Sovereign wealth funds – state-owned entities that invest excess foreign exchange reserves – are emerging as the “new bogeymen of global finance”, but critics are too worried about other aspects of the phenomenon to really consider its impact on corporate governance, warns the FT’s John Plender in a Friday comment column.
While US politicians fear these new public-sector money moguls will dampen reform momentum among Asia’s managed currency regimes, others worry that vast sums of money are now being shunted around international markets with minimal transparency. Another concern, especially since China announced the creation of its own sovereign wealth fund, is that global capital flows could become dangerously politicised, thereby increasing systemic risk in banking.
Amid this plethora of worries, the threat these flows pose to high corporate governance standards in the developed world has gone largely unnoticed, Mr Plender says.
In essence, the growth of SWFs reflects a change in the approach to managing official reserves at a time of mounting financial imbalances, he notes. Most Asian countries now sit on far greater reserves than they would need to ward off speculative attacks on their currencies — primarily due to their mercantilist desire to hold down currencies to promote exports.
But this policy has a high opportunity cost, Mr Plender says. The majority of reserves are invested in US Treasury bonds and bills, so returns have been low. Reserve managers have therefore opted to diversify away from the dollar and take on more portfolio risk. Having first moved into US agency debt and corporate IOUs, Asian reserve managers have now started to dabble in equities.
This seems logical, from their viewpoint. But for recipients of these flows, “the consequences could be profound and not uniformly comfortable”, Mr Plender says.
The recent upward adjustment in global bond market yields suggests that some of the heat may be coming out of the credit bubble — possibly, in part, due to the change in asset allocation by reserve managers. But if surplus liquidity is diverted from bills, bonds and structured credit products into equities, a distortion may end up shifting from one asset class to another. Instead of the “conundrum” of unusually low interest rates, we will have the conundrum of an artificially low cost of equity capital, he says.
A consequent risk is that the equity market will experience something similar in corporate governance to the collapse in lending quality that has afflicted credit markets, where the growing popularity of “cov-lite” lending has undermined traditional protection of creditors’ interests, he says.
In fact, argues Mr Plender, the high-profile flotation of the Blackstone private equity group shows this is already happening. China’s new foreign reserves agency agreed to buy $3bn of equity alongside this week’s IPO. Yet that $3bn will go not into conventional equity but into mere common units, which have limited voting rights and no right whatsoever to elect Blackstone’s general partner, which is owned by the directors, who retain control.
So China has lent support to an IPO where the liability of the general partner to the common unit-holders is limited, Mr Plender warns.
The governance picture is not all bad, he adds. “Yet, the reality is that the Blackstone IPO currency is no more than junk equity”, and the prospectus “represents a low point in US corporate governance”.
The conclusion might be that this $3bn investment for China is “peanuts” and that good governance at Blackstone matters less to the Chinese than obtaining access to US intellectual capital and management skills for use in their own fledgling private equity sector. “The message, once again, is that China’s role in globalisation brings costs as well as benefits”, he concludes.
Driving home Mr Plender’s view, the FT reports in Friday’s paper that the US Treasury department, for its part, ushered through Blackstone’s deal with the Chinese, giving it an informal nod that meant it did not merit a national security investigation, according to people familiar with the deal.
Blackstone received the “favourable” opinion after approaching the Treasury before and after the $3bn deal with the Chinese was sealed, the FT says. The Treasury department chairs the secretive inter-agency panel, known as CFIUS, that vets foreign deals on national security grounds. Certain congressmen have raised questions about the issue. But Washington experts were sceptical that the Bush administration would initiate an investigation into the deal because such passive investments “would not traditionally trigger a security review”, the FT said.