(This article appears courtesy of International Financial Law Review, sign up for a free trial on their site)
IFLR's journalists in London, New York and Hong Kong all agree: people are overreacting to sovereign wealth funds.
These controversial investment vehicles have become increasingly political since the turn of the year. French President Nicolas Sarkozy spoke out against them and German Chancellor Angela Merkel reinforced her stance against them. Even in the midst of the US race for President, Hillary Clinton tried to turn the topic into a vote winner.
But lawyers all round the world say the same thing: sovereign wealth funds are old news, there is no need to panic and any reaction needs to a considered one.
At the moment, it is estimated that the top sovereign wealth funds hold around $2.5 trillion in assets. By 2015, this is expected to have risen to $12 trillion. China Investment Corporation can already afford to buy Morgan Stanley four times over. Imagine what it could purchase by the middle of the next decade. So despite a general feeling among lawyers that alarm is unnecessary, government panic will persist and action is inevitable.
The danger is that any regulatory response could turn into protectionism. And that's the last thing a western economy needs right now.
Europe: stop panicking
Last month, Standard Chartered claimed that sovereign wealth funds are potentially "irresponsible participants in the world economy." This was an overreaction, according to UK counsel.
In an interview in mid-January, the bank's chairman Mervyn Davies called for a code of conduct to create more transparency. This was significant given that Temasek, the Singapore state fund, holds an 18% stake in Standard Chartered.
One UK corporate partner reacted by saying: "I don't understand all this fuss about sovereign wealth funds. Qatari funds have been active in London since the early nineties and no one has ever made a big deal about it.
| Update from Davos |
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It emerged during the World Economic Forum in Davos in January that the IMF has already asked Singapore, Norway and Abu Dhabi to help it draw up disclosure benchmarks for sovereign wealth funds, according to reports in the Financial Times.
The three funds are amongst the oldest and highest profile SWFs, though they differ in their levels of transparency. Norway's government fund is highly reputable and respected. The Government of Singapore's Investment Corporation and Abu Dhabi's Investment Authority meanwhile, are considered by some to be more secretive.
However, Tony Tan, deputy chairman of GIC said the fund would become more transparent and recognised there was a broader effort by sovereign wealth funds to agree a set of common standards. |
"The national papers have suddenly latched onto them in much the same way that they did with private equity last year. It's pure scaremongering."
But it was exposure in the media and public pressure that led to Sir David Walker drafting a private equity code of conduct in November last year.
The focus on sovereign wealth funds can be attributed to the governments of Kuwait, Singapore and South Korea providing most of the $21 billion lifeline to Citigroup and Merrill Lynch in January. The media sunk its teeth into this and it is unlikely to let go easily.
Also, Davies' position as leading business advisor to the UK Prime Minister Gordon Brown will increase the likelihood of a code being drafted for state-backed investment funds.
"A code of conduct would only serve to quieten people who are panicking for little reason," the UK corporate partner continued. "No one was concerned about transparency of sovereign wealth funds before, why should they start now?"
Lessons should also be learned from last year's UK private equity code. People quickly realised that the code was merely a sop to their concerns and there is now pressure to strengthen it. If a similar code is drawn up for sovereign wealth funds, it will have to have more weight to it.
Some at an international level are also arguing that policy makers need to avoid over-zealous regulation that could smack of protectionism. The day after Davies' comments, secretary general of the OECD Angel Gurria issued a warning to regulators.
"The OECD is saying buyers have to have transparency, abide by market rules. But sellers: don't overreact, don't over-regulate, don't over-control, don't over-legislate. They are helping investments, solving some of the problems, like global imbalances. They could become sovereign development funds," he said.
US: It's a liquidity boost
Lawyers in the US also say that sovereign wealth should not be feared. Indeed, it will help improve liquidity.
"One factor is their huge dollar surplus, which needs to be invested. Putting that in the US is a good thing overall," said Paul Lee, partner at Debevoise & Plimpton.
Many say the increased deal speed that is possible at sovereign funds will help the US steer clear of recession. It could reduce liquidity problems at America's large banks, and help to keep loans flowing.
Deals are often processed faster within sovereign funds as they are subject to less regulation and have a streamlined internal decision-making process, unlike pension funds and other large investors.
That lack of regulation could be a cause for concern, but lawyers point out that the funds rarely take more than a 5% stake, suggesting they do not intend to take over any part of it. The acquisition of less than 5% of voting securities establishes the presumption that the acquirer is not taking control.
Investors would only gain a voice in the management of the company if they held more than 5%. That would involve greater regulation and so transparency. An acquirer of 5% or more of voting securities of a public company must report the acquisition to the SEC; 4.9% acts as a reporting and regulatory clearance threshold.
"The natural inclinations of sovereign funds are consistent with the natural inclinations of investors in the US financial sector. Those normally mean acquiring no more than 4.9%, or in some cases 9.9% of the financial institution," said Lee.