LOSING CONTROL (19 page)

This has happened before and, doubtless, will happen again.
On 31 October 1989, the
New York Times
reported:

At the time, the sale of the Rockefeller Center was seen as the beginning of the end for the American way.
Over the previous ten years, as rustbelt industries had declined and as the Savings and Loans crisis had swollen, the US economy seemed to have lost direction while Japan, meanwhile, was enjoying a period of extraordinary success.
As a symbol of American decline, the Rockefeller Center’s transfer to Japanese ownership was hard to beat.

Six years later, on 12 September 1995, the
New York Times
offered a new story:

No one, as far as I can tell, bothered to ask how the Rockefeller family’s trust funds had been diversified.
It’s quite possible that the money made through the initial sale of the Center was invested somewhere else in the US or, instead, in some attractive opportunity elsewhere in the world.
Either way, the returns may have been more attractive than those received by the Mitsubishi Estate Company following its buccaneering adventure in US real estate.
If so, the deal was attractive for the Rockefellers and, possibly, for Americans more generally.

Trophy assets are not linked solely to buildings.
They are also linked to sport (the typical businessman may not have the physique, but, in the gladiatorial confines of the boardroom, he may have the competitive spirit).
For the Japanese in the late 1980s and early 1990s, golf courses were the favoured investment.
Minoru Isutani purchased Pebble Beach in California for $841 million in 1990.
His company then went bankrupt, forcing the sale of the course for only two-thirds of the original purchase price two years later.
⁴
With the arrival of the new millennium, soccer clubs replaced golf courses as the trophy assets of choice.
Clubs in the English Premier League began to fall into the hands of rich foreign investors: Manchester United and Liverpool were bought by Americans, Manchester City and Portsmouth by investors from the United Arab Emirates,
⁵
West Ham by an Icelandic businessman who subsequently went bust, and Chelsea by Roman Abramovich, the quintessential Russian oligarch.

But these investments are no more than the playthings of the very rich.
Whether they make any money for the sporting billionaire
doesn’t really matter very much (although, should a wealthy benefactor end up in financial trouble, the fans would be none too happy).
⁶
The very rich, however, increasingly come from the emerging markets.
According to Forbes.com, the number of billionaires hailing from the emerging world has been on the increase.
In 2000, only two of the world’s twenty-five richest billionaires came from the emerging world (one from Saudi Arabia and the other from Hong Kong, which some might think is sufficiently wealthy not to be an emerging market).
By 2007, nine hailed from emerging economies, with a further increase to fifteen in 2008.
By 2009 the number had fallen back to five, suggesting that the global financial crisis was not good news for emerging-market billionaires.
Nevertheless, consistent with the emerging economies’ rising share of global income, emerging-market billionaires have become steadily richer and more influential on the world stage.
They are symbols of growing emerging-market power.
⁷
But, as the experience of some English soccer clubs suggests, they are also symbols of murkiness.

Markets supposedly work best when those involved are driven purely by ‘commercial’ considerations.
Assets are purchased and sold for commercial profit, not for political influence.
For Adam Smith, the invisible hand is represented by the market, not shady deals struck in smoke-filled rooms.
Yet, as the emerging economies have increased their savings and, therefore, increased their purchasing power over Western assets, so non-market outcomes become more likely.
This is not just an issue regarding the activities of sometimes shady billionaires: governments are also flexing their muscles in ways that threaten to upset the laws of the commercial jungle.

Sovereign wealth funds have been around for decades.
The first, in Kuwait, was founded in 1953 and called the Reserve Fund for Future Generations.
Others with a respectable longevity include the Abu Dhabi Investment Authority (ADIA) and, in Singapore, the Government Investment Corporation and Temasek.
The really big changes, though, have occurred since the beginning of the new millennium, with the emergence of major funds in China and Russia.
Most of these funds are state-run institutions investing money on behalf of their populations: because they are state run, it’s not obvious they will always pursue a purely commercial agenda.

The growth of these funds is really not surprising.
They are ultimately a reflection of three key developments: (i) as we have seen, some emerging economies have excess savings as a result of poorly developed domestic credit markets; (ii) other emerging economies have excess savings because they happen to be major producers of raw materials and, therefore, have benefited from higher commodity prices; (iii) many emerging economies have been unwilling to allow their exchange rates to rise in response to growing foreign demand for their products and, as a result, they have ended up with big increases in foreign-exchange reserves.

The aims of the various SWFs vary, but, in my view, there are three prime objectives.
⁸
First, where a country is a major producer of a basic commodity with a volatile price history, a fund can be used for stabilization purposes, exemplified by Joseph’s desire to put grain aside to protect Egypt from future famine.
Second, the funds can be used for savings purposes to protect a country when non-renewable assets – oil, for example – run out.
Third, for countries experiencing big increases in foreign-exchange reserves, SWFs can be used for diversification purposes to increase yield and, perhaps, lower risk (in that sense, foreign-exchange reserves should be counted as highly liquid SWFs).

