28 April 2008
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Tension has been increasing between East and West over the West's calls for greater transparency and regulation for sovereign wealth funds (SWFs). The story: big international banks lose money and, with the blessing of their governments, ask SWFs to bail them out. The markets become calmer, and then Western officials have the audacity to request regulation of the SWFs' activities.
Hypocrisy is one word that springs to mind - red faces over the credit crunch should not result in red tape for SWFs.
Why the rising scrutiny of Middle Eastern SWFs? The latest statistics show that SWFs manage assets worth $3.2tr (£1.6tr) worldwide. It has been predicted that within a decade the value of SWFs could be bigger than the gross domestic product of the US economy. The United Arab Emirates boasts the largest SWF - the Abu Dhabi Investment Authority (ADIA), which manages assets estimated at $900bn (£451.21bn).
The Middle Eastern SWFs' unprecedented growth was thrust into the limelight in November 2007 when the ADIA put $7.5bn (£3.76bn) into Citigroup for a 4.9 per cent stake. This has been followed by a string of high-profile investments in Western assets. Mubadala Development, an Abu Dhabi government investment vehicle, bought a 7.5 per cent stake in the Carlyle Group. The Dubai government-affiliated Dubai International Capital and Istithmar own stakes in HSBC and Standard Chartered Bank respectively. Bourse Dubai and the Qatar Investment Authority (QIA) both acquired stakes in the London Stock Exchange.
SWFs are owned by the state and traditionally their investment criteria and management have remained a closed book. But then so has the private equity market in the West.
Norway's Government Pension Fund, worth $380bn (£190.51bn), has been accruing an impressive portfolio over the past 20 years without impediment, but as the Middle Eastern SWFs' influence has grown, so have the concerns regarding their political and economic intentions.
Chuck Schumer, the New York senator and influential Democrat, who last year blessed the Citigroup investment by ADIA, recently backed calls for greater transparency from SWFs. He pointed out that because such funds "by definition are potentially susceptible to non-economic interest, the closer they come to exercising control and influence, the greater concerns we have". In January 2008, the US Deputy Treasury Secretary Robert Kimmitt stated: "The growth of these funds, both in number and size, does require vigilance."
EU Monetary Affairs Commissioner Joaquin Almunia and EU Internal Market Commissioner Charlie McCreevy made statements late last year branding SWFs as too "opaque".
This all sounds dangerously like regulation is just around the corner, but it is clear there is little ground for legitimate concern. SWFs have been investing in Western corporations for decades, without a trace of political agenda. They favour taking small stakes in companies while avoiding any control, board or management rights. For example, the Kuwaiti Investment Authority was established in 1953 with the intention of investing surplus oil revenue - taking small stakes in Daimler-Benz in 1969 and British Petroleum in 1984. ADIA, formed more than 30 years ago, also had a low-profile portfolio. This political stance has not been altered, despite the growing size of investments. Recent Middle Eastern SWF activity has shied away from replicating Western private equity-style behaviour and instead has focused on becoming an ally or co-investor.
Western reservations have been simmering since 2006 when the Dubai government-owned DP World acquired P&O but had the acquisition of P&O's five US ports blocked by the US government. In November 2007, the US Treasury renewed calls for the International Monetary Fund (IMF) and the World Bank to develop a list of best practice for SWFs. In response, Abu Dhabi sent a three-page letter to US Treasury Secretary Henry Paulson. It outlined general principles which have guided the investments it has made and a pledge not to use its money to further political aims. It seems that this was not enough. On 31 March 2008, a voluntary code of conduct outlining basic principles for both SWFs and their recipients was agreed by Paulson and officials from Abu Dhabi and Singapore. The code is designed to encourage all SWFs to invest for commercial rather than political reasons. At this rate, it is not out of the question that there will soon be calls for actual legislation. This is surely unfair treatment for funds that were such willing investors during the Western markets' hour of need.
The West needs to be cautious in its approach to Middle Eastern SWFs. Its unnecessarily suspicious approach may have unwelcome consequences. Omar bin Sulaiman, ;governor ;of ;the ;Dubai International Financial Centre, has warned that growing suspicion could lead to a protectionist backlash. There have been murmurings from officials within the QIA of exposure and investment in Asia, a continent which is overtly receptive to SWFs. It is unlikely Middle Eastern SWFs will give Western financial markets the cold shoulder completely, but they may be more likely to move their money where it is wanted, depriving Western markets of much-needed liquidity. Voluntary codes of conduct are one thing, but any further regulation of SWFs by the West would be both unfair and a mistake.
• Neil Nicholson is a corporate partner at Denton Wilde Sapte Dubai