Sovereign Wealth Funds and U.S. Policy

1. Sovereign Wealth FundsandU.S. Policy Frantz Price, Jr. ITRN 701-008

2. Contents 1) Overview of Sovereign Wealth Funds (SWFs) 2) Current Role of SWFs in US and Global Economy 3) Overall Concerns 4) Policy Proposal

3. What Are Sovereign Wealth Funds? • Four main types of sovereign wealth investment vehicles: 1) Sovereign Wealth Funds (SWFs) 2) International Reserves 3) Public Pension Funds 4) State-Owned Enterprises • Like the other forms, SWFs are owned and managed by national governments. • In contrast however, SWFs have traditionally had the capacity and mandate from their national governments to take on riskier investments with a higher rate of return. • Run purely to increase the wealth of the state, not to pay off any specific debt.

4. SWF Overview • SWFs currently manage close to $5 trillion in assets, with that number expected to grow to over $12 trillion by 2015. • Growth due to rapid rise in commodity prices, large trade surpluses in emerging economies, and surging foreign exchange reserves.

5. SWF Overview • Two types of SWFs: • Commodities Based • Oil producing countries in the Middle East, Norway • Foreign Exchange Oriented Funds • Strong export-led economies that have developed vast foreign exchange reserves, are investing that wealth through SWFs (i.e., China, Singapore) • First SWF, Kuwait Investment Authority, created in 1953 to invest country’s oil revenues. • Since 2005 at least 17 new SWFs have been created, including the China Investment Corporation (“CIC”), which was launched in 2007 to manage a portion of China’s enormous foreign exchange reserves. • CIC, Temasek Holdings of Singapore and the Government of Singapore Investment Corporation, represent alternative model of SWFs built on mercantile power and huge export-led growth rather than vast oil reserves of petroleum.

6. SWF Breakdown Source: SWF Institute, 2010

7. Largest SWFs (Total Assets) Source: SWF Institute, 2010

8. SWF Funding and Investment Top Countries for SWF Direct Investment Inflows 2005 to 2011 (US$ billion) Source: SWF Institute, 2010

9. SWF Governance • SWFs increasingly managed by western-trained experts. • ADIA’s CIO for Private Equity, Chief Economist and Chief Risk Officer are all American educated Wall Street veterans. • The Korean Investment Corporation has an American CIO who has emphasized his intention to diversify their portfolio. • SWFs are generally run like pension funds, looking to preserve capital and maximize returns. • Most of the private equity investments made by SWFs are actually intermediated through large private equity firms (KKR, Blackstone, etc.)

10. US Policy/Legal Concerns “A lack of transparency that characterizes many SWFs undermines the theory of efficient markets at the heart of our economic system. In addition, …government owned-entities may have interests that will take precedence over profit maximization. Just as the United States has geopolitical interests in addition to financial ones, so do other countries. …Why should we assume that other nations are driven purely by financial interests when we are not?” - Former US Senator Evan Bayh

11. US Policy/Legal Concerns • Greatest US Congressional and policy concerns over SWFs have focused on: • the lack of transparency within SWF governance and investment portfolios, and • the potential use of SWF capital for strategic geopolitical (i.e., non-commercial) purposes, with possible national security consequences.

12. Transparency • No international regulations or disclosure requirements re: size of SWFs, their investment strategies, or portfolio composition. • With the lack of transparency, difficult to assess whether SWFs are pursuing strategic, non-commercial investment strategies, or are engaging in mismanagement/corruption. • The Peterson Institute of International Economics (IIE) and the SWF Institute (the Linaburg-Maduell Transparency Index) created indexes quantifying SWF transparency and accountability. Both found that the largest funds (i.e., owned by the UAE, Qatar, Kuwait, and China) scored poorly.

13. Geopolitical Concerns • Significant concern over SWF investment motivated by non-commercial, geopolitical considerations. • US policy makers worry that countries will use SWFs to support “state capitalism,” employing government-controlled assets to secure strategic stakes in areas like telecom, natural resource extraction, and financial services. • Recent examples illustrating US political sensitivity include China’s global investments in mining, minerals and energy assets, and DP World’s bid to takeover operations of 6 US ports.

14. SWF Reform Measures / Santiago Principles • “Santiago Principles” for SWF transparency/disclosure were formally adopted in October 2008 by 24 nations and many of the world’s leading SWFs. • Key points include commitments to increase transparency, adopt best practices for risk management, and keep decision-making more independent from sponsoring governments. • Slowly, the Santiago Principles have begun to take hold: • In 2010, the CIC filed a voluntary report with the SEC. • The Singapore Government Investment Corporation and the ADIA also recently published their first annual reports.

15. Recent SWF Investment in the US • The financial sector has been the biggest target for SWF investment in the US. • However, heavy investment in that sector meant heavy losses; SWFs are looking to further diversify investments as a consequence. Top Sectors for SWF Direct Investment Inflows into the US from 2005 to 2011 (US $billion) Source: SWF Institute, 2010

16. Recent SWF Investment in US Banks/Investment Funds Source: Bolton, Patrick, Samama, Frederic, and Stiglitz, Joseph. Sovereign Wealth Funds and Long-Term Investing. Columbia University Press, November 2011.

17. Policy Proposal – Infrastructure Investment • It would benefit US policy makers on the federal, state and local level to encourage SWF investment into infrastructure. • The public sector is facing drastic capital shortages; the aggregate public debt is about 94% of GDP. • Since the 1980’s, less than 2% of our GDP has been allocated to infrastructure, versus 5-7% in other parts of the developed world. • As recently as 2009, outages and disturbances to our power grid were costing the US economy up to $180 billion per year. • ¼ of our bridges are considered structurally deficient or functionally obsolete.

