Sovereign Wealth: Shifting Sands - Jonathan Watson


The shifting dynamics of the global economy are giving rise to difficult questions. Although sovereign wealth funds tend to be passive investors, worries remain that their approach conceals aggressive intent.

In January 2012, UK Chancellor George Osborne went on a trip to China. Unlike many other visitors to the country, he made no plans to walk along the Great Wall, marvel at the Forbidden City or take a leisurely cruise down the Yangtze River. His main aim was to persuade Chinese investors to put money into transport, energy and utility projects in cash-strapped Britain.

One of those he sought to persuade was Lou Jiwei, chairman of China Investment Corporation (CIC). He had good reason to be hopeful of success. In November last year, Mr Lou wrote an opinion piece in the Financial Times newspaper in which he said CIC was ‘keen to team up with fund managers or participate through a public-private partnership in the UK infrastructure sector as an equity investor’.

The planned High Speed two rail link from London to Birmingham and the north of England is among the projects that could attract interest from China, along with big industrial developments such as the so-called ‘Atlantic Gateway’ in the north-west of England. Other projects under discussion included updates of the UK’s energy infrastructure, broadband investment and road schemes.

‘Now infrastructure in Europe and the US badly needs more investment,’ Mr Lou added. ‘Traditionally, Chinese involvement in overseas infrastructure projects has just been as contractors. Now Chinese investors also see a need to invest in, develop and operate projects.’

Lou who?

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CIC is a sovereign wealth fund (SWF), one of a growing number of investment vehicles established and controlled by government entities with funds separate from official reserves. They manage billions of dollars of public money. Their funding comes from balance of payments surpluses, official foreign currency operations, the proceeds of privatisations, governmental transfer payments, fiscal surpluses and/or the revenues generated by exports of resources, such as oil.

The origins of SWFs can be traced back to 1953, when Kuwait established what was then called the Kuwait Investment Board. In the early 1950s, Kuwait experienced a surge in oil revenues and decided to plan for the day when its oil supplies would run out. The idea was that proceeds in excess of what was needed for its government to function should be transferred into a separate ‘fund for the future’ for investment in less volatile areas. The Board, which was controlled by the Kuwaiti Government, would then invest these surpluses accordingly.

Carefully structured, SWF investments will not raise a huge amount of political attention

Rodgin Cohen

Sullivan & Cromwell;
member of the IBA Task Force on the Financial Crisis

Fast-forward to today and you will find that the world’s largest SWFs are still those from oil-rich countries. At the top of the league is the United Arab Emirates’ Abu Dhabi Investment Authority (ADIA), which has assets valued at US$627 billion, according to the Sovereign Wealth Fund Institute (see table). Oil aside, some SWFs, such as CIC (worth US$410 billion, with the Chinese Government widely expected to be on the verge of adding another US$50 billion) and the Government of Singapore Investment Corporation (GIC), invest wealth from fiscal surpluses or foreign currency reserves.

Saviours or predators?

Although many of them have been operating for many years, SWFs now get much more attention than they used to. The scale of their investments is impossible to ignore. The Qatar Investment Authority (QIA), for example, which is not even among the ten largest funds, made headlines in Europe last year by purchasing French football club Paris Saint-Germain. The group also bought a 15 per cent stake in the UK’s Barclays Bank in the wake of the financial crisis. In recent years, the Qataris have also added stakes in supermarket chain J Sainsbury, Canary Wharf owner Songbird Estates and the London Stock Exchange.

CIC’s recent deals include paying €2.3 billion (US$3.2 billion) for a 30 per cent stake in the gas and oil exploration and production business of GDF Suez in August last year. It also bought the French-based utility’s ten per cent share of a natural gas liquefaction plant in Trinidad and Tobago for €600m (US$768 million). And in May 2010, it paid US$1.2 billion for a five per cent stake in Canada’s Penn West Energy Trust and US$805 million for a 45 per cent stake in a planned oil sands project.

Largest ten Sovereign Wealth Funds by assets under management
Country Fund name Assets
(US$ billion)
Inception Origin
UAE – Abu Dhabi    Abu Dhabi Investment Authority $627 1976 Oil
China SAFE Investment Company $567.9* 1997 Non-commodity
Norway Government Pension Fund – Global $560 1990 Oil
Saudi Arabia SAMA Foreign Holdings $472.5 n/a Oil
China China Investment Corporation $409.6 2007 Non-commodity
Kuwait Kuwait Investment Authority $296 1953 Oil
China - Hong Kong Hong Kong Monetary Authority Investment Portfolio $293.3 1993 Non-commodity
Singapore Government of Singapore Investment Corporation $247.5 1981 Non-commodity
Singapore Temasek Holdings $157.2 1974 Non-commodity
China National Social Security Fund $134.5 2000 Non-commodity
*best guess estimate   Source: Sovereign Wealth Fund Institute


All this activity, coupled with the increasing willingness of SWFs to take on riskier investments, has left some feeling rather rattled. ‘Of all the questions raised by sovereign wealth funds, the leading one is whether there are sinister motives lurking behind their investments,’ wrote John Walker and Mark Chorazak of Simpson Thacher & Bartlett in a working paper published by the Washington Legal Foundation. ‘The fear is that these funds could be modern-day Trojan horses, with political, not economic or commercial, considerations being the basis for investment decisions and, in turn, jeopardising national security.’

