Fund flutter

Fund flutter

Sovereign wealth funds are the new vehicle of economic nationalism. And many governments around the world are in a tizzy about how to regulate their activities. India’s national security adviser, too, has reportedly expressed concern about the growth of these funds.

Countries with huge trade surpluses and bulging foreign exchange reserves have set up sovereign wealth funds, which will invest in companies outside their countries. Singapore and Norway were pioneers, but now many oil-rich Arab states and China have also jumped into the fray. Investment bank Morgan Stanley estimates that these funds had $2.5 trillion to invest at the beginning of 2007; that will rise to $12 trillion in 2012.

It’s easy to see that no country can afford to turn its back on such a rich vein of capital. As China’s trade surplus grows and oil prices climb, sovereign wealth funds could grow fatter by the year; one estimate is, by $500 billion a year. This is the sort of money that can move markets and feed corporate ambition.

But there are genuine concerns that government-controlled investment funds could be used to make strategic rather than financial decisions. An authoritarian country such as China is quite ready to use money to further its strategic interests. In a different context, we have seen this in Africa, where China has got into bed with all sorts of bloodthirsty regimes to ensure that it gets the commodities to feed its industrial boom. China uses its government firms in Africa; now, it can use its investment fund.

Of course, there is no reason to believe that all government investment funds will behave in the same way. As of now, most of the investments they have made have been non-controversial. The Qatar Investment Authority, for example, had shown an interest in British supermarket chain Sainsbury’s. The world will have to adjust to this new reality. And there are stray signs that some ground rules have started emerging.

Germany is already debating a new takeover Bill that gives its government the power to block the acquisition of more than 25% of a company in a strategic sector within four weeks (currently, this law may cover the defence and encryption sectors, though some expect the list to grow longer in the coming years). There are proposals to set up a government fund that will be used to block acquisitions of German companies.

These are imperfect beginnings, as all beginnings are. A restrictive takeover Bill could be misused to protect existing company managements and end up as a protectionist tool. And a local government fund could end up spending money in a wasteful bidding war. But the debates and policy proposals that come out of Europe this winter could be very good starting points for countries such as India as well.

It would also be a good idea to push for a global transparency deal. Countries that feel they are under threat from sovereign wealth funds could insist on greater disclosure of portfolios and investment intent. As of now, Norway is the only country whose investment fund follows modern governance and reporting standards. Such tactics could work. Singapore’s Temasek has shown signs of removing some of the veils that hide its operations from the public eye.

Our own view is that countries should not rush into hasty regulations. The worst alternative is case-by-case clearance—it is inefficient, encourages rent seeking but is loved by bureaucrats. Let the rules emerge through trial and error. Europe’s initial attempts are thus important. At the same time, sovereign wealth funds, too, have to become more transparent.

Is all this too hard to achieve? Not necessarily. The world has dealt with precisely these issues over the past 10 years with another type of investment vehicle. It is called the hedge fund.

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