Attack of the SWFs

♠ Posted by Emmanuel in at 7/30/2007 02:11:00 PM
Purportedly, sovereign wealth funds (SWFs) are becoming more aggressive in their operations according to the Wall Street Journal. This article provides a good backgrounder on SWFs in operation. Particularly interesting is the backlash against them in the home countries of target firms:

Foreign governments, flush with cash and no longer content with the meager returns to be had on safe but low-yielding investments like Treasurys, are becoming increasingly aggressive players on the equity front.

The new boldness of these government-controlled investors was on display Sunday night when entities controlled by the governments of China and Singapore agreed to invest as much as $18.5 billion in return for stakes in the big British bank Barclays PLC.

In doing so, Chinese lender China Development Bank and Temasek Holdings Pte. Ltd., the Singapore government's investment agency, could play a role in the outcome of the biggest bank-takeover battle ever. That increasingly bitter contest pits Barclays against a consortium of European banks led by Royal Bank of Scotland Group PLC in seeking to acquire Dutch banking giant ABN ABN Amro Holding NV.

The Barclays deal is the latest in a string of investments in U.S. and European companies by governments in Asia and the Middle East. Temasek last year became the largest shareholder in London-based Standard Chartered PLC, a bank that has most of its assets in Asia. In May, the Chinese government invested $3 billion in Blackstone Group on the eve of the U.S. private-equity giant's initial public stock offering.

And last week, an investment fund controlled by the government of Qatar made a $21.8 billion takeover approach for British supermarket chain J Sainsbury PLC, one of the largest potential acquisitions ever by a state-owned fund. hile potentially boosting their investment returns, such deals expose the government-controlled funds and other entities involved to risks that range from simple investment losses to political backlash. If it continues, the trend could also reshape global financial markets, bidding up prices for more speculative assets like stocks, corporate bonds and real estate, while crimping demand for safer investments like Treasury bonds.

"There has been a fairly spectacular increase in financial assets under management by governments," said Dominic Wilson, director of global macro and markets research at Goldman Sachs Group. "The scale of the issues around such nvestment is different than anything the world has ever seen. Neither [governments] nor the arkets know exactly what they should do with the assets."

China Development Bank plans to invest as much as $13.5 billion in Barclays, in what could become the largest overseas investment by a Chinese company to date. The planned investment is part of a broader deal that also includes as much as $4.97 billion in funding from Temasek, and would enable Barclays to buttress its bid for ABN Amro.

Should Barclays succeed in acquiring the Dutch bank, the deal ultimately could leave China Development Bank with a stake of about 8% in the newly enlarged Barclays, making it by far the biggest shareholder.

If completed, the Barclays deal would provide further evidence of an important global shift in wealth. "This is basically a flow of capital from merging markets to established markets," says John Studzinski, former chief of investment banking at HSBC Holdings PLC and now head of Blackstone Group's mergers-and-acquisitions advisory group, which advised China Development on the deal. The private-equity firm's role shows how private and public investors are joining together to create powerful forces.

"Going forward, you have to look at where wealth is being created...I think it's a very logical trend," adds Mr. Studzinski.

To be sure, investors controlled by foreign governments have bought stakes in Western companies before. One example, the Kuwait Investment Office, which grew into an investment heavyweight as oil prices boomed in the 1970s, amassed sizable holdings in several major companies, including the then-British Petroleum and Germany's Daimler-Benz AG. But what distinguishes the latest wave of investment is the sheer size of the sums involved, which could give those investors the potential to affect strategy and bolster or block corporate transactions like takeovers.

China Development Bank's agenda in the Barclays deal is somewhat unique, say people close to it. It hopes that substantially expanding its existing, but narrower, relationship with the 300-year-old British bank will help accelerate its own transformation from a policy institution to more of a commercial bank, and give it a much higher profile overseas.

But many other recent deals reflect the quest by China and other countries for higher returns on their mounting foreign-exchange reserves. Those holdings traditionally were invested in safe, liquid investments that could be quickly converted to cash to buy up local currency if it came under speculative attack. But in many countries, especially China and the oil-producing nations of the Middle East, global trade has swelled those holdings to far more than might be needed to stabilize their currencies.

Since 2002, such holdings have increased 20% a year, according to U.S. Treasury calculations, well ahead of the average 6% rate of 1997-2001. Global foreign-exchange reserves now stand at about $5.6 trillion. An additional $1.5 trillion to $2.5 trillion held by "sovereign wealth funds" brings total assets controlled by governments to "roughly $7.6 trillion," or 15% of global gross domestic product, the Treasury says.

