comm3203 Sovereign Wealth Fund The report must be typed and written as if you were writing a recommendation to a CEO or other major decision maker. Questio

comm3203 Sovereign Wealth Fund The report must be typed and written as if you were writing a recommendation to a CEO or other major decision maker. Questions to help you with the analysis:Should we be afraid of sovereign wealth funds?Should sovereign wealth funds be regulated? How? By whom? single-spaced, 12 point font Times New Roman and 1” margins). Supporting appendices (graphs, tables and references 1.
Financial Institutions COMM 3203
Dalhousie University
Maria Pacurar
COMM 3203 Winter 2019
Dalhousie University
Financial Institutions COMM 3203 Dalhousie University
Maria Pacurar
COMM 3203 Winter 2019
Dalhousie University
Table of Contents
Sovereign Wealth Funds: Barbarians at the Gate or White Knights of Globalization?…………………5
Standard Chartered Bank: Valuation and Capital Structure…………………………………………………..29
Cutting through the Fog: Finding a Future with Fintech…………………………………………………………41
2.
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ALDO MUSACCHIO
EMIL STAYKOV
Sovereign Wealth Funds: Barbarians at the Gate or
White Knights of Globalization?
Sovereign wealth funds are not a big bad wolf at the door. They have injected liquidity and helped stabilize
financial markets. They can offer reliable long-term investments our companies need.
— Jose Barroso, President of the European Commission 1
I’d like nothing more than to get more of that money.
— Henry Paulson, U.S. Treasury Secretary2
What about the day when a country joins some “coalition of the willing” and asks the US president to
support a tax break for a company in which it has invested? Or when a decision has to be made about whether to
bail out a company, much of whose debt is held by an ally’s central bank?”
— Lawrence Summers, Director of the US National Economic Council 3
While foreign governments may invest money in our country to make a profit, they may also do so in order
to further their foreign policy ambitions, to acquire national security assets or to purchase a stake in strategic
industries,”
— Virginia Senator Jim Webb4
2007 saw the first slump in housing prices in the US in five decades. Some of the largest financial
institutions in the world were in dire need of fresh capital to shore up their suddenly fragile balance
sheets. Few had the necessary billions of cash available to readily invest quickly in the ailing Wall
Street giants. That is when sovereign wealth funds (SWFs), a somewhat unknown source of
investment up to that point, came to the rescue with a total of $50 billion of investment in less than
half a year5. At the time, these investments were more than welcome – Treasury Secretary Henry
Paulson claimed he would “like nothing more than to get more of that money”6. Such enthusiasm
was, however, quite recent. Prior to that, a rising wave of direct SWF investment in US and European
companies had elicited mixed responses. The foundation and rapid expansion of China’s SWF which
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Professor Aldo Musacchio and Emil Staykov (MBA 2011) prepared this case. HBS cases are developed solely as the basis for class discussion.
Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
Copyright © 2011 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
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OCTOBER 4, 2011
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Sovereign Wealth Funds: Barbarians at the Gate or White Knights of Globalization?
SWFs were symbolic of two major trends in the global economy in the previous decade: 1) a
redistribution of wealth and financial clout from mature to emerging economies; and 2) the return of
the state as a major economic player 7 to a level of importance not seen since the chain collapse of
command economies in the late 1980s. This time around, governments were embracing rather than
denouncing free markets in what was becoming known as “state capitalism”.
The increasing activity and size of SWFs fueled heated debates in politics and business. Were
SWFs worse asset managers than the private sector, or did they contribute to the stability of the
global financial system with large pools of capital and long-term horizons? How should cross-border
flows of state-owned capital be regulated? Should foreign states with different cultural and political
characteristics be allowed to own major stakes in large domestic enterprises at all? Where was the line
between financial protectionism and national security?
What are Sovereign Wealth Funds?
History of SWFs
The term “sovereign wealth fund” was coined by State Street analyst Andrew Rozanov in 20058.
Rozanov did not provide a clear definition at the time and ever since the term has been used to
describe a group of funds that are highly diverse in geography, capital source, size, age and
investment strategies. The Government Pension Fund of Norway ($430 bn of assets under
management), the Chinese Investment Corporation (at estimated $330 bn) and Kiribati’s Revenue
Equalization Reserve Fund ($0.6 bn) all can belong to this group depending on the definition.
While this heterogeneous group was only recently lumped together in the same investor class,
some of its members had been around for a while. The first SWF, the Kuwait Investment Authority,
was set up in 1953, a good eight years before Kuwait even gained political sovereignty from the
United Kingdom. Some of the largest funds, such as the Abu Dhabi Investment Authority (ADIA)
and the Government of Singapore Investment Corporation (GIC), dated back to the 1970’s. Recently,
however, the number and size of SWFs had increased and they had gained unprecedented attention,
particularly with the considerable investments in marquee Western financial institutions at the
beginning of the global financial crisis and the inception of the China Investment Corporation (CIC)
in 2007. The remaining BRIC countries had generally followed suit and either established their own
SWFs recently (in Russia and Brazil) or stated their intention to do so soon (in India, Angola, Bolivia,
and Thailand).
Following some international pressure and realizing their own growing significance in global
markets, SWFs moved to set up their first industry association, the International Working Group
(IWG) of SWFs, in 2007. The IWG included most of the biggest SWFs, had the OECD and the IMF as
observers and drafted the Generally Accepted Principles and Practices for SWFs, named the Santiago
Principles (Exhibit 5a).
Definitions
There is no shortage of definitions on what a SWF is. The UK House of Commons says SWFs are
“state-owned bodies intended to deliver financial returns from the investment of a country’s foreign
exchange reserves or other assets acquired through those reserves” 9. The political and risk consultant
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wasted no time in purchasing stakes in flagship US companies like Blackstone, Morgan Stanley and
energy giant AES exacerbated the debate on SWFs.
Sovereign Wealth Funds: Barbarians at the Gate or White Knights of Globalization?
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SWFs themselves put down a definition in the Santiago Principles that outlined their three key
characteristics – they are owned by governments, they invest at least partially in foreign assets and
invest to achieve financial objectives with a long time horizon (Exhibit 5b). Some of the funds
discussed here have even explicitly stated that they do not consider themselves SWFs, but are still
included as they meet these broad criteria.
There has been some confusion between SWFs and other agents of state capital. It is important to
distinguish SWFs from large state-owned enterprises (e.g., Russia’s Gazprom), privately owned
corporations or investment funds that are accused of receiving implicit assistance by states (e.g. some
of the Middle Eastern airline carriers), large but privately owned pension funds (e.g. the Canada
Pension Plan) and standard central bank reserves.
What makes SWFs important?
Large and concentrated
SWFs controlled very large pools of capital. At $4 trillion in 2007, the estimated size of assets
under management (AUM) of SWFs exceeded the combined assets of the private equity and hedge
fund industries (Exhibit 1). Following a drop in market value during 2008 and 2009, estimated AUM
of SWFs surpassed the $4 trillion threshold in 2010 again. SWFs had smaller assets than pension,
mutual and insurance fund assets, and even smaller relative to total global financial assets, estimated
at US$190 trillion11. However, they were significant relative to total stock market capitalization in
both mature and emerging markets12. SWFs combined features of all other investor classes. They had
the financial prowess of large pension funds but, similar to PE funds and hedge funds, often had
greater flexibility with regards to the risk profile of their investments. SWFs were also unique in that
they only reported to a single shareholder – the respective national government.
Furthermore, the SWF industry was significantly more concentrated than other investor classes
(Exhibit 2). At the financial markets peak in 2007, the Abu Dhabi Investment Authority (ADIA) was
said to manage close to $900 billion13, or about a quarter of all SWF assets. When the Chinese
government set up the Chinese Investment Corporation in 2007, it did so with a capital infusion of
$200 billion overnight, about four times the size of the largest hedge fund at the time. The assets of
the largest hedge funds and private equity firms still barely exceed $50 billion. Despite the shortage
of publicly available data and the recent proliferation in the number of SWFs, one can safely assume
that 50-70 percent of sovereign wealth is still concentrated in the five largest funds 1. The five largest
players in the PE and hedge fund industries make up for less than 10% of total industry assets.
Bound to grow larger
The Financial Times announced in 2007 that SWFs were “rapidly becoming a huge force in global
markets and economies”14. The latest growth rates of SWF assets were impressive [Exhibit 3a], albeit
likely generated through government deposits and still not mostly through financial returns.
Rozanov conservatively estimated the size of SWF assets at close to 900 billion in 2005. The IMF
reported that “total size worldwide has increased dramatically over the past 10–15 years”15.
1
Assuming SWF assets of $4 trillion; 4 of the 5 largest SWFs (ADIA, SAMA, SAFE, GIC and CIC) do not disclose the size
of AUMs.
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Ian Bremmer defines SWFs as “state-managed pools of excess cash that can be invested
strategically”10.
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Sovereign Wealth Funds: Barbarians at the Gate or White Knights of Globalization?
The trend of increase in size was likely to persist. First, there was potential for immediate growth
in SWF assets through the vast holdings of foreign currency already available in some central banks.
Net exporters in emerging markets accumulated up to $6 trillion of foreign exchange reserves; China
alone controlled at least a third of that17. If China deposited most of its foreign exchange holdings in
the CIC, it could become one of the top three asset managers in the world overnight. Second, the
current account imbalances and high commodity prices that funded some of the rapid growth of
SWFs in the past ten years were expected to continue in the short term. Lastly, SWF assets could
grow organically too through appreciation of already existing investments. SWFs assets were forecast
to grow to $13.4– 17.5 trillion by 201718. SWFs were expected to account for one eighth of world’s
investment flows by 2012.19
The different types of SWFs
The industry was certainly diverse. Allocating different funds to specific categories was,
unfortunately, often done on the basis of limited information given the widespread lack of
transparency in the industry. In general, SWFs could be classified in four categories based on their
investment mandate and the source of funding: stabilization funds, savings/ pension reserve funds,
economic development funds or reserve investment corporations depending on their primary
objective. Some SWFs had multiple objectives (e.g. Kuwait Investment Authority and Norway’s
Government Pension Fund-Global), and a number of countries also had more than one SWF,
including Chile, Russia, the UAE and Singapore.
The majority of established SWFs are either savings funds for future generations or fiscal
stabilization funds. There are only a handful of traditional pension reserve funds operating today that
are owned by governments, and even fewer reserve investment corporations.
Saving and pension reserve funds
These funds have been set up with the primary purpose of capital preservation for future
generations. They are generally large, relatively old funds that invest in minority holdings in public
stocks, as well as fixed income securities, and are primarily focused on developed markets. Notable
examples include the Abu Dhabi Investment Authority (ADIA), Norway’s Government Pension
Fund – Global (GPF) and Chile’s Pension Reserve Fund.
Stabilization funds
These funds had mostly been set up in the past 20 years with the primary purpose of providing a
fiscal stabilization mechanism for their countries (spending during recessions and accumulating
reserves during times of growth). They were often similar to savings SWFs in their investment
strategies but had formally outlined responsibilities to engage in countercyclical investment activities.
Chile’s Economic and Social Stabilization Fund and Mexico’s Oil Income Stabilization Fund were
typical examples of such funds.
Economic development funds
These were also mostly young funds whose goal is to promote economic development and, in the
case of resource-rich countries, economic diversification away from the dependence on a single
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International Financial Services London (IFSL) supported that estimate saying SWF assets more than
doubled between 2001 and 200716.
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commodity. These funds generally preferred direct investments with some focus on the domestic
economy and often held majority shares of both public and private companies. To distinguish
themselves from other, more traditional state-owned investment vehicles, economic development
funds sometimes explicitly stated they were not SWFs. The first and largest fund of this type is
Singapore’s Temasek Holdings, which was set up in 1975. More recent funds include Mubadala
Development Company in the UAE, Khazana and 1MDB in Malaysia, and Brazil’s BNDESpar.
Reserve investment corporations
These were funds created as a result of the accumulation of large foreign exchange reserves by
national banks. They typically sought to invest these reserves in liquid assets that provided higher
returns than money market and government bonds, and could also help manage currency risk. While
smaller in number, reserve investment corporations were some of the largest SWFs. The most famous
reserve corporation was arguably the Chinese Investment Corporation, which was set up in 2007 to
manage around $200 billion (at the time) of China’s $2.5 trillion in dollar-denominated securities in
the context of increasing expectations for dollar depreciation. Other large reserve corporations
included the Saudi Arabia Monetary Authority (SAMA), the Korean Investment Corporation (KIC)
and the Government of Singapore Investment Corporation (GIC).
Benefits of SWFs
A solution to the resource curse
There was a tendency to discuss the importance of SWFs in terms of their influence on global
financial markets and, more broadly, the world economy. This often resulted in neglecting the
primary reason for their existence – the benefits they brought to their own nations.
First, SWFs were a natural solution to the “resource curse” problem. In countries that had large
reserves of natural resources (such as oil, gas, or metal ores), the strong world demand for that
resource could lead to real exchange rate appreciation through either nominal appreciation, inflation,
or a combination of both. This lowered the competitiveness of other exports and could leave the
national economy dependent on a single commodity that was both impossible to replenish and
vulnerable to unpredictable price fluctuations.
This was where SWFs were particularly useful. They could convert finite, expendable natural
assets into financial assets that generated returns in perpetuity. For instance, the oil reserves of some
of the GCC countries had already run out (e.g. in Bahrain and Dubai) and while others had reserves
that can last a few decades, oil and gas could not be replenished in the short run. Furthermore, a
technological breakthrough in alternative energy sources might cause the demand for oil and gas to
greatly diminish long before that. Thus SWFs allowed resource exporters to switch from a relatively
unpredictable cash inflow that is limited in time to a well-diversified and more stable cash inflow in
perpetuity through a portfolio of financial and real assets.
SWFs helped to maintain export competitiveness as well. In an environment of high commodity
prices, the sudden inflow of cash from export earnings or fiscal surpluses into the real economy could
overheat the economy through consumption bubbles and rising inflation. Channeling that excess cash
into a SWF was a form of sterilization that kept a lid on inflation (and real exchange rate
appreciation) and preserved the competitiveness of non-commodity exports.
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Sovereign Wealth Funds: Barbarians at the Gate or White Knights of Globalization?
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Sovereign Wealth Funds: Barbarians at the Gate or White Knights of Globalization?
SWFs, particularly stabilization funds, also helped governments of resource-rich countries
manage rapid falls in commodity prices and smooth out economic cycles. SWFs could provide the
necessary financing for fiscal stimuli and the ensuing boost in demand, saving jobs and protecting
against speculative attacks on national currencies.
During the prolonged hike in oil prices in the 1970s, GCC countries chose to drastically raise
government spending. Those without well-developed SWFs suffered serious budget problems in the
1980s when oil prices fell back to levels unseen for a decade. In the latest oil and gas price hike,
governments diverted excess earnings into SWFs and kept a lid on spending increases. As a result,
they went through the rapid drop in oil prices from $147 per barrel to $46 per barrel in 2008 largely
unscathed and preserved balanced or surplus budgets.
Bolstering national security
SWFs could be a mechanism of national defense for smaller countries in politically unstable
regions since their assets were difficult to seize. The reason behind setting up SWFs in places like
Qatar, the UAE, Kuwait and Singapore might have partially been the realization of national leaders
that their countries are geographically indefensible. Investments abroad represen…
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