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Funds that shake capitalist logic

By Lawrence Summers

 July 29 2007 

For some time now, the large flow of capital from the developing to the industrialized world has been the principal irony of the international financial system. In 2007 this flow will total well over half a trillion dollars, a figure that will be comfortably exceeded by the build-up in reserves and sovereign wealth funds (SWFs) in developing countries.

Indeed, Morgan Stanley has estimated on reasonable assumptions that there is now close to $2,500bn (£1,200bn) in SWFs and that this figure will increase to $5,000bn by 2010 and $12,000bn by 2015.

Inevitably, and appropriately, countries possessed of publicly held foreign assets far in excess of anything needed to respond to financial contingencies feel pressure to deploy them strategically or at least to earn higher returns than those available in US Treasury bills or their foreign equivalents. Even without this pressure, SWFs are now growing at a faster pace than the global rate of new issuance of traditional reserve assets.

There is plenty of room for debate over how large these funds should become. (Does China really need a saving rate in excess of 50 per cent that all but forces hundreds of billions of dollars in reserve growth?) But on any plausible path over the next few years, a crucial question for the global financial system and indeed for the global economy is how these funds will be invested.

The question is profound and goes to the nature of global capitalism. A signal event of the past quarter-century has been the sharp decline in the extent of direct state ownership of business as the private sector has taken ownership of what were once government-owned companies. Yet governments are now accumulating various kinds of stakes in what were once purely private companies through their cross-border investment activities.

In the last month we have seen government-controlled Chinese entities take the largest external stake (albeit non-voting) in Blackstone, a big private equity group that, indirectly through its holdings, is one of the largest employers in the US. The government of Qatar is seeking to gain control of J.Sainsbury, one of Britain's largest supermarket chains. Gazprom, a Russian conglomerate in effect controlled by the Kremlin, has strategic interests in the energy sectors of a number of countries and even a stake in Airbus. Entities controlled by the governments of China and Singapore are offering to take a substantial stake in Barclays, giving it more heft in its effort to pull off the world¡¯s largest banking merger, with ABN Amro.

To date most of the official commentary on the issue of SWFs has been framed in terms of traditional arguments about cross-border capital flows. US and UK officials have raised concerns that focus only on the desirability of reciprocity and transparency and on how to treat sectors that trigger national security questions. Others, particularly in continental Europe, have been less positive and have emphasised nationalist considerations about the benefits of local ownership and control.

What has received less attention are the particular risks associated with ownership by government-controlled entities, particularly where the ownership stake is taken through direct investments. The logic of the capitalist system depends on shareholders causing companies to act so as to maximise the value of their shares. It is far from obvious that this will over time be the only motivation of governments as shareholders. They may want to see their national companies compete effectively, or to extract technology or to achieve influence. 

We have seen the degree of concern over News Corp¡¯s attempt to buy The Wall Street Journal. How differently should one feel about a direct investment stake of a foreign government in a media or publishing company?

Apart from the question of what foreign stakes would mean for companies, there is the additional question of what they might mean for host governments. 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?

All of these risks would be greatly mitigated if SWFs invested through intermediary asset managers, as is the case with most institutional pools of capital such as endowments and pension funds. The experience of many endowments and pension funds suggests that this approach is in most cases likely to produce the best risk-adjusted returns.

To the extent that SWFs pursue different approaches from other large pools of capital, the reasons have to be examined. The most plausible reasons the pursuit of objectives other than maximising risk-adjusted returns and the ability to use government status to increase returns are also most suspect from the viewpoint of the global system.

None of this is to propose policy. That can come only after the investment policies of SWFs have been much more extensively debated and many details have been clarified. But it is to register a cautionary note about the debates over SWFs so far.

Governments are very different from other economic actors. Their investments should be governed by rules designed with that reality very clearly in mind. 

   £¨ The writer is Charles W. Eliot£¬ university professor at Harvard£¬ Copyright The Financial Times Limited 2007£¬£©

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China's Unique Cash Pool for Building Africa 

Caijing Magazine By staff reporter Zhang Yuzhe 

2007-07-26 

Combining market principles with a desire to promote progress in Africa, the Beijing government¡¯s China Development Bank has patterned its huge China-Africa Development Fund after private equity funds. 

China¡¯s recent US¢C 3 billion injection into the U.S. private equity firm Blackstone Group may have attracted more media attention, but the Beijing government also turned heads by creating a huge, PE hybrid designed to accelerate development in Africa. 

