Sovereign Funds Take Center Stage in 2007, Pose Huge Regulatory Challenge.
Two of the biggest global business stories of 2007 are merging as the year ends: the subprime-spawned crisis in debt markets and financial services, and the rise of sovereign wealth funds. Large investment funds putting money to work at the discretion of national governments are taking advantage of the blows suffered by some of the globe's leading financial institutions to make minority investments on advantageous terms.
The investment in Merrill Lynch & Co. by Temasek Holdings PTE Ltd., owned by the government of Singapore, is just the latest in a string of sovereign wealth fund investments in such international stalwarts as Citigroup Inc., Morgan Stanley and UBS AG.
By their monetary votes of confidence in the world's financial services structure at this critical time, the sovereign wealth funds are doing more than making what likely will prove to be timely investments: They are allaying fears, at least for now, about the power of government-run entities.
Investments motivated by anything other than financial returns, for example national strategic advantage, would be greeted with concern. The minority stakes being taken in the world's financial services giants look like bargain hunting, so they aren't raising many rumblings. That said, they don't eliminate the larger issues posed by the growth of sovereign wealth funds.
Corporate governance and the related area of securities rule enforcement are among the important areas likely to be challenged as sovereign wealth funds grow and take larger stakes in companies open to investors.
The phenomenon is emerging just as the U.S. Securities and Exchange Commission and other key national regulators are trying to coordinate rules in an acknowledgment of the increasingly interconnected world of investments and publicly traded companies.
These are early days, but sovereign wealth funds won't make that task any easier. The questions are whether these investors can be considered just another group of mutual funds, or will there be more at stake than just maximizing returns on capital. Also, will governments' pursuit of national financial interests work against the swift and effective enforcement of securities laws?
SEC Chairman Christopher Cox, in a speech earlier in December, took on the sovereign wealth issue with a series of questions and observations that at least frame the issues faced by securities regulators. Here are a few excerpts from that speech, which is worth quoting at some length:
"Today, when a foreign private issuer is suspected of violating U.S. securities laws, our experience working with our overseas regulatory counterparts indicates that we could almost always expect the full support of the foreign government in investigating the matter," Cox said in the Dec. 5 address. "But if the same government from whom we sought assistance were also the controlling person behind the entity under investigation, a considerable conflict of interest would arise.
"Another issue is the conflicts of interest that arise when government is both the regulator and the regulated. When the government becomes both referee and player, the game changes rather dramatically for every other participant. Rules that might be rigorously applied to private sector competitors will not necessarily be applied in the same way to the sovereign who makes the rules."
Later in the talk, Cox addressed the issue of transparency. "In many industrial countries today, the ability of journalists and citizens to inquire into government affairs, or to criticize the conduct of government, is severely limited. In some countries, criticism of government policies lands you in jail, or worse. Is it reasonable to expect that these same governments will be magically forthcoming with investors? This raises significant questions for regulators such as the SEC, whose mission includes investor protection. Indeed, when it comes to transparency, the track record to date of most sovereign wealth funds does not inspire confidence."
Cox also raised the issue of what he politely termed the "significant disparities in the information that is available to government as compared with private marketplace actors." In other words, governments could use information gathered by their national intelligence services, among other sources, to help guide their investment decisions. Or they could conceivably put those intelligence services and other resources explicitly to work for their commercial advantage.
Cox wisely says trying to form a protectionist shell against these new investors is the wrong path: "Far better would be to address the underlying issues of transparency, independent regulation, de-politicizing of investment decisions, and conflicts of interest." Yes, that is far better. But, as the saying goes, good luck with that.
Two of the biggest global business stories of 2007 are merging as the year ends: the subprime-spawned crisis in debt markets and financial services, and the rise of sovereign wealth funds. Large investment funds putting money to work at the discretion of national governments are taking advantage of the blows suffered by some of the globe's leading financial institutions to make minority investments on advantageous terms.
The investment in Merrill Lynch & Co. by Temasek Holdings PTE Ltd., owned by the government of Singapore, is just the latest in a string of sovereign wealth fund investments in such international stalwarts as Citigroup Inc., Morgan Stanley and UBS AG.
By their monetary votes of confidence in the world's financial services structure at this critical time, the sovereign wealth funds are doing more than making what likely will prove to be timely investments: They are allaying fears, at least for now, about the power of government-run entities.
Investments motivated by anything other than financial returns, for example national strategic advantage, would be greeted with concern. The minority stakes being taken in the world's financial services giants look like bargain hunting, so they aren't raising many rumblings. That said, they don't eliminate the larger issues posed by the growth of sovereign wealth funds.
Corporate governance and the related area of securities rule enforcement are among the important areas likely to be challenged as sovereign wealth funds grow and take larger stakes in companies open to investors.
The phenomenon is emerging just as the U.S. Securities and Exchange Commission and other key national regulators are trying to coordinate rules in an acknowledgment of the increasingly interconnected world of investments and publicly traded companies.
These are early days, but sovereign wealth funds won't make that task any easier. The questions are whether these investors can be considered just another group of mutual funds, or will there be more at stake than just maximizing returns on capital. Also, will governments' pursuit of national financial interests work against the swift and effective enforcement of securities laws?
SEC Chairman Christopher Cox, in a speech earlier in December, took on the sovereign wealth issue with a series of questions and observations that at least frame the issues faced by securities regulators. Here are a few excerpts from that speech, which is worth quoting at some length:
"Today, when a foreign private issuer is suspected of violating U.S. securities laws, our experience working with our overseas regulatory counterparts indicates that we could almost always expect the full support of the foreign government in investigating the matter," Cox said in the Dec. 5 address. "But if the same government from whom we sought assistance were also the controlling person behind the entity under investigation, a considerable conflict of interest would arise.
"Another issue is the conflicts of interest that arise when government is both the regulator and the regulated. When the government becomes both referee and player, the game changes rather dramatically for every other participant. Rules that might be rigorously applied to private sector competitors will not necessarily be applied in the same way to the sovereign who makes the rules."
Later in the talk, Cox addressed the issue of transparency. "In many industrial countries today, the ability of journalists and citizens to inquire into government affairs, or to criticize the conduct of government, is severely limited. In some countries, criticism of government policies lands you in jail, or worse. Is it reasonable to expect that these same governments will be magically forthcoming with investors? This raises significant questions for regulators such as the SEC, whose mission includes investor protection. Indeed, when it comes to transparency, the track record to date of most sovereign wealth funds does not inspire confidence."
Cox also raised the issue of what he politely termed the "significant disparities in the information that is available to government as compared with private marketplace actors." In other words, governments could use information gathered by their national intelligence services, among other sources, to help guide their investment decisions. Or they could conceivably put those intelligence services and other resources explicitly to work for their commercial advantage.
Cox wisely says trying to form a protectionist shell against these new investors is the wrong path: "Far better would be to address the underlying issues of transparency, independent regulation, de-politicizing of investment decisions, and conflicts of interest." Yes, that is far better. But, as the saying goes, good luck with that.
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