Thursday, October 23, 2008

Sovereign Wealth Funds and the Financial Crisis: Norwegian Sovereign Wealth Funds, India, and the Rising Private Power of Public Organizations

We are all well aware of the current financial crisis--a very slow train wreck almost a decade in the making, ignored (and indeed encouraged) by certain elements of the private sector with the collusion of states and now burst well beyond the capacity of any state to contain it. The brunt of reaction to the crisis has been traditional and conventional. States have sought to intervene directly in their markets and aid domestic enterprises. The American Emergency Economic Stabilization Act of 2008 is typical of these efforts. For an analysis see Larry Catá Backer, The Emergency Economic Stabilization Act in Its Own Words: Complexity, Confusion and Open Questions Law at the End of the Day, October 15, 2008. Other states have adopted similar measures, principally in Europe. In Asia, places like Hong Kong have moved to shore up confidence in its banks by guaranteeing all funds in Hong Kong Bank accounts. And the central banks of several Asian states have been intervening to the extent of their abilities.

In addition, there is talk of grand inter-governmental schemes to coordinate financial regulatory activity and even to replace the current intergovernmental transnational financial system and its star institution, the World Bank and the International Monetary Fund, at a grand convocation of powerful states to be held in November 2008.
"Pressed by European allies also to start work quickly on overhauling the financial system, Bush agreed to host the November 15 summit -- the first of a planned series. . . . The leaders will discuss progress in addressing the crisis, analyze its underlying causes, set principles for reforms and instruct working groups to begin developing recommendations for those solutions, White House spokeswoman Dana Perino said. . . . Invited will be leaders of the G20, which includes the Group of Seven major industrialized nations and key emerging economies like China, Brazil, Saudi Arabia and India. Leaders of the World Bank, International Monetary Fund, United Nations and the Financial Stability Forum have also been invited."
See Jeremy Pelofsky, Financial Crisis Summit Set for November 15: White House, Reuters, October 22, 2008. Much is up for discussion, and there is a chance that little will be done. If only because the consensus possible after 1945 will elude the emerging groups of nations that make up the current internatonal politico-financial order. And more important, perhaps, because key private stakeholders will not be actively participating directly.

And that may be a problem. Most of the schemes floated by desperate states are both highly regulatory and interventionist. "Welcoming the summit details, Sarkozy said the meeting would be "followed by several others aimed at rebuilding the international financial system and making sure the current crisis does not happen again thanks to better regulation and more efficient surveillance of all players."" Jeremy Pelofsky, Financial Crisis Summit Set for November 15: White House, supra. Even in connection with national efforts to contain the financial crisis, such attempts tend to revolve around a willingness to provide ailing sectors of the economy with direct or indirect infusions of capital in return for acceptance of both macro and micro regulation. Micro regulation is taking the form of the petty and vindictive, though as a post facto effort it serves merely as a gesture to assuage the public and preserve the images of politicians as somehow working in the public interest. Among the more publicized of these are the requirements that executive pay arrangements be reformed and specifically that golden parachute payments not be made. Waiting in the wings are the social policy efforts to reform the terms of "bad" mortgages to keep people in their homes. Macro regulation is taking the form of changes in the regulation of banks and their financial arrangements. But there is an element of hybrid action as well. The governments will be taking interests in many of the entities they are "saving"--in the form of warrants from banks and other forms of equity stakes in other enterprises taking state largess. These arrangements will pose something of a conceptual difficulty for the future because the character of those investments--and the power of the state as "shareholder" rather than regulator remains nebulous at best. On the one hand, the state is, as a formal matter, investing in the market in the same way as any other private investor. To the extent it is participating in the market rather than regulating it, then the investment might be characterized as private rather than public. On the other and, this private investment is undertaken in entities over which the "investor" has strong regulatory authority. And indeed, the "investor" has utilized this regulatory power as a critical component of its private investment decision. On a substantive basis, then, the private investment appears to be incidental to the regulatory activity of the state.

But there has also been highly publicized private efforts to shore up confidence (and free up capital) for the debt markets. Among the more well known of these private efforts was tat of Warren Buffet to inject billions into the financial markets. The efforts by the larger and more stable investment houses to shore up its weaker members is another example,. To date, though, these grand gestures have had little short term effect. See Erik Holm, Buffett Buys Goldman Stake in `Economic Pearl Harbor' (Update2), Worldwide, September 24, 2008. But the effort might be viewed as a private effort not so much to shre up the private markets but to prod appropriate state intervention. "Billionaire Warren Buffett, calling turmoil in the markets an "economic Pearl Harbor,'' said his $5 billion investment in Goldman Sachs Group Inc. is an endorsement of the Treasury's $700 billion bank rescue plan. "I am betting on the Congress doing the right thing for the American public and passing this bill,'' Buffett said on cable channel CNBC today. "I certainly have a vote of confidence in Goldman and vote of confidence in Congress.''" Id.