The China-Africa Development Fund was launched in June with an initial US¢C 1 billion and a goal of expanding the pool to US¢C 5 billion. Sponsored by the state but targeting private enterprise, the fund was formed with a unique structure that blends the practices of global PE firms and China¡¦s industrial development funds. 

At the helm is Beijing¡¦s policymaking China Development Bank (CDB), which forecasts a 50-year lifespan for what¡¦s being called the world¡¦s largest, single fund aimed at African development. 

But fund managers are not seeking purely capital returns. Building on CDB¡¦s previous experience with six industrial funds, the China-Africa fund will continue the bank¡¦s development model by combining commercial interests with political and economic needs. 

Gao Jian, chairman of the new China-Africa Development Fund Co. and vice president of CDB, told Caijing that ¡§profits are not the fund's first priority. The China-Africa Fund first seeks to advance economic, political, and societal development. 

At the same time, this is an independently managed fund operating on market principles and incurring a certain degree of risk,¡¨ Gao said. ¡§If managed appropriately, the fund could realize significant gains.¡¨ 

Gao's confidence is backed by CDB's previous investments. In recent years, the CDB has created a development lending model which, in terms of loans for basic construction, has exceeded those of commercial banks. Although CDB¡¦s industrial fund has had extensive policy implications, it has provided valuable opportunities to accumulate experience and resources. 

However, an expert familiar with CDB's model added a word of caution. 

¡§Governments can utilize the market to invest in any industry or area, but should adhere to market principles as closely as possible so as not to disturb the laws of 
resource allocation and commercial principles,¡¨ the expert said. ¡§CDB's model functions?well in?a transition period, but can't be copied easily.¡¨ 

Behemoth Fund 

Before launching the China-Africa Fund, CDB invested in five funds including four international pools and the Bohai Industrial Investment Fund, founded last year.?Unlike western PE firms, the bank keeps its hands on the funds¡¦ investments. As an investor itself, CDB?has undergone regular evaluations of its loan projects while gaining experience in managing industrial funds. 

Chi Jianxin, president of the China-Africa Fund, said CDB learned to develop its own programs and make investment recommendations by participating in private equity funds. CDB's Investments Bureau would analyze recommended projects from each branch and recommend the most promising programs to fund managers. Meanwhile, CDB denied itself controlling stakes. 

¡§In general, shares from a single investment will not exceed 40 percent of a given enterprise¡¦s total equity,¡¨ Chi said. 

He gave the example of one fund ¡V a Sino-Swiss industrial fund -- in which no single investor¡¦s stake can exceed 33 percent. Why? ¡§Controlling shares would increase management costs. Instead, we only invest in firms with the most capable management teams,¡¨ Chi said. 

The new fund¡¦s management structure also stands out. While CDB¡¦s other funds operate separately from their management companies, the China-Africa Development Fund Co. puts fund and management operations under one roof. 

The scale of the new investment set a record. CDB will provide the initial US¢C 1?billion in full, and China Everbright Bank will be custodian.?CDB has assured potential participants that the first round of capital is available and ready at any time. Outlays are expected over the next three years. 

The second round of capital is expected to boost the fund to US ¢C3?billion. A proposed final round would raise the stakes to US ¢C5 billion. 

The focus of the fund¡¦s investments is above initial industry expectations. ¡§The China-Africa Fund is not allocated by country but collaborates with preexisting projects and enterprises,¡¨ Gao said. ¡§Regardless of ownership or size, we will give our support where the fund sees need.¡¨ Gao said investments would be aimed at?providing capital for Chinese enterprises operating in development, investment, economic and trade activities in Africa. Investments would also be made in companies providing consulting services and to win local support for policies. 

But an established rule will apply: The fund?will not take a controlling stake in any project. 

Furthermore, equity investments can be made in accord with Chinese policy and the laws of host countries including, but not limited to, preferred stocks, mixed capital tools and convertible bonds. Additionally, the China-Africa fund can allocate an appropriate portion of capital to other African funds.

