Disclosure concerns have surfaced in three areas: to SWF beneficiaries, to securities markets, and to the U.S. Treasury. Pozen focused on the latter two, since he believes it is inappropriate to question the level of disclosure between SWFs and their investor governments. With respect to the securities markets, SWF are subject to the same disclosure rules as any other investors, for example requiring filing if they control 5% or more of a public equity class. They must disclose to the U.S. Treasury any direct investment of 10% or more of an entity. The European Union has taken a more aggressive stance on the disclosure issue, and has issued proposals that would require SWFs to provide their investment objectives, asset and currency allocations, and quarterly portfolio holdings. Pozen noted that the Norway, Canada, and New Zealand SWFs already provide this level of disclosure. Some SWFs have rejected the idea of investment codes stipulating disclosure requirements, and a couple (Abu Dhabi and Singapore) have adopted codes pledging never to use investments as foreign policy tools and to invest solely based on maximizing risk-adjusted returns. In return, they want assurances against discrimination, insofar as they will not be subject to rules not imposed on other investors.
Pozen predicted a wave of protectionism in the face of growing investments by SWFs. For example, a bill under consideration by the California assembly would prevent California pension plans from investing in private equity funds that also have SWF investors. “There will be a backlash,” says Pozen, “but the public needs to be reminded that SWF investments may be responsible for cutting interest rates by as much as 1% by buying Treasuries, and they have certainly propped up stock prices.” He notes that SWFs have bailed out many financial institutions, without demanding board seats, and have helped these institutions expand abroad. In order to assuage protectionist fears, Pozen recommends the U.S. insist on reciprocity for U.S. investments in other countries.
Pozen said SWFs have been victimized by misperceptions, and are not buying security-related companies, dominating strategic industries, destabilizing the securities markets, or trading on inside information. “The reality is there are tough issues on how much more to disclose and the degree of reciprocity as a response to protectionism,” says Pozen.
Pozen also noted that SWFs represent a big opportunity for U.S. asset management firms, but warns SWF investors are sophisticated and “drive a hard bargain.”
Our Analysis
We concur with Pozen’s assessment of the issues facing SWF investment. The benefits far outweigh the risks. We believe protectionist measures, such as those proposed by the California legislature, are misguided. In the current environment, SWFs are providing an extremely important source of liquidity for financial institutions, and represent a valuable opportunity for U.S. investment managers. Pozen perhaps understates the importance of the liquidity SWFs have provided to the market. The bulk of their investments have been in U.S. Treasuries, so they have effectively lent the U.S. government huge sums, and it is these investments that are jeopardized by the devaluation of the dollar.
Disclosure is the important issue, and voluntary measures may help, but it is unrealistic to expect significant progress in this area, given the general lack of transparency in private investment vehicles, such as hedge funds, in the U.S. markets. Expect more SWF investments in financial firms, as these firms continue to deal with write-offs from the credit crisis.
Wirehouse reps will come under pressure, as some clients will be reluctant to place funds in institutions with SWF ownership, and this will benefit independent RIAs. Wirehouse reps will need to devote resources to educating clients about SWFs, and may face some defections, but we do not see how independent RIAs can capitalize on this through proactive marketing.
At a macro level, the risks posed by SWFs to the financial system are relatively insignificant in comparison to the risks posed by highly leveraged pools of capital in an era of increased volatility.
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