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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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February 11, 2008 12:01 AM ET
The newest bogeyman in the Wall Street-to-Washington nexus is the sovereign wealth fund, and its emergence as dealmaker in several industries—most notably, banking and private equity—has led lawmakers, regulators and analysts to argue over whether greater safeguards are warranted. Although sovereign wealth funds have limited their recent forays into the United States to small, passive investments, some say state-owned funds still wield enormous power and need additional checks and balances to protect against national security violations and economic chicanery. The pressure to rein in these and similarly politically tinged deals has intensified lately: President Bush has expanded the mandate of a group charged with investigating them, a congressional committee has threatened to scuttle one high-profile transaction backed by the Chinese government, and the International Monetary Fund is drafting a set of transparency practices and a voluntary code of conduct for deals involving sovereign wealth funds. At the same time, however, the administration is striving to contain what it views as protectionist fervor. The heightened political tensions have already convinced at least one sovereign wealth fund to take its money elsewhere. For investment banks, money from sovereign wealth funds came as manna from heaven. The deals with Merrill Lynch ($5 billion), Citigroup ($7.5 billion), Morgan Stanley ($5 billion) and UBS ($9.75 billion) helped offset some of the losses from the credit crisis. Transactions involving sovereign wealth funds and Western financial institutions spiked to nearly $45 billion in the last three months of 2007. This plethora of deals stoked criticism that state-owned funds were invading Wall Street while regulators were sitting idle. Leading the charge has been former Treasury secretary Lawrence Summers, who said the funds could pose not only national security threats—like those perceived in the scuttled Dubai Ports World deal in 2006—but could also jeopardize the economy. “What about the day when a country joins some ‘coalition of the willing’ and asks the U.S. 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?” Mr. Summers wrote last summer. Most sovereign wealth deals have involved small stakes—typically under 5% or 10% thresholds—with no voting rights, to avoid regulatory scrutiny. Nevertheless, lawyers who shepherd target companies through regulatory reviews expect more regulatory investigations of sovereign wealth fund transactions, especially those from Russia, the Middle East and China. “The test really is not whether [sovereign wealth funds] are active or passive investors…but whether or not they use investment for something other than maximizing financial return,” said Peter Navarro, a business professor at the University of California at Irvine. Not all sovereign wealth funds are created equal. China’s fund, for example, seeks to maximize profits through returns 150 or 200 basis points above certain global indexes. The China Investment Corp., created last year, has opaque investment goals and does not publish its asset allocation, leaving some analysts wondering whether it will pursue a more active role down the road. “Basically they’re saying that they don’t just want to invest in index funds,” said Rachel Ziemba, an Asian and Middle Eastern analyst for RGE Monitor. She noted that the Chinese fund is a hybrid of active and passive investments, and has $50 billion left unallocated, though so far all its U.S. investments have been passive. “We’ll have to see which motivation gets the upper hand” for the remaining funds, she said. The big question is whether such investments are part of a larger strategy. Even Norway’s fund, often cited as a model for transparency and passive investing, excludes certain companies from its portfolio because of poor corporate governance and environmental practices. China’s sovereign wealth fund seems to be one of the biggest targets of criticism now. According to Mr. Navarro, China has a proven record of minimizing profits in order to manipulate its currency and keep jobs on its shores. He noted that China’s central bank has employed a strategy of selling bonds to sterilize its excess reserves and then buying U.S. Treasury bonds at a loss. “That is the definition of bad behavior,” he said, noting that the sovereign wealth fund will likely try to fight inflation and keep the yuan undervalued using similar means. A fund with a passive, minority stake could become a dominant minority in a company and wield its influence in other ways, some warn. Christopher Corr, a partner with White & Case who helps companies to gain regulatory approval on sovereign wealth fund deals, said funds with minority stakes could veto key board decisions or threaten to dump the stock, which is why regulators are likely to examine even funds that take 5% stakes. Larger funds tend to be less transparent, declining to explain where they allocate money or the currency composition of their investments, according to a Congressional Research Service report last month. The IMF code of conduct, which may be unveiled this fall, is expected to include disclosures about asset allocation. A Jan. 23 executive order by President Bush has increased the workload of the Committee on Foreign Investment in the United States (CFIUS), which scrutinizes cross-border transactions. The committee, which is made up of eight cabinet officers and four presidential advisers, meets on an ad hoc basis to review deals that would lead to a foreign company or fund controlling a U.S. company involved in “critical infrastructure” or national security. It suggests denials or approvals directly to the president. CFIUS rarely blocks a transaction—it has done so only once since 1990. In fact, it approved the widely criticized proposed deal two years ago by Dubai Ports World, which tried to acquire a U.K. company that ran several U.S. ports. After a political firestorm, Dubai Ports divested the U.S. portion of the deal, which was less than 10% of the total purchase. Withdrawn deals are the more typical way out, with roughly a dozen of 1,500 cases brought before the group having been pulled back. Most companies don’t want the stigma of a failed CFIUS review attached to them for fear it will taint future dealmaking, said Bob Schlossberg, a partner with Freshfields Bruckhaus Deringer, who represented the U.K. port company bought by Dubai Ports World in 2006. Obtaining CFIUS approval may get tougher in the near future as Congress begins focusing on the latest financial sector buyouts. Sen. Evan Bayh (D-Ind.) last week told a special committee examining U.S.