Suppose your company had just suffered one of its worst quarters in history. Revenue is absent and an influx of cash is much needed. Along comes an investor handing you $5 billion. The investor: Kuwait. Still interested?
This is the world of sovereign wealth investments. It is a world of overflowing nationally held piggy banks looking to invest aggressively in U.S. corporations. And it is one that can no longer be ignored.
To date, nearly 40 sovereign wealth funds exist and although estimates vary by source, the total assets of the sovereign wealth market come in somewhere around $3 trillion. Moreover, this wealth is expected to top $12 trillion by 2015, according to Morgan Stanley, and it is now pouring into the United States by the billions. While this fact should be making both capital-strapped U.S. companies and Washington giddy, it is also wrought with fear and hesitation.
Why? These are not your typical private investors or public pension funds. These are government-owned investment tools from countries that often do not support U.S. foreign policy or interests and include nations with strained relations with Washington. Oil-rich nations such as Kuwait and United Arab Emirates (UAE) top the list of investors looking to strategically invest in U.S. companies and although their goal is by and large the same as any other good capitalist-high returns on investment-the level of scrutiny paid to the source is only increasing.
The most infamous sovereign wealth fund story nearly drew President Bush and Congress to a stalemate. In 2006, the sovereign wealth fund Dubai Ports World (DPW), a subsidiary of Dubai World and a holding company located in the UAE, purchased Peninsular and Oriental Steam Navigation Company (P&O), a UK-based port-operating company. P&O was the fourth-largest ports operator in the world, overseeing 12 of the largest U.S. ports, including Baltimore, Miami, New Orleans, New Jersey, New York and Philadelphia. After DPW bought P&O for $7 billion, Washington's Committee on Foreign Investment (comprised of members of the Treasury Department and the Departments of State, Commerce, and Homeland Security) reviewed the deal. After deliberation, the committee approved the transaction.
Some members of Congress, however, opposed the deal, citing 9/11 Commission reports that two of the 9/11 hijackers may have been UAE nationals. As Congress deliberated, President Bush threatened to veto any attempt to block the deal. "It would send a terrible signal to friends and allies not to let this transaction go through," said the president.
DPW postponed its takeover to allow time for Congress and the White House to reach an agreement. They did not. Instead, a House panel voted to block the deal-a move not supported by the Senate. The President vowed once again to veto any legislation that blocked the deal, and amid the growing controversy, DPW stepped in to announce it had sold P&O's American operations to AIG's asset management wing, thus ending the political storm.
Regulating Sovereign Wealth Investments
On the surface, there is little to fear from a sovereign wealth fund. They exist as a means to stabilize surplus revenues from the sale of a commodity, such as oil or gas. Still others exist as channels for surpluses in government pensions, social security or other tax or government revenue, which are then invested in a variety of domestic and foreign assets with the understanding that they can benefit from foreign exchange differences, trade imbalances and the like. Sovereign wealth funds operate with many of the same investment strategies of more traditional investment funds-they seek maximum return for minimal risk.
"The Central Bank of China has about $1.7 trillion in assets," says Eliot Kalter, senior fellow at the Medford, Massachusetts-based Fletcher School at Tufts University, a world-renowned international affairs institute. "Of that, they transferred $200 billion to a newly created sovereign wealth fund that then invests the money for the central bank."
American companies have already been the glad recipients of much-needed sovereign wealth funds. Following its large subprime-related losses, Merrill Lynch recently received $6.6 billion in sovereign funding and Citigroup added $14.5 billion, most of which originated in Asia or the Middle East.
Below the surface, however, is where things become murky. Many legislators and regulators have questioned the purpose of some sovereign wealth investors, and with money now pouring into the United States from foreign sources, the heat is increasing as Capitol Hill debates with investment analysts about how much regulation is too much.
There are currently few formal regulations or guidelines surrounding sovereign wealth funds. As with Dubai Ports, the federal government does review certain investment deals when national security concerns exist or the amounts are substantial, but until recently, most sovereign wealth investments have evaded scrutiny if the funds were less than 10% of voting equity.
That is about to change. The Treasury Department is working to clarify new regulations that would call for investigations on investments below the 10% threshold if there are associated national security concerns. In April, the Committee on Foreign Investment in the United States (CFIUS) announced proposed regulations that implement the Foreign Investment and National Security Act of 2007 (FINSA) and attempt to ensure compliance with amended Section 721 of the Defense Production Act of 1950 (also known as the Exon-Florio provision). This requires a "certification of compliance, accuracy and completeness" in any deal and gives the president the authority to block any foreign acquisition, merger or takeover of a U.S. corporation if there is proof it could threaten national security. Specifically, foreign investors are given a voluntary chance to submit their intent to acquire a U.S. company, which will trigger a 30-day review by CFIUS, followed by a 45-day national if necessary. The president then has 15 days to review the deal and approve or deny it.
