After social distancing may come national distancing – and increased scrutiny of state-owned investors.
Globalisation is in retreat. The Covid-19 pandemic has reduced trust between nations, and has triggered a desire to shorten supply chains and to re-shore production across the world: no-one wants to be at the mercy of possible disruptions to essential trade from another pandemic. And with an isolationist White House and a determinedly nationalistic China, it remains to be seen when, or even if, international trust can be rebuilt. Just as social distancing has become the norm within countries, we could see a trend for national distancing between countries.
The global financial system is also feeling the cold wind of renewed nationalism, and international capital flows are also coming under a spotlight. State-owned investors such as Sovereign Wealth Funds (SWFs) and Public Pension Funds (PPFs) are unusual in that they are embedded in the political and regulatory regimes of both home and host nations; in the future they may be asked to do more to prove to their hosts, to the countries they invest in, the legitimacy of their investment intentions.
This represents quite a change in sentiment. Cross-border investment flows have traditionally been seen as a positive aspect of globalisation. For the period 1950 to 2000 the vast majority of these flows came from developed nations and went to emerging nations. The risk to investors of expropriation and the risk to recipient nations of an erosion of national sovereignty were believed to be outweighed by the benefits of cooperation. The Pax Americana liberal capitalist order was in the ascendency and provided comfort. Western rules facilitated access for western nations, and at the same time recipient nations viewed these rules with respect and thought them worth emulating. And certainly, if developing nations had had to rely entirely on their own financial resources, their road to greater prosperity would have been a very much longer and slower one.
Since the turn of the century we have seen a growth in capital moving in the opposite direction: from the emerging world to developed nations. These flows have coincided with the emergence of China, especially after the country secured membership of the World Trade Organisation (WTO) in 2001, and the growing importance of hydrocarbon wealth, particularly amongst Middle Eastern nations. Many of these East to West flows occurred via a SWF. At the same time there has been a growing challenge to the liberal Western world view, especially by China, and a simultaneous growing resentment in the West towards foreigners having access to a system which they may not fully respect.
Increased mistrust has characterised international discourse in recent years, and this has been intensified by successive policy announcements by the Trump administration and by the fallout from the Covid-19 pandemic. News stories surrounding the provision of Personal Protective Equipment helped to frame this problem. In the event of a crisis, which nation’s interest would a foreign investor in a PPE production facility seek to prioritise? Would the home or host sovereign have first call on the factory’s output, have ultimate control?
This is leading to calls to monitor investment across national borders in a manner that we have not seen since 2006-2008. That was a period when there were concerns in Europe over the intentions of the Russian gas monopoly Gazprom, whilst in the US the senate actually blocked the planned sale of port facilities to an Abu Dhabi based company. These actions led to a group of SWFs working with the IMF and producing the Santiago Principles, a series of guidelines that helped to smooth access to international capital markets in the aftermath of the Global Financial Crisis for those SWFs who chose to recognise the aims of the principles. Crucially though, adherence to the Principles was largely voluntary, largely unaudited and limited to those who self-declared themselves to be SWFs covered by them.
A recent study takes the assessment of a key segment of the state owned investor universe to a higher level. It looks at the Governance, Sustainability, and Resilience (GSR) scores of 100 of the largest state-owned investors in the world. The assessment involves 25 separate criteria applied to a group of 71 SWFs, and 29 PPFs. In addition to having a wider coverage brief than the Santiago Principles, it benefits from being shaped by the current concerns of the climate crisis and the Covid-19 pandemic – and importantly, it is independently monitored. The GSR regime may become a new market reference for the authorities in nations receiving inflows from those state-owned investors recognised as SWFs and PPFs.
The governance section of the GSR study explores the clarity of mission of SWFs and PPFs by asking if their key investment objectives are published, and whether the existing investment portfolio is both visible and consistent with an observable investment strategy. This seems entirely reasonable. But in practice it may be hard to avoid conflicts of interest. Take a simple example: a state-owned investor which buys a stake in a football club whilst already having stakes in football clubs in other nations. The football authorities might well have concerns about the future integrity of international club football competitions and the transfer of players between clubs.
In a similar vein, a single investment in a seaport facility by a SWF or PPF might not appear significant, but similar investments in several countries might start to raise concerns. Sensitivity would apply (as it did in the mid-2000s) to investments in fields such as energy and transportation, but also to infrastructure investments such as water, and technology.
The sustainability section of the GSR scoreboard is focused on ESG considerations, and inevitably this leads to a discussion on China. The emphasis on economic growth in China during the last 30 years has helped create the wealth that has flown into the Chinese SWF. However, this growth has arguably come at a great environmental cost for the planet, and at great social cost for many of China’s citizens. China is the leading polluter in the world, social conditions for its population remain well below western standards, and its governance at both the corporate and political level is opaque and inspires neither confidence nor trust. It seems reasonable that investment flows from a Chinese fund should be assessed differently from those from nations with exemplary ESG scores.
Resilience measures in the GSR scoreboard have been influenced by the Covid-19 pandemic. In this section there are assessments that will help to establish if the overseas investor is a fit and proper controller of a national asset. For example, football fans might be keen to welcome wealthy owners to their clubs, but only if that wealth is real, and if the ownership is a long-term strategic investment. Short term aggressive management of a football club’s balance sheet to meet the owner’s other objectives can create existential risks for the club itself – as supporters of Wigan Athletic FC have recently found out.
And my focus on football clubs helps to make another important point. Paris St Germain are owned by a company controlled by the Qatari royal family, and Manchester City by a company owned by the Abu Dhabi royal family. These companies are not considered to be SWFs. Newcastle United are expected to be bought by Saudi PIF, which is recognised as a SWF. In reality is there any significant difference in the type of owner behind these purchases?
The fact is that although all SWFs and many PPFs are state owned investors, not all state-owned investors are SWFs or PPFs. It might be argued that the 2008 Santiago Principles helped a subset of SWFs operate under a flag of convenience that elevated them to a “preferred investor status”. In the current climate it is unlikely that a state-owned investment vehicle will be able to achieve a better overall assessment than that of the sovereign nation that owns it. This will make it difficult for the China Investment Corporation (CIC) to be viewed more favourably than Huawei, especially in nations such as the US, despite the fact that CIC is a recognised SWF with an established institutional architecture. Regulators may fear that in a situation of stress, the goalposts may be shifted, and both CIC and Huawei would become equally answerable to Beijing.
The GSR scoreboard will help host nations to assess the relative merits of any SWF or PPF that has capital to deploy in their economies. The scoreboard is strong on analysing how the fund is governed, and the linkage between the fund and the home nation. Future versions of the GSR regime might include an analysis of how well governed the home country is, and perhaps include a national risk score of that home country, and an assessment of how durable the institutional architecture of each SWF or PPF might be during a future crisis. It seems clear that recipient nations are increasingly uninterested in differentiating between portfolio investment by a state-owned fund, and direct investment by a state-owned company. A regime based on GSR might also want to extend the analysis to all state-owned investors rather than limiting the study to SWFs and PPFs.
The kneejerk reaction in many states towards what I have termed national distancing, and the resulting pressure to dismantle the existing fairly liberal framework of international investment, is understandable. But international investment flows under a well-constructed regime benefit both the investor and the recipient nation. The GSR study is an important and necessary start towards constructing such a regime.
Gary Smith is Managing Director of Sovereign Focus, and a consultant for Tabula Investment Management
 Governance, Sustainability & Resilience Scoreboard for Sovereign Wealth Funds and Public Pension Funds. Diego Lopez et al, Global SWF. 1 July 2020.