Thursday, February 09, 2017

Sovereign Wealth Funds as Development Mechanisms--The Emerging Case of Turkey and its SWF-SOE Hybrid

I have written about the move among certain developing states to transform the sovereign wealth fund into a mechanism for development and for cross border investment deals. See here, here here and generally here). It is increasingly common to speak of "strategic development sovereign wealth funds" as a contextually relevant mechanism for national development within international investment and project markets. And SWFs are becoming more important actors in development finance (see e.g., Javier Santiso, Sovereign Development Funds: Key financial actors of the shifting wealth of nations (OECD 2008)).

Recently Turkey announced a new wrinkle on the model. Turkey is now using its sovereign wealth fund to aggregate assets that can be used as collateral for investment and development projects at home and abroad. The story and my brief comments follow.

Turkey transfers stakes worth billions in major public companies to wealth fund
Hurriyet Daily News
February 6, 2017

Turkey has transferred stakes worth billions of dollars in Ziraat Bank, the Borsa Istanbul stock exchange, Turkish Airlines and state-owned pipeline operator BOTAŞ, among others, to a new sovereign wealth fund, in a bid to help finance giant infrastructure projects.

The transfers were announced in two separate statements on Feb. 5 and 6, stirring strong criticism from various opposition deputies and economists, mainly due to its audit-free structure and a complicated financing structure, along with the treasury and the finance ministry, which may pave the way for destruction to the country’s fiscal discipline.

The state’s 49.1 percent stake in flag carrier Turkish Airlines - worth roughly $1 billion - and its 51.1 percent of lender Halkbank - worth some $2 billion - have been transferred to the fund, a statement from the government’s privatization administration said on Feb. 6.

Stakes in state-owned Ziraat Bank, the country’s biggest lender, the Borsa Istanbul stock exchange and state-owned pipeline operator BOTAŞ have also been transferred, according to an announcement on the Official Gazette on Feb. 5.

Other assets that were moved to the fund include stakes in fixed-line operator Türk Telekom, oil company TPAO, the PTT post office, satellite communications company TÜRKSAT, Eti Maden mining company and tea producer ÇAYKUR.

Some 3 billion liras of funds under the control of the defense industry support fund will also be transferred, according to the Official Gazette. Some 2.3 million square meters of land, owned by the treasury and located in tourism sites, have also been transferred to the fund.

The value of the transferred assets is estimated at over 31 billion Turkish Liras ($8 billion).

The government aims to generate additional annual growth of 1.5 percent over the next decade through the fund, which was recently launched with an initial paid-in capital of 50 million Turkish Liras ($16 million). Ankara wants the fund to manage $200 billion in assets as soon as possible.

Collateral to secure funding for big projects

The sovereign wealth fund will be able to use the stakes as collateral to secure funding for major infrastructure projects, a senior official told Reuters.

“There will be a search for credit abroad to implement very big projects in the period ahead,” the official said, as quoted by Reuters.

“Turkey’s most important companies have been transferred to the sovereign wealth fund. It will be possible to secure credit at low rates for these projects by offering the shares in these companies as a guarantee,” the official added.

The official did not specify which type of projects the wealth fund may help finance.

Deputy Prime Minister Numan Kurtulmuş said the cabinet took the step to run the companies “more effectively.”

“We also aim to raise the financial resources in the hands of the state through this move,” he said in a press meeting on Feb. 6 following the cabinet meeting.

No audit on fund

The fund will, however, not be subject to review by the court of auditors, according to critics.

While sovereign wealth funds are often associated with oil-rich countries such as Norway or Gulf states, Turkey imports almost all of its energy needs. Some economists have said Ankara could better spend the money by paying down a national debt that runs at roughly 30 percent of economic output.

The fund is headed by Mehmet Bostan, a former finance sector executive who was appointed head of the Privatization Administration (ÖİB) board last year. A top adviser to President Recep Tayyip Erdoğan, Yiğit Bulut, Borsa Istanbul Chair and Chief Executive Officer Himmet Karadağ, and academics Kerem Alkin and Oral Erdoğan have been appointed to the board of the wealth fund, according to the trade registry.

