Sovereign wealth funds have joined the list of economic threats that the more timorous members of the EU believe Europe faces from China. Although a number of these funds have been around for decades, they are growing in number and profile, attracting increasing attention on both sides of the Atlantic.
China, with its establishment of the China Investment Corp (CIC), which has US$200 million to spend, is only the latest example of a government choosing the method as a way to invest some of its accumulated foreign exchange reserves.
According to IMF calculations, sovereign funds account for about US$2-3 trillion in assets. This is small in the context of a global total of US$165 trillion in traded securities, but they are expanding rapidly. Investment bank Morgan Stanley predicts that they may grow to US$12 trillion by 2015.
Of course this will only become reality if present conditions hold, and energy producers and export-oriented economies like China’s continue to garner large quantities of foreign exchange reserves.
Financial pariahs
Sovereign wealth funds join hedge funds and private asset management as recent targets of criticism in Europe. For critics, there are two essential problems: transparency and control. Most sovereign funds are far from transparent, and the idea of foreign governments gaining control of prized assets raises greater fears then if they were merely rapacious private financial investors.
The assumption these funds are by their nature damaging to the recipients of their investment is open to debate. When the likes of CIC are busy bailing out the West’s leading banks it may seem ungracious to criticize them too much. After all, the potential damage of such funds in the US and Europe is hardly likey to be greater than that inflicted recently by their own financial institutions.
The reality is that China’s share of sovereign wealth fund activity remains small. This is unsurprising given that Chinese outbound investment in general is still in its early stages. Apparently only one-third of CIC’s current assets will be invested overseas and, while it has made major moves in the US, it has made no equivalent moves in Europe.
However, China Development Bank (CDB) did take a stake in Barclays Bank, and CDB, like most of the country’s major corporations investing overseas, is government controlled. State directed investment from China is nothing new, as are questions of transparency and control – so to what extent does CIC represent a radical departure?
The EU is only beginning to form a coherent position on this issue, and almost inevitably the usual battle lines are being drawn.
French President Nicolas Sarkozy has pledged to protect domestic industry from sovereign funds, although specific measures have still to be adopted. Germany has proposed legislation that would allow the government to limit their activities. The UK, while urging vigilance, has insisted that it is open to all investors.
A unified approach
Brussels has responded to the concerns, and is seeking to forge a coherent European policy. For the moment it appears that the more extreme demands for restriction on the activities of sovereign wealth funds are likely to be disappointed.
Charlie McCreevy, EU commissioner for the internal market, said in December that it comes down to two key issues: who controls these sovereign wealth funds and the nature of their investment strategies. But he added that raising such issues should not be an excuse for fomenting protectionism.
The European Commission points out that member governments are already permitted to limit foreign investment in specified industries on national security grounds. France and the UK already have legislation along these lines, although they are not specifically directed at sovereign wealth funds, and Germany could follow suit.
As Europe tries to move toward a common position, China will continue to be a primary concern as the issue of sovereign wealth funds will inevitably be mixed with other perceived threats from Beijing. Any significant moves by CIC into the EU will intensify this focus, especially if it pursues assets in sensitive sectors.
China could do much to forestall the concerns, by for instance ensuring that CIC is as open as possible in its activities, and avoiding controversial investment targets. If it can win Europe’s trust then many problems will be avoided.