As a result, governments are treating these reserves less like rainy-day funds and more like pools of investment capital.

Sameer Al Ansari, executive chairman and chief executive officer of state-back investment firm Dubai International Capital, says he is scouring the world's 500 largest publicly traded companies looking for a place to invest as much as $10 billion. His next target: a U.S. company that he has already identified but will only describe as "a household name."

Mr. Ansari says Dubai International, which has $6 billion under management, is hoping to announce the U.S deal in September. His company bought a major stake in London-based HSBC Holdings PLC earlier this year, and this month bought 3% of Airbus maker European Aeronautic Defence & Space Co. and 3% of India's ICICI Bank Ltd.

The new wave of investment carries numerous risks. Most obvious is the potential for political backlash. Political pressure to block or restrict these investments appears to be mounting.

In the U.S., a Dubai company's deal last year to buy a British ports operator that operated several American ports ran into political obstacles, as did a 2005 attempt by Chinese oil company Cnooc Ltd. to buy U.S. oil producer Unocal Corp. Dubai Ports World ultimately agreed to sell off the U.S. holdings, and Cnooc pulled out of the Unocal bidding.

In Europe, there is a rising clamor to restrict foreign investment. German Chancellor Angela Merkel said last week that state-controlled investors might use stakes in European companies to pursue political, rather than only financial, goals. The European Union should think about ways to protect its firms from politically motivated buyers, she said, mentioning the U.S.'s interagency Committee on Foreign Investment in the U.S. as a possible model. CFIUS reviews the national-security aspects of overseas deals.

Others have been more outspoken. Ms. Merkel's powerful conservative colleague Roland Koch, governor of the German state of Hesse, has warned in stark terms about encroachment by industrial groups such as Russia's OAO Gazprom, as well as financial investors controlled by China and other emerging economies. "We haven't only recently gone through the trouble of privatizing companies like [Deutsche] Telekom and Deutsche Post so that the Russians can nationalize them again," he told German media.

Even the idea of such sales could inflame nationalist passions, as occurred last year when there were riots in Thailand following Temasek's attempt to buy Thai telecommunications provider Shin Corp.

Critics say backlashes could go beyond issues of foreign investment and hurt global trade. "Once you start to define what sensitive sectors are, you realize that clever lobbyists can identify nearly every sector as sensitive, because everything is connected with everything," says Norbert Walter, chief economist at Deutsche Bank in Frankfurt. "This will open a wide door for protectionism," he says.

Another risk is that the investments go bad. The financial landscape is littered with examples of foreign buyers being duped by savvy locals into overpaying for assets. The Singaporeans, for example, lost money on dot-com flameouts.

"The government's management of its hoard of cross-border assets either in the form of reserves or in some type of sovereign wealth fund is likely to be a source of political controversy and frictions as the inevitable losses are recorded," Edwin Truman, a former U.S. Treasury official and now a senior fellow at the Peterson Institute for International Economics, warned in a recent speech.

The trend toward more aggressive government investments also has the potential to reorder global financial markets. "We have entered a whole new world," says Jim O'Neill, head of Global Economic Research for Goldman Sachs International in London. "We are at the early stage of a secular process where the relations between the prices of stocks and bonds will change. The whole world is discovering the equity culture."

While Singapore's Temasek, which manages about $85 billion in assets, has long invested in private companies mostly in Asia, the Barclays deal launches onto the international stage a large but so-far little noticed Chinese institution. In contrast to Temasek, whose main role is to invest government money, China Development's main business is lending to companies and local governments for government-backed infrastructure projects in China.

Under 62-year-old chief Chen Yuan, China Development Bank has been run increasingly like a commercial entity, and one with a growing international agenda. China Development boasts an international advisory council including major figures in global finance like Maurice "Hank" Greenberg, the former head of insurer American International Group, and Sir Edward George, former Bank of England governor.

Mr. Chen is the son of one of the Chinese Communist Party's most senior early leaders, the late Chen Yun, who along with Mao Zedong and Zhou Enlai isenshrined in modern Chinese political lore as one of the party's "Eight Immortals." The younger Mr. Chen graduated from Beijing's prestigious Tsinghua University, and served for many years as a Chinese central bank official before taking the helm at China Development in 1998.

Under terms of the Barclays deal, China Development will buy up to €2.2 billion ($3 billion) of new Barclays shares initially, amounting to a 3.1% stake. China Development will then buy as much as €7.6 billion worth of additional Barclays's shares, if the British bank's bid for ABN succeeds, and if regulators agree. China Development had just $6.6 billion in cash and cash equivalents at the end of last year. To finance the deal, it will raise funds by issuing debt on China's domestic market.