Cicero Policy Briefer

Issue 26, July 2008

The West’s response to sovereign wealth funds

By Chris Jackson

They have been around since the 1950s – but interest in sovereign wealth funds (SWFs) has increased markedly following a series of high profile investments during the credit crunch.

The definition of sovereign wealth funds is yet to be nailed down, but the working notion is that they are effectively pools of money which are derived from a country’s resources with the aim of using this spare capital to diversify its revenue streams. For instance, the Kuwait Investment Authority (KIA), like many SWFs, was established to invest the fiscal surplus that emerged after exporting oil. Since then the majority of SWF financial reserves have been increased, due to growing demand in the West for oil. It seems that despite the large sums the West has been spending on this resource, many were uninterested in where their petro dollars went, provided that they received their liquid gold.

The prominence of SWFs only really emerged during the summer of 2007, after a number of them invested in troubled banks who were struggling due to the impact of the credit crunch. It is estimated that SWFs pumped more than $40 billion into these struggling financial institutions, and these significant investments unquestionably helped to prop up a number of firms, preventing the credit crunch fall-out from being much worse.

However, rather than being treated like the West’s knight in shining armour, some have reacted with hostility towards SWFs. The credit crunch displayed the vulnerabilities in the West’s financial systems – but concurrently the strengths that SWFs had at their disposal. Thus, the traditional financial hegemony of the West was not only weakened by the credit crunch but also challenged by new financial powerhouses – prompting bursts of anger from those who felt threatened.

The most common criticism levelled at SWFs is their reclusive nature and lack of transparency, which has made many fear that their investment strategies are guided not by financial returns but efforts to enhance their geo-political influence. This point was raised by Angela Merkel when she asked:

“[Are these funds] solely concerned with attaining a high return on capital? State owned funds can also have politico-strategic aims in mind that could be problematic in sensitive areas.”1

The establishment of the American Committee for Foreign Investment into the United States (CFIUS), an interdepartmental panel that examines large foreign direct investment from a national security perspective, is also illustrative of the undercurrent of fear. The unease that many in the West feel following the emergence of SWFs and their “unknown objectives” is fully on display.

When discussing the aims of SWFs with people who have dealt with them, though, it is clear that long-term investment performance is their goal. Furthermore, when SWFs have bought companies outright – for example, Dubai SWF Istithmar World’s purchase of legendary New York clothing retailer Barney’s, or the Qatar Investment Authority’s attempted purchase of J Sainsbury’s – such interest has been focused on non-sensitive economic sectors.

More prosaically, SWFs are also feared because of their size. But it is important to remember that they do not comprise one homogenous block, but are competing funds hoping to maximise their investment returns. Each fund will have different needs, objectives and personalities – something that the West must remember when dealing with them. Arguably one of the most interesting future developments in the sector will be to observe the growing relations between SWFs, rather than the West’s relations with them. It has already been commented by some that there are a number of intra-SWF relationships are already uneasy.

So where does this leave the West’s relations with SWFs? Whether we like it or not, sovereign wealth funds are here to stay and are going to be key players in financial markets. But rather than treating them with hostility, it is paramount that the West embraces them. Only by interacting with them will we have the opportunity for dialogue and a cultural exchange that can help break down the barriers between these funds and the West – and ultimately ensure the potential for prosperity on both sides.

1. Forbes.com, “Merkel plays protector”, 20/7/2007, http://www.forbes.com/2007/07/19/merkel-germany-eu-cx_vr_0716autofacescan02.html

Chris Jackson can be contacted on +44 (0)20 7665 9530 or click here to email.