Saturday, January 30, 2010

Sovereign Wealth Funds and Internal Contests for Control of Sovereign Investing: Considering China and Brazil

Generally, the simplest answer or assumptions are bound to be correct. But sometimes efforts to simplify, and especially simplifying assumptions as a foundation to analysis, can lead away from useful analysis. These truisms are well known, yet for all the knowing the temptations of oversimplification are quite strong. This may be especially true when confronting new politico-legal phenomena like sovereign wealth funds. This short essay is meant to highlight a potentially harmful oversimplifying assumption in the construction, implementation and use of sovereign wealth funds—that they represent a considered and unified policy of a state. The operations of a sovereign wealth fund may appear to be part of a set of coordinated efforts by a state geared to the single minded projection of their wealth abroad in the context of external contests for control of economic power through private markets. However, it appears that sometimes sovereign wealth fund activity may also evidence the projection abroad of internal contests for control of significant sectors of the state governmental apparatus. To illustrate this, I will look briefly at the contexts in which sovereign wealth fund as are formed and operate in Brazil and China.

Conventionally, the focus on the character of the ownership of sovereign wealth funds is grounded in the assumption of an identity between the sovereign and the investment vehicle. Because the state is the owner, the fund is the state. “SWFs are, by definition, extensions of the state. They are therefore viewed as maximizing their country’s long-term strategic interests rather than as profit-maximizing actors.” (Daniel W. Dezner, Sovereign Wealth Funds and the (In)security of Global Finance, 62 J. Int’l Aff. 115, 117 (2008)). But that assumption, true enough, is grounded on a further assumption—that the state is a unitary actor in which all of its ministers and departments work together for a singular purpose. But of course, even a short reflection tends to suggest the error of this assumption. In China, for example, no functional distinction is made between its sovereign wealth fund, operated by the China Investment Corporation (CIC) and the State Administration of Foreign Exchange (“SAFE”), a purely sovereign entity charged with the conventional task of managing China’s reserves reporting to the State Council and charged with managing China’s foreign exchange. (State Administration of Foreign Exchange, Major Functions). Both now appear to invest directly in offshore equities. “As the CIC begins to expand its own outbound investments, SAFE is demonstrating its own intentions to occupy the same space. SAFE recently sank $2.5 billion in a $17 billion fund managed by TPG for private-equity investments. In addition, the foreign exchange manager has bought around $2 billion in shares of British Petroleum and around $2.5 billion in shares of France’s Total.” (Logan Wright, CIC and SAFE: Coordination or Bureaucratic Conflict?, China Stakes, June 24, 2008).

Yet what appears to be a coordinated effort to deploy China’s wealth outbound, actually masks a set of what may be extremely powerful institutional (and perhaps personal) antagonisms between two powerful sectors of the Chinese state apparatus. To some extent, CIC competes with the State Administration of Foreign Exchange (SAFE), the traditional agency charged with managing the nation’s foreign reserves, and the People’s Bank of China, which “formulates and implements monetary policy.” (People’s Bank of China, Major Responsibilities). There are some indications that the relationship between them is not necessarily cooperative, but instead reflects contests for power to control China’s significant national wealth. One account suggests an intention at the highest levels of government to create competition of sorts among state sector entities, and principally between the People’s Bank of China and the Ministry of Finance, to induce better performance based on an assessment that conservative policies to protect the Chinese currency no longer needed to limit the use of reserves. The result was a decision to create a sovereign wealth entity. “Eventually, the CIC was created under the control of the State Council, and out of the bureaucratic reach of either ministry, but was staffed primarily with personnel tied to the Ministry of Finance and the NDRC.” (Logan Wright, CIC and SAFE: Coordination or Bureaucratic Conflict?, China Stakes, June 24, 2009).