"It's hard to imagine this would encourage people to invest here," says Edwin Truman, senior fellow at the Peter G. Peterson Institute for International Economics in Washington. "It raises the transaction costs. While it's true they always reserved the right to look at transactions below 10%, it's more explicit now. It's a change in presentation rather than fact. With a broader set of best practices, it would make this process easier."
Others agree that new regulations and greater scrutiny could do more harm than good. "If the U.S. starts erecting wider barriers to sovereign investment, the sovereign investment funds may decide not to invest in the U.S.," says Kalter. "We're heavily dependent on that money coming in and not just at the company level. We have a huge external deficit. It needs to be financed by capital coming from abroad. If the funds don't invest in our country, our deficits will have to shrink very quickly."
A Gift and a Curse
For the most part, sovereign wealth funds are beneficial for the United States and its companies. They offer potentially huge cash influxes to shore up sagging revenue. In times of need-the credit crisis being a prime example-these funds represent a capital-infusion option that could help any CEO better navigate turmoil. "The investments could stabilize the market," says Mark Ruloff, director of asset allocation for Watson Wyatt's Arlington, Virginia office. "Merrill Lynch needed to raise money. The source of funds that was otherwise difficult to come by came from the sovereign wealth funds."
The balance sheets of these funds are another major plus for investment recipients. "If you look at the balance sheets of sovereign wealth funds, many of them have no liabilities-they have only assets," says Kalter. "They're not a pension fund with assets as well as liabilities, such as those to the workers...Because of this, they are increasingly able to invest long-term money."
American companies are not the only ones embracing sovereign wealth funds either. "Not only will they be investing in private entities, they'll also invest in emerging market countries that would not have seen that type of investment normally," says Kalter. "A classic example is the Chinese sovereign wealth fund investing in Africa. The emerging market countries in Asia and Latin America will have access to long-term capital that would not have been there otherwise."
Overcoming the Risks
There is a downside, to sovereign wealth fund investments, however. And the two biggest risks for companies receiving these investments are also the most difficult to mitigate. Neither the political motives of the investing country nor the domestic political backlash in the United States can be controlled by the risk management team. "If they're investing for political reasons, there's the potential that the investments could be a disruptive force," says Ruloff.
The main issue is transparency. In many cases, there is little evidence available to assuage fears, which can lead to deal participants-on either side-dropping out. The International Monetary Fund has issued statements urging better transparency and risk management of sovereign wealth funds, but currently, few have complied.
For this reason, companies are often caught in situations where an investor is conducting business, and perhaps mingling business with countries that U.S. corporations are restricted from doing business with, such as Cuba or Iran. "You have to insulate yourself from business intermingling in these countries," says Davis. "Should a foreign investor [discuss] doing business in a country in which the U.S. has economic sanctions, even bringing it up at your investor meeting can cause potential problems. Following up on that and involving any U.S. personnel, or even considering it can raise potential liability risks under U.S. sanction laws, which are strictly enforced."
Despite the risks, the expert consensus is that sovereign wealth funds are much more beneficial than detrimental-to both corporate bottom lines and the nation's overall economic health. With a more logical approach to handling the investments, says Kalter, both sides should be able to interact with less fear and more confidence.
To promote better deals, he has helped develop the Sovereign Wealth Fund Initiative at the Fletcher School. Kalter hopes that the school can provide an impartial arena for sovereign wealth investors to work together to understand transparency and develop guidelines that resonate with member countries. "We're a neutral venue," says Kalter. "It's an academic venue within a school of diplomacy. Many of the sovereign wealth fund investors graduated from Fletcher. The idea is to get the sovereign wealth funds together with us to discuss what transparency means to them."
The G8 has asked the International Monetary Fund to come up with best practices for sovereign wealth funds. The hope is that as sovereign wealth funds become more transparent, the recipient countries will be better able to determine if the investment is for commercial purposes and not for political purposes. The thought is that transparency will breed trust, thus eliminating congressional roadblocks.
Truman has developed a policy brief, "A Blueprint for Sovereign Wealth Fund Best Practices," which outlines the criteria companies should look at to determine the viability and transparency of the sovereign wealth fund. Using four distinct measurements (structure, governance, accountability and transparency, and behavior) Truman and his colleague Doug Dowson developed a scorecard containing 33 questions that help to uncover information that can help both the company and government work better with sovereign wealth investors.
With all these global initiatives underway, it should help demystify the world of sovereign wealth funds. And eventually, the companies who have historically spent most of their resources trying to determine what they should invest in will also be able to know who is investing in them. And, most importantly, why.
Lori Widmer is a Valley Forge, Pennsylvania-based freelance writer over 15 years experience writing on business and risk.
