Loss of U.S. Competitiveness from the Perspective of the CIC

As reported by Asian Investor, Jin Liqun, who chairs the CIC’s supervisory board, made some trenchant (but accurate, imo) comments at a conference in Mumbai about the state of US equity markets. 

Here are a few of his points:

  • In the US and Europe, over-regulation is all the rage. Excessive regulation in any sector is detrimental to the economy, just as excessive taxation is destructive.
  • There is a discrepancy. On the one hand people cling to Western economic theories of free markets. On the other hand the governments and the regulators in the West are tightening their control of capital flows.
  • The financial industry is particularly sensitive to excessive regulation.  It imposes high costs that drive capital and companies to freer jurisdictions. Financial investors vote by foot, or nowadays by a click on the computer screen.
  • The reason behind this loss of US competitiveness is not hard to find: the Sarbanes-Oxley Act of 2002 placed extremely costly additional financial burdens and cost the US market $1.4 trillion of lost market value.  [Jin is referring to this study by Ivy Xiying Zhang, which found that “the cumulative abnormal return around all legislative events leading to the passage of the Act is significantly negative. The loss in total market value around the most significant rulemaking events amounts to $1.4 trillion.”]
  • [Sarbanes-Oxley] has also reduced the willingness of US corporations to take risks, which has had an adverse long-term impact on the US economy. And this is meant to be the paramount free market in the world. 
  • Sarbanes-Oxley Act played precisely no role in preventing the outbreak of the financial crisis in 2007-2008. This attempt to cure problems that are not problems at all has clearly not helped the US economy.

And finally, there is this bomb:

The SEC has placed a number of costly new regulations on companies that have not been justified by competent cost-benefit analysis. Worse, the SEC has engaged in a number of enforcement abuses, notably charging companies in the press with possible securities violation without sufficient proof. This makes these companies subject to SEC … blackmail.

I can’t comment on “charging companies in the press . . . without sufficient proof” without knowing which cases he has in mind, although it is true that the SEC regularly uses the press as a bully pulpit in order to leverage its resources.  As to his other point, I do believe (and the DC Circuit has so held) that the SEC has done–at best–an inconsistent job of justifying its regulations through cost-benefit analysis. 

Undoubtedly, cost-benefit analyses are difficult, and costs may be easy to find while offsetting benefits are difficult to calculate.  But that is not a convincing reason for excusing the SEC from a rigorous exercise of justifying its regulations, especially when many millions of dollars in company (and, by extension, shareholder) dollars are at stake.  Some may worry that cost-benefit analysis opens up the SEC to industry capture–the argument is that companies will lobby vigorously to show that costs exceed the benefits of any proposed regulation, and the SEC will be cowed into weakening its regulation.  I think that argument has the value of cost-benefit analysis completely backward–it is a rigorous cost-benefit analysis that protects the agency from accusations of capture by showing a clear, thorough evaluation of the merits of its proposed rulemaking.  And while we are considering issues of capture, what does it tell us that, according to Stratmann and Verret, “the unanticipated application of the proxy access rule to small firms, particularly when combined with the presence of investors with at least a 3% interest (who are able to use the rule), resulted in negative abnormal returns”?  [But see conflicting evidence here.]  Did the three commissioners at the SEC who approved the proxy access rule really believe that the market–the shareholders they were trying to protect through the proxy access rule–would actually value proxy access, or is there another explanation for the rule?

Moody's: "Glenstrata" Integration at Risk

In an interesting turn of events, Xstrata shareholders approved the merger with Glencore, but did not approve of the £140 M golden parachute pay package for key Xstrata executives.  Offshore Technology International reports that:

Moody’s said the tie-up agreed last week by shareholders will create the world’s biggest combined commodity trading and mining group, strengthened by its diversity. However, the agency said it “notes the risk of Xstrata’s senior managers leaving the combined group” after investors rejected the plan to pay £140m to 70 top staff, a decision which prompted Xstrata chairman Sir John Bond to resign.

The group’s credit rating could face pressure if the post-merger integration faced “severe disruptions, which could be caused by several key Xstrata managers leaving”, Moody’s added.  

