October 2, 2008
HP-1174
Assistant Secretary Clay Lowery Remarks on Sovereign Investing
at the Third Columbia Investment Conference
New York - It's a pleasure to join you today and to participate in this conference on sovereign investing. The schedule that you have put together over the last couple of days appears intense and focuses on many of the issues that we have been trying to address within the U.S. Government for the last couple of years – how do we view sovereign investing in the United States.
Recent Developments
Before discussing the primary motivation of your conference, however, let me first take a moment to acknowledge the context in which today's discussion on sovereign investment takes place. As you all know, we are in the midst of an historic reassessment of risk by the world's financial markets, triggered by the bursting of the U.S. housing bubble and the subsequent steep decline in U.S. housing prices. The U.S. government has taken a number of bold steps to stabilize markets, mitigate the impact of a number of failing or troubled institutions, and address the underlying sources of market uncertainty. We are working to resolve the current crisis and re-establish stability. No doubt there will 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 supervision and risk management on the part of financial sector participants contributed to the crisis. When we emerge from this difficult period, our next task will be to strengthen the financial regulatory structure to forestall such excesses in the future. The interdependence of our global economy makes this challenge more complex, and it also makes our work with international counterparts to promote openness and financial stability all the more important.
The current crisis also serves as a reminder that the enemy of financial policymakers is complacency and the friend is to worry about vulnerabilities. It puts a premium on constantly thinking about "what is around the corner?" and how should we address the issues that such analysis reveals. Otherwise, those vulnerabilities can manifest themselves in front of your eyes as an outright crisis.
One of those vulnerabilities that we see in the United States has been the rise of protectionist sentiment, in many respects, epitomized in the rhetoric surrounding international investment. While I'd like to think that in times of economic difficulties, it would be enough to remind people that international investment fuels our own economic prosperity by bringing new technology and business methods and by providing healthy competition that fosters innovation, productivity gains, lower prices, and greater variety for consumers. Or I'd like to think that it would be enough to recall that over 5 million Americans are employed by foreign-owned companies, and foreign-owned companies pay on average 25 percent more than U.S. companies. I, unfortunately, realize that I would be wrong – it is not enough.
Therefore, let me try to explain how we are attempting to "see around corners" when it comes to sovereign wealth funds and CFIUS.
Sovereign Wealth Funds (SWFs)
Sovereign wealth funds have garnered much attention in the past year, both for their growing relevance as global financial market participants and for their recent investments in major financial institutions. For instance, according to Monitor Group, in the first half of 2008 alone, sovereign wealth funds invested $24 billion in 23 deals in the financial sector. These investments come on top of a flurry of deals involving financial institutions at the end of 2007.
SWFs are not a new phenomenon, but their rapid growth both in number and size is relatively new, and a trend that is expected to continue. From the current estimated level of roughly $3 trillion, the IMF and private sector analysts project SWF assets could reach $7 to $11 trillion or more in the next five years. Even though many sovereign investors have been around for decades, the expected growth of sovereign wealth fund assets, the number of new sovereign wealth funds and recent "headline" deals involving SWFs have all contributed to an intensified interest in sovereign wealth fund activities among public and private actors, alike. This interest often manifests itself in the form of questions about the "true" motivations for sovereign wealth fund investments; the degree of control a sovereign could exercise over the investment target; as well as the processes by which recipient countries – the United States, in particular – review sovereign investments for national security concerns.
So what do we know about sovereign wealth funds and their investments?
The IMF recently published a Survey of SWF Institutional and Operational Practices that provides a good baseline of information – in aggregate – on 20 different sovereign wealth funds. While the data set is limited, the results provide additional information about SWF objectives and roles in policy making; data availability; and asset allocation. For instance, two-thirds of responding SWFs have long term savings/stabilization as their operating mandate and do not generally engage directly in macroeconomic policies. Most of the respondents make data available to national compilers of macroeconomic statistics, but not necessarily to the public. The majority of respondents use external asset managers to some degree, while SWFs that are established as separate legal entities typically are permitted higher allocations to alternative asset classes.
In addition to this survey, it is pretty clear that SWFs are in principle long-term investors that historically have maintained their strategic asset allocation in the face of short-term losses. They typically are not highly leveraged. SWF managers generally have a higher tolerance for risk than reserve managers and seek higher returns by investing in a wider range of asset classes. They have access to, and frequently make use of, well-regarded private fund managers, consultants, administrators and custodians. SWFs as a group, but particularly the more longstanding funds, generally have a track record of making investment decisions on economic and financial grounds.
US Treasury Response
It is this last area that has probably raised the most concerns – do SWFs invest for some sort of political and strategic purpose or do they invest to maximize returns. In the U.S. Government, our view was that we needed to address this concern head on and do it in a way that would not resort to protectionist measures.
