An apparent willingness to pre-empt demands for transparency is unlikely to make governments open their airports to sovereign wealth funds, says Shayla Walmsley

The New Zealand government's recent rejection of a bid by the Canada Pension Plan Investment Board (CPPIB) for a stake in Auckland International Airport marked a protectionist end to a tortuous saga.

After gaining critical shareholder approval - including the 6% shareholding of the public pension fund - the C$119.4bn (€73.5bn) pension scheme met the stone wall of the Overseas Investment Act.

Hastily assembled to pre-empt a foreign acquisition, this legislation allows the government to block overseas acquisitions by sovereign wealth funds (SWFs) - in this case because of concerns for jobs, export receipts, investment for development purposes, and state control of ‘strategic' infrastructure.

The irony is that CPPIB has long - and vociferously - denied that it's a SWF at all. In a speech she gave at an OECD seminar in December, CPPIB chair Gail Cook-Bennett warned that protectionist action directed at SWFs would likely penalise "return-driven pension funds" too.

She pointed out that CPPIB, unlike SWFs, does not manage government assets, does not receive "tax revenues or fiscal top-ups", segregates its assets from government assets, operates at arm's length from the government, and has a single mandate to maximise investment returns.

It's a growing trend among public pension funds: to draw a distinction between themselves and sovereign wealth funds. "The position with regard to public pension reserve funds such as the NPRF is quite different to SWFs," says John Corrigan, investment director at the Irish National Pension Reserve Fund (NPRF).

"The NPRF has a specific purpose - to meet as much as possible of the costs of future social welfare and public service pensions - and a clear statutory investment mandate - to maximise the return to the fund subject to prudent risk management."

Not so sovereign wealth funds, set up by governments to invest foreign assets for long-term returns. Yet rarely have so many made so much fuss over what so few are willing to define. In a speech he gave at the end of last year, EU competition commissioner Charlie McCreevy pointed out: "There is no commonly agreed definition of what is a sovereign wealth fund."

Around 45% of SWFs came from oil-rich countries in the Middle East at the end of 2007, fewer than 30% from Asia. Europe, predominantly Norway, accounted for most of the remaining funds.

"The issue of definition is indeed problematic," says Juan Yermo, co-author of an OECD report on sovereign wealth funds. "For the OECD the defining feature of a public pension reserve fund (PPRF) is its use to finance the public pension system. What is fuzzier is the definition of SWF."

Clearly, there are funds and funds. Some - like the Norwegian oil fund, and GIC, Russian and Qatari SWFs - are directly managed by the government or central bank. The €267bn Norwegian ‘oil' fund, only this year announced it would divert 5% of its portfolio to real estate from fixed income after years of lobbying from investment professionals appointed to manage the fund. Others, such as the Korea Investment Corporation and Dubai International Capital, are operated effectively as private companies.

Currently, the level of disclosure varies. Kuwait and Singapore has disclosed some benchmarks. Norway has disclosed benchmarks, the deviation between their strategic asset allocation and holdings, and returns. Russia is as yet an unknown quantity: with its investment strategy under discussion, the fund has not disclosed benchmarks.
Yermo redefines Irish and Norwegian funds as sovereign pension reserve funds (PPRFs). The difference, he says, is that "PPRFs tend to invest less in international assets than SWFs. SWFs are typically fully invested overseas, given their origin as central bank reserves or resource exports."

What he effectively recommends is a two-level regulatory framework, with transparency, effective disclosure and control of conflicts of interest as common factors. Governments "may wish to have a say in the investment policy of SWFs," he says.

"On the other hand, PPRFs are ideally run by autonomous entities with professional investment teams that have been given a clear mandate to maximise investment performance to improve public pension financing."

Yet the distinction is moot. Ted Truman, a former Federal Reserve director and now a senior fellow at the Peterson Institute for International Economics  - who favours a standard that would cover both SWFs and PPRFs - rejects the distinction. "The Norwegian fund is not really a pension fund, nor is it tied to future pensions," he says.
Yermo's is a generous approach to regulation that is unlikely to prevail. Philip Whyte, a senior research fellow at the Centre for European Reform, a think tank, says: "People are interested in their motives. If an SWF buys a bank, they want to know whether the motive is commercial or otherwise, for instance geopolitical. The transparency issue adds uncertainty about their motivations - where they intend to invest and how much."

He adds: "No-one worried about Norway because it's relatively transparent - and it isn't Russia."

It has as much to do with who's worrying as what they're worrying about - in other words, less to do with sovereign wealth funds than with protectionist-minded governments.

The UK sees SWFs as generally beneficial, Whyte points out. "France and Germany tend to be suspicious. They instinctively feel nervous about it," he says. It isn't just infrastructure; it's yoghurt, too. PepsiCo's mooted acquisition of Danone would require prior French parliamentary approval. Draft legislation currently before German legislators would restrict overseas investment in German companies considered ‘strategic'. In contrast, Ferrovial's acquisition of BAA, in the UK, generated "no fuss".

Similarly, Associated British Ports went to a consortium led by Borealis, the infrastructure subsidiary of the Ontario Municipal Employees Retirement System (OMERS), with few protests other than a hostile parliamentary sub-committee report. In contrast, a deal that would have given a UAE company control of operations at US ports was scuppered.

"There's a wide and elastic understanding of what's strategic - and it includes casinos," says Whyte. " It's the thin end of the wedge. If the EU isn't careful, it could end up with protectionism."

