Tuesday, December 21, 2010

LI Hong on "Depoliticization and Regulation of Sovereign Wealth Funds: A Chinese Perspective": Global Accountability, National Needs

I have recently noted the enormous importance of an inward turn by Chinese academics, and its potential effects on global engagement in the structuring of the production of knowledge.  Larry Catá Backer, Fracture, Translation or Substitution in Knowledge Production: 19th Century European Ethnic Nationalism With 21th Century Chinese Characteristics, Law at the End of the Dy, Dec. 9, 2010.  I have also suggested the fundamental connection between that deepening of Chinese efforts to re-conceive the foundations of knowledge production and the development of Deng Xiaping's vision for Chinese autonomy carefully nurtured and naturalized within China through the cultivation of the Three Represents, Scientific Development (科学发展观) and Harmonious Society concepts.

The 17th National Congress of the Communist Party of China (CPC) started its closing session in Beijing on Oct. 21, 2007.(Xinhua Photo) ("In light of the basic reality that China is in the primary stage of socialism, the scientific outlook on development has been formulated to meet new requirements of development by analyzing China's own practice and drawing on the experience of other countries in development," reads a report delivered by Hu Jintao on behalf of the 16th CPC Central Committee and passed at the closing session of Party congress on Sunday." ) Special Report: 17th CPC National Congress, China.com, Oct. 21, 2007.

It was with this in mind that I read LI Hong's excellent article, "Depoliticization and Regulation of Sovereign Wealth Funds: A Chinese Perspective," recently published in the Asian Journal of International Law (2010) (html version here).  LI explores "the justification and method for depoliticizing sovereign wealth funds. . . from a Chinese perspective" (id., 1) by examining the Chinese sovereign wealth fund umbrella entity, the China Investment Corporation (CIC)  between 2007 and 2009.  (Id.).  LI deplores the early hostility and suspicion with which SWFs were greeted  immediately before the Financial Crisis of 2007 but notes the rehabilitation of the device in the aftermath of the need for SWF recipient states to be less fussy about sources of investment after 2007.  LI notes that CIC appeared to be an especial object of fear and loathing (id., at 2) noting that after a series of well known reorganizations and deals, CIC continues to "face the danger of being misinterpreted as possessing a non-commercial goal."  (Id.).   The object, then, becomes clear--to attempt a theoretics of politicization to counter the suspicions of host states.  To that end LI proposes a four part analysis:  "art I proposes a dual-layer accountability mechanism to define depoliticization. Part II presents the background of the CIC, the legal framework surrounding it, and the flaws of such a system. Part III reviews the investment policies and practice between CIC and financial markets. Part IV concludes with a brief three-step approach to depoliticize CIC." (Id.).


LI starts with the project of depoliticization, which is defined as a move from regulation through political mechanics to one grounded in law and markets (" the term is used to refer to replacing a form of political accountability for regulating SWF operations, with legal and market accountability." (Id., at 3-4)).  By changing the focus of accountability from a demos to markets and their stakeholders, the political can be replaced with the imperatives of wealth maximization shorn of the policy overlay of any state and operated through a set of common rules. 
The market accountability model suggests that market competition provides rewards and sanctions through the aggregation of individual investor or consumer choices. . . . The legal accountability mechanism emphasizes the role of enforceable and explicit rules, which are preset and rule-based, rather than discretionary and sometimes unpredictable rules which can be subject to arbitrary power held by political elites.  (Id., at 4). 
To make this work, LI suggests the importance of transparency as well.  (Id., 5).  Yet there are acknowledged limits to this movement toward depoliticization.  LI notes, tellingly, notes that "there are SWFs—from countries like China and those from the Middle East—which rely on guidance from the political sphere." (Id.).  And that, perhaps, suggests a difficulty with the model that might merit further reflection:  while it may be possible to create a governance system beyond the state, one that relies on markets operating within autonomous rule sets, it is unlikely that SWFs operating within these governance frameworks can themselves entirely escape politics.  As such, it is not clear that political actors (like state-guided SWFs) can escape politics solely by operating within a non-political structure within which they act.  Moreover, legal accountability itself can serve as a medium for the expression of politics and public policy.  For example, it remains unclear whether the Ethics Commission of the Norwegian Sovereign Wealth Fund, in applying international norms are applying such norms from an international perspective or are applying Norwegian law in internationalist guise.

These cautions are made more evident in Part II of the analysis, when LI turns to CIC and its operation (id., 5-14).  LI starts with a background of CIC and its formation before examining the legal status of CIC.  LI argues that CIC is not a sovereign wealth fund when considered through the lens of the International Monetary Fund and its definition creating organs.  (Id., 7).    Instead, LI argues that "CIC should really be legally classified as a special State-Owned Enterprise (SOE) rather than a SWF."  (Id.).
First, the registered capital of CIC comes from fiscal revenue rather than foreign exchange reserves. . . . Second, there is no dynamic linkage, either institutional or practical, between the PBOC and CIC, suggesting that CIC will operate on the basis of the US$200 billion registered capital separately and independently of forex reserve administration. . . .  Third, CIC is viewed as a full ministerial enterprise. . . . They have been periodically scaled and estimated by the State Assets Supervision and Administration Commission (SASAC), and the Organization Department of the Communist Party of China (CPC), in terms of administrative ranking, such as full-ministerial, deputy-ministerial, and so on, according to the strategic importance and performance of the enterprises in their charge.  (Id., 8).
I would tend to agree with LI.  See, 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, 19(1):3-144 (2009) (see especially Part III). Yet I am not sure that from a functional perspective, the legal distinctions is significant.  LI suggests that CICs legal structure might contribute both to the limitations of a necessary transparency required to effectuate market and legal accountability (LI, supra, 10-11) and that it remains subject to popular accountability as a political rather than an economic organ in China and that opens CIC to construction as a political organ of the Chinese state within host countries.  (Id., 11-12). "All of these factors have a negative impact on the accountability and independence of CIC’s decision-making. They also weaken the function of market accountability and are excuses for trade protectionism. The reality in the past year shows that home regulators should play a more important role in the development of SWFs and make their lack of expertise and experience in international investment a top priority." (Id., 12). 

Yet CIC's real difficulties are not in the form of state control but the movement away from it, a movement that has not been appropriately recognized and rewarded within host state governments. 
On the one hand, while still under the control of the State Council, CIC has been placed in the current legal framework and even pushed into international markets without most, if not all, of the privileges enjoyed at home. This legitimization is indeed a kind of progress. In the context of CIC’s formation, the State Council does not (at least not so arbitrarily or publicly), play its old roles as a money- maker with a soft budget or as a de facto self-disciplined market regulator. Instead, it is an indirect and implied controller behind the scenes and a tax collector. On the other hand, this progress is not as apparent, especially in Westerners’ minds—most of whose states have achieved the fiscal as well as governance transformations of modern states even before the last century. (Id., 13)
These difficulties, for LI, suggest the importance of legal and market based accountability regimes to avoid host state regulation. It might, instead, suggest that depoliticization might suggest a set of meanings in host states that are different from those within CIC's home state apparatus.  The difficulty here is not so much with CIC or its formal organizational ties to the state apparatus, but with the more integrated organization of Chinese economic and political life, tied together through the glue of the CCP and its policy goals. This is not to suggest error so much as complexity in the translation of normative perspective between systems.It might be useful to consider the direct application of the scientific development line (科学发展观) and the construction of the relationship between CIC, state and Party apparatus, and then to evaluate those connection s in their own right and in a way that might translate to Western sensibilities.

For LI, correction of this problem and a re-conception of the character of the CIC as non-political,  is not so much a matter of translation as of emulation.  LI elaborates this in Part III (Id., 14-18). 
If the lack of legal accountability could be corrected in some proper way, CIC and other SWFs could be equated with other institutional investors in the global financial market, such as hedge funds, private equities, or pension funds. In other words, on the condition that non-commercial motivations can be separated from the operation of SWFs by an effective legal accountability mechanism, SWFs share plenty of similarities with other institutional investors, especially in decision-making and risk management. (Id., 14).
For that purpose, LI considers CICs investment strategy both outbound and inbound.  LI notes the complexity of CIC's investments.  "CIC is like Temasek as well as like a de facto SASAC; CIC is not only a heavyweight business entity, or even a quasi-monopolist, but also a quasi-governmental agency performing multiple functions. . . . CIC also has a mandate to advance the governance of its affiliated Chinese enterprises and support their attempts to expand globally. Therefore, it is clear that CIC serves strategic purposes beyond purely commercial functions."  (Id., 16-17).   LI lays the blame on the fracture and incoherence of CIC's role in the market . (cf. id., 18).  It might be as useful to suggest that the consequences are not so much that CIC does not function like other SWFs, but that CIC's function make it difficult for it to effectively operate as a non-political entity, even within de-politicized market-legal frameworks.

Yet LI is right to suggest that CIC is not so much an aberation as a harbinger of the future of the successful SWF.  "The near future will witness more CIC-like state-controlled conglomerates or national champions emerging in certain businesses vital to the national interest and people’s wellbeing. From this perspective, CIC is just a microcosm of the transfer of global wealth and economic power now under way, the origins of which lay in China’s market-oriented reforms during the last three decades."   (Id., 19).   For LI  the solution lies in changing the behaviors of state and SWFs.  The goal is the deepening of systems in which state funds can participate in private markets without prejudice or special regulation. 
 Therefore, it is imperative for China and other governments to substitute political mechanisms with legal and market mechanisms. This means that home countries should move first to mitigate the concerns. As for China, the State Council or NPC should clarify the legal status of CIC in special legislation and ensure ‘‘arm’s-length’’ relationships between the professional investment institutions and administrative agencies. . . . As for market accountability, special efforts should be made to create an incentive-compatible remuneration scheme. This should also be different from a valuation system for either civil servants or CPC cadres, in order to attract experts and skilled staff.  . . . The second step is to eschew laws and regulations that target SWFs specifically, and by definition treat them differently from other large institutional investors." (Id., 19-20). 
For LI, then, the conceptual basis that frames recent efforts at the development of a global governance architecture for SWFs, like that memorialized in the Santiago Principles, remains an important and attainable goal. It may be as important as  a method of detaching investment policy from the state as it is focused on opening foreign investment markets to those investments.

The effort is laudable--the deepening of global investment markets more detached from the control of states serves as a great counterweight to the parochial interests of states.  It also serves a s a mechanism through which private power can be deployed to soften the rougher edges of state policy, especially when it seeks to assert influence beyond its borders. But the fundamental character of states is difficult to overcome, and it is unclear that states can shed their fundamental nature merely because they assume a form available to non-state actors. As a consequence, the insight that leads LI toward the necessity of legal and market accountability frameworks is powerful--especially when that sort of accountability is detached from any state (and perhaps is invested in the community of states producing consensus through a blending of their adversarial interests). But LI also demonstrates the difficulties of SWF entities overcoming their own natures.
In a sense the problem of SWFs, like that of SOEs engaging in investment activities abroad, can be reduced to issues of abuse. These include the abuse of power, abuse of corporate form, abuse of the corporate franchise, and abuse of the market. Much of what is required, then, are rules that ensure that, like their private or individual counterparts, abuse is controlled and the integrity of markets is preserved. This is both a tall order and a manageable task. But to that end, a solution requires a reconception of states when they engage in market-participatory activities. (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, 19(1):3-144 (2009), at pp. 144).
LI provides an excellent window on the complexities of sovereign investing within global markets in which a host of participants with different characteristics and powers compete.  LI suggests that the avoidance of fracture, and the need for appropriate translation may produce not so much substitution as accommodation.  That is a worthy objective.

No comments: