Leveraging international law to incentivize value-added shareholding: why foreign sovereign wealth funds still matter and how they can improve shareholder governance.

Author:Sandor, Anna
 
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  1. INTRODUCTION II. WHAT IS A SOVEREIGN WEALTH FUND? III. POLICYMAKERS AND THE FEAR OF SWF ACTIVISM IV. TENSION BETWEEN FEAR AND THE BENEFITS OF ACTIVE INSTITUTIONAL INVESTORS V. TRANSPARENCY AND ACTIVENESS A. Proxy Voting and Shareholder Proposals B. Assessing Independence C. Disclosure VI. ENCOURAGING TEMPERED ACTIVISM AND REASONABLE DISCLOSURE BY HARNESSING INTERNATIONAL LAW A. Improving the Santiago Principles B. Moving Beyond Multilateral Approaches C. Domestic Regulatory Reform VII. Conclusion I. INTRODUCTION

    "The relationship between international politics and international investment is an issue as old as commerce." (1)

    Coca Cola, Visa, Apple, Bank of America, and Johnson & Johnson are as American as apple pie. Coincidentally, they are also partially owned by China's sovereign wealth fund (SWF) and are some of its $9.6 billion share in U.S. traded companies. (2)

    In 2008, Western companies appeared to be surrounded by foreign investors--Qatar's Sovereign Investment Fund purchased a twenty percent share in the London Stock Exchange; entities in Singapore and Abu Dhabi purchased a $14.4 billion share of Citigroup; and Singapore's Sovereign Wealth Fund (SWF) and entities in Kuwait and Korea purchased a $10 billion share of Merrill Lynch. (3) Pundits wondered: what was this foreign economic invasion?

    These transactions paralleled controversial acquisitions by state-owned companies. In 2005, the U.S. Congress blocked the Chinese National Overseas Oil Company's acquisition of Unocal. In 2006, popular opposition pressured Congress to block Dubai World Ports' acquisition of port facility operating rights. (4) Neither of these proposed transactions involved an SWF, but the backlash against foreign-state involvement in U.S. companies spread like a wildfire. (5) In the spring of 2007, the controversy seemed to hit a new high. Blackstone, a large American private equity company was nearing its high-profile initial public offering (IPO). As a final twist before the IPO, a Chinese state-owned investment company purchased $3 billion in non-voting equity shares. (6) This high-profile purchase triggered a strong public response. (7)

    Unsurprisingly, in 2008 and 2009, as investments increased, SWFs were widely discussed among scholars, investors, and politicians. (8) However, since their debutante ball starting in 2007 and ending in 2009, discussion about SWFs has begun to wane. (9) During the financial crisis and the peak of the banking system's vulnerability, SWFs effectively threw a life vest to American banks by purchasing $60 billion in new stock during the subprime mortgage crisis. (10) As a result of these and other investments, SWFs lost about $80 billion, (11) or around twenty percent of their asset value in 2008. (12) Even today, SWFs are more relevant than ever--in 2013, SWFs conducted $36.5 billion worth of deals. (13) At the end of 2009, the Chinese SWF, China Investment Corporation (CIC), reported holding securities in over sixty different American public companies. SWFs continue to be institutional investors with deep pockets and significant buying power in America and internationally. (14) But this begs the question: do we trust these entities as shareholders of American companies, and if not, why? Is there a way to incentivize these new global financial actors to behave such that companies benefit on a micro-level and the economy benefits on a macro-level?

    It is undeniable that SWFs are still, and will continue to be, important. Because of rising commodity prices and global imbalances, (15) SWFs will foreseeably continue to grow in relevance and serve as important actors in corporate governance. The global worth (16) of SWFs is estimated to be anywhere between $2.5 trillion (17) and $6 trillion, which is the size of Japan's GDP. (18) For the sake of perspective, total assets under management of private equity are valued at about $2 trillion, and hedge funds have about $2.6 trillion in assets under management. (19) SWF size is also comparatively concentrated, with the three largest SWFs owning over $1.5 trillion in assets. (20) As such, although interest has waned, (21) SWFs still merit attention.

