Saturday, January 23, 2010

China's Sovereign Wealth Fund's Operations August 2009 Through January 2010: The ActionPlans of Sovereign Activity in Private Markets

The Chinese Sovereign Wealth Fund has emerged at the end of last year as a powerful force in private markets. A review of its activities during the last six months suggests the way in which state policy, political objectives for economic activity can be harmoniously mixed with profit maximization to deepen a new form of investing that is neither entirely private (as conventionally understood) or wholly public. 

I have suggested that
The Chinese efforts to coordinate sovereign investing present a potentially substantial advance in the integration of programs of sovereign investing, public policy, and private markets.[1] This integration suggests that it may not make sense to segregate SWF regulation from other investment vehicles. Instead it may be possible for a state to employ a policy of politically motivated interventions in foreign markets and markets for control that is, simultaneously, financially motivated. It follows that sovereign investing may not be adequately regulated through frameworks that pretend sovereigns can detach pieces of themselves and operate them as if they had no connection to them or interest in them. At the same time, this integration suggests that sovereign investing is, to some extent, a captive of the markets in which they operate—sovereign investment entities abroad will be subject to those host state national regulatory regimes that affect, in equal measure, all economic organs and the markets in which they operate. Yet, the measure of that success, actualized in conventional terms, may continue to reflect a public and sovereign purpose effectuated within the territory of competitor sovereigns. The rise of sovereign market participatory entities, operating as a coordinated network of both sovereign and private actors, seeking to maximize economic and political objectives, will require a responsive regulatory framework substantially different from those currently in gestation. Larry Catá Backer, Sovereign Investing in Times of Crisis: Global Regulation of Sovereign Wealth Funds, State Owned Enterprises and the Chinese Experience. Transnational Law & Contemporary Problems, Vol. 19, No. 1, 2009; Penn State Legal Studies Research Paper No. 12-2009
Xie Ping & Chao Chen, Sovereign Wealth Funds, Macroeconomic Policy Alignment and Financial Stability 3 (China Investment Corporation, Working Paper Series, 2008), suggested that  CIC was engaged in a sovereign investment strategy that coordinates all elements of public and private power, and, to some extent, private actors as well, to project state power abroad in a coordinated and directed way. “It is possible for size and behavior of investments by SWFs to affect a country’s financial market, monetary policy, balance of international payments, and fiscal policy, even wealth allocation in public sector and investment behaviors in private sector.” Id. at 3. The pattern of investment of CIC provides some support for this view.

I. Investment in Natural Resources and Energy Developing Companies

UP to the end of year 2009, CIC has reached out to the U.S., Canada, Kazakhstan, Indonesia, and several other countries in its hunt for resources. The reason is simple: China needs more resources to fuel its economy and it is a good time to buy. In the past, political opposition from developed countries encumbered China from seeking natural resources in these countries, so that China used to target areas like Central Asia and Africa to secure energy resources. “China has good relations with developing countries like Nigeria and Angola and this helps secure deals.”[1] The economic recession has rendered some natural resources firms in most developed countries in urgent need of finance. As a result, these firms would not say no to CIC’s investment, which suggests a possibility that, from now on, China might be able to secure natural resources not only from developing countries, but also globally through its investment in large international entities that have presence all over the world.

A. AES Corp. In September 2009. The Wall Street Journal reported CIC’s negotiation and prospective investment with the Virginia-based power-plant developer, AES Corp..[2] AES Corp. describes itself as “a global power company with generation and distribution businesses.”[3] “Founded in 1981, AES built its first power plant in 1985 in Texas, which was also one of the first competitive power plants in the United States.”[4] AES has also been seeking global expansion. Currently, it is active in 29 countries. Also according to The Wall Street Journal, about two-thirds of its investments are in the power-generation business and one third in utilities.[5]

Two possible reasons drove AES’s seeking of cooperation and investment in China. First, AES suffered as Enron Corp.'s collapse prompted investors to pull back from power-plant developers and credit got tight.[6] Second, although it has a significant power-plant development business, AES has had little presence in one of the fastest-growing markets -- China.[7] At the same time, “China is especially alluring to AES because many other nations, including the U.S., are experiencing declining electricity demand, while demand in China is still growing. About 6% of AES's megawatts under development are in China, compared with 37% in Chile, 25% in Bulgaria and 12% in Jordan, its top three countries for expansion.”

