Keiretsu State Capitalism? SWFs Buy Into SOEs

Yesterday it was announced that Norway, Qatar and Azerbaijan’s SWFs were buying shares of Russian state-controlled bank VTB.  From Fox Business:

VTB said in a statement it received “firm and binding commitments” from existing and new shareholders, including bids from Norges Bank Investment Management, Qatar Holding LLC and the State Oil Fund of Azerbaijan.

VTB is planning to issue 2.5 trillion of new ordinary shares worth 102.5 billion rubles ($3.23 billion) to meet capital adequacy targets and provide funding for the continued growth of the business.

Demand for VTB shares from all the three sovereign funds could be driven by the commodity-focused nature of these economies along with interest in liquid shares of major issuers, said Natalia Orlova, chief economist at Alfa Bank.

“They understand the oil environment, it creates a rather comfortable situation for them,” Ms. Orlova said, referring to Russia’s focus and dependence on commodity markets.

I find these types of investments fascinating.  Effectively, states are acting like Keiretsu companies in Japan.  As The Economist explains,

Keiretsu is a Japanese word which, translated literally, means headless combine. It is the name given to a form of corporate structure in which a number of organisations link together, usually by taking small stakes in each other and usually as a result of having a close business relationship, often as suppliers to each other. The structure, frequently likened to a spider’s web, was much admired in the 1990s as a way to defuse the traditionally adversarial relationship between buyer and supplier. If you own a bit of your supplier, reinforced sometimes by your supplier owning a bit of you, the theory says that you are more likely to reach a way of working that is of mutual benefit to you both than if your relationship is at arm’s length.

However, Keiretsus were often seen as restraining trade with other firms (such as U.S. firms that wanted access to Japanese markets):

Jeffrey Garten, once under-secretary of commerce in charge of international trade and then dean of Yale School of Management, said that a keiretsu restrains trade “because there is a very strong preference to do business only with someone in that family”.

Similar concerns arise, no doubt, if states engage in similar behavior.  I’m not sure that is what this is about, however.  As the Alfa Bank economist stated, these investments may be merely about “comfort.”

Norway to Be More Active In Governance

Last week a variety of news outlets reported that Norway intended to take a more active role in the governance of its portfolio companies.  Here’s a blurb from International Venture Capital Post:

The sovereign wealth fund of Norway, amongst the world’s biggest investors, has said that it wants to participate more actively in the management of firms it has heavy investments in, such as Volvo and other firms.

The fund has under its management totalling US$728 billion and said it is aiming to become active participants of company activities such as election of board members.

According to the fund’s CEO Yngve Slyngstad, “It means having an ownership in the order of 5 percent and that we find ourselves among the top five investors. Our ownership should be significant, in the order of $1 billion.”

Norway’s activism will be an important test of how far sovereign investors are willing to go to pursue governance rights, and how much other countries’ regulators will allow.  I am willing to bet, however, that the type of governance activity that Norway has in mind is not likely to cause much of a concern, since I believe they will engage in “negative governance” efforts, rather than “positive governance.”  As I explained in another post,

Negative rights operate like negative covenants in a bond agreement.  Under the agreement, the bondholder (or the Trustee) can prohibit the company from taking an action.  This contrasts with a positive right (which bondholders typically do not have, but shareholders may try to exercise) to force a company to take an action.  I see this as a significant difference because regulatory review of transactions involving foreign-controlled entities will generally be triggered only where positive shareholder rights are exercised.  This regulatory posture makes good sense from a policy perspective.  Negative rights do not tend to divert management authority away from the directors and officers to the extent the exercise of positive rights might (which is precisely the kind of activity that one might worry about with SWFs, i.e., that management is influenced to do something that inures to the political benefit of the SWF), but negative rights place limits on the ability of directors and officers to impair the rights or interests of the negative right-holder.  Exercising positive rights makes you an activist.  Exercising negative rights makes you a responsible shareholder.

Watch this space for updates on Norway’s activities.

CIC's Chief, Gao Xiqing, Says the CIC is "Stigmatized" in the U.S.

Not a lot of argument from me, and I’m skeptical that the CIC can do much about it except 1) continue to invest in a commercial manner, and 2) complain about it once in a while, as they seem to be doing already.

Here are some comments from a recent WSJ article


The U.S. is telling China’s $500 billion sovereign-wealth fund to “go away,” according to the fund’s top executive, in the latest sign of strained investment ties between the world’s two largest economies.

During the financial crisis, “we were sort of welcome” in America, said Gao Xiqing, head of China Investment Corp., in a panel discussion on Sunday at the Boao Forum for Asia. Since then, “somehow we’ve become stigmatized,” he said, adding that “there have been quite a few cases where the U.S. says ‘go away.'”


Mr. Gao didn’t offer details. However, he later told a questioner at the panel, the mayor of the U.S. city of Bellevue, Wash., that the mayor’s own state had lately turned down an investment by CIC.

