New Research: Toward a National Resilience Fund

This essay, still in draft, will soon be forthcoming in the Northwestern University Law Review Online. Here’s the abstract:

COVID-19’s economic impact has been catastrophic for state and local governments. By Federal Reserve estimates, income and sales revenues will have declined by over $50 billion in fiscal year 2020 and may decline by as much as $137 billion in 2021. Pandemics are, of course, not the only catastrophic risks we may face in coming years. Financial crises, natural disasters, social justice crises and climate change-related catastrophes all present serious risks, and often have a compounding effect on one another. These risks are especially salient for state and local governments, which are at the forefront of crisis response. A government’s legitimacy is tested and measured by its ability to respond to these challenges, but existing state and local financial frameworks have proven too thin and brittle to absorb shocks like COVID-19 or the Financial Crisis of 2007. This Essay describes how a national resilience fund, with subaccounts created for each state and territory, would strengthen the ability of state and local governments to respond to crises that will likely arise in the coming years. A national resilience fund could be based on a familiar, flexible structure that has been used for decades: the Unemployment Trust Fund. Such a structure would help insulate the resilience fund from local political pressures, yet would have the financial strength to help state and local governments absorb the costs associated with severe crises such as pandemics and natural disasters, thereby helping to preserve government’s legitimacy in times of severe social stress.

The essay can be downloaded here.

New Research: Debt for Climate: Green Bonds and Other Instruments

Forthcoming in the RESEARCH HANDBOOK ON CLIMATE FINANCE AND INVESTMENT LAW (Edward Elgar, forthcoming 2021). Here’s the abstract:

This chapter, prepared for the Edward Elgar Research Handbook on Climate Finance and Investment Law (2020, Michael Mehling and Harro van Asselt (eds.)), examines the rise of green bonds, climate bonds, and other green financial instruments. Although climate finance has enjoyed positive momentum in recent years, this momentum is at risk—with the possibility of reversal—if climate markets fail to provide competitive risk-adjusted returns. For climate finance to compete effectively, governments, issuers, and investors must resolve a set of interrelated problems. First, green investments must compete with traditional “brown” investments, some of which enjoy significant subsidies. Even when not competing against subsidized industries and investments, green investments may still lack an advantageous risk-return profile and may suffer lower demand compared to standard investments. Second, green investments must create sufficient trust in their “greenness” so as to avoid accusations of greenwashing that would not only jeopardize a given issuer’s offerings, but would also erode trust in green markets generally. This chapter describes public and private efforts to develop a robust deal infrastructure for climate finance, including mechanisms like distributed ledgers and other financial technologies that are designed to make green investments more competitive with brown investments, while also increasing trust and reducing transaction costs.

The paper may be downloaded here.

Halland, Dixon, In, Monk, and Sharma: Mobilising institutional investor capital for climate-aligned development

Through the OECD, a group of some of the leading experts on sustainable financing have just published an important and impressive new policy paper on catalyzing institutional investor engagement in sustainable and climate finance. Here’s the abstract:

Financing from institutional investors will be critical to achieving the sustainable development goals and curbing climate change. However, these large investors have been largely absent from multilateral initiatives to mobilise private capital. Partly as a result, such initiatives have been unable to reach the scale required for development finance to go “from billions to trillions”. Successful mobilisation of private capital – including from institutional investors – has instead frequently taken place at the local level, by strategic investment funds and some green banks. At the same time, some institutional investors have been changing their modus operandi, from an intermediary to a collaborative model, and are re-localising their operations. The elimination of financial intermediaries with a short-term focus removes a bottleneck between two categories of long-term investors – institutional investors and multilateral finance institutions. That opens new opportunities for collaboration, as discussed in this paper.

The paper can be downloaded here.

Chang & Lebdioui: From fiscal stabilization to economic diversification – A developmental approach to managing resource revenues

The management of revenues from exhaustible natural resources involves a number of challenges. In this paper, we argue that the standard policy advice to managers of resource revenues has been dominated by short-termism and the lack of a perspective on economic development and structural transformation. As a result, mainstream approaches have often addressed only the symptoms of commodity dependence (e.g. vulnerability to commodity price volatility) rather than its root causes (insufficiently diversified productive structures). This paper starts by mapping out the various options for managing resource revenues, and reviews their respective economic and political implications. After discussing the limitations of existing theoretical approaches, we suggest an alternative resource revenue management model that is more suited to the context of commodity-dependent developing countries. This approach, which consists in the gradual scaleup of investments in productivity-enhancing assets, enables the alignment of the dual objectives of short-term stabilization and long-term diversification.

The paper may be downloaded here.