In November, the said negotiation came to a close. As CIC declared on its official website,

“[CIC] made an investment through a wholly-owned subsidiary in the amount of USD 1.58 billion in AES Corporation (“AES”). At close, CIC will acquire 125.5 million shares of AES stock for USD 12.6 per share, representing approximately 15% equity interest in the company. According to the investment agreement, CIC will nominate one director to the AES board.”[8]
In addition, CIC also declared that CIC had signed a letter of intent with AES to invest an additional USD 571 million for an approximate 35% in the wind generation business of AES.[9]

The Wall Street Journal commented on this deal:
“A deal with AES would demonstrate China's increasing comfort with politically sensitive investments. Historically, the U.S. has been leery of any Chinese investments in American infrastructure companies, fearing potential espionage. …… In 2005, China created an uproar in the U.S. when a state-owned oil company made a bid for California-based Unocal Corp. But fears in the U.S. and elsewhere about China taking control of major companies have subsided in recent years, largely because tight credit has made both companies and governments eager to gain access to Chinese capital.”
B. Noble Group Limited. CIC declared on its official website in November that it had completed a USD-858-million investment in Noble Group Limited (“Noble”).[10] In this investment, CIC purchased 573 million shares in Noble, at SGD2.1137 per share, accounting for 14.91% of Noble’s outstanding shares on an undiluted basis.[11]

Earlier than CIC’s declaration on this investment, the Noble Group announced the investment agreement. Transactional statistics provided by both parties are consistent. Noble stated that
“[The investment] comprised of 438,000,000 newly issued shares by the Company and 135,000,000 shares from trusts associated with the interests of Noble founder and CEO Richard Elman.”[12] Noble further stated that
“The shares sold by interests associated with Mr. Elman represent a small fraction of his holdings in the Noble Group and are only the second such sale by Mr. Elman since he founded the Group. It is the intention of Mr. Elman to use some of the proceeds associated with the sale of his interests in Noble to fund a charitable foundation with a focus on fostering international relations amongst Asian nations.”[13]

Noble engages in the business of supply chain management. It manages the global supply chain of agricultural, industrial and energy products.[14] Expanding from its traditional business of transportation, Noble has showed interest in natural resources.

“With 2008 annual revenues exceeding US$36 billion, Noble continues its transition to owning and managing more strategic assets, sourcing from low cost producers such as Brazil, Australia and Indonesia and supplying to high growth demand markets including China, India and the Middle East. Today, Noble has interests in coal and iron ore mines, grain crushing facilities, sugar and ethanol plants, fuel terminals and storage facilities, vessels, ports and other infrastructure to ensure high quality products are delivered in the most efficient and timely manner to its customers.”[15]

C. Kazakh Gas Companies. In September 2009, it was reported that CIC had bought a stake in the London-traded unit of Kazakhstan’s state-run energy company, taking its spending on resources to at least $3.69 billion.[16] “[CIC] bought an 11 percent stake in Astana, Kazakhstan-based JSC KazMunaiGas Exploration Production for about $939 million by purchasing global depositary receipts.”

At the same time, PetroChina Co., the country’s biggest listed oil company, agreed in April to pay up to $1.4 billion for half of a gas joint venture in Kazakhstan. PetroChina will hold 50 percent of the venture and state-owned KazMunayGaz National Co. will own the remainder.[17]

D. PT Bumi Resources Tbk – CIC’s “First Significant Investment in Indonesia”[18]. CIC declared on its official website that CIC invested US$1.9 billion strategic investment in PT Bumi Resources Tbk (“Bumi”).[19]

In addition, CIC also declared that it and Bumi have agreed to form “a strategic alliance, which would allow CIC to facilitate and participate in the future financing needs of Bumi or its affiliates, including project finance for its expanding infrastructure. CIC and Bumi will also jointly pursue other investment opportunities in the mining sector.”[20]

E. Russia Nobel Oil group. CIC has agreed to invest US$ 300 million in aggregation in Russia Nobel Oil Group.[21]
“The US$ 150 million in Phase I investment includes $ 100 million for the purchase of equity stake from Russian shareholders and $ 50 million for Nobel's operating expenses. In Phase II, the remaining US$ 150million is to be used within 9 months for acquiring and developing oil reserve assets (approximately 150 million barrels) in close proximity to Nobel's existing oilfields.”[22]
By November 2009, CIC had completed the settlement for its Phase I investment in 45% of the equity in Nobel. HongKong’s Oriental Patron had acquired 5% equity stake. The original Russian shareholders maintain their 50% stake. The name of the new holding company is Nobel Holdings Investments Limited ("Nobel").[23]

F. GCL-Poly Energy Holdings Limited (“GCL-Poly”). In November 2009, CIC signed a binding framework agreement with GCL-Poly Energy Holdings Limited (“GCL-Poly”) for the subscription of approximately 3,108 million shares of GCL-Poly at a price of HK$1.79 per share.[24] “CIC and GCL-Poly intend to establish a joint venture to invest in and develop photovoltaic projects or other solar energy projects based on an initial capitalization of US$500 million.”[25]

II. Investment in Financial Companies

A. Oaktree. The Wall Street Journal reported that CIC had agreed to invest about $1 billion in Los Angeles-based Oaktree Capital Management.[26] CIC may further invest another $2 billion directly into other hedge funds, but it is pressing for lower fees.[27] “The paper said other funds that could get CIC money include Winton Capital Management, Lansdowne Capital, Och-Ziff Capital Management and Canyon Partners.” [28]