“Try again,” the mayor, Conrad Lee, told Mr. Gao.

Mr. Lee later told The Wall Street Journal that he is looking for Chinese investment to fund a toll road needed to bring high-technology investment to Bellevue. U.S. mayors “think Chinese money is good,” Mr. Lee said, “but [some] politicians look at Chinese investment as suspect.”

China is still investing in the U.S., of course, and more now than ever: 

According to Rhodium Group, a New York consulting firm that tracks Chinese outward investment, companies there invested $6.3 billion into U.S. companies and projects between January and September, the most recent statistics available. That was more than the $5.8 billion invested in all of 2010, the previous record for annual investment. U.S. officials also recently approved a deal that allowed Chinese state-run oil company CnoocLtd. to acquire Canada’s Nexen Inc., a deal that gave Cnooc significant assents in the Gulf of Mexico.Still, Chinese companies and officials have complained about U.S. barriers to entry in a number of industries. Most recently, Chinese officials criticized U.S. legislation that effectively banned federal dollars from being spent on information technology from companies “owned, directed or subsidized by the People’s Republic of China,” amid concerns that they could represent a security risk.

Mr. Gao said that CIC is still heavily invested in the U.S. “I’m not diminishing it, but I’m not hanging everything in one tree,” he said. “The U.S. is not one of the most welcoming countries in the world for us.”

Encouraging Pension Fund Investment in Infrastructure

Pensions funds and SWFs seem natural investors in infrastructure, yet as Clark, Monk, Orr and Scott point out, ” variety of constraints are preventing these investors from taking up their theoretical place of prominence in the market for private infrastructure.” 

A recent white paper from the Center for American Progress also discusses this challenge, focusing particularly on U.S. pension funds.  Among the challenges is the  favorable tax treatment of municipal bonds, a benefit that is of no benefit to pensions:

One key factor in the relatively low level of pension-fund engagement in U.S. infrastructure investment is the existence of the robust tax-exempt municipal-bond market, typically referred to as the “muni market.” In 2012 this nearly $400 billion market offered states and localities easy access to low-cost capital for infrastructure projects. Municipal bonds are financially beneficial to investors with tax liabilities. Since pension funds are not taxable entities, infrastructure projects financed with tax-exempt debt don’t offer pension funds a financially attractive vehicle through which to make investment in U.S. infrastructure projects. That’s the reason pension funds don’t enter the muni market. Likewise, neither state and local governments nor quasi-governmental entities such as ports and airports need to engage pension investors because of the strength of the muni market.

The white paper authors also catalog a number of other limiting factors beside the tax treatment of munis:

Beyond the muni market’s effect of crowding out tax-exempt investors, where there are infrastructure investments in the United States that offer a competitive rate of return to pension funds, the funds themselves have confronted significant barriers to investments. These barriers include a lack of experience; lack of investment-review capacity; the paucity of opportunities for investments that align with pension-fund needs and expectations; a mismatch between infrastructure deal structure and size and pension-fund needs and obligations; an aversion to operational and headline risks where there is a possibility of negative publicity associated with the investment; and political conflict and uncertainty where the viability of an investment can become subject to legislative action.


Plea for More Canadian SWFs

Madelaine Drohan recently provided an excellent commentary on why SWFs are created and why resource-rich Canadian provinces should follow the SWF trend: 

Why is this a good idea? If done right—which means sticking to commitments to put money in, investing it wisely and resisting temptation to raid the fund—this use of non-renewable resource revenues fulfills at least three important purposes: it ensures that future generations will benefit; it stabilizes government revenues; and it dampens the impact commodity price movements have on a currency (when fund assets are invested abroad) and on wage and price inflation (when assets are invested in neighbouring provinces or countries).

This isn’t a new idea. Kuwait used its petroleum revenues to set up a sovereign wealth fund in 1953. There are now about 45 such resource-backed funds around the world, and more are being created all the time.

Norway sets the gold standard. Since 1996, it has put almost all of its revenues from oil and gas into a separate savings fund, drawing only on the income for government spending. Its fund is now worth more than $600 billion. Alberta, which started its fund 20 years earlier, has a mere $16 billion set aside because it quickly lost the will to make regular deposits. Quebec, which began in only 2006, has saved even less.

The brief commentary also responds to several objections to SWFs:

There are four main objections to such schemes. We need the money now. We should pay down debt first. Future generations already benefit from current spending on education and health. And, politicians are never able to resist temptation and will surely raid the fund. These are valid objections, but none is insurmountable. True, setting revenues aside is not an attractive idea at a time of deficits and debt. The solution is to do it gradually, setting out a time frame for putting an increasing share of resource revenues into a fund. Norway, for instance, set up its resource fund in 1990, but only made the first deposit in 1996. Political temptation can be curtailed by erecting sturdy barriers against raids. The Canadian Pension Plan Investment Board, which has never been raided, can serve as a model.