SWFs: Enemies of the state?

Sovereign funds are buying into businesses around the globe, but the backlash is beginning to take hold. By Danny Fortson

They control more than $2.2 trillion in a handful of funds sprinkled around the world, their cash coming from everything from diamonds to oil, phosphates to foreign exchange reserves. By some estimates, they now control more money than the global hedge fund and private equity industries combined. Yet, so far at least, sovereign wealth funds, the massive, state-controlled investment funds being set up by countries including China and Qatar, have not been given anything like the same treatment that other rising financial powerhouses have. Buyout barons have been hauled over the coals by politicians here and in America. Hedge funds are trying to head off a regulatory clampdown after having drawn the ire of the leaders of the G8, who issued calls for new rules governing the $1.7bn industry this past summer.

All the while, sovereign wealth funds, or SWFs, have been growing into a major new force that threatens to eclipse them both. They have managed to do so with relatively little of the flack that one might expect for a sector of its size and makeup. Until now.

Several high-profile deals, from Qatar's pursuit of J Sainsbury, its and Dubai's moves to take over half of the shares in the London Stock Exchange, and China's purchase of a $3bn (£1.48bn) stake in US buyout giant Blackstone, have, finally, piqued the attention of politicians and regulators, who have started to clamour for greater disclosure from the often-opaque groups.

When the finance ministers of the G7 nations meet later this week, the US, with the support of Japan and Germany, is expected to call for increased transparency from the sector. Japan's Finance Minister, Fukushiro Nukaga, said yesterday: "There are a variety of uncertain aspects in what those funds are doing. There will be debates in terms of their transparency."

SWF's have been around since the 1950's, but it will be the first time that they will make onto the G7 agenda. So why all the fuss?

Gerard Lyons, the chief economist at Standard Chartered, has predicted that these funds could grow to control $13.4 trillion in the next decade, up from the $2.2 trillion they hold today. Fed by record oil prices and America's ballooning current account deficit, central bank reserves in countries in the Middle East and Asia have exploded to levels far beyond the minimum thresholds necessary to protect their currencies. Increasingly, they are looking to invest the excess outside their borders. The super seven SWF's, as Mr Lyons terms them, include those of Abu Dhabi, Singapore (it has two), Norway, Kuwait, China, and Russia, which together hold an astonishing $1.8 trillion.

The backlash against them is growing because of their increased interest abroad, where they are swooping on listed, high-profile companies with increasing frequency. "There are some long-time funds but they have been run by countries... like Singapore or Norway. But the new breed look very different," said Katinka Barysch, a deputy director of the Centre for European Reform. "Some of them are run by oil-producing countries that are not market economies and are not democratic and it is not clear how they are run or what their priorities are. It's legitimate to have a debate about this."

There is also a pervading sense that their growing ambitions portend a reordering of the global economic order. Ms Barysch said: "As rich countries we have always thought of these places as developing nations, and the relationship has been one in which we give them money and aid. But is just no longer the case."

Merrill Lynch predicted that these funds, which have traditionally been partial to safe-haven investments like American Treasury bills, will make "a massive shift into riskier assets". In practical terms that means investments in foreign, public companies as well as in private equity groups and hedge funds. China alone has set aside an initial $200bn nest egg for its nascent fund, the China Investment Corporation, which was formally set up just three weeks ago.

The issues most likely to cause them problems will revolve around national security and companies governments deem to carry a strategic interest, such as energy providers.

There have already been flashpoints, most notably in the US, where the government forced Dubai Ports World to get rid of the US sites controlled by P&O before its acquisition of the latter could go through. This was due to worries that these entry points to the country would be controlled by a Middle Eastern government.

Given that the protectionist wind in America is blowing even stronger, the UK's laissez faire attitude toward foreign investment means that SWF's will continue to look here as a first port of call.

Deep pockets: the leading state-backed investment funds

Abu Dhabi Investment Authority

The largest sovereign wealth fund in the world, with $625bn (£308bn) under its control, it maintains a remarkably low profile for its size. No one knows the exact amount it has. Set up in 1976, it has never declared the value. Last month it bought a stake in US buyout giant Carlyle, following an investment in another US private equity giant.

China Investment Corporation

The newest fund on the global scene only came into being last month. The government has transferred $200bn to get the fund started, but some are predicting that it could triple that within two years. Before it was formed it bought a 10 per cent stake in Blackstone, ahead of the US buyout firm's flotation. It is headed by Lou Jiwei, the former vice-minister of finance.

Temasek (Singapore)

The world's seventh largest fund is chaired by Ho Ching, the wife of the Prime Pinister. It was started in 1974 and controls $108bn. Seen as one of the sector's most transparent, it has holdings in Standard Chartered, Barclays, Bank of China and Singapore Airlines. The firm is run by New Zealander Simon Israel and operates separately from GIC, its other SWF.

Qatar Investment Authority

Started two years ago. Led by the Prime Minister, Sheikh Hamad bin Jaber al-Thani, the fund has $60bn under management. Delta Two, a UK fund backed by it, is close to launching an offer for J Sainsbury. It recently bought stakes in the London Stock Exchange and Sweden's OMX, the latter's prospective merger partner. The QIA could try to engineer a full takeover for both.

Dubai International Capital

Controlled by the ruling family, DIC has become one the most active buyers of UK assets. Its holdings include Travelodge, Doncasters and Merlin, owner of Madame Tussaud's. It has minority stakes in HSBC and European aerospace giant EADS. Istithmar, another Dubai fund, owns New York fashion chain Barneys and has a stake in Standard Chartered.