The result may substantially affect analysis of the investment activities of SWFs. Thus, for example, it may be as useful to analyze the pattern and scope of CIC investments for their effects on the distribution of policy and management power in contests between CIC and SAFE (or between the People’s Bank of China and the Chinese Finance Ministry) as it may be to focus on the way in which such investments speak to policy determinations by the highest levels of Chinese government. Of course, it is most likely that financial decisions at a micro level may reflect more the need to meet outward investment objectives. But in the aggregate, the flow and direction of investments may be as pointed to acquiring advantage over internal rivals as it is focused on acquiring dominance in foreign private markets in those sectors deemed important by the state. The regulatory consequences of this more subtle approach can be different from that of a more simple-minded conception of SWFs as merely a publicly owned private enterprise substantially disconnected from the state apparatus that owns and funds it, and whom it ultimately serves.

A similar complexity can be discerned in the development of the Brazilian Sovereign Wealth Fund.  The Sovereign Wealth Fund was created by Lei No. 11,887, of December 24, 2008 (in Portuguese). In an important article by Arthur Oscar Guimarães, Fundo Soberano, Revista de Conjuntura 23-27 (July 2009), a similar pattern of external unity masking significant internal contests can be discerned involving the central bank (Banco Central e Tesouro Nacional) and the ministry of finance (ministerio da fazenda). As in China, it appears that the Finance Ministry was able to assert authority over the opposition of the Central Bank in the construction and construction of the Brazilian version of this investment vehicle.
[N]o final de 2007 o debate sobre a constituição de um “fundo soberano” brasileiro se fazia presente na mídia. . . . Naquele momento a falta de consenso quanto ao papel destinado a um fundo desta natureza já se explicitiva no seio do governo e mesmo entre outros especialistas. Para alguns membros do governo o acúmulo de reservas internacionais tendência crescente seria usado (essa era a expectativa de então) na criação de um fundo soberano, que serviria para o governo investir recursos na eventualidade de uma crise financeira de grandes proporções. Entretanto, a falta de consenso alcançava até mesmo o objetivo do fundo. O presidente do Banco Central, Henmrique Meirelles, refutava a idéia de que o fundo poderia fazer um uso alternativo das reservas do país. Id., at 23-24. (At the end of 2007 the debate on the creation of a Brazilian "sovereign fund" was reported in the media. . . . At that time the lack of consensus about the role intended for such a fund had been already pointed out within the government as well as other specialists. For some members of the government the accumulation of upward trending international reserves would be used (this was the expectation at the time) to create a sovereign fund, which would provide the government with resources to invest in the event of a financial crisis of major proportions. However, the lack of consensus even included the goal of the fund. The chairman of the Central Bank, Henrique Meirelles, refuted the idea that the fund serve as an alternative use of nation’s reserves.)

Nonetheless, a SWF of asome kind was in the offing. The critical question was reduced to one of control—whether the fund would come under the control of the Central Bank or the Ministry of Finance. And that question subsumed within it the question of funding. In other words, if the Central Bank was opposed to the idea of the SWF and unwilling to allow funds under its control to be used for that purpose, could the Ministry of Finance go forward with the fund and without the Brazilian reserves controlled by the Central Bank?
Em maio de 2008, ganhava relevo a criacão de um fundo de poupança fiscal, denominação então utilizada pelo ministro da fazenda para o fundo soberano brasileiro, cujos recursos, aplicados em dólar, seriam usados para financiar, a taxas subsidiadas, empresas brasileiras com atuação no exterior. A proposta do ministro Guido Mantega estava praticamente formatado e aprovada faltando fechar uma questão importante: quem iria administrar esse fundo, se a Fazenda ou o Banco Central. A mídia noticiava que o BC permanecia não muito entusiasmado com a proposta, particularmente porque temia influências indevidas na formaçã da taxa de câmbio. Por isso, no caso de criação do fundo, defendia que a administração ficasse com a diretoria da autoridade monetária. Id., at 24. (In May 2008, the creation of a tax savings fund gained prominence, [the tax savings fund being] then the name used by the finance minister for the Brazilian sovereign wealth fund, whose resources were to be applied in dollars, to be used to finance, at subsidized rates, Brazilian companies with operations abroad. The proposal of the Finance Minister Guido Mantega was essentially structured and approved except with respect to an important issue: who would manage this fund, the Finance Ministry or the Central Bank. The media reported that the Central Bank was still not very enthusiastic about the proposal, particularly because of the fear of undue influence in setting the exchange rate. Therefore, in the case of creation of the fund, the Central Bank insisted that administration stay with the board of the monetary authority.).
The essence of the contest was thus both simple and complex—at one level the issue was about the use of Brazilian reserves. At another level, the issue was the power to control those reserves and the scope of permissible investment of those funds. This was not merely a matter of monetary policy, or of a refined analysis of the legitimacy of national authorities projecting financial power in private markets abroad. Rather, the more important issue was on the division of authority over those funds (and the direction of investment) between two coordinate sectors of the state government apparatus.