Technology, Venture Capital and SWFs: The Role of Government in Forging Innovation and Change

The IE University annual report on sovereign funds is a must-read for researchers, fund managers, and policy-makers. I have had the pleasure of working with Javier Capape on a couple of articles for the 2019 annual report, which was published earlier this year. In this “Technology, Venture Capital and SWFs”, we looked at SWFs and sovereign development funds as catalysts for innovation. Here is the abstract:

SWFs have pursued VC investments for a variety of reasons that can be summarized in three main motivations: 1) Strong returns from innovative technologies (disrupting incumbents); 2) Asset class diversification; 3) Diversification of local economies and other positive economic spillovers

The focus on returns is perhaps most obvious, but also one of the more difficult to achieve. While VC has enjoyed historically high returns, a flood of investors into the space, often driven by a need to overcome low returns in debt assets, risks making the asset class a victim of its own success. While SWFs are eager to invest in venture capital, many SWFs are also recognizing that they must be careful in selecting when and how to invest. The search of stable and durable returns may include hedging against incumbent leaders. When they invest in a unicorn, they also aim to be part of the new economy that will lead the corporate world in the coming decades and back those companies that will amass the industry profits and market share. For example, it is reasonable for a SWF with a strong portfolio exposition to the banking industry to invest also in fintech companies that may disrupt the whole financial sector in the near future. The same logic applies to sectors such as retail, logistics, healthcare, hotel management, or transportation, that are being already disrupted by startups using new technologies, procedures and solutions. SWFs’ interest in VC is not drive solely by returns, however. Venture investing is also part of a broad strategy of diversification. SWFs want to diversify their portfolios to balance and smooth their exposure
to different asset-classes.

There is a third reason for SWF interest in VC that is specific to government-owned funds such as SWFs: economic development and the logic of learning how to foster innovation ecosystems. When a pension fund invests in tech-based startups it pursues the first two objectives mentioned above: returns and diversification. Yet, in the case of SWFs, implementing a VC investment program may have a third motivation and benefit: the economic spillovers.

SWFs can use these new technologies developed in their portfolio companies to foster economic
development, enhance change, and diversify their economies beyond natural resources into stronger value-added economic sectors. In this way, getting access to the latest technologies would allow developing economies with established SWFs (recall that most of SWFs are located in developing economies) to leapfrog in terms of economic development. SWFs can help to transfer the most advanced technologies used by innovative startups in their portfolios to the rest of the economy, looking for efficiency gains in traditional and new sectors.

The paper can be downloaded here, and the full report can be found here.

Certifying the ‘Climate’ in Climate Bonds

Climate bonds are growing at a tremendous pace, both as corporate and sovereign issuances. The Climate Bonds Initiative, which tracks green and climate bonds offerings, reports a steady increase in green bond offerings over the past few years:

Source: Climate Bonds Initiative 2019 Green Bond Market Summary.

Against this backdrop, I have been working on several pieces over the last couple of years on green and climate bond issuances. In the first piece, published in the Capital Markets Law Journal, I review the certification process for climate and green bonds:

The market for climate bonds is expanding quickly, but the continued vitality of the market will depend in large part of the quality of the reviews and assurances provided by climate bond verifiers, who assure that the bond proceeds will be used to fund climate-related projects. The Climate Bond Initiative (CBI), a self-regulatory organization that promotes the climate bond market, employs an existing regulatory framework (ISAE 3000) to manage potential conflicts of interest. However, additional steps may help the climate verification market develop and maintain credibility. Because CBI has adopted an issuer-pays model, CBI should consider encouraging the use of entity forms by climate verifiers that either limit profit incentives (such as mutual, cooperatives and non-profits) or that encourage attentive risk management (such as general partnerships).

As the climate verification market matures and an oligopoly of verifiers emerges, CBI should consider allowing investors and issuers to pursue claims against climate verifiers for poor quality verifications.

The article can be downloaded here.

FIRRMA and US National Security

In the past few years, largely as a result of increased foreign investment activity (especially by China), many countries have amended their foreign transaction screening regulations. In general, this has resulted in enhanced screening processes: more scrutiny of foreign transactions, more call for mitigation arrangements to protect national security interests in deals that do go through, and higher transaction costs. These trends are likely to accelerate due to the COVID-19 pandemic, which is demonstrating the importance of short, dependable supply chains, particularly for health care products that form part of a nation’s critical health infrastructure. UNCTAD reports:

The pandemic has resulted in intensified screening of foreign investment for national security reasons as countries strengthen their legal frameworks or introduce new regimes. These measures aim at safeguarding domestic capacities relating to health care, pharmaceuticals, medical supplies and equipment. Consequently, countries either expand their screening mechanisms to cover these sectors or broaden the meaning of national security and public interest to include health emergencies. Furthermore, they employ FDI reviews to protect other critical domestic businesses and technologies that may be particularly vulnerable to hostile foreign takeovers. More specifically, foreign investment screening thresholds have been lowered, and the possibility of initiating ex officio screening procedures has been enhanced.