The Turkish SWF evidences a number of significant developments that will impact both development and the development of law in international economic activities.  It suggests as well the advanced stage of the merging of public and private sectors as states increasingly operate as commercial ventures abroad (and now within their borders) while also seeking to act as sovereign regulators when it suits them and gains them advantage. Eventually this sort of activity will collapse the centuries old project of segregating public from private activity.  The effect will be contentious and shift power in unforeseeable ways.  I consider ssome of these briefly.

1.  Despite near heroic efforts to retain the conceptual distinctions between sovereign wealth funds and state owned enterprises, these distinctions are blurring rapidly.  To some extent the Turkish move exposes more clearly the fragility of conceptual barriers between SWFs and SOEs.  Both represent economic ventures of the state.  One may be commercial in nature (SOEs) and the other investment oriented (SWFs), but that difference touches on function rather than character. Regulatory efforts will likely follow this conflation.  To the extent that regulation focuses on function--commercial and financial regulation may continue to follow separable tracks.  But with respect to governance and issues of sovereign immunity, they need not.

2.  The invocation of the SWF form to monetize SOE economic potential for national projects of development within and outside the state puts front and center the issue of the sovereign or state character of these enterprises.  States have managed to have the best of both worlds in this context--they hide behind the protections of sovereignty (and sovereign immunity) when it suits them (usually when liability is incurred), yet they insist on the commercial and private character of these ventures when it suits them (when projecting their economic power outward and into other states).  Perhaps these forms of economic activity will continue to preserve their dual character.  Yet increasingly such dual character offers advantages in markets in which private actors may participate that will corrupt and weaken their legitimacy. We are now well beyond Roscoe Pound's world of Public Law and Private Law (Cornell Law Review 24:469 (1939). This is a world of sovereign conflict of interest (here) and of regulatory governance (here). That conflict of interest will inevitable produce the sort of systemic corruption that will permit public domination of private markets or the governmentalization of private actors. 

3. These hybrid forms can be used to produce structures of systemic corruption that aid the project of national authoritarianism.  The key is in the arrangements of power distributed amnong the state, the SWF and the underlying SOEs. That corruption is bound up in the absence of transparency.  This is an absence not merely relating to SWF activity, but touching on basic financial accounting either for the SWF or the SOEs now within its portfolio. For states with string leaders that give themselves the authority to direct the operations of the SWFs (and the SOEs that form part of it) the temptaiton to use these as power enhancing vehicles may be great indeed.  With reduced transparency accountability and discipline becomes more difficult. 

4.  The result of systemic corruption in development SWFs or SWF-SOE hybrids may be to shift accountability outward.  The state itself becomes the object of monitoring and management by its investment partners.  What will drive this will be the usual incentives of markets and economic activities--SWF-SOE partners will work hard to protect their own interests.  To that extent--and to that extent alone--might they be inclined to monitor and impose accountability standards.  But there are substantial constraints on the value of this shifting.  First, such arrangements may not produce greater transparency and reporting to the public; only the transaction partners will have access to information.  Second, the standards used for accountability be not reflect international consensus or standards. Third, such accountability might produce collusion of the sort that may destroy any pretense of a level playing field in international economic markets or investment markets. 

5.  Where states become more powerful simultaneous regulators and participants in the markets they regulate, the private sector actors will face a challenge of competition.  That may require banding together as a counter force (which states themselves will block through the use of their competition law regimes, but in what might be understood as a corrupt way in aid of their own economic activities) or they will have to vest themselves with governmental authority--and the subsidy benefits that creates.  At its limit (and this is a highly speculative scenario at the moment) the largest enterprises might well purchase their own states for the regulatory power it provides them.  The deal would be simple--powerful economic actors and least developed states would form partnerships in which the regulatory power of those states--their sovereignty and entry into public international forums, and their sovereign immunity would be put at the service of powerful private actor sin return for substantial subsidies out of profit.  Buying sovereignty will be a natural evolutionary step in the development of global markets dominated by enterprises that can deploy both governance and economic authority.