As in China, the ultimate decision favored the Finance Ministry over the Central Bank apparatus. But in the case of Brazil, there was a twist.
A decisão então tomada seria a de criação de um fundo soberano de US $10 bilhões para atender à demanda de financiamento de BNDES [the Brazilian Development Bank, see] para 2008. Tratava-se, portanto, de um fundo que seria alimentado pela “aquisição de dólares que estão sobrando no Mercado. . . . O BNDES tinha a intenção de captar pelo menos R$ 25 Bilhões, metade dos recursos já disponíveis. Id., at 24. (The decision taken would be to create a sovereign fund with $ 10 billion to meet the demand for financing from BNDES [the Brazilian Development Bank] for 2008. It was, therefore, a fund that would be powered by the "acquisition of additional dollars from the market. . . . BNDES intended to raise at least $ 25 Billion, half of the resources already available.)
Whether or not the sovereign wealth fund succeeds, it has succeeded in producing a significant shift in monetary policy from the Central Bank to the Finance Ministry. 
Portanto, qualquer posicionamento definitivo sobre o erro ou acerto a respeito da criação do FSB, parece hoje precipitado, mas a título de conclusão ficamos com a afirmação do próprio Paulo Nogueira Batista: “Por que então a barulho na imprensa e a indignação da turma da bufunfa? Arrisco uma hipótese: a criação de um fundo soberano com parte das reservas, ou com reservas adicionais a serem adquiridas no mercado pelo Tesouro, resultaria em uma certa redistribuição de poder dentro do governo. Perderia o Banco Central, ganhariam o Tesouro e o BNDES.” Id., at 27 (Therefore, any definitive statements about the error or arrangement concerning the creation of the SWF, now seems premature, but in conclusion we get the affirmation of the very Paulo Nogueira Batista, "Why then the fuss in the press and the indignation of the monied classes? I venture a hypothesis: the creation of a sovereign wealth fund with part of the reserves, or with additional reserves to be acquired by the Finance Ministry in the market would result in the certain redistribution of power within the government. The central bank’s loss would be the gain of the Finance Ministry and BNDES).
In this Brazil and China appear to be going down similar paths. And in both cases, internal contests for control of the direction of the investment of national wealth appears to be a significant factor in the formation and deployment of sovereign wealth vehicles. But it does more than that—the movement of control of reserves, or other form as of national wealth, from the Central Banks to the Ministries of Finance signals a global move toward more aggressive interventions in both public finance and private markets. SWFs are here to stay because as a consequence of globalization, global private markets are a far more lucrative method for managing national wealth, and a more potent arena for effectuating national policy. Central Banks are, by the reality of the traditional limiting cultures of their operation, less capable of exploiting these new methods of government operation.  Central Banks  may be capable of engaging in the regulation of global markets, but appear less willing to participate in those markets. Such market participatory activities are more likely to be taken up by the more entrepreneurial Ministries of Finance.  This seems to be the case in Brazil.  On the other hand, in China, the move toward more aggresive intervention in private markets seems to have pushed the Central Banks and SAFE to change their more cautious approaches.  That has sparked a measure of competition both for shares of power within the government, and for investment opportunities outside China, 


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