UNCTAD World Investment Report 2020

The trend towards enhanced scrutiny has been gaining steam for several years. In a (relatively) recent and brief article, I discussed the most recent changes to the US foreign investment screening process:

As a result of growing American insecurity related to Chinese investment, the U.S. Congress is again revising its foreign investment law, less than a dozen years after the last major overhaul. This brief article, prepared for the 2018 Annual General Conference of the European China Law Studies Association, will describe the history of U.S. foreign investment regulation and its chief regulator, the Committee on Foreign Investment in the U.S. The article then turns to the development of the recently proposed Foreign Investment Risk Review Modernization Act (FIRRMA), with particular focus on how FIRRMA is meant to respond to U.S. concerns about the rise of China as a technological power and, more specifically, about whether China is unfairly using investments in sensitive U.S. technologies to facilitate that rise. In previous versions of U.S. foreign investment regulations, Congress was careful to avoid what might have been perceived as discriminatory treatment of a particular country in its foreign investment laws. That is not the case with FIRRMA, which targets China in a variety of ways. Yet, there is significant uncertainty surrounding the final CFIUS rules enacting FIRRMA. This uncertainty is magnified by the Trump administration’s apparent willingness to evaluate foreign investment through a transactional lens, rather than relying on a stable policy view that would benefit both foreign acquirers and U.S. firms and reduce the risk that other countries will take a similarly transactional tack in response to U.S. policies.

The article is available for download here.

What Responsibilities Do Sovereign Funds Have to Other Investors?

My associate dean duties have made it difficult to continue blogging over the past few years. However, with a new position as “associate dean of strategic initiatives,” I should have a bit more time to blog than I did when in my academic affairs role. I will continue to highlight and discuss news and research on sovereign wealth funds, development funds, pension funds, and state-owned enterprises.

I’d like to start by shamelessly promoting–over the next few weeks–some of my recent research (while my blogging has slowed down, I have still been able to keep up with research to some extent). One of the first pieces I’d like to highlight is my essay in the Wake Forest Law Review, What Responsibilities Do Sovereign Funds Have to Other Investors?. Here is the abstract:

With trillions of dollars in assets, sovereign wealth funds (SWFs) play a major role in financial markets around the world. With billions (and probably well over a trillion) dollars’ worth of equity investments around the world, the investment behavior of SWFs is of primary concern to regulators, portfolio firms and other investors. The routinely cited perils of sovereign investment, such as politicization, corporate espionage, and mercantilism, are typically seen as emanating from equity investments by SWFs. On the other hand, SWFs offer the promise of patient, sustainable investment by engaged stewards who take a long view of the impact of their investments.

This essay, prepared for a Wake Forest Law Review symposium on sovereign wealth funds, seeks to provide a realistic appraisal of the benefits and potential costs of SWF investment for other investors. Most work on SWF investment has focused on the challenges that SWFs present to regulators, portfolio companies or their own domestic constituencies. Although a few studies have examined SWF investment price impacts, SWF analyses have tended to ignore the effect of SWF investment on other investors. What, if anything, do SWFs owe to other investors? The essay calls for sovereign investors to recognize the special responsibilities they have to co-investors. While these responsibilities may not constitute actionable fiduciary duties, SWFs should embrace a model of transparent, engaged ownership that will benefit their co-investors and their common portfolio companies.

The essay first outlines the concept of fiduciary duties generally, and describes the way that such duties (or their civil law equivalents) impact SWF governance. The next section addresses the complex question of the object of SWF duties. The sponsor government, at least, has claim to these duties, but what of other impacted constituencies, such as citizens? The essay then turns to the issue of investor obligations, and notes that while investors typically do not owe one another fiduciary duties, they can mutually benefit by minimizing costs for one another as they adhere to basic principles of transparency and predictable investment behavior. The essay then evaluates the ability of the Santiago Principles to encourage this kind of transparency and predictability through a review of recently completed SWF self-assessments of compliance with the Santiago Principles.

The paper can be downloaded here.

Public Funds Investment Policies: 2016 Survey

The Public Funds Investment Policies Survey is an annual publication, now in its fourth year, which surveys the current investment policy disclosures of the 25 largest (by AUM) sovereign wealth funds (SWFs) in the world, as listed by the Sovereign Wealth Fund Institute, and the 25 largest (by AUM) sovereign pension funds (SPFs). The policies reviewed in this survey were obtained directly from the funds when possible, using data available as of summer 2016. Because a minority of funds (primarily SWFs) do not disclose investment policies, caution should be used in interpreting these results. Many funds may have extensive internal policies but choose not to disclose these policies, and the lack of disclosure should not be taken as evidence that such policies do not exist. When possible, reference was made to other sources of data to corroborate or augment disclosed data.


Thanks to Yuxin Li and Paxton Endres for valuable research assistance.  The survey can be downloaded here.