Our thinking led us to proposing approaches that are measured, multilateral, and maintain openness. This is in the best interest of participants on both sides of the investment equation -- countries that have these funds and countries in which these funds invest. Recognizing that better understanding and communication is necessary on both sides of the investment relationship, Treasury has undertaken substantial outreach to strengthen communication with SWFs and build support for multilateral initiatives. These efforts included agreement in March with Singapore and the United Arab Emirates on a set of principles that would create a strong incentive among SWFs and recipient countries to hold themselves to high standards.
Generally Accepted Principles and Practices
More robustly, Treasury proposed a large multilateral effort to develop voluntary best practices for SWFs. Roughly one year later, officials from 23 countries are prepared to unveil an historic agreement among the world's major sovereign wealth funds. This agreement represents a milestone in enhancing the openness and transparency of the global financial system and in promoting open investment worldwide.
The IMF facilitated the establishment of a group of 23 countries with SWFs, the International Working Group of Sovereign Wealth Funds or "IWG." The IWG drafted and agreed on the Generally Accepted Principles and Practices or "Santiago Principles" in less than half a year – an impressive achievement given the number of participants, the complexity of the issues and the unchartered territory that the agreement represents for a number of sovereign wealth funds. The group welcomed input from recipient countries as the group deliberated, demonstrating a collaborative spirit and a common interest in a credible product.
The Principles will be released publicly during the IMF's annual meeting next weekend. Broadly speaking, it is a voluntary framework that consists of principles and supporting commentary, which will guide SWFs in establishing sound practices in three key areas:
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Legal framework and coordination with macro policies;
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Institutional and governance framework; and
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Investment framework, including risk management.
Adoption of the Principles by SWFs will address many of the key issues that have been dealt with only at the discretion of each individual fund up until now: for instance, what is the policy purpose of an SWF? What guides specific investment decisions? What stance does an SWF take with regard to voting shares? And how does an SWF manage risk? In the process, the Principles will also directly address financial stability and investment issues raised by the rapid growth in the size and number of SWFs.
Even though the Principles are not yet public, the process and substance behind it are already bearing fruit. In June, the Abu Dhabi Investment Authority (ADIA) – one of the world's largest sovereign wealth fund and also co-chair of the IWG – expanded the amount of information available through its website to include information on its Investment Strategy, Governance and Organizational Structure. Just last week, the Government of Singapore Investment Corporation (GIC), also one of the largest SWFs, disclosed for the first time its asset composition and historical returns.
The Principles demonstrate a significant positive shift in SWF practices relative to current practices--but useful work remains to be done. Their effectiveness in helping to reduce protectionist pressures and contribute to global financial stability ultimately will depend on their widespread adoption by SWFs. We expect SWF ownership of the Principles – a key goal of our original proposal – will lead to a high rate of implementation among participating SWFs. Early adherents will serve as an example to other SWFs, and result in a rise to the top in institutional and operational practices among the vast majority of funds. We expect the successor to the Working Group will continue to meet to consider implementation issues and proposals for further work.
When Treasury first started looking at the issue of sovereign wealth funds in great detail, some observers worried that an "overemphasis on transparency of SWFs alone may lead to unnecessary conflicts with allies." A leading economic thinker noted that it was the unwillingness of sovereign wealth funds to agree to standards openly that raises concerns about sovereign wealth fund motivations. Still others concluded that "a global solution to SWF concerns is unlikely to emerge," given a lack of international consensus regarding foreign investment rules.
They were right to be cautious – even pessimistic – with regard to the chances of reaching agreement on a wide-ranging set of principles, among a diverse group of countries, each with unique institutional arrangements, objectives and disclosure requirements. Such long odds makes the Working Group's achievement that much more impressive. We commend the IMF's efforts in convening and supporting the group's work, and IWG members for reaching consensus on a wide-ranging and groundbreaking agreement. Their efforts demonstrate a collaborative spirit and common interest in a credible product. Now it is up to SWFs to implement the Principles in support of maintaining an open and stable global financial system.
Recipient Country Policies
Committee on Foreign Investment in the United States (CFIUS) and Regulations
When I think of our work on SWFs, I like to think of it as the U.S. Government being proactive, "seeing vulnerabilities around the corner", and designing policy responses that are prudent, and hopefully coherent.
When I think of the other major area of foreign investment in the United States – CFIUS – I also think about the word "proactive," but as a lesson. As folks are probably pretty aware, Dubai Ports World became a major issue in 2006. The reasons it became an issue is a study in itself, but the important part of that "experience" are the lessons learned. And the key lesson is to be proactive.
As we have done for SWFs, policy makers need to see around the corners and think proactively about the vulnerabilities that can arise from an issue and the consequences. While Dubai Ports World was a painful episode (almost like being hit by a truck), it also lead to strong proactive work that has ensured the continuation of our long-standing open investment policy.
Instead of taking Thomas Friedman's thoughts of a few days ago and curling up into the fetal position…we figured that we had to address the two important challenges before us: restore confidence that the United States remains open to foreign investment and restore confidence that our national security process is thorough, accountable, and targeted.