-China economic relations that CFIUS “has largely been a toothless watchdog.” Congress should tighten regulations now, he said, “otherwise we risk another Dubai Ports deal situation....It’s time to start asking questions about these Wall Street investments.” The president’s executive order expands CFIUS’ ability to review deals, allowing a single agency member to initiate a review instead of requiring a majority. The executive order also clarifies that a transaction that has already been approved may be reopened only under extraordinary circumstances. Regulations under last year’s Foreign Investment and National Security Act are due by April 21, but could come as early as this month. Those regulations are expected to clarify whether investment banks fall under the “critical infrastructure” designation, as well as the size at which a foreign investment warrants review. CFIUS typically reviews only deals involving controlling stakes. Similar banking regulations require federal scrutiny in cases where at least 5% of a bank is purchased by a foreign interest, according to Carter McDowell, a legislative counsel at the American Bankers Association and former House staffer. Many such deals do not involve voting rights or other features of active investment, experts say. The partnership between private equity and sovereign wealth funds has begun to ruffle a few feathers as well. Abu Dhabi wealth funds, in particular, have been buying up stakes in private equity firms, including an investment in the Carlyle Group last fall. The 7.5% stake in Carlyle by Abu Dhabi-owned Mubadala Development Co., however, could put the kibosh on other Carlyle deals. The Service Employees International Union last month criticized Carlyle’s rumored deal with Booz Allen’s government consulting business, saying that because the Abu Dhabi government owns a large stake in Carlyle, the deal could pose a national security threat. Booz Allen had $1.2 billion in Department of Defense contracts last year, according to the union. Carlyle declined to address the concerns, and the deal is ongoing. China’s 9% stake in last year’s Blackstone initial public offering raised red flags about Blackstone’s holdings in military software and satellite technology companies. Sen. Jim Webb (D-Va.), who sits on the Senate Foreign Relations Committee, asked the Securities and Exchange Commission to delay the IPO. The SEC ignored the request and approved the IPO within weeks. If concerns persist, and sovereign fund stakes get larger, Congress could nix some deals, including even those involving foreign private companies. Take the proposed buyout of manufacturer 3Com by a Chinese government-backed consortium that includes private equity group Bain Capital Partners, for example. As part of the deal, Bain would grant a sizable but minority stake in 3Com to Chinese telecommunications company Huawei Technologies. CFIUS is currently reviewing the deal. Huawei is a private company, but ranking members of the House Committee on Energy and Commerce are leery of the deal. In a Feb. 1 letter to Treasury Secretary Henry Paulson, the lawmakers asked the department to report on whether Huawei would be able to appoint members to 3Com’s board, whether a technology-sharing agreement would be in place after the deal, and whether 3Com would be required to divest itself of subsidiaries that provide “critical network infrastructure components to the U.S. government.” National security concerns were raised related to the fact that 3Com provides intrusion detection systems to the Pentagon. “We believe these concerns are more than justifiable, especially in light of recent increases in attacks on government and private networks,” the lawmakers wrote, citing reports that the Chinese military hacked into the Pentagon’s computer network last year. The committee wants answers by Feb. 28 and is prepared to denounce the deal officially. 3Com warns that if the deal is scuttled it will have to cut jobs. Meanwhile, the Bush administration is trying to curb what it sees as protectionist fervor. “I don’t think we should fear sovereign wealth funds any more than we should fear any investment entity in the United States,” Robert Kimmitt, deputy secretary of the Treasury, told reporters late last month. He admitted there are legitimate policy concerns, such as a sudden shift of the funds—which are typically long-term investors—into illiquid markets, causing price volatility, as well as concerns about transparency. Such funds often disclose little about their investment policies. Compared with pensions and endowments, which manage $53 trillion, sovereign wealth funds are still minor players in the dealmaking world. But they manage $2.5 trillion in assets so far, and their numbers are growing exponentially. Twelve new funds have been created since 2005, and Treasury officials estimate the funds will grow by $1 trillion a year, and could manage almost 10% of all financial assets by 2015. Some sovereign wealth funds already see the United States as too protectionist. The Libyan sovereign wealth fund, National Oil Corp., has chosen to shun U.S. markets and instead invest in European stocks, real estate and banks. In a recent interview with Bloomberg, fund chairman Shokri Ghanem explained, “[the U.S. is] a very active market, but it is full of politics and unpleasant actions. In Europe, politics is not very much interfering in trade.” FW Foreign oil money sloshing into banks
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