Now comes word that governments, or at least the fince related instrumentalities's of states, are also entering the fray in another form. "In a move that will bring considerable relief to Indian equity markets roiled by the global credit crisis, the Norwegian Sovereign wealth fund (SWF), plans to invest around $2 billion (about Rs9,772 crore) in India, primarily in equities, over the next two months." Sanjiv Shankaran, Norway Fund to Put $2 Bn in India, (India), Oct. 22, 2008). It is managing to do this not by fiat but by the manipulation of its objective investment standards, "because it has increased India's weightage in its investment portfolio." Id.

There are at least two principle ways of characterizing this move. On the one hand, the Norwegian SWF might be in the same position as Warren Buffet. It is, in this case, acting as a private investor in markets outside of its territory--that is outside of its power to regulate. It is because the investment is undertaken both (1) in the ordinary course of such investment (that is undertaken in the same manner of that available to private investors) and (2) is not subject to regulatory leverage (the case if the investment were undertaken domestically) that one could characterize this as akin to private investment activity. And there have been great efforts to arrive at a consensus to this effect. See Larry Catá Backer, Sovereign Wealth Funds: A Smattering of Opinions that Count But Perhaps Ought Not, Law at the End of the Day, August 22, 2008. But that is not the way the Indian media see it.
An SWF is a global investment fund owned by a government. Unlike a private international investment fund, which is governed by profit motives, SWF's might have national strategic objectives that ave made them controversial investment vehicles.
Sanjiv Shankaran, Norway Fund, supra. And one can see why: Norwegian 'investment' will "come into the country at a time when foreign institutional investors (FIIs), the main driver of Indian stock markets, have taken out close to $11.2 billion from the country since January." Id. If the Norwegian SWF is acting counter-intuitively, then its motives must be something other than profit. Or better put, the Norwegian SWF may be wiling to accept financial losses for a greater political value vis-a-vis India. But that is not investing, that is state political activity. And in this case, one that suggests a significant (though in this case positive and welcome) intervention by one state in the internal affairs of another through the form of private participatory activity.

It is for that reason that governments, including that of India, have viewed SWF investment as a political threat--discounting the private character of the investment as well as the power of the state to effectively regulate that private investment by foreign public organizations.
In October 2007, RBI governor Y.V. Reddy flagged India’s position on the global concern about SWFs during a speech in Mumbai.
“India has a stake in the on-going debate by virtue of its increasing importance in global capital flows. The critical issue relates to standards of governance and transparency that are adopted by such funds and the extent of comfort that investee countries have in this regard,” Reddy said.
Sanjiv Shankaran, Centre Puts SWFs Under the Scanner, (India), March 10, 2008. But that reaction has been sidelined by the hard realities of the need for cash. The por cannot afford the scruples of the well off, even in matters of law. In India's case, "the government decided to follow the finance ministry's suggestion tat India could at this time ill afford to be picky about the kind of overseas investors who bring in money." Sanjiv Shankaran, Norway Fund, supra.

The position of states with respect to SWFs, already complicated, appears to be getting even more interesting from a legal perspective. Beyond the usual arguments--that SWF activity is political (and indirectly regulatory) rather than participatory and essentially private) because investment decisions are made to maximize the political agendas of investing states rather than to maximize profit as more conventionally defined. But that distinction is itself highly dubious. Investors sometimes invest for strategic reasons with incidental profit effects--corporate social responsibility movements attest to the popularity and legitimacy of such private investment strategies. Certainly in the United States socially responsible investing similar to that followed by the Norwegian SWF are quite respectable as legitimate private investment aims. States sometimes invest strictly to make a quick return on their investment in the most narrow traditional sense. Private investors sometimes choose to invest to use their shareholder power to effect changes in corporate culture in accordance with their values. States sometimes do the same. States sometimes work through interests in private investment funds. Private investment funds sometimes work in parallel with SWFs. This was the conundrum acing the Indian government:
At one level, it is easy to identify some SWFs, such as Norway’s Government Pension Fund. However, as the aim is to separate a standard foreign institutional investor driven by profit objectives from a sovereign investor with strategic objectives, complications come up.
Some investors from West Asia, for instance, invest in their own capacity. However, loose governance standards can mean an individual’s money snakes in and out of the country’s SWF, making demarcation tough, the official said.
Similarly, if a state-owned firm motivated by strategic aims uses a private multinational investor to invest money in specific Indian companies, identification becomes difficult, he added.
Sanjiv Shankaran, Centre Puts SWFs Under the Scanner, supra. But the equation has changed a bit. No longer worried about either private self regulation models based on transparency, and adherence to some sort of idealized "reasonable private investor" model, nations are becoming more eager for the money held by SWF and will overlook much to attract investment. The Americans have led the way on this one as well. See Larry Catá Backer, Sovereign Wealth Funds And Hungry States: Adjusting the Borders of Public and Sovereign Activity Across Borders, Law at the End of the Day, June 6, 2008. Need changes everything--even in law. The recent reluctance about SWF investment will give way to agreement to treat SWFs like other private investors, at least until the present crisis ends. And then we will see the expected great wave of calls for reform, regulation and distinct treatment for state investors. It is not clear, either now or later, that such distinction is necessary as a general rule.

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