    Investors in companies are able to influence a corporation's behavior by embracing shareholder democracy. Because SWFs purchase relatively large stakes in private and publicly traded firms, they are extremely capable of influencing (22) boards of directors and affecting corporate governance dynamics in American public and private companies. (23) However, due to their relative novelty, whether SWF's embrace such power as shareholders is still unclear. As private, foreign entities, information from SWFs themselves is limited; thus, it is hard to clearly ascertain whether SWFs are passive, long-term investors, more active investors, or something in the middle. Thus, the role SWFs play in corporate governance must be assessed by analyzing empirical information and indicators of SWF behavior.

    This Note argues that when SWFs behave like responsibly active shareholders their behavior is value maximizing for the firm they invest in on a micro-level and, in turn, to the global economy at a macro-level. In order to ensure that SWF shareholders remain responsibly active, SWFs must be more transparent. This Note, therefore, first endeavors to define what constitutes a sovereign wealth fund (Part II) and to describe why unhindered SWF shareholder activism may be undesired (Part III). Next, this Note chronicles the tension between the problems with active investing and the problems with passive investing (Part IV) and proposes a middle ground--responsible activism. Part IV also explains how such tempered active investing improves firm value by closing the monitoring gap and argues that, in order to obtain such benefits, SWFs should become more transparent. The Note then proceeds to analyze transparency and active shareholding indicators including proxy voting (Part V.A), independence (Part V.B), and disclosures (Part V.C). The Note then recommends how international law can be leveraged to address the shortcomings highlighted in Part V and to encourage responsible shareholder activism discussed in Part IV.

    Although the goals of this Note appear lofty, the primary goal is to highlight previously un-discussed linkages between SWFs, active investing, microeconomic and macroeconomic value, international law, and transparency. This Note also aims to reanimate discourse about SWFs in a post-financial crisis world where empirical evidence about SWF behavior is more readily available.

  2. WHAT IS A SOVEREIGN WEALTH FUND?

    Kuwait was one of the first countries to establish a sovereign wealth fund, (24) the first domino in a chain of SWF creations that accelerated through the oil price spikes in the 1970s and 1980s. (25) In many ways, Kuwait's experience is emblematic of the rise of SWFs. Kuwait originally sought to harness the profits of non-renewable oil by taking oil income in the present, and making it last into tomorrow, thereby avoiding a "boom and bust" scenario. (26) Since Kuwait, many other countries have established similar investment vehicles, some with similar objectives and some to account for trade surpluses or other volatility preventing reasons. Between 2005 and 2012, over thirty-two SWFs were established. (27) Most SWFs are located in oil- or resource-rich countries where fiscal surpluses or balance of payments surpluses exist. (28)

    As SWFs have grown in size they have also grown into diverse forms--many have come to realize that SWFs are an amorphous concept without a single definition to provide clarity. Generally speaking, SWFs can be defined as "funds established, owned and operated by local or central governments, [and] which investment strategies include [the] acquisition of equity interests in companies listed on international markets." (29) The fund itself is a pool of money or assets from the country's reserves established for policy reasons and invested domestically or abroad in the private marketplace.

    Some scholars attempt to elucidate the boundaries of what is and is not an SWF. For example, the Monitor Company Group (30) has argued for specific definitional requirements for an SWF, which include the following: direct sovereign government ownership, independent management, no explicit pension obligations, and investment in assets for economic returns, usually abroad. (31) Other scholars, such as Paul Rose, have embraced the lack of definitional consensus and advocated for an ad hoc fact-based test instead of a categorization approach to defining SWFs. (32) Still others, such as Velijok Fotak, contend that SWFs are those private investment entities that exist in order to avoid the inefficiencies that are inherent in state ownership. (33) This Note employs a more flexible, fact-based approach to SWF definitions.

    Whichever definition is used, SWFs have certain undeniable characteristic qualities, including the following: SWFs tend to act as investment vehicles seeking commercial return; SWFs have pools of capital that are wholly owned by a government, but are simultaneously organized separately from the central government's official reserves to avoid invasive government involvement; (34) and SWFs fall within a class of investors called "institutional investors," which include pension funds, mutual funds, and hedge funds. In addition, SWFs tend to be long-term investors, meaning they invest over an indefinite period of time--for example, Australia's SWF measures performance over a ten-year period. (35) Lastly, SWFs "hold diversified portfolios that 'range across equity, fixed income, real estate, bank deposits, and alternative investments such as hedge funds and private equity.'" (36)

    Institutions and scholars have sought to categorize SWFs. SWFs can be classified by the source of their sovereign wealth and by their objectives. (37) The International Monetary Fund's (IMF) classification seems the...

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