¡§The investment size for the China-Africa Fund spans a wide range -- US¢C 100?million for the largest and a few million for the smallest, placing even greater requirements on management proficiency,¡¨ Chi said. ¡§An enterprise's stage of development does not affect the fund's ability to invest.¡¨ 

The fund can choose to invest in startups or mature enterprises. ¡§We don't have strict requirements for a business to show several years of profitability before investment,¡¨ he said. ¡§A firm's future prospects are more important.¡¨ 

Unlike previous funds involving CDB, the China-Africa Fund is completely funded by CDB and dedicated solely to supporting the African investments of Chinese companies. 

¡§The China-Africa Fund is registered in Beijing, and can thus better represent China and embody China's support of Africa,¡¨ Chi said. Among other CDB funds, the ASEAN Development Fund is based in the Cayman Islands, Sino-Swiss is in Beijing, and the Mandarin Fund in Luxembourg. The fund has a supervisory board and?a board of directors, which is composed of boards for investment decisions and risk management, as well as a steering committee for setting policy with members from CDB, Ministry of Commerce, Ministry of Foreign Affairs, and National Development and Reform Commission. 

The steering committee only provides policy assistance and?will not?interfere with the fund's normal operations,¡¨ Chi said. 

Multiple Challenges 

So far, the China-Africa fund has signed letters of intent with six Chinese companies. ¡§We hope to make substantial investments by the end of this year,¡¨ said Chi. 

The market is ripe. In 2006, trade between China and Africa reached US¢C 55.5 billion, making China the continent's third largest trading partner. Investment coming from Chinese enterprises, especially privately owned enterprises, has rapidly increased in recent years. According to the Export-Import Bank of China, only 100 of the more than 800 Chinese enterprises operating in Africa in 2006 were medium or large state-owned enterprises; the rest were private firms. 

And support?for the fund comes from the very top. The proposal was first advanced by President Hu Jintao 2006 at the China-Africa Summit Forum as one of his ¡§Eight Actions for Africa.¡¨ Even though the China-Africa Fund operates according to market principles, it is different from purely private funds. 

Gao?drew a distinction between the fund and international assistance, saying aid programs usually only invest in a few projects and shoulder no risks. The new fund would neither focus on resources in Africa nor increase those nations'?debts. 

'Profiting from investments is not the fund's main aim,¡¨ Gao said. ¡§The goal is integrating the Chinese and African economies in a way that is mutually beneficial to both countries. 

'For instance, in recent years, Chinese companies had excess production capacity and started to climb the value chain, whereas African companies in the development stage had a hard time producing enough consumer goods.¡¨ 

The fund's main purpose will be assisting in the recovery and development of African economies. One goal is to invest in projects to improve people¡¦s lives, another is to invest in basic infrastructure -- housing, city infrastructure, water conservation, irrigation projects, and industrial zones. 

¡§We will synthesize the relationship between risk and reward, improve companies' administrative structures, and gradually improve the level and efficiency of operations,¡¨ said Gao. The CDB also plans to appoint professional teams to handle management operations and risk control. 

Gao told Caijing that, in the past two years, the CDB has provided traditional loans as part of China's outreach program to encourage Chinese companies to invest overseas. While these loans were small, totaling less than US  1 billion, they gave the bank invaluable experience. 

Reportedly, CDB is currently tracking 50 projects in Africa involving more than US ¢C2 billion. Gao emphasized that CDB's outreach work could be beneficial to the China-Africa Fund as well. For example, some projects previously handled by traditional loans from the CDB might need additional equity funding that could be provided by the fund. Conversely, some projects could also benefit from CDB's loans. 

¡§Adhering to national policy and economic goals is of greater importance than commercial benefit,¡¨ Gao said. ¡§We have to be aware of international norms while satisfying domestic interests. We have to be aware of political and economic requirements, but also the requirements CDB places on us as a commercial organization.' 

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The Economic Restructuring Shares (ERS) are part of the offset package meant to help Singaporeans adapt to the structural changes in the economy, especially the increase in the GST rate. The ERS will be given out in three lots, with one lot each year starting from 2003. The shares will earn annual dividends, in the form of bonus shares, over 5 years. The bonus shares will be calculated at a rate of 3% plus the real GDP growth rate of the preceding calendar year, with a guarantee of at least 3%.

The New Singapore Shares (NSS) were introduced in 2001 to help the lower income group tide over the economic downturn. The NSS will earn annual dividends, in the form of bonus shares, over 5 years. The bonus shares will be calculated at a rate of 3% plus the real GDP growth rate of the preceding calendar year, with a guarantee of at least 3%.

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