Foreign investment will always have the potential to cause controversy. In 2005, there was considerable opposition in the US to an all-cash US$18.5 billion offer to buy US oil company Unocal Corporation from CNOOC, a Chinese state-backed offshore oil and gas producer. US politicians argued that with US$13 billion of CNOOC’s bid for Unocal coming from the Chinese Government, the offer did not represent a free market transaction and had questionable motives. It was also argued that the foreign – particularly communist – ownership of oil assets could represent a regional and economic security risk.


China Investment Corporation

China Investment Corporation (CIC) was set up in 2007 to invest some of the country’s foreign exchange reserves. These were estimated to be about US$3.2 trillion in October 2011. Most of China’s reserves are invested by other funds in safer investments such as US Treasury bonds – CIC was given the task of making riskier offshore investments and earning higher returns.

Initially, most of its offshore investments were in the financial sector, but more recently the fund has invested in companies that exploit natural resources – such as the gas and oil exploration and production businesses of GDF Suez – and has even become involved in real estate.

Established with about US$200 billion in assets under management, its assets had grown to US$410 billion by the end of 2010. Its capital is funded through the issue of special treasury bonds. The fund made a return of 11.7 per cent on its portfolio in 2010.

CIC said in its annual report for 2010 that 27 per cent of its investments were in bonds and other fixed-income assets, while four per cent was held in cash and 21 per cent in alternative investments, such as private equity and hedge funds.

CIC established a subsidiary in Hong Kong in 2010 and set up its first foreign office in Toronto in 2011.

And in the following year, the US$6.8 billion sale of UK-based ports and shipping group P&O to government-backed venture Dubai Ports World caused further anxiety. US politicians claimed the deal meant the security of some US ports would not be entirely in US hands and it proved very unpopular with the US public.

One could also mention the 2006 purchase by the former Soviet trade bank Vneshtorgbank of a five per cent stake in European Aeronautic Defence and Space (EADS), which was also believed to have security implications, and the increasing investment by the China Development Bank and China Eximbank in Africa and Latin America, particularly in extractive industries, which has generated concerns about the extent of China’s control of the world’s natural resources.

In 2009, the German Foreign Investment Act was amended to enable Berlin to restrict or prohibit acquisitions by investors from outside the European Union and EFTA if the acquisition ‘jeopardises the public order or security’ and represents an ‘actual and sufficiently serious threat that affects a fundamental interest of the society’.

According to Hans-Jörg Ziegenhain, a partner with IBA member firm Hengeler Mueller, this law was ‘directed against the SWFs’. However, the German Government has not used the law to impose any restrictions so far. It did not prevent Daimler, which makes Mercedes Benz cars, selling a 9.1 per cent stake to an Abu Dhabi state investment fund, Aabar Investments, for €1.95 billion.

Pavel Shevtsov, a partner in the regulatory, funds and financial products group of Allen & Overy, says that SWFs usually manage to steer clear of political controversies. ‘State-backed corporates from the Middle Eastern and Asian markets could trigger a greater backlash than SWFs, especially in the energy sector, for example, because they tend to invest for strategic reasons,’ he says. ‘They might want to secure the marketplace for a particular commodity.’

By contrast, he argues, most SWFs tend to be passive investors interested in investment returns rather than securing something for strategic reasons. ‘Most investments tend to be fairly routine, rather than headline-grabbing takeovers,’ he says. ‘An acquisition by a big foreign state-backed oil company would probably generate a bigger reaction than an acquisition by an SWF.’

Nevertheless, ever since SWFs started investing in some of the US’s most preeminent banking institutions in the latter half of 2007, they have inevitably started attracting more attention. ADIA acquired a 4.9 per cent stake in Citigroup for US$7.5 billion in November 2007; CIC acquired a 9.9 per cent stake in Morgan Stanley for US$5 billion the following month; and Singapore acquired a 9.46 per cent stake in Merrill Lynch in January 2008 through its investment arm Temasek for US$4.4 billion.


Government Pension Fund of Norway

The Government Pension Fund of Norway is divided into two separate SWFs owned by the Norwegian Government. One of them (The Government Pension Fund – Global) makes international investments, while the other (The Government Pension Fund – Norway) concentrates on investments in Norway.

