October 28, 2008
HP-1241

Deputy Secretary Robert M. Kimmitt
Remarks at the Dubai International Financial Centre

Dubai - Thank you, Nassar, for that kind introduction.  It is a pleasure to be back in Dubai, especially at this magnificent financial center.  I want to thank Dr. Omar for hosting our delegation here today and congratulate him for his success in building the DIFC into an important financial center for the region and beyond. 

As we meet today, countries around the world are encountering unprecedented economic challenges.  Financial market conditions are severely strained, and risks to the global economic environment are the most serious and challenging in memory.  In recent weeks, it has become evident that the turmoil is not isolated to the United States and Europe, but has ramifications for all countries, including in the Gulf. 

Our capital markets are more integrated than ever before, allowing opportunities, but also financial difficulties, to spread rapidly across borders.

It is critical to learn the correct lessons from the current turmoil, starting with the fact that our economies are stronger acting together than in isolation.  Collectively, we need to rebuild confidence in our markets so that capital can flow again to help spur global growth.

In the past two weeks alone, we have witnessed an unprecedented international response to this financial turmoil.  The Group of Seven industrialized countries are implementing a coordinated action plan to stabilize financial markets and restore the flow of credit.  Others around the world, from Hong Kong to Denmark, have adopted similar approaches.  Countries are taking steps to provide liquidity to markets, strengthen financial institutions, prevent failures that pose systemic risk, protect depositors, and enhance confidence in financial institutions.  While financial markets have begun to respond positively to these unprecedented efforts, much work remains.   

The Emirates' financial authorities have also taken decisive actions to bolster local markets and provide valuable feedback on the steps the United States and other countries have announced.  For some time, the United Arab Emirates have been an example of strength through cooperation, working together to channel natural resource wealth toward economic diversification.  The Emirates have shown leadership and vision in economic modernization and have become a beacon for financial market liberalization in the Middle East.  The Dubai International Financial Centre represents the incredible strength that can be achieved through openness.  The DIFC's promotion of better business practices and financial sector reforms has helped transform Dubai into a globally-recognized hub for international business and finance. 

The UAE's openness has also brought exposure to global economic turmoil, and changes in global credit markets are affecting both the Emirates and the Gulf more broadly.  This is even more reason why we need to continue to work together to get through this difficult period.  To give investors confidence, promoting a consistent message on the importance of market stability and investment flows is more important than ever before.  We are economic partners and allies who are taking decisive steps to address the situation at hand. 

Before looking forward to actions we and others need to take, however, it is important to understand how we got to this point.

Root Causes of the Market Turmoil

The story begins with a decade of benign economic conditions marked by low interest rates, low inflation, and less volatile asset markets, leading many to ignore the "risk" half of the risk-reward equation at the heart of financial markets.  Investors around the world, who in preceding years had enjoyed above-historical returns on most assets, continued reaching for ever-higher gains.  In response, the financial services industry created a variety of complicated financial products designed to meet this demand, and regulators and investors alike showed a growing complacency toward risk.  These factors, blended together, created underlying conditions ripe for instability.

The imbalance between risk and reward was most evident in the U.S. housing market, where lenders significantly loosened credit standards, particularly for a new generation of adjustable-rate mortgages.  Last summer, these vulnerabilities in our financial system became clear, as looser credit standards in the housing market, combined with an end to years of rapid home-price appreciation, led to a significant rise in delinquent mortgages.  This in turn contributed to immediate and unexpected losses for investors and a reconsideration of the risk-reward relationship--first in housing, and soon after, across all asset classes.  Shaken investor confidence in housing-based assets had a domino effect throughout world markets, ratcheting up demand for cash and liquidity, and curtailing the pace of the new lending and investment necessary for continued growth.

