Sovereign Wealth Funds (SWF) are recognized as an important source of new capital to get the world economy moving again, but many countries worry that significant amounts of SWF investment could threaten their interests. This was evidenced by statements made by the Prime Minister of the United Kingdom during his trip to the Middle East in November to ask the Gulf states to deploy their substantial foreign exchange reserves to avert further deterioration of the global financial markets. He was quoted as saying: “The Gulf States will have a vital role to play ... [in getting] the world economy moving again. They are an increasingly important source of inward investment to the U.K. As long as they play by our rules and operate in a commercial manner, we welcome investment from sovereign wealth funds.” In this article, we look at the increasing importance of SWF investment to the world economy and the efforts to address, through self-imposed guidelines and governmental regulatory initiatives, some of the concerns associated with SWF investment.
In existence since the early 1950’s, “sovereign wealth funds” are funds or similar organizations that manage money and make investments on behalf of a state or sovereign jurisdiction. Some prominent examples of SWFs include Temasek of Singapore, Dubai International Capital and the Abu Dhabi Investment Council. Initially, there were a small number of SWFs and they tended to invest surplus foreign exchange reserves of their home jurisdictions in foreign financial assets, usually government debt of industrialized countries. However, both the number of SWFs and their access to capital have increased dramatically in recent years due in part to certain emerging economies experiencing account surpluses supported, in some instances, by strong commodity prices. Further, SWFs are now investing in a wider range of asset classes than had previously been the case and have become very significant investors in the global markets. Collectively, it is estimated that the current value of all SWF investment is two to three trillion dollars. This amount is expected to grow to $10 trillion by 2012.
The depth of this capital pool, especially in the context of contracting global credit markets, has made the SWF community an important stop for those enterprises seeking to shore-up their balance sheet, and over the last few months SWF’s have made very significant investments in numerous financial institutions such as Citigroup, Merrill, and, most recently, Barclays PLC. Other prominent SWF investments include Sony, Barney’s New York, Ferrari, Doncasters and, in Canada, Cirque de Soleil and Prime West.
However, the diversification of SWF investment into asset classes such as equity, infrastructure, technology and commodities, as well as the increased pace of SWF investment and the depth of the financial resources available to the SWF community has not been free from controversy. Indeed, a number of jurisdictions, such as the United States, routinely subject SWF investment to greater scrutiny than other forms of investment. On occasion, such regulatory action has resulted in significant restructuring or abandonment of transactions by SWF’s such as CNOOC’s bid for Unocal and Dubai Port’s bid for P&O. Other jurisdictions, such as Canada, Germany and Australia, have passed legislation or developed policies enhancing the ability of those countries to review SWF investment. Some commentators have characterized these measures as protectionist.
The concern typically expressed by regulatory authorities is that SWF investment activities are not motivated by the same commercial criteria that guide private sector investment and SWFs may act in support of strategic interests that run counter to those of the states in which they are investing. Anxiety in this regard extends beyond worries, for example, that control over strategic domestic resources may fall into the hands of a foreign state. It also encompasses more nuanced concerns that SWF control over companies could be used to suppress ready access to key technologies or to impede the development of acquired companies in support of competing enterprises in the SWF’s home jurisdiction.
There is practically no evidence to suggest that SWFs are being used for these purposes, and our experience suggests that SWFs apply the same commercial criteria to their investment activities as other investors. However, there has been a strong reaction in many developed countries to the increased investment activity by SWFs and, as mentioned above, some countries have taken steps to more heavily scrutinize SWF investment activities.