The global fund, which changed its name from ‘The Petroleum Fund of Norway’ in 2006 and is now generally referred to as ‘The Oil Fund’, was set up in 1990. Its aim is to distribute the country’s oil gains across generations and ensure the sustainability of certain social welfare expenditures.

The fund is administered by Norges Bank Investment Management (NBIM), a division of the Norwegian Central Bank.

As of June 2011, it was the largest pension fund in the world, although one might argue it is not actually a pension fund as it derives its financial backing from oil profits rather than pension contributions. Its total value was US$525 billion at the end of 2010 and has now reached US$560 billion. With 1.78 per cent of European stocks, it is said to be the largest stock owner in Europe.

Investments made by the fund have to follow ethical guidelines based on sector and company behaviour. The guidelines restrict investment where there is a risk that a company is involved in activities that can contribute to violation of human rights, corruption, environmental damage or ‘other particularly serious violations of fundamental ethical norms’.

The fund has a Council of Ethics that keeps a close eye on the companies the fund invests in and has excluded a number of companies for activities that breach its guidelines. For example, it does not invest in tobacco companies, firms that help any country’s armed forces maintain nuclear missiles or companies that produce components that can be used in cluster bombs.

Away from traditional financial institutions, the influence of SWFs also extends to private equity, with notable investments being CIC’s purchase of a 9.3 per cent stake in The Blackstone Group for US$3 billion and the Abu Dhabi-based Mubadala Development Company’s purchase of a 7.5 per cent stake in The Carlyle Group for US$1.35 billion. ‘These investments represented a marked departure from sovereign wealth funds’ traditional focus,’ Walker and Chorazak said. This led to them experiencing newfound scrutiny and, ‘fairly or not, being characterised by many as either the saviours of Wall Street or its invaders’.

Fears of an ‘invasion’ proved to be unfounded. ‘In 2007, there was a big increase in the amount of money being spent by SWFs as they competed with private equity firms for trophy assets,’ says Richard Good, a senior corporate partner at Linklaters. ‘Some of the SWFs got very badly bitten and are now very shy of the banking sector as a result. Although some of them could afford it, others couldn’t.’

Since then, some SWFs have chosen to focus on investments closer to home. Edward Greene, senior counsel at Cleary Gottlieb in New York and a member of the IBA’s Financial Crisis Task Force, argues that ‘because a lot of the cross-border investments led to huge losses in connection with investment in financial institutions, and because of the high level of scrutiny under CFIUS [The Committee on Foreign Investment in The United States] and other regimes, more and more of the investment is becoming regional, especially in the Middle East and Asia’. He suspects this trend will continue.

Legendary banking lawyer Rodgin Cohen, senior chairman at Sullivan & Cromwell and another member of the IBA’s Financial Crisis Task Force, is well placed to understand the workings of SWFs. He was involved with many of the SWF investments into US banks, including ADIA’s acquisition of its stake in Citigroup. Cohen represented UBS (in the US) in December 2007 when Singapore’s GIC invested US$11.5 billion; CIC when it acquired a stake in Morgan Stanley; Merrill Lynch when it received its infusion from Temasek and three other funds; then Citigroup again in its blockbuster US$18.4 billion recapitalisation by six different investors in January 2008. Cohen believes that the need for money can override sensitivities about political influence. ‘When money is needed and there are not readily available optional sources, some of the constraints which might otherwise apply may be liberalised,’ he says. ‘It depends a lot on the specific type of industry and on the level of control that the SWF exercises. It’s a combination of those two factors that determine attitudes to SWF investments. Carefully structured, SWF investments will not raise a huge amount of political attention.’

Cohen says the ‘intrinsic nervousness’ many people feel about SWF investments is not grounded in reality. ‘What is an investor going to do? Threaten to sell their position? It wouldn’t be much of a threat. I’m not sure there are political strings attached. That would be very difficult for a passive investor to achieve.’

It also seems to be the case that few countries have had problems with SWFs so far. ‘SWFs are well established in Germany now,’ says Ziegenhain. ‘They have been investing in German entities for the last 40 years, so this is nothing new for us. Kuwait Petroleum held a stake in pharmaceuticals firm Aventis, and now we have Aabar investing in Daimler… the German experience of SWFs has not been bad at all.’

As the banking crisis of 2007/8 mutated into a sovereign debt crisis, expectations have again arisen that SWFs are set to save / invade (delete as appropriate) the world economy, especially the struggling eurozone. However, Richard Good does not expect that to happen. ‘Until there is clarity on what is going to happen in the eurozone, I would be surprised if there were large amounts of funds flowing in from the Middle East, Asia, Canada or wherever,’ he says. ‘I don’t see the SWFs pumping in lots of money that might evaporate in a financial crisis.’