Current Market Developments

We now find ourselves in the midst of an historic reassessment of risk by the world's financial markets.  For its part, the U.S. Government has taken a number of bold steps to stabilize markets; mitigate the systemic impact of a number of failed institutions; and address the underlying sources of market uncertainty.  These measures include:

• First, in early September, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac, the government-sponsored enterprises that are the largest sources of mortgage finance in the United States, into conservatorship.  Under the conservatorship, Treasury will ensure that each company maintains positive net worth and can fulfill its financial obligations.   
• Second, central banks from around the world have acted together in recent months to provide additional liquidity for financial institutions.  The U.S. Federal Reserve has established swap lines with a number of central banks to reduce pressures in global short-term U.S. dollar markets.  Moreover, to further increase access to funding for businesses in all sectors of our economy, the Federal Reserve just yesterday launched a Commercial Paper Funding Facility, which provides a broad backstop for the commercial paper market by funding purchases of commercial paper of three-month maturity from high-quality issuers. 
• Third, in early October, Treasury implemented a temporary guaranty program for the U.S. money market mutual fund industry, which had experienced funding problems. This temporary $50 billion guaranty program offers government insurance to assure investors that these money market investments are safe and accessible.  The Federal Reserve has followed up with its Money Market Investor Funding Facility, which supports a private sector initiative designed to provide liquidity to U.S. money market investors.
• Fourth, with the support of Treasury and the Federal Reserve, the FDIC has temporarily guaranteed newly-issued senior unsecured debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing deposit transaction accounts.  These actions are specifically designed to unlock interbank lending by mitigating counterparty risk.  Regulators will implement an enhanced supervisory framework to assure appropriate use of this new guarantee.  This important action, combined with the increase in the FDIC's deposit insurance from $100,000 to $250,000, will provide confidence in the banking system and encourage liquidity between banks in the United States.  
• Fifth, and what has attracted the most attention, Congress passed and the President signed a financial rescue package that includes, among many provisions, the authority for Treasury to purchase troubled assets from banks and financial institutions and also to inject capital into banks through a voluntary capital purchase program.  In mid-October, nine of the largest U.S. financial institutions indicated that they would seek an aggregate of $125 billion, and Treasury has begun to approve capital injections into other institutions on a rolling basis. 

Together, these actions significantly strengthen the capital positions and funding ability of U.S. financial institutions, enabling them to perform their role of underpinning and facilitating overall economic growth. These actions demonstrate to market participants around the world that the United States is committed to taking all necessary steps to unlock our credit markets, minimize the impact of the current instability on the U.S. economy, and restore the health of the global financial system.

As Secretary Paulson has said, it will take time for these measures to work.  The U.S. economy faces difficult quarters ahead.  But, the underlying long-term strengths of the U.S. economy, based on a skilled, productive, entrepreneurial, and flexible labor force, will enable us to recover stronger than ever.  

The steps being taken in the United States are consistent with the efforts underway around the globe to provide liquidity, strengthen financial institutions, prevent failures that pose systemic risk, protect savers, and enforce investor protections.  I want to acknowledge in particular the close and constructive engagement we have had over the past weeks and months with officials from the Gulf, including the UAE, regarding responses to the global market developments. 

Authorities in the Gulf have been proactive in responding to their own tightening credit markets and weakening investor sentiment, employing a comprehensive set of policy tools.  The authorities here in the UAE have taken important steps to strengthen the financial sector through the introduction of a large liquidity facility and measures to recapitalize banks.  The region's authorities have complemented global policy responses by reducing repo rates, injecting capital into banks, and announcing deposit guarantees.  These measures will help restore liquidity to the markets and rebuild confidence in the financial sector in the region and around the world. 

Moreover, many central banks and financial institutions have worked together during the past few months to lend Treasury securities from their large portfolios to encourage deep, liquid Treasury markets.  This is another tangible step demonstrating leadership and cooperation to bolster market stability. 

There will undoubtedly be much analysis of the current crisis in the months and years ahead.  But one fact is already clear: opaqueness in our capital markets and inadequate risk management and supervision by financial sector participants contributed to the crisis.  When we emerge from this period – and we will emerge from it – our next task will be to strengthen the financial regulatory structure to forestall such excesses in the future.  And we will need to ensure that, just as the balance is restored between risk and reward in the marketplace, a balance is also struck between smart regulation and market discipline.  The global effort to achieve these goals will continue with the G-20 leaders meeting on 15 November in Washington.  This leaders meeting is just one step in what will be an ongoing process, and we will continue to consult closely with key friends in important economies around the world, including with officials from the Emirates. 

The current crisis also reminds us that complacency has no place in financial policymaking.  We need to be proactive and focus vigorously on vulnerabilities, including how to address emerging threats to our economic stability.  One of the current vulnerabilities that we have seen in parts of the world is the rise of protectionist sentiment, epitomized in rhetoric questioning the benefits of cross-border investment.  President Bush and members of his cabinet, led by Secretary Paulson, are consistent voices urging that the United States and the world keep markets open for the benefit of their people.  The Treasury Department has worked hard to combat investment protectionism on multiple fronts, and I would like to describe actions we are taking to ensure that protectionist pressures do not prevail.