Managers are finding their pay under increasingly strict scrutiny in 2012; Broc Romanek reports 60 say-on-pay failures this year.  Granted, that is not a large number in terms of the percentage of public companies, but it is an important indication of increasing shareholder engagement.  The big difference between the Xstrata vote  and the say-on-pay votes, however, is that one is binding while the others are not.  Xstrata was willing to get creative to get the Glencore deal done, but they played a dangerous game with their shareholders.  I can only imagine that they thought they had the votes for the golden parachute plan, and believed that the shareholders would realize that approving the deal but not locking in key executives for the transition would be penny-wise and pound-foolish.  Moody’s certainly thinks that is the case.

CIC Concerned with Western "Protectionism"

Over the weekend, a Reuters article quoted Lou Jiwei, CIC’s chief executive, as saying:

There is a rise in protectionism in both trade and investment in some Western countries. . .. As compared to other financial investors we feel that the scrutiny on us is a little more strict, because of issues like national security.

As I have argued before, this should not come as a surprise to the Chinese.  In fact, I’m sure they make statements like this not because they are surprised by host country reactions, but in part to publicly push back in hopes for some correction.

In any event, China is China, and Norway is Norway, and Abu Dhabi is Abu Dhabi, and the regulatory challenge posed by each of these sovereigns’ funds is slightly different.  An investment in a telecom company by Norway’s NBIM should be viewed differently from an investment by a telecom investment by the CIC–that is simply a political and national security reality.  My worry (and perhaps this is what Lou is getting at as well) is not that financial investments are discouraged for political reasons–“political” meaning here, legitimate concerns about national security–but that financial investments are discouraged for non-national-security-based concerns, such as a desire to protect a local, regional or “national champion” firm.

Another interesting aspect of his interview was that CIC was looking out for infrastructure investments, and liked the reception it was receiving in the UK:

“We like the UK. It is very open on its infrastructure sector,” he said, adding that Britain’s use of private capital to build public sector assets was a model for other developed economies to follow – particularly those struggling to recover from the effects of the 2008-09 global financial crisis.  Infrastructure investment can boost economic growth and employment and in fact it is fiscally neutral.”

One of the impediments to SWF infrastructure investing in the U.S. is the set of rules governing foreign investment in U.S. entities, most recently updated by the Foreign Investment and National Security Act of 2007 (FINSA).  Importantly, FINSA clarified that “critical infrastructure” was an aspect of national security.  Critical infrastructure is defined as:

a system or asset, whether physical or virtual, so vital to the United States that the incapacity or destruction of the particular system or asset of the entity over which control is acquired pursuant to that covered transaction would have a debilitating impact on national security.

This broad definition would cover a multitude of infrastructure projects, thus potentially subjecting the investor to a rigorous CFIUS analysis for each such project, greatly adding to the transaction costs associated with the project and creating uncertainty for the investors.  With these rules in place, the best opportunity for SWFs to invest in US infrastructure would be through co-venture projects in which they are minority, non-controlling investors (though admittedly that is not ideal for the SWFs in many cases, which may help explain why they do not invest much in US infrastructure compared to the UK).


Italian Firms to Return Funds to Libyan SWF

From libyaninvestment.com

The chairman of the Libyan Investment Authority Muhsan Drija declared that the Court in Rome ordered release of the share of the Authority in the Italian UniCredit Bank and the Italian Vina Mechanic Group of Plane and Defense Industries.

Muhsan Drija said that he is delighted of the results that they obtained which mean more than one billion euro of assets will be under the supervision of the new elect Libyan government.




SWFs and Investment Disclosure

While SWFs generally have been criticized for a lack of transparency, a few SWFs are quite transparent, and even disclose more than host country regulators require them to disclose.  The best example of this is–no surprise to SWF watchers–Norway’s Government Pension Fund-Global (GPF-G).

My research assistant and I have compiled SEC data on 13D and 13G transactions (involving investments of more than 5% of a class of a company’s outstanding securities), and the following list of GPF-G investments is striking:


The investments in yellow–the majority of GPF-G’s filings–were not required to be disclosed (although perhaps some were above the 5% disclosure level at some point).  So why would GPF-G disclose?  For one thing, Norway has very little to lose.  They have a reputation for being transparent and apolitical (at least with respect to US investments).  To the extent they are “activist,” they are activist in the same way that CalPERS or a public pension fund might be: focused on environmental, social or governance issues, and not on activism that might create national security risks.