Most investments tend to be fairly routine, rather than headline-grabbing takeovers

Rodgin Cohen

Pavel Shevtsov
Allen & Overy

That said, it is likely that levels of SWF investment across the globe will continue to increase. ‘It’s much more likely to be evolutionary than revolutionary,’ says Cohen. ‘I would expect more in the way of investment because there is so much need for additional capital at this time. But this will be a gradual increase. It’s not going to be a revolution.’

Hidden agenda?

SWFs might be able to reduce any anxiety felt about their growing influence by being a bit more upfront about their activities. There is little information available about how some of them invest and they regularly face calls for more transparency.

The lack of transparency that characterises some SWFs is not going to change for the time being, says Ziegenhain. ‘In the Arab region in particular, it is their strategy to hold their cards very close to their chest,’ he says. ‘As long as no one can force greater transparency on them, there is no real reason for them to change that.’


Abu Dhabi Investment Authority

The Abu Dhabi Investment Authority (ADIA), set up in 1976, is responsible for managing the Emirate’s surplus oil revenues. ADIA replaced the Financial Investments Board, created in 1967 as part of the then Abu Dhabi Ministry of Finance.

ADIA is the world’s largest SWF. It is wholly owned and overseen by the Government of Abu Dhabi. The fund is an independent legal identity with ‘full capacity to act in fulfilling its statutory mandate and objectives’. As much as 80 per cent of its assets are administered by external managers, which includes around 60 per cent that is passively managed through tracking indexed funds.

ADIA’s funding derives from oil, specifically from the Abu Dhabi National Oil Company (ADNOC) and its subsidiaries, which pay a dividend to help fund ADIA and its sister fund the Abu Dhabi Investment Council (ADIC). These payments are on a periodic basis if the government runs a surplus to its budgetary requirements and other funding commitments. About 70 per cent of any budget surplus is sent to ADIA, while the other 30 per cent goes to ADIC.

ADIA invests in all the international markets – equities, fixed income and treasury, infrastructure, real estate, private equity and alternatives (hedge funds and commodity trading advisers).

In 2008, ADIA co-chaired the International Working Group of 26 SWFs that produced the ‘Generally Accepted Principles and Practices of sovereign wealth funds’ (known as the Santiago Principles).

According to Shevtsov, an SWF’s willingness to disclose information about its activities depends on the country it comes from. ‘They’re a very diverse group, all rooted in their local political and general cultures,’ he says. ‘If you have a more transparent country, then a SWF based there will be more transparent as well.’

One example is Norway’s SWF, which is seen as a model of transparency.

The fund files financial reports every quarter, publishes information on its corporate governance structure, provides disclosure of every asset held by the fund in a given year and helps the Norwegian ministry of finance in publishing an annual report to the Norwegian Parliament detailing, among other things, its investment strategy and information on investment returns. The Norwegian fund has also adopted a strategy of responsible investment. In December 2011, for example, Norway’s finance ministry said the SWF would no longer invest in chemical and engineering conglomerate FMC Corporation or fertiliser-maker Potash Corporation due to ethical concerns. In addition, the fund recently put French energy company Alstom ‘under observation’ for four years due to what the finance ministry said was ‘the risk of gross corruption in the company’s operations’. If it is not satisfied with the way Alstom deals with the alleged situation during that period, the fund will no longer invest in the company.

In an attempt to address transparency concerns, a set of 24 voluntary guidelines was proposed in 2008 through the joint efforts of the International Monetary Fund and the International Working Group of Sovereign Wealth Funds (since replaced by the International Forum of Sovereign Wealth Funds). Dubbed the ‘Santiago Principles’, they are intended to assure countries that SWFs will have transparent structures and act on the basis of financial returns rather than on behalf of their governments. So far, 25 nations have signed up.

According to Shevtsov, the funds are raising their game. ‘We can see them being run more and more professionally,’ he says. ‘They are becoming more sophisticated users of legal services and investment consulting services and do proper due diligence on investments now. Hopefully transparency will follow, because that too is part of being a well-run institution.’

Good expects SWFs to be far more careful about their investments in the medium term, and more careful about what they pay for them. ‘CIC, for example, is inputting a large amount of money into other funds to do its business on its behalf,’ he says. ‘They are looking at assets, but they are being very careful not to jump in where angels fear to tread. There is a lot of money that will wait to find a home until the euro crisis is sorted out.’

In which case, George Osborne may have to wait a while before he gets that all-important call from Beijing. But if it does come, it will have been worth the wait. There has already been one encouraging sign: at the end of January, CIC took a minority stake in London water supplier Thames Water. It is tempting to assume that more investment will follow.



Jonathan Watson is a journalist specialising in European business, legal and regulatory developments. He can be contacted by e-mail at

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