6. The move toward sovereign development mechanisms like these also shifts the trajectories of development from market responses to economic conditions to a state planning model.  It is, in the end, a markets limiting and markets rejecting model.And inevitably state planning has tended to serve as a very poor substitute for market responses.  States do not operate well in risky environments.  State planning is too slow for the sort of responses necessary in fast moving markets.  Infrastructure and training requirements tend to be misdirected because of the substantial disjunction between state planning and front line operations in markets. In the end one winds up with the excesses of systems like that of Cuba--where planning is presumed to be perfectible and that its failures must be ascribed to the labor inputs of state planning--reducing economic activity to a quest for the perfectible worker (e.g., here).

7.  Yet this device can also be markets enhancing.  Chinese SWFs have evidenced the way that sovereign investing through SWFs might both leverage state planning and economic objectives through private market activities abroad and at home (see, e.g., here). But even here, cross subsidization produces stress where state enterprises compete with private concerns. The answer might be to again permit national subsidies of private enterprises--the 45th American Presidency  a might be moving in that direction through tax subsidies, tough it is not clear whether the effort will be well directed or successful.  

8.  Absent from the discussion is the effect of these reorganizations on the duty of the Turkish state to use its resources and powers to protect human rights, and of the responsibility of Turkish SWFs and SOEs to respect human rights in its activities within Turkey but especially in connection with its operations and investment activities abroad (e.g., here). Within international markets, the duties and responsibilities of states and their economic organizations has become clearer.  And market expectations at the global level are not subject to the desires of home states if only because they lack the capacity to coerce agreement beyond their borders.  But this new hybrid organizational form asks more questions than it answers about the resulting obligations of the enterprise and especially its obligations to engage in human rights due diligence and transparent reporting (generally here). 

9.  It is not clear where the Turkish experiment will lead.  It has all the elements for great success or for dismal failure.  It is not clear that a Turkish need for collateral required the reorganization of its SOEs. Direct collateralization might have been as easily effected.  The value added of the reorganization is unclear.  Perhaps it is that the Turkish state means to direct all operating profit of the SOEs as well to or through its SWF to generate further financial resources for stabilization or other projects.  Perhaps consolidation would produce changes in the regulatory environment.  None of this is clear yet.  The dangers and the temptations are quite clear however.   And it is that lack of transparency ad into that ought to cause the greatest worry as Turkey experiments with potentially useful new forms of economic engagement.

10.  More interesting still, my colleague Dini Sejko of the Chinese University of Hong Kong pointed out the military ramifications of the move, specially where the SWF becomes the repository for economic activity that advances military aims.  IHS Jane's 360 reported that:
The Turkish government has transferred stakes worth billions of dollars in major companies as well as a portion of the national Defence Industry Support Fund (DISF) to a recently established sovereign wealth fund (SWF) that is intended to help finance large infrastructure projects.

A total of TRY3 billion (USD811 million) was transferred from the Defence Industry Support Fund; a fund managed by the Undersecretariat of Defence Industries (SSM) used to supplement armament programmes, and which draws income from sources including military-owned defence ventures.

The transfer - announced in the government's Official Gazette on 6 February - is for a three-month period. (Kerry Herschelman, Turkey transfers defence procurement funds to a new sovereign wealth fund (9 Feb. 2017).
 The news is interesting for its implications.  Here we enter the world of 5th generation warfare, of the deep embedding on conflict management and networked systems within webs and clouds (and here).  One is not speaking here of the operationalization fo war but of the embedding of factors within webs that can then affect or manage the conduct or access to resources of potential opponents.  The theory is new and evolving, but the entry of a military apparatus within the hybrid SWF-SOE mechanism ought to make those into whose states these mechanisms seek to enter perhaps somewhat more leery. 

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