Sovereign Wealth Funds: Their Operation and the Economic, Political and Legal Responses
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Sovereign Wealth Funds: Their Operation and the Economic, Political and Legal Responses Georges Kratsas UCL PhD I, Georges Kratsas, confirm that the work presented in this thesis is my own. Where information has been derived from other sources, I confirm that this has been indicated in the thesis. 1 Abstract Abstract This thesis deals with the investment behaviour of government-led investment vehicles, widely known as Sovereign Wealth Funds (SWFs), and the implications that arise from their investments in Europe and the western world. In the last 10 to 15 years SWFs have grown in size and number and have drawn the attention of many government officials because of their non- transparent nature and their expansionary investment policies. Although SWFs have been a valuable source of foreign investment in the past, their non- transparent nature, combined with their government-controlled status, raises fears that their investments might be politically, rather than economically, motivated. Specific examples of those concerns are the risk that SWFs use their economic influence in order to obtain critical information, to transfer Jobs abroad or compromise the operation of strategically important companies such as telecommunications or energy companies. The above concerns have led many western governments to take active measure to regulate sovereign investors. Such regulation comes in the form of legislation establishing procedures to control the impact of their investments. Additionally, various forms of regulation have been established at the international level, through the adoption of Codes of Conduct. The main case studies used in this thesis are those of France, Germany, the USA as well as instruments promulgated by international bodies, such as the Organisation for Economic Cooperation and Development, the International Monetary Fund and the European Union. In this thesis, it is argued that the maJority of the legislative measures adopted at the national level are overly protectionist and go far beyond what is necessary to respond to the potential concerns associated with SWFs, while they seriously risk damaging their positive effects. It is also argued that international instruments are better placed to address the potential negative impact of SWFs while preserving the benefits of their operation. 2 Content INTRODUCTION 1. Subject and Focus 11 2. The Background 13 3. Formulation of the Research Question 14 4. Assessment Method and Challenges 15 5. Structure 17 3 Content CHAPTER ONE - Definition and Characteristics of SWFs INTRODUCTION 22 A. DEFINITION AND PURPOSE: 23 1. Definition of SWFs 23 i. Broad and narrow definitions 23 ii. Stabilisation funds 27 iii. State-owned Enterprises 28 iv. Public Pension Funds 29 2. Purpose Behind the Creation of SWFs 31 i. The first SWFs 32 ii. Common objectives 33 iii. Political motivations? 34 B. CHARACTERISTICS 35 1. Size 35 i. Where does their wealth come from? 35 ii. Their size and growth projections until the middle of 2008 36 iii. Their size in the wake of the Global Financial Crisis (mid 2008 – middle of 2009) 39 iv. Future growth projections 45 2. Transparency 47 i. Most SWFs typically reveal little if any information 47 ii. Democracy and accountability 51 iii. There’s a clear trend towards openness 53 CONCLUSION 56 4 Content CHAPTER TWO – The Investment Behaviour of SWFs INTRODUCTION 58 A. ASSET ALLOCATION AT TIMES OF ECONOMIC GROWTH 59 1. The Presence of SWFs in the West 61 2. Characteristics of SWFs’ Investment Behaviour at Times of Economic Growth (period from 2000 including the first quarter of 2008) 66 i. SWFs are relatively risk averse investors 72 ii. SWFs are passive investors 75 iii. SWFs are long-term investors 79 iv. Although they acQuire large stakes, most SWFs do not pursue takeover policies in western countries 80 3. SWFs Compared 81 i. SWFs vs. Hedge funds 81 ii. SWFs vs. Institutional Investors 83 B. ASSET ALLOCATION AT TIMES OF ECONOMIC ‘CRISIS’ 86 1. The ‘Global Financial Crisis’ 86 2. The Effects of the GFC 88 i. Interruption or modification of foreign investments plans 91 ii. Shifting focus on domestic issues 95 iii. Investing against the flow 98 3. The Behaviour of SWFs post crisis (end of 2009 onwards) 101 CONCLUSION 102 5 Content CHAPTER THREE - SWFs: Potential Benefits and Challenges INTRODUCTION 104 1. Benefits Brought by the Operation of SWFs 105 i. SWFs as special foreign investors 105 ii. Stabilising western economies 108 2. Risks Posed by the Operation of SWFs 110 i. Risks associated with the motivations behind the investments of SWFs 114 ii. The motivations behind the investments of SWFs and national security concerns 118 iii. Risks associated with undue leverage 126 iv. Risks associated with the impact of the operation of SWFs on the economy 128 v. Risk of increased protectionism 133 CONCLUSION 136 6 Content CHAPTER FOUR - Regulation of SWFs: The Avoidance of Investment Protectionism INTRODUCTION 138 1. The Rationale for Regulation 139 i. The avoidance of investment protectionism 139 ii. The rationale for regulatory intervention 146 iii. ‘Transparency’ at the centre-stage of the discussion 154 iv. Can foreign investments be blocked? 158 2. Potential regulatory frameworks 162 i. Limiting SWFs’ acQuisitions and protecting strategic industries 163 ii. Incentive-type regulation: restricting voting shares or imposing taxes 165 iii. Command and control regulation: increase transparency through reporting requirements 169 iv. Self-regulation 171 3. Analysis 172 i. Theory 172 ii. Implementation 175 iii. Costs 179 CONCLUSION 185 7 Content CHAPTER FIVE - National Regulatory Models INTRODUCTION 187 A. EU LAW AND EU NATIONAL MODELS 188 1. EU Law 188 i. Free movement of capital 188 a. Ex ante restrictions 191 b. Ex post restrictions 196 ii. Freedom of establishment 198 iii. The ‘Golden Shares’ debate and other ex post rules 199 2. National Measures 205 i. France 208 a. French openness to foreign investments 208 b. French ‘economic patriotism’ 210 c. The French legal response 212 ii. Germany 216 a. German industry and foreign investments 216 b. The German legal response 221 iii. Additional national measures 225 B. THIRD COUNTRY MODEL 227 Non-EU Countries 228 i. The USA 229 a. The USA – the holy grail of SWF investments 229 b. The Committee on Foreign Investment in the United States (CFIUS) regulatory process 232 c. The Foreign Investment and National Security Act of 2007 (FINSA) 233 C. ASSESSMENT 235 A. Lessons learned 235 i. Protectionism and costs 237 ii. Compatibility with EU law 243 CONCLUSION 247 8 Content CHAPTER SIX - Supranational Regulatory Models INTRODUCTION 249 1. National vs Supranational 250 2. Codes of Conduct as a Regulatory Option 253 i. OECD/IMF 259 ii. Reactions to the IMF CoC 263 iii. The European ‘Common Approach’ to SWFs 266 3. Can GAPP and other CoCs offer an appropriate regulatory response? 271 i. The experience of the UK Corporate Governance and Stewardship Codes 273 ii. Compliance with GAPP 279 3. Additional Recommendations advocated by this thesis 283 5. SWFs and the Regulation of Hedge Funds 286 CONCLUSION 293 9 Content CONCLUSION 1. Significance and contribution of this research 295 2. Lessons drawn 296 3. Recommendations for policy makers 297 4. What the future holds for SWFs and national regulations? 298 BIBLIOGRAPHY 10 Introduction INTRODUCTION 1. Subject and Focus This thesis deals with the investment activities of Sovereign Wealth Funds (SWFs) in the European Union (EU) and the legal responses adopted by EU Member States to address them. The definition of SWFs given by the European Commission is ‘state-owned investment vehicles, which manage a diversified portfolio of domestic and international financial assets’.1 These are typically found in developing nations that manage natural resources, such as Qatar and Russia, or simply enjoy significant positive trade balances, such as China2 and Singapore.3 More recently, SWFs have appeared in western4 nations with budget deficits, such as France. It is common for a SWF to invest its capital internationally in search of opportunities to diversify its country’s income or simply to achieve better returns than those provided in its home market. Recipient countries, meaning countries receiving SWF investments,5 usually consider SWFs as a separate type of investor, mainly due to their state-owned nature and their unusually large size, and often have concerns about their investment motives. While private investors are normally profit-driven, the same cannot be guaranteed for SWFs, which are state-owned and therefore may hide political agendas. Such motives may include using financial investments in order to obtain political benefits to the detriment of recipient economies by, for 1 Commission, ‘A Common European Approach to Sovereign Wealth Funds’ COM(2008) 115 4. 2 Commission, ‘China Trade Statistics’ (2012) Directorate General for Trade <http://trade.ec.europa.eu/doclib/docs/2006/september/tradoc_113366.pdf> accessed 21 October 2012. 3 Singapore Government, ‘Balance of Payments’ (2012) Singapore Department of Statistics <www.singstat.gov.sg/stats/themes/economy/bop.html> accessed 21 October 2012. 4 As western countries, for the purposes of this thesis, are taken, the Member State countries of the European Economic Area (Ireland, United Kingdom, France, Portugal, Spain, Belgium, Luxemburg, the Netherlands, Austria, Germany, Denmark, Finland, Sweden, Norway, Iceland, Lichtenstein, Switzerland, Greece, Italy, Slovenia, Cyprus, Malta, Estonia, Lithuania, Latvia, the Czech Republic, Hungary, Poland, Bulgaria, Romania, Slovakia), the EU candidate members (Croatia, Serbia, Montenegro and Turkey), Albania, Bosnia Herzegovina, Kosovo, the United States of America, Canada, Australia, New Zealand and Israel. 5 Also called ‘host’ or ‘target countries’. By analogy, the terms ‘host’, ‘target’ and ‘recipient companies’ are also used to describe those individual companies that receive the investments of SWFs. 11 Introduction example, gaining access to confidential national security or critical technological information.6 The opacity7 of those institutions means that external observers cannot easily verify if there is or is not any basis for those concerns.