18. US Infrastructure Spending • The US ranks No. 16 in world infrastructure spending, falling from No. 6 in 2007-2008. • According to Reuters, “the quality of American roads is on par with those of Malaysia.”

19. Infrastructure Investment • Traditionally, the financing of infrastructure programs falls on state and local government through issuance of municipal debt. • Recently, as states/municipalities have struggled with budget deficits, those historical sources of state/local capital formation have dried up. • As an alternative to that model, state/local governments have been exploring greater public – private partnerships in order to attract investment.

20. Infrastructure Investment • SWFs have expressed increased public interest in taking on minority stakes in infrastructure investment vehicles. As an asset class, infrastructure investment is appealing because of low risk and predictable returns. • Many private infrastructure funds already exist, pooling money from investors including SWFs. A broader range of investment models could be created to balance needs of SWFs with political need to limit foreign control and ownership of US infrastructure investments. • This limits the role of individual investors to minority shareholder without rights of operational control, creating a buffer between municipalities and SWFs, and protecting against the politics of a SWF investing directly in sensitive infrastructure (DP World, etc.). • SWFs are not generally built to take on operational control; they are investment funds that look to collect returns rather concern themselves with management of assets. • Obama has proposed this nationally (“Infrastructure Bank”), but the same could be accomplished on a state/local level. Such an investment pool could invest with private infrastructure funds, make direct investments or partner with operating companies.

21. Infrastructure Investment • A March 2011 Brookings study encouraged US policy makers to become more open to foreign investors (including SWFs), and consider offering tax breaks and loan guarantees as incentives to get SWFs to invest in U.S. infrastructure. • Some distrust still remains, both on the US side and with SWFs wary of our regulatory/political environment (i.e., CIC’s first foreign office opened in Canada rather than the US). • To build greater trust, a regular dialogue should take place between SWFs and US political entities.

22. Infrastructure Investment • Default Risk to SWFs? • From June 2011 Fitch Ratings study: • The long term nature and essential public necessity of infrastructure assets create a “potential annuity value for investors that cannot be matched by the corporate sector.” • “Although projects’ default risks may vary case by case, there is little likelihood of winding down a national airport, a state highway or a municipal water system.” • SWFs have the desire to invest and the US has a clear need for a capital infusion to rebuild our infrastructure.

23. Questions?

24. Sources • Bolton, Patrick, Samama, Frederic, and Stiglitz, Joseph. Sovereign Wealth Funds and Long-Term Investing. Columbia University Press, November 2011. http://www.cup.columbia.edu/media/7190/bolton-sovereign-wealth-funds.pdf. • Clinton, Hillary Rodham. “Remarks at the G20 Ministerial.” U.S. Department of State, February 19, 2012. http://www.state.gov/secretary/rm/2012/02/184623.htm. • Ferguson, Niall. “We’re All State Capitalists Now.” Foreign Policy, February 9, 2012. http://www.foreignpolicy.com/articles/2012/02/09/we_re_all_state_capitalists_now?page=full. • Fotak, Veljko and Megginson, William. “Are SWFs Welcome Now?” Vale Columbia Center on Sustainable International Investment, No. 9, July 21, 2009. http://www.vcc.columbia.edu/pubs/documents/FotakandMegginson-Final.pdf. • “Funding the Future.” Columbia Business School: Ideas at Work, January 31, 2012. http://www4.gsb.columbia.edu/ideasatwork/feature/7322021. • International Working Group of Sovereign Wealth Funds. “Santiago Principles.” October 2008. http://www.iwg-swf.org/pubs/eng/santiagoprinciples.pdf. • Jackson, James K. “Foreign Investment, CFIUS, and Homeland Security: An Overview.” Congressional Research Service, March 30, 2011. http://www.fas.org/sgp/crs/homesec/RS22863.pdf. • Kornbluh, Karen. “Remarks of the US Ambassador to the OECD.” October 16, 2011. http://usoecd.usmission.gov/swf.html.

25. Sources (cont.) 9. Laing, Keith. “Obama Pushes for Infrastructure Bank Proposal After Debt Deal.” The Hill, July 11, 2011. http://thehill.com/blogs/transportation-report/highways-bridges-and-roads/170681-obama-pushes-for-infrastructure-bank-proposal-after-debt-deal. • Martin, Michael F. “China’s Sovereign Wealth Fund: Developments and Policy Implications.” Congressional Research Service, September 23, 2010. http://www.fas.org/sgp/crs/row/R41441.pdf. • Nandakumar, S. “Debt Capital Markets & Infrastructure Investment.” Fitch Ratings, June 19, 2011. http://www.fitchratings.lk/download-article-135.pdf. 12. “Sovereign Wealth Funds.” New York Times, December 7, 2009. http://topics.nytimes.com/top/reference/timestopics/subjects/s/sovereign_wealth_funds/index.html. • SWF Institute. http://www.swfinstitute.org/. 14. Teslick, Lee Hudson. “Sovereign Wealth Funds.” Council on Foreign Relations, January 28, 2009. http://www.cfr.org/international-finance/sovereign-wealth-funds/p15251#p10. 15. “The Largest Sovereign Wealth Funds by Assets Under Management.” Sovereign Wealth Funds News, September 16, 2011. http://www.sovereignwealthfundsnews.com/ranking.php. 16. Weiss, Martin A. “Sovereign Wealth Funds: Background and Policy Issues for Congress.” Congressional Research Service, September 3, 2008. http://fpc.state.gov/documents/organization/110750.pdf. 17. West, Darrell M., et al. “Rebuilding America: The Role of Foreign Capital and Global Public Investors.” Brookings Institute, March 11, 2011. http://www.brookings.edu/~/media/Files/rc/papers/2011/0311_sovereign_wealth_funds/0311_sovereign_wealth_funds.pdf.