CIC CEO Talks for First Time in Five Years

By David Dittman • June 15, 2012 • Canadian Edge Weekly

In the middle of the last decade it was thought by some, including carnival barkers among the US political elite such as Sen. Charles Shumer (D-NY), that sovereign wealth fund (SWF) China Investment Corp (CIC) was the instrument of the Middle Kingdom’s effort to bring down the post-World War II consensus that had brought decades of financial stability, economic growth and peace among Western powers.

It turns out we were capable of achieving much of this end all by ourselves, largely through a bipartisan effort that got underway in the late 1970s and by the late 1990s had surrendered entirely to financial institutions on the concept of regulation. As it turned out SWFs such as CIC provided much-needed capital and stability to a teetering global financial system leading up to and in the aftermath of Lehman Brothers September 2008 implosion.

Last week CIC Chairman and CEO Lou Jiwei gave his first interview in five years with reporters from The Wall Street Journal at the SWF’s headquarters in Beijing. Excerpts from the interview were subsequently published on the WSJ’s blog DealJournal. Mr. Lou provided intriguing insights into the current crisis in Europe and the struggle to achieve a solution with 27 constituent states–versus just one government dealing with the aftermath of Lehman, which even then required more than one attempt.

He also shared his view: on the ill-fated Facebook (NSDQ: FB) initial public offering: “I can’t understand it. Such opportunities as Facebook are not for us.”

I and my co-authors Yiannis Mostrous and Elliott Gue argued for the positive impact and influence of SWFs, including CIC, in our 2010 book The Rise of the State: Profitable Investing and Geopolitics in the 21st Century.

The emergence of SWFs and other similarly structured state-sponsored and state-owned entities is more evidence of emerging economies exercising increasing influence in the global economy. SWFs have been key institutional players in the aftermath of the Great Recession, even after many suffered serious losses in their efforts to prop up damaged Western financials.

What they do and how they do it were once the object of intense scrutiny, then the source of stabilizing capital. Now they’re fixed in the 21st century international financial machine. The Rise of the State provides a starting point for understanding how they came to be known in the US, the nature of their investment activities and what might come of their increasing influence.

Following is an excerpt:

The most remarkable aspect of sovereign wealth funds (SWF) and related vehicles is what their emergence says about the present and future of the global economy.

Special-purpose investment funds or businesses created and owned by the general government for macroeconomic purposes have existed for decades. The term “sovereign wealth fund” was coined by Andrew Rozanov in a May 2005 article in Central Banking Journal to describe, generally, government investment activities. The definition most useful for our purposes, which is to understand the rising role of the state and how this impacts decisions for individual investors, comes from Bryan J. Balin’s paper Sovereign Wealth Funds: A Critical Analysis:

Sovereign wealth funds are defined by the US Treasury Dept as “government vehicles funded from foreign exchange earnings but managed separately from foreign reserves.” Along with financing, sovereign wealth funds also differ from other government vehicles in their objectives, terms, and holdings: while foreign reserves have historically invested in sovereign fixed income notes for the purpose of intervention on the foreign exchange market, SWFs typically take a longer-term approach, where international equities, commodities, and private fixed income securities are used to achieve the long-run strategic and financial goals of a sovereign.

It should be strongly noted that sovereign wealth funds are not the only vector through which sovereign entities make foreign private investments. Another way through which countries invest in foreign entities is through purchases by state-owned enterprises.

The history of such activities has been traced to 1953, when the Kuwait Investment Board was created to manage the excess oil revenue for what was then still an “independent sheikhdom under British protectorate.” But rapid growth in their number and a shift in investing behavior brought SWFs and state-operated enterprises (SOE) to the attention of politicians and the public shortly before an otherwise normal downturn became the Great Recession with the near-collapse of the Western financial system. SWFs, several of which came to the aid of weakened US and European banks, have proven resilient in the aftermath of the 2007-09 turmoil. Once happy to quietly work the wings, SWFs have fixed themselves prominently on an otherwise evolving global financial and economic stage. The composition of the leadership will change, with less agile markets receding in importance. The influence of these types of vehicles, however, will only grow. They are important instruments that will help sponsoring countries diversify their economies, provide for future generations, stabilize government revenue in times of economic crisis, and also access particular knowledge that will help development in the present.    

Controversy stoked for domestic political purposes in the US obscures the more nuanced case that on the whole state-sponsored entities present no inherent threat to public markets, and that their long-term focus, objectives and behavior as investors in fact add to financial and economic stability. Whether convenient for the US and the West or not, SWFs are here to stay. Current estimates–because so few report portfolio information in the manner of Western institutional investors, these are ballpark figures–place their total assets under management somewhere between USD1.5 trillion and USD3 trillion.

During the proliferation phase of 2005-08 some market observers projected SWFs aggregate assets under management would reach USD12 trillion, USD15 trillion, even USD20 trillion by 2020. One study has identified more than 2,500 investments worth an aggregate USD3 trillion in the listed equity of private firms by state-owned investment companies, stabilization funds, commercial and development banks, pension funds, and state-owned enterprises. Including state purchases of government and corporate bonds, SWF holdings and foreign exchange reserves, the total value of state-owned financial assets may already exceed USD15 trillion.

It wasn’t until an SOE tried to buy strategic US assets that the new prominence of state actors in the global economy came to wide political and public attention in the US. Shortly thereafter the US financial system began to buckle under the weight of subprime-mortgage backed securities, among other synthetic financial instruments; sovereign wealth funds were able to at least paper over balance-sheet holes in the short term via the infusion of more than USD31 billion into three US-based financial institutions.

Indeed, the economic crisis forced a reevaluation of deeply held convictions about the role of the state and state-sponsored entities in the economy. Among the many issues still under consideration by global policymakers are the roles of regulation and regulators in financial markets. In addition, governments and extra-governmental organizations have had to reconsider how foreign trade and capital flows impact at the local as well as the international level. Specifically regarding the West, the crisis has also forced a reassessment of economic orthodoxy that touts the self-regulating nature of free market economies and suffers lightly intrusions by the state into private economies. The top criticism of SWFs is that they lack transparency; however the depth and breadth of the global recession can be blamed on a financial crisis arguably caused by opacity in the over-the-counter derivatives market, in the composition of synthetic mortgage-backed securities and with regard to banks and special investment vehicles. 

Understanding the reasons for and the consequences of the increasing prominence of state actors in the global economy will help open-minded investors profit in the coming decade.

This trend emerged well before an ordinary recession became a global financial and economic crisis and has only strengthened with the extraordinary participation of Western governments in the rescue and support of their respective economies.

Treated with skepticism by Western elites in 2005-08, Middle East and East Asia-based SWFs and SOEs have become critical pillars of the global financial system in the aftermath of the Great Recession. Their rapid growth in the years preceding the crisis resulted from the accumulation of massive excess foreign reserves by sponsoring governments due to the rapid rise in the oil price and credit-fueled consumption in the West. Their contribution to mitigating the worst effects of the global economic downturn at home and abroad as well as the resumption of consumption trends that will help them grow mean the individual investor with a long-term view must understand their activities.

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