III. IFC's Debt and Asset Recovery Program (DARP)

World Bank President Robert Zoellick said in October 2009 that the CIC had shown interest in investing in a new International Finance Corp program to acquire and restructure distressed debt in developing countries.[29] IFC's Debt and Asset Recovery Program (DARP) is aimed to mobilize private investment to buy into pools of distressed debt and invest directly in businesses that need to restructure debt.[30]

IV. CIC May Receive Additional Funds from China’s Foreign Exchange Reserves

The Financial Times reported in December 2009 that CIC may get $200 billion in new funds from China’s foreign exchange hoard.[31]

China set up CIC to actively manage the country’s foreign exchange reserves. It was reported that CIC could earn more than 10 percent from its investment for 2009, up from 6.8 percent for the previous year.[32] In addition, people expect CIC’s assets to increase as the global economy and financial markets showed signs of recovery. Under these circumstances,  it is no wonder the Chinese government would like to allocate more funds to CIC, looking forward to more return.

In an excellent article, Ashby Monk and Gordon Clark recently provided insightful context to these moves:
The rapid ascent of the CIC proves that, despite the global financial turmoil, China's economic power is intact. In 2009, China may have supplanted Japan as the world's second-largest economy and edged past Germany as the world's leading exporter. Meanwhile, the country's foreign exchange reserves have continued to set records, recently reaching $2.4 trillion, almost all of which has been accumulated during this millennium.  In fact, rather than stemming the CIC's growth, the global financial crisis has had a profoundly positive effect on China's SWF. Although the fund struggled to overcome a series of managerial, financial, and geopolitical hurdles upon its creation, the financial crisis set the stage for a remarkable transformation. Now, the fund has matured into perhaps the world's largest and most influential strategic investor. Ashby Monk and Gordon L. Clark, Singing in the Rain: How China's fund of billions prospered during the financial crisis -- and what that means for the future of Asia's fast-growing economic superpower, Foreign Policy, Jan. 24, 2010.

The Chinese sovereign wealth fund moves over the course of the last six months suggests not merely power within global private markets, but also the mechanics of an operation that are neither entirely public nor private.  The size, strength and character of Chinese sovereign investing is now poised to change the nature of our understanding of "private" global markets in ways that will pose a challenge not to states, but to the power of private capital.  Monk and Clark suggest "Perhaps the crisis illustrated to many the benefits of having a fund that can underwrite a public purpose and facilitate long-term planning, when compared to the apparent failure of our politicians and financial institutions to look beyond the present election or fiscal quarter."  Id.  That is certainly true; but it also suggests a growing acceptance of sovereign activity in markets, the consequences of which may be both hard to gauge and will affect everything from conceptions of sovereign immunity, to the governance role of private institutions.  Most importantly, where global regulators become major players in the markets they regulate (and now increasingly  in the form of transnational norms) the conceptual basis of globalization dominant since the 1980s may also give way to emerging realities.   Jurists in the European Union developed  the notion that a state may only rarely (and with difficulty) shed its sovereign and regulatory character even when engaged in private market activity especially within its own regulatory space.  Larry Catá Backer, The Private Law of Public Law: Public Authorities as Shareholders, Golden Shares, Sovereign Wealth Funds, and the Public Law Element in Private Choice of Law. Tulane Law Review, Vol. 82, No. 1, 2008  In such a context state investment  inevitably had a distorting effect on the operation of private markets to its advantage.  If this notion is correct, then the extension of global sovereign investing in transnational markets regulated by its principal political players will require close scrutiny as it developes over the next half decade. 


[5] The Wall Street Journal further stated, “[AES] owns 14 utilities that serve 11 million customers, including customers in Indianapolis. It also has power facilities in New York, Texas, and California. AES's earnings growth is largely driven by its construction program, as projects are completed and begin producing cash. Earlier in the decade it was considered a hot stock and traded for $50 to $70 a share.”

[7] “It has about 200 megawatts of wind-generating capacity under construction there now, half-owned by a Chinese partner, Guohua Energy.”

[24] “The total investment is around HK$5.5 billion. The subscription is conditional upon, among other things, the signing of definitive documentation and approval by GCL-Poly’s shareholders. Upon completion of the subscription, CIC will own an approximately 20% stake in GCL-Poly on a fully-diluted basis.”

[26] “Oaktree was founded in 1995 in Los Angeles and New York by a team of debt investors including Howard Marks, who is still its chairman. In July, Oaktree was among nine big asset-management firms chosen by the U.S. Treasury as fund managers for the Public-Private Investment Partnership, or PPIP, the government program designed to rid banks of toxic assets.”

No comments: