A War Chest to Fend Off Sovereign Wealth Funds?

Concrete policies responding to Sovereign wealth funds are emerging - the first from Germany.  The German government has been worried for some time about the takeover of key companies by sovereign investors with non-commercial motives and who might acquire politically sensitive material and dominate sectors. The latter concern resembles those raised by the SEC's Cox a few weeks ago. 

 Two proposals have been circulating in the press and may be joined by others including EU-level discussions. So what responses can and should governments have to sovereign investment? 

First the outline of a pending new takeover bill was announced. Under this new legislation, the government would have the right  (within four weeks) to block the acquisition of more than 25% of  a company in a strategic sector. The authorities would have even longer (three months) to force a roll-back of holdings acquired through the equity markets – likely to encourage disclosure by potential takeover sponsors. Currently only defense and encryption sectors are signaled - both of which are already protected. but the language could change.

These proposals come a few weeks after an ECJ ruling overturning Germany's so-called Volkswagen law which capped foreign voting shares at 20%. Some Germans are particularly wary of Russian and Chinese investment in its banks, financial and transportation sector.

Such legislation is designed to differentiate between sovereign actors - as well in practice to restrict acquisitions by non-government actors also. It does not target largely passive portfolio investors and or those taking smaller stakes. Instead legislation is targeted towards Sovereign investment companies which take strategic stakes while tending to be less than transparent (Temasek of Singapore is an exception). Or perhaps the real target is state-owned enterprises like Gazprom or state banks whose links with their government backers and to some extent sovereign funds are less clear - and in some cases

Those wary of restricting investment worry about potential uncertainty and unpredictability. On the one hand, instituting such a law might actually make acquisitions more predictable as the laws are set and decisions could not be made on an ad-hoc basis. On the other hand, one might worry that it would be used to block other purchases.  Or that further and more restrictive rules might be introduced.

At first glance, given the restriction that only national security grounds can block takeovers, this seems less restrictive than rumors of this summer. While some commentators have seized on such revisions as protectionist, such a law also creates a means to assess takeovers -something  increasingly difficult to fit within EU regulations and trade law. The government suggests that law is not so different from existing legislation in the UK, US and other countries.

According to press reports,  the proposed law does not necessarily differentiate between different acquirers - something Adam Posen suggests should be the standard. He also points to the drawbacks of following the US CFIUS process which remains a somewhat unwieldy inter-agency process.

It is unclear what restrictions if any there would be on this type of action- it is likely being crafted with an eye to meet EU regulations. Peter Mandelson, the EU trade commissioner previously suggested that  EU members might use golden shares (a nominal share that out bids other shares) to block outright takeovers in strategic sectors.  Details were not disclosed. but it could be a policy reversal reversal as the EU previously restricted such usage  although it allowed some new members to gradually phase them out. but perhaps it is seen as preferable to a regulatory race to the bottom or dueling member state responses.

More recently,  a new (but related) policy emerged. German officials suggested that a new superfund of perhaps 15-20b euros (or $21-30b) might be collected to block the acquisition of key companies by foreigners such as sovereign wealth funds or state owned banks and other companies. A stake of 25%+1 would be sufficient to block such acquisitions. 

so what might be the implications of using such a warchest?

• In theory the government could end up in a bidding war with private and foreign government actors. acquiring blocking stakes could introduce not only a form of the SWF and also moral hazard. There has already been a lot of speculation that  presumed and actual interest by SWFs may inflate the price of a given asset or asset class even before SWFs have been involved. witness the jump in the equity of the Hong Kong Exchange when rumors of CIC's interest circulated. It might also be a way to compensate losers domestically. 
• Sectors previously under government control attract a major concern. A form of renationalization is possible. Others have noted the paradox of a foreign government acquiring assets/interests in sectors vacated by national governments (utilities, privatized banks, railroads etc). But this response goes one further - in a sense a sovereign investment vehicle would be used to to banish a foreign government in a sector or area that has been privatized. Furthermore this might be a government backed but private sector supported policies.  What would the role of the government (or the financial institutions expected to seed the fund) in corporate governance
• How does such policies interact with other existing regulation and competition policy both at the national and multilateral (EU and WTO) level?  Or are there instead fears of a race to the bottom in which tighter regulation might mean that the country in question would lose access to the investment.

Within Germany and Europe, the debate will likely to continue this winter. Germany's five wise men (who advise the government) suggested that the concern about SWFs was excessive, with one of the panelists suggesting: these funds 'have existed for a long time and have until now not presented any significant danger for German companies.'. She noted that the competition law already provides adequate protection. 

They might in fact anticipate not actually using such a fund or see it as a temporary tool pending investors responses. actually using it could be quite costly in monetary and reputational terms. Perhaps the announcement of the fund is in itself a signaling device, to show the seriousness of the concern and to put the onus on the investors to increase transparency and accountability, to prove their value-added to companies process.

But it may imply holding Sovereign actors to a higher standard than private actors. Since some of the private competitors are also financed by sovereign wealth funds, this might not only seem unfair. Who is to say that SWFs do not add as much or more value to their aquisitions as their private counterparts? then again, without transparency who is to know besides the direct parties involved - which may not be very different from the private counterparts.  Officials like Clay Lowery argue that the costs of non-transparency and lack of accountability may obscure systemic risks (potentially outweigh the possible positive outgrowths.) more transparency of action might be in the interest of all parties.  But pushing too hard for transparency of SWFs might backfire. 

SWFs could be among actors providing liquidity in the financial sector.  Gordon suggested that the SWF demand for riskier assets is actually necessary for recirculating financial assets in light of the credit crunch - something that demand for bonds would not.

A final note: this discussion assesses policy responses to the continued existence and growth of SWFs rather than an assessment of whether more adjustment will take place domestically  that might reduce some of the imbalances that contribute to this build up of assets. Some argue that SWFs should be held to a higher standard since their war chest is the result of their economic policies.  Although domestic investment and savings are picking up in most oil exporters, with oil above 90 savings rates are high and many other countries continue to have high savings rates. It is hard to believe that SWFs will continue to grow at their current rates, but unless underlying policy changes these pools of capital might only become more significant - so policy responses will likely continue.