sovereign Wealth Funds.” 29 We suspect there may be a bias built into the data given a higher likelihood of disclosing OECD transactions. 30 SWFs invested about $93 billion in fi nancial institutions during 2007-2008, as compared with about $23 billion between

2000 and 2006. 31 ADIA, CIC, GIC, Istithmar, Libya, Mubadala, New Zealand, Temasek. 32 The most notable deal, Temasek’s 2006 investment in the large Thai company Shin Corporation, sparked controversy

because the seller was the family of then-Prime Minister Thaksin Shinawatra. Shinawatra was already a controversial fi gure in Thailand and later was ousted in a coup. The new government accused him of corruption, citing the Shin transaction among other evidence.

33 The database includes data on a further 18 deals for which we do not have an exact year, but which are from funds formed since 2000.

34 “Istithmar Says Price Paid to Acquire Barney’s is not Hish,” Gulf News, August 13, 2007 35 “Standing of Qatar Laid Low Following Surprise Exit,” Financial Times, November 6, 2007 36 Lyons (2007). A very similar matrix appears on the SWF Institute website: http://www.swfi nstitute.org/research/strat-

egytransparency.php. 37 Truman, “Scoreboard .” In April 2008, Truman updated and expanded the transparency data. See Truman, “Blueprint.” After

we completed our analysis, another scorecard of SWF transparency, the Linaburg-Maduell Transparency Index, became avail-able at www.swfi nstitute.org/research/transparencyindex.php

38 China’s attitude toward fi nancial risk may be changing, and it may not extend its investment in Blackstone beyond four years. See a March 2008 report from XFN-Asia: http://www.hemscott.com/news/latest-news/item.do?newsId=61518964236066.

39 As proof that this can be done, consider that Ho Ching, head of Temasek Holdings, a widely respected fund, is married to Lee Hsien Loong, the prime minister and fi nance minister of Singapore (and son of Lee Kwan Yew, the longtime prime minister).

40 Steven Weber, Naazneed Barma, and Ely Ratner,” A World Without the West,” The National Interest, July-August 2007. 41 “Threat to German Action on Foreign Investors,” Financial Times, March 7, 2008. 42 “Rules of Game for Sovereign Wealth Fund Should Be Made by All,” Xinhua, March 12, 2008

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