Open Investment

I am pleased to report, especially here in Dubai, that much has changed, and changed for the good, in the two and half years since the Dubai Ports World issue was an international headline.  That controversy made clear to U.S. policymakers the importance of reconfirming our commitment to open investment and of taking proactive steps to respond to the lessons learned.  Specifically, we have implemented five stages of reform in the Committee on Foreign Investment in the United States (or as we call it: CFIUS).

• First, we significantly improved our internal processes as to how cases are handled among the agencies that constitute CFIUS. 
• Second, we worked with Congress to pass a new CFIUS law last summer -- the Foreign Investment and National Security Act (FINSA).  FINSA codifies many of our internal improvements, and reflects our strong and continuing commitment to maintaining an open investment climate while protecting U.S. national security.  FINSA requires that CFIUS focus solely on transactions that raise genuine national security concerns, and it formalizes the current practice of seeking to resolve any concerns, rather than prohibiting transactions. 

FINSA also improves predictability by maintaining strict deadlines:  First-stage security reviews must be completed within 30 days.  Second-stage investigations must be completed within 45 days, and any action by the President must be taken within 15 days following the conclusion of an investigation.  The law also improves accountability to our Congress, while considerably insulating CFIUS from political pressures by requiring detailed reporting to Congress only after CFIUS has concluded action on a transaction. 

• Third, a new Presidential Executive Order improves coordination among CFIUS agencies and imposes additional discipline through greater analytical rigor on the use of mitigation agreements. 
• Fourth, in April of this year, we began to rewrite the 1991 CFIUS regulations and received extensive public comments, all of which are posted on the Treasury Department website.  Our aim is to provide investors as much clarity as possible while still providing the government with the flexibility it needs to protect national security.  We are carefully considering those comments, and very soon we will issue final regulations that outline how CFIUS approaches key concepts such as "control" and numerous other issues raised by public comment. 
• Finally, we will soon also publish guidance on the types of transactions CFIUS has reviewed that have raised national security concerns.  Again, our goal with the guidance is to make the process more transparent for investors.  Let me stress, though, that while we have made considerable progress with our CFIUS reforms, we do not see the job as complete.  We will continue to seek improvements to our own policies, just as we encourage our counterparts in other countries to implement policies that welcome foreign investment.

Let me shift briefly from the theoretical to the practical.  In 2007, there were 2,000 cross-border acquisitions in the United States, only 125 of which – or fewer than 7% – came before CFIUS, and none was blocked.  From 2005 to 2008, CFIUS has reviewed or is reviewing 30 cases from countries in the Middle East; 20 involved foreign government control; only six went into a second stage review; only one came before the President; and none was prohibited. 

I lay out this important track record because investment from the Gulf region is playing a growing role in the success of the U.S. economy.  The stock of foreign direct investment in the United States from the Middle East and North Africa was over $7 billion in 2007, up over 130% from 2001.  And the benefits that the United States receives from foreign investment, including from the UAE, is clear.  Foreign firms employ 5.3 million U.S. workers, or about 4.6% of the U.S. private sector labor force.  Recent figures show that these workers in foreign-owned firms generate 19% of U.S. exports, 14% of R&D spending, 11% of capital investment, and 13% of corporate tax revenue. 

We believe that these statistics provide evidence that neither the United States, nor the UAE, nor the rest of the world, can afford to turn inward.  Instead, we must rely on increased interaction with each other to help drive our economies forward and make the benefits of foreign investment available to all countries.

Sovereign Wealth Funds

A little over a year ago, however, even as the furor over Dubai Ports had subsided, investments by sovereign wealth funds began to attract increased media and political attention.  While some of the attention was focused on legitimate questions such as the opaqueness of certain funds, much of the commentary raised the possibility of national security concerns and the potential for sovereign wealth funds to make investment decisions on political rather than economic grounds.  To help blunt these protectionist pressures, we proposed and strongly supported multilateral open investment initiatives to help maintain a stable and successful international financial system. 
 