While there were many concerns raised about the Dubai Ports World transaction, the most significant were the apparent lack of accountability, the lack of communication with Congress, and the lack of clarity in terms of the law. To reform those problems, we focused on two key actions: getting our house in order and revising the legal context within which CFIUS operates.
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Getting our house in order: In over two years, we have made it our mission at Treasury to fix the problems that I just identified. We reorganized the Department and our procedures so that accountability is now at the highest levels within Treasury; we changed our practices and now keep Congress informed of every transaction after we have concluded the examination; and we remade the inter-agency process so that key responsibilities of agencies are clear so as to improve coordination and make decision making more efficient.
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Revising the legal context within which CFIUS operates: Given that this is a law school and I'm not a lawyer, I thought about skipping this part -- but instead -- I'll summarize the legal context in two areas.
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First, we worked hard with Congress to re-write the CFIUS statute, and that law passed with wide bipartisan support last year. The law:
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Maintains a very selective focus on only the cases that raise genuine national security concerns.
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Formalizes the current practice of seeking to resolve any concerns, rather than prohibiting transactions.
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Maintains 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.
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Provides Congress with an extensive annual report detailing CFIUS activities and the cases it reviews.
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Second, in April of this year, we proposed a rewrite of the 1992 regulations. Our aim was to provide as much clarity as possible while still providing the government with the flexibility it needs to protect national security. We have received a number of comments on the regulations from a broad array of public and private entities, both domestic and international. We are carefully reviewing those comments, and will issue final regulations soon, as well as separate guidance on the types of transactions that CFIUS has reviewed and that have raised national security considerations. The guidance will help investors and their counsel decide whether or not to file a voluntary notice requesting CFIUS review of their transactions.
At Treasury, we believe that these reforms have built confidence in our ability to carry out the important role that Congress and the President have entrusted to the CFIUS process. In addition, we now have an important message – backed up by statistics – that we have been delivering to both domestic and international audiences, demonstrating that the new and improved CFIUS operates fully within the context of the U.S. commitment to open investment.
Let me assert that CFIUS is an efficient, disciplined process that reviews only a small number of transactions. CFIUS is narrowly focused on national security risks posed by the specific transaction under review, not broader considerations such as economic security, industrial policy or "national interest."
To provide some statistical proof of this assertion, Thomson Financial reports that in 2007, there were over 11,000 mergers and acquisitions in the United States, of which about 2,000 involved foreign acquirers. CFIUS reviewed only 138 transactions covered by the statute, or fewer than 7% of these foreign acquisitions. Six cases went to investigation, and none of the six required a Presidential decision. Over 80 percent of the cases were closed out within the 30 days of the beginning of the CFIUS examination. In other words, barely more than 1% of all cross border mergers and acquisitions in our country had a national security review that lasted longer than 30 days and 0% of all cases were blocked by the Federal Government.
In 2007, less than one-fifth of the covered transactions that CFIUS reviewed involved a foreign government-controlled acquirer, and even fewer cases involved sovereign wealth funds. Foreign government control is a factor that CFIUS considers in its review of covered transactions, and under FINSA, acquisitions by foreign-government controlled entities are subject to clearance by higher level officials. Nevertheless, CFIUS reviews have not prevented acquisitions by foreign government-controlled companies from proceeding, including within 30 days in numerous cases in which that is appropriate.
In sum, the nature and practice of CFIUS demonstrates that the United States continues to welcome foreign investment. President Bush reaffirmed our commitment to open investment in a statement in May 2007 in which he said we welcome foreign investment in this country and will work to ensure fair treatment and equitable opportunity for our investors abroad.
Conclusion
I'd like to close by summarizing just how far we've come in dealing with the consequences of higher levels of foreign investment, including sovereign investment. As noted, there was great skepticism with regard to the willingness of sovereign wealth funds to voluntarily participate in a process premised on greater transparency. Likewise, the firestorm surrounding the 2006 Dubai Ports World transaction severely damaged confidence in the CFIUS process and increased the risk of a protectionist response. Yet on both counts, we are in a substantially better place then most observers would have guessed two years ago.
Sovereign wealth funds have sought to address the underlying concerns about their investment intentions by voluntarily adopting a framework of sound principles and practices, and increasing the amount of information available about their operations. Likewise, the United States has comprehensively reformed our own processes for reviewing foreign investment, in a manner which reassures foreign investors that the United States remains open to foreign investment, while clearly prioritizing national security. No doubt, the issues surrounding sovereign foreign investment will continue to evolve. But I am confident that the structures and processes currently in place are capable of adjusting to these changes, and sufficiently robust to respond in a manner consistent with our open investment policy objectives.
Progress toward greater transparency and accountability on the part of sovereign wealth funds and recipient countries alike place these actors at the forefront of a move toward greater transparency among financial market participants more broadly. These efforts will build confidence on both sides of the investment relationship and support the future stability of the global financial system.
I would be happy to take any questions from the audience.