In response to a number of proposed transactions (including three significant energy sector acquisitions -- Northrock Resources Ltd., PrimeWest Energy Trust and the assets of Pioneer Canada Ltd.) by the Abu Dhabi National Energy Company PJSC (TAQA), a company that is majority owned by the Abu Dhabi government, Canada introduced new guidelines (the SOE Guidelines) under the Investment Canada Act to address proposed investments in Canada by SWFs (referred to in the Guidelines as “state-owned enterprises”). Under the Investment Canada Act, certain investments by foreign entities (whether SWFs or not) resulting in the acquisition of control of a business in Canada are subject to review and ministerial approval if the value of those investments meets or exceeds certain financial thresholds. If a transaction is reviewable, the Federal Minister of Industry (the Minister) must determine whether completion of the transaction will result in a “net benefit to Canada”.
The SOE Guidelines prescribe a set of specific criteria that the Minister will apply when assessing whether a reviewable investment by an SWF satisfies the net benefit to Canada test. In particular, SWF investors will be subject to additional scrutiny of their governance structure and commercial orientation in determining whether their investments meet the “net benefit to Canada” test, and undertakings may be sought as a condition of obtaining approval. To our knowledge, the SOE Guidelines have not yet been applied to a live transaction. However, we believe that SWFs that are motivated by commercial objectives and that employ recognized governance structures will not have difficulty in satisfying the criteria set out in the SOE Guidelines (although there will likely be greater scrutiny in the case of proposed investments in Canadian businesses considered to be of strategic or national importance, as would be the case for any investors). Some commentators have even suggested that the SOE Guidelines may result in greater SWF investment in that they provide clarity as to what is required by SWFs in meeting the net benefit to Canada test. It should also be noted that the Canadian federal government recently confirmed its policy of ensuring that Canada remains a preferred destination for foreign investment.
The SOE Guidelines do not expand the scope of transactions that are subject to review under the Investment Canada Act, and Canada does not currently have an alternative regime, such as a national security review regime, that would permit review of SWF investments not otherwise subject to the Investment Canada Act. However, new legislation that would enable the Canadian government to review transactions on national security grounds is expected to be introduced shortly. Details of what a new national security review regime would entail have not yet been disclosed (including how broadly the concept of “national security” would be defined and the scope of transactions that would be subject to review).
As a result of the increased regulatory scrutiny of foreign investment activity by SWFs, many countries and international organizations, including the International Monetary Fund and the Organization for Economic Cooperation and Development (OECD), have called for a set of shared principles and practices that SWFs would adhere to when making investments in foreign countries. The culmination of this international effort was the publication of a set of best practices, known as the Santiago Principles, by the International Working Group of Sovereign Wealth Funds (IWG) on October 11, 2008.
The Santiago Principles are a set of 24 principles, to be implemented by IWG members on a voluntary basis, that are intended to address many of the issues that have been raised by countries receiving SWF investment. Of major focus are principles relating to increased transparency, enhanced governance practices and commerciality.
In releasing the Santiago Principles and recommending that its members adopt the stated best practices, the IWG hoped to prevent the onset of further protectionist legislation in developed countries. However, it remains to be seen whether or not the Santiago Principles will achieve that goal. The early reviews have not been positive. Some commentators have suggested that the voluntary nature of the Santiago Principles and the fact that the principles will not be monitored means they will not be sufficient to deter the implementation of further legislation targeted at SWF investment.
Ultimately however, market forces may trump the concerns of regulators regarding the desirability of attracting further SWF investment. In the current economic environment, SWFs will be an increasingly important source of capital for enterprises as other sources of capital dry up. Countries that subject SWF investment to enhanced regulatory scrutiny without a principled basis for doing so may well be criticized for failing to act in the best interests of constituents. We do not believe that this will be the case in Canada, where the benefits of foreign investment are well recognized. We expect that the Canadian government, in its approach to reviewing investments by SWFs, will recognize the positive aspects of SWF investment, and will seek to avoid placing unnecessary regulatory burdens on SWFs seeking to invest in Canada. However, SWF investors will need to carefully consider whether the nature of their proposed investments in Canada may attract scrutiny based on their potential impact on Canada’s interests, particularly if a national security review regime is implemented, and be prepared to address concerns that may arise.