Regulatory noises have come from the developed world; not so SWF investment. It's almost a geographic irony, given GIC's aggressive international acquisition strategy, that the Kuwaiti SWF has joined with Macquarie and an Indian infrastructure firm to bid for power companies in Singapore.

There's nothing new about sovereign wealth funds per se. The first, the Kuwait Investment Authority, was set up in 1953; Abu Dhabi Investment Authority came into existence in the wake of the 1973 OPEC crisis, at around the same time Singapore set up Temasek.

Temasek is the older sibling to GIC, which embodies policy-makers' worst fears about SWFs: it's aggressive, opportunistic, hyper-liquid and coming to take your assets.
"What is new is that that these funds have emerged in recent years as active direct investors - acquiring sizeable international assets in sensitive industries, such as transportation infrastructure…and they are growing at an astounding pace," says Cook-Bennett.

When it isn't mopping up trophy assets, the US$100bn (€63bn) GIC is also enthusiastic about real estate. This year to date, it has acquired The Westin Tokyo, Finland's Iso Omena shopping centre, and Roma Est Shopping Centre in Italy. It has also set up joint ventures to invest in Asian and Australian hospitality, and to develop Russian residential.

Despite international investment barely short of swaggering - it points out proudly that it is one of the world's top 10 real estate investors -  even GIC is growing pre-emptively cautious. Although it declined an interview, a spokeswoman points to statements made in December by GIC executive director Tony Tan Keng Yam supporting increased disclosure.

"There is a case for further disclosure on the part of SWFs, in the interest of transparency," he said. Such disclosure can include clarity on the relationship between SWFs and their respective governments, their investment objectives and general strategies, and their internal governance and risk management practices."

In return, GIC wants free markets. "Financial protectionism should be avoided," said Tan.

Likewise the $500-800bn Abu Dhabi SWF denied in March that it would invest to increase political clout. The SWF, which is 5-8% invested in real estate, said its investments - 80% of which are externally managed - were "solely commercial in nature".

Despite SWFs' efforts to mitigate the suggestion of opacity, Rachel Ziemba of RGE Monitor points out that many SWFs have been cagey, if not about investment targets, about returns. The Kuwaiti SWF, for instance, publishes its alternative asset targets, but not returns.

"Increased transparency may help to stave off protectionism, though it is unclear whether sovereign funds will want to disclose all of the details that recipients want to know," she says. "More transparency is in the interest of the sovereign funds and the recipient countries, since it makes motivations clearer and establishes the investor profile, making sudden course changes that could move the market less likely."

Unlike the protectionist barriers, the economic threat is slightly more credibly concerning because there is an outside chance SWFs could disrupt the international financial system. "Large agglomerations of money can make large mistakes or miscalculations," says Truman of the Peterson Institute for International Economics. "SWFs fit that description. The likelihood is low but not zero."

Despite SWFs' efforts to pre-empt it, some form of regulation - or quasi-regulation, such as the standards being developed by the IMF - seems inevitable, even if it's more likely to reinforce the barriers against foreign hordes than to ensure economic stability. But greater transparency may not be enough.

In any case, if these funds have a foolproof plan for world domination, they're going about it in a less-than-foolhardy manner and are, apparently, subject to the same quotidian deal-breakers. A proposed €3.1bn deal by which the Investment Corporation of Dubai (ICD) would acquire Spanish property firm Colonial, for instance, fell through after the sovereign wealth fund failed to reach agreement with Colonial's creditors.

In the meantime, what's changed is not SWFs' purpose but the sheer weight of cash. International Financial Services London (IFSL) claims assets under management of SWFs increased 18% in 2007 to reach US$3.3tn, with US $6.1tn held in other sovereign vehicles including pension reserve funds. It estimates that SWFs' assets under management increased 18% in 2007 to reach US$3.3tn. Interest in private real estate is also high, with 62% of SWFs actively involved in the sector.

This liquidity - they have money when few other investors do - is one reason why some have already made their peace with SWFs.

"I suspect in the time ahead we will see many more enterprises seeking investments from such funds," said McCreevy. "Cutting off access to these important sources of liquidity would be like cutting off our noses to spite our faces."

One such enterprise is the New Jersey Pension Fund, which earlier this year began scouting institutional partners for infrastructure investment as part of a broader strategy aimed at gaining better deal terms. The scheme is targeting co-investment partners including other public pension funds and sovereign wealth funds.

"We're interested in anything that will deliver a positive, strong return. Nothing is off the table," says chief administrative officer Susan Burrows-Farber.

There are good reasons to scout SWF investment - apart from cash. A recent Citigroup report points out that SWFs' political support can help lower political risk (and smooth approvals processes) for companies seeking to make investments in some emerging markets.

In any case, suspicion apart, you could argue that SWFs are the new pension funds - at least in terms of liquidity, long-term investor characteristics and reliance on external managers.

The IMF, with SWF-holding countries, will eventually come up with a transparency standard. But it may not be enough. In the meantime, some things we can forecast with reasonable certainty. SWFs will grow - and they'll increase their share of alternative assets. Merrill Lynch expects them to double or triple their share of riskier alternative assets by 2010.

So should we believe the anti-hype? "I am old enough to remember the concerns when oil rich Middle-Easterners were buying up prestigious companies and landmark London properties," said McCreevy in his recent speech. "As time went by and oil reserves tapered off, so did the fuss."