Their growth raises all sorts of issues about the operation of international capital markets.
It’s frankly anybody’s guess how large these
funds are because many of them lack any kind of transparency.
In 2008, the IMF stated that ‘estimates of foreign assets held by sovereigns include about $7 trillion in international reserves (including gold) and an additional $2–3 trillion in SWFs’.
⁹
As international reserves are, in effect, very liquid SWFs, it’s reasonable to conclude that the total amount of funds held by sovereigns stood at almost $10 trillion – 5 per cent of the global total – in 2008 or, put another way, about five times the amount of assets held by the international hedge fund community at that time (the hedge funds’ market clout is actually considerably higher than these numbers suggest because, unlike SWFs and foreign-exchange reserve managers, they are heavy users of leverage to increase their power in financial markets).

With size comes potential influence.
It’s at this point that leaders in the developed world cry foul.
The reasons are obvious.
SWFs are government-run funds.
They’re not very transparent.
Many of them don’t have well-defined investment strategies or, indeed, any investment strategies.
It’s not clear whether they choose to invest purely on the basis of profit or whether they are pursuing political objectives.
And because SWFs are no longer restricted to a few city-states in the Middle East and Asia, the political stakes are much higher.
Singapore is not a democracy but it is very small.
China isn’t a democracy but it is very large.
And Russia’s democratic credentials are weaker than they once seemed.

The response from international organizations has been to come up with codes of conduct both for the SWFs themselves and for the recipient countries in the developed world who find their assets being snapped up by others.
It’s difficult to take these codes of conduct seriously.
Different countries vary in their attitudes towards sales of assets to emerging investors.
The UK, for example, has been rather laissez-faire in its approach whereas Germany and France have been more cautious.
The bigger difficulties, however, lie with hypocrisy and a blinkered view of how state capitalism operates.

Demanding, for example, that SWFs should be transparent is all very well (Norway’s Government Pension Fund is often cited as the ‘model citizen’ when it comes to transparency), but hedge funds are no better.
Of course, it can then be argued – and often is – that hedge funds are ‘pure’ funds because they are motivated by profit (or greed, depending on your point of view).
However, the argument quickly collapses because hedge funds manage other investors’ money – and those other investors include SWFs.

Arguing, meanwhile, that the ambitions of SWFs should be restricted because the involvement of government inevitably distorts market signals is nonsense for the simple reason that Western governments do it all the time, whether through defence contracts, bank bailouts (as happened in 2008 and 2009) or through mixing commercial interests with military muscle (Halliburton, the oil-services giant once led by former US vice-president Dick Cheney, did rather well in the initial stages of the second Iraq War, perhaps modelling itself on the earlier success of the East India Company).
The case for restriction, then, rests not on transparency, nor on government involvement, but on the fact that the developed world doesn’t trust leaderships in emerging economies.

The lack of trust extends far beyond any specific issues with regard to sovereign wealth funds.
If sovereign wealth funds merely hold non-controlling shares in a range of developed-world companies, it’s difficult to know why anyone should be overly worried.
Moreover, to the extent that all companies have to abide by the laws and regulations of the land, ownership alone is not enough to provide a threat to national security.
At the extreme, the assets of a sovereign wealth fund that decided to flex its financial muscles in an undesirable way from the host country’s perspective could always be seized.
Sovereign wealth funds have to tread carefully.

In the high-stakes world of energy, raw materials and logistics, it’s a different matter.
The issue here is not so much one of ownership as of control.

Imagine this.
A government brimming with free-market principles decides to privatize its electricity industry.
Being a wise government, it chooses to separate the generating companies from the distributors in an attempt to avoid any semblance of monopoly power.
For a while, the new companies are owned by a group of pension funds and insurance companies who are intent on earning acceptable returns for their policyholders.
Then the fund managers receive an offer too good to refuse from a government-owned foreign corporation, which wants to buy a couple of the electricity distributors.
The investors sell out.
In effect, the domestic power companies have been renationalized through a foreign government, leaving the privatization process seemingly in tatters.
A little later, the government-owned foreign corporation decides it wants not just the distributors but also a slice of the generation business.
Given its own background, it’s particularly interested in nuclear energy and so makes a successful bid for the nuclear power stations.
Suddenly, the country’s power supplies, and its nuclear reactors, are in foreign hands, raising all sorts of issues for competitive markets and national security.

While this might seem a decidedly implausible scenario, it is, in fact, a reasonably precise description of events surrounding the UK electricity industry.
On 29 January 1999, the Commission of the European Union cleared the acquisition of London Electricity plc, the distributor of electricity to the UK’s capital, by EdF International SA, a wholly owned subsidiary of Électricité de France (EdF).
On 1 October 2008, EdF acquired British Energy plc, which happens to operate eight out of the UK’s ten nuclear power stations.
According to EdF’s 2008 Annual Report, 84.66 per cent of
EdF’s share capital is owned by the French state.
Fortunately for the UK, the Entente Cordiale signed in 1904, which brought to an end almost a thousand years of fighting between the British and French, is still in place.
And, whereas EdF owns British energy assets, the ultimate control, through law and regulation, is in the hands of the UK government.