Working closely with 26 countries that have sovereign wealth funds, the International Monetary Fund facilitated a process to develop Generally Accepted Principles and Practices for sovereign wealth funds, now known as the "Santiago Principles," derived from a meeting in Santiago, Chile.  The group included a diverse set of nations; all GCC members participated as either members or observers, with the Abu Dhabi Investment Authority (ADIA), playing a particularly important role as co-chair. 

The Santiago Principles could not have come at a better time, as they promote better understanding of sovereign wealth fund practices and underscore the commitment of sovereign wealth funds to global financial stability and the free flow of capital across borders.  The Principles recognize that sovereign wealth funds are generally long-term investors that make decisions based on commercial, not political, grounds.  These Principles will help give confidence to investors and the public alike by providing information on sovereign wealth funds' investment policies and risk frameworks, as well as objectives and coordination with macroeconomic policies. 

In addition, the Principles underscore the fact that sovereign funds have a decades-long track record of investing on sound economic and financial grounds, and are in principle long-term investors that can tolerate short-term volatility.  This is certainly welcome in the current environment, and we are thankful for the collaborative efforts that produced these principles at such an important moment.  The Principles' effectiveness in reducing protectionist pressures and contributing to global financial stability depends on their widespread adoption.  We encourage all funds that invest sovereign wealth to examine these Principles closely and take steps to implement them.  And the Principles also should be considered carefully by State-Owned Enterprises (SOEs) as they seek overseas investment opportunities.

Of course, investment is a two-way street, and recipient countries also have important responsibilities.  The United States was an early advocate for the Organization for Economic Cooperation and Development (OECD) to identify a broadly-accepted set of principles that underpin open investment policies for countries that receive sovereign wealth fund investments. 

Our goal is to promote a global paradigm for the free flow of capital, both from sovereign wealth funds and all other overseas investors.  The principles identified by the OECD – transparency, predictability, proportionality, accountability, and non-discrimination among investors – add needed structure to the concept of open investment.  And rather than presenting a piece of paper that may soon be forgotten, the OECD will move forward with peer reviews of each country's investment regimes and will publish the results of these reviews to encourage greater openness to cross-border investment.   

Other Vulnerabilities

During this time of turbulence, investors are seeking safe investments and so are heavily scrutinizing market integrity and discipline in all countries.  It is, therefore, more important than ever for countries to bolster confidence in their markets, something that can be greatly aided by preventing the use of their financial systems for illicit finance.  Countries that carefully and systematically address anti-money laundering and counterterrorist and counterproliferation financing issues will have a competitive advantage in the marketplace as trusted partners with a good reputation for clean financial flows. 

Protecting the integrity and reputation of a country's financial system is especially difficult when business is done with Iran.  The Financial Action Task Force (FATF) has highlighted the threat posed to the international financial system by Iran's lack of a sufficient anti-money laundering and counterterrorist financing regime.  Just recently, on October 16, the Task Force issued a fourth statement calling for countries to strengthen preventive measures to protect their financial systems from the risks posed by Iran. 

We have seen that a combination of targeted financial measures and isolation from the private sector has put real pressure on the Iranian regime and its continued pursuit of a nuclear capability and support for terrorist groups.  Enhanced vigilance over all business with Iran is necessary as we have seen Iran abuse its access to financial and commercial markets in order to further its proliferation efforts.  Iran continues to employ deceptive practices to mask its illicit activities, which makes it even more difficult for a business partner to know the true beneficiary of a transaction or service with an Iranian entity. 

We commend the measures taken by regulators in the Gulf to protect their financial systems from abuse.  Sanctions, and especially targeted financial measures, are always more effective when done on a multilateral basis.  We will thus continue to engage our international partners to safeguard the international financial system and address issues of mutual interest and concern. 

Conclusion

The United Arab Emirates and the United States have a strong and enduring relationship based on mutual and reinforcing policy interests:  political and security as well as economic and financial.  We see this common commitment demonstrated in the recent decisions of the UAE to cancel Iraq's debt and expand diplomatic engagement there, for which we are appreciative.  And, as I have discussed, the UAE and we are also now working more closely together than ever before on addressing the current global financial crisis and resisting protectionist pressures, as demonstrated by our partnership leading to the Santiago Principles.  As we emerge from the current turmoil, which we will, it is through this constant communication, coordination, and collaboration that we enhance the prospects for prosperity not only in our own countries, but in the Gulf region and beyond. 

Thank you for your kind attention, and I would be pleased to take some questions.