On the other hand, the unintended (but not unexpected) consequence of disclosure for many other funds is heightened public and political attention to their investments, and that attention can create political problems (see Dubai Ports) that harm both the investor and the host country.  I am not advocating non-disclosure, but simply calling attention to the fact that equity investment decisions are very context-specific.  Which host country, which company, which industry, which SWF, how much to invest, what kind of security to take–all of these factors go into the mix, and affect how and why deals get done and investments get made.  Most SWFs simply would not be able to do what Norway does in the United States because, well, they are not Norway.  So many choose to invest under the radar, with very small stakes, and to stay out of the papers as much as possible.

Barclays Investigated for FCPA Violations Involving a SWF

Barclays’ dealings with a sovereign wealth fund are apparently under investigation by both US and UK authorities.  The disclosure from the UK’s Serious Fraud Office (SFO) states:

On 15 August 2012 the Director of the SFO formally opened an investigation into certain commercial arrangements between Barclays Bank and Qatar Holdings in 2008.

Qatar Holdings is a subsidiary of the Qatari SWF, Qatar Investment Authority, and has been in the news (and on this blog) recently for their high-profile influence on the proposed Glencore-Xstrata merger.

The SFO’s investigation was recently followed up by a SEC and DOJ investigation of potential FCPA violations, as described in Barclays’ Interim Management Statement released yesterday.

Subsequent to reporting the investigations of the Financial Services Authority and Serious Fraud Office in July and August 2012 respectively, Barclays has been informed by the US Department of Justice (DOJ) and US Securities and Exchange Commission (SEC) that they are undertaking an investigation into whether the Group’s relationships with third parties who assist Barclays to win or retain business are compliant with the United States Foreign Corrupt Practices Act. Barclays is investigating and fully co-operating with the DOJ and SEC

It is likely that the FCPA investigation also involves Barclays’ dealings with Qatar Holdings. 

I have gone on record as saying that efforts to treat SWF employees as “foreign officials” for purposes of the FCPA seem to be misplaced in many–if not most–cases.  I gave three reasons for that judgment: 

First, it is unclear whether the FCPA can or should be read to cover state-owned funds.  There are several practical reasons for arguing that it should not, among them a recognition that most of these enterprises and funds operate as quasi-independent entities that should not be viewed as direct agents of their respective governments.  These funds also typically (but admittedly not always or exclusively) serve economic and financial purposes, rather than a political or governmental purpose.

Second, even if foreign enterprises and funds can be viewed as foreign instrumentalities, it is not clear that the FCPA provides the best remedy for the type of harm that occurs when a state-controlled fund employee is bribed. In non-FCPA contexts, the SEC has characterized the acceptance of bribes by fund managers as a breach of fiduciary duty to the fund investors.  Cast in these terms, the harm was an agency cost, and the SEC assists the fund investors by applying their enforcement resources to cover some of the investors’ costs of monitoring the fund managers.  If the fund investors are the beneficiaries of this shifting of agency costs from private investors to public enforcers, who are the beneficiaries of a similar shift when foreign officials are bribed?

A third concern, related to the foregoing, is the apparent agency and judicial drift away from the original purpose of the FCPA as a tool to prevent corruption that affects foreign policy.  If this original purpose is to have any meaning in the context of state-controlled enterprises and funds, there must be a link between the foreign government, the instrumentality of the government, and the foreign officials who work for the instrumentality.  Each of these entities must be connected like three links of a chain—the foreign government linked to the instrumentality, and the instrumentality linked to the foreign official.  In this way, the acts of the foreign government have an effect on the foreign official, and the acts of the foreign official have an effect on the government.  Only if there exists this linkage between the foreign official and the foreign government—in the case of state-controlled enterprises and state-controlled funds, through their respective links to an instrumentality—should we expect to find the kind of foreign policy effect that the FCPA was designed to police.  Current SEC and DOJ interpretations, as well as the scant jurisprudence that has tested these interpretations, tends to look only at the connection between the foreign government and the instrumentality.  The legislative history of the FCPA, however, suggests that because foreign policy concerns are central to the FCPA, the link between the instrumentality and the foreign official must also be tested. To more directly rephrase the question of who is benefitted when the U.S. government pays for foreign fund agency costs, why are U.S. taxpayers paying for enforcement that serves to reduce agency costs for foreign governments, their citizens, and in some cases, the stockholders of partially state-controlled enterprises, but has no effect on U.S. foreign policy considerations?

My full paper on SWFs and the Foreign Corrupt Practices Act can be found here.