PRINT THIS PAGE Sovereign wealth funds and private equity07/05/2008. Source: SJ Berwin. Simon Witney 
Sovereign wealth funds (SWFs) are not a new phenomenon, and have been enthusiastic investors into European private equity funds for a very long time. But their recent growth, and their investments into some of America's best known banking institutions - Citigroup, Morgan Stanley and Merrill Lynch, for instance - has alarmed some policy makers on both sides of the Atlantic. There is now a risk that the policy response could damage private equity. More than 30 countries - from Brunei to Botswana - now have SWFs. In many cases relatively little is known about them. But estimates of the total assets held by SWFs range from $1.9 to $2.9 trillion - considerably more than the total assets under management of either hedge funds or private equity funds. This massive firepower has taken some by surprise - even though it is a natural consequence of the global shift in the balance of payments, mainly due to the meteoric rise in the price of commodities, especially oil.
Much of the increased scrutiny can be traced back to the Dubai Ports controversy of March 2006, when national security concerns were widely cited as a reason to prevent a foreign owned company taking over six major US ports. Since then, a number of private equity related investments, and the high profile opportunities afforded by the global credit crunch, have increased the profile of SWFs in the US and in Europe.
Interestingly, SWFs now have to respond to some of the same criticisms levelled at private equity funds in recent years: lack of transparency and disclosure. But, actually, the underlying concern is very different. For many, the concern with buyout funds was that they were only interested in (short term) financial gain; conversely, politicians worry that some SWFs have ulterior (longer term) motives. Russian and Chinese funds, for example, are growing extremely quickly and some fear they are investing for political or strategic reasons and are not just looking for a profit. Others point to human rights issues. For many, the knee jerk response is investment protectionism - a good example being the proposed Californian law that sought to prevent two of California's largest state pension schemes from investing in private equity firms backed by SWFs. But official responses have, on the whole, been more measured and have favoured a 'light touch' approach, often involving voluntary principle-based systems.
The US Treasury has recently agreed with Singapore and Abu Dhabi a set of complementary principles for SWFs and recipient states to adhere to when investing. The SWFs agree to invest on a solely commercial basis, have strong governance structures and offer greater information while complying with host country regulation in their investments. In return, the US will not erect protectionist barriers to investment or intrude in investor decisions. The US expressed the hope that these principles would form the basis for the guidelines to be drawn up by the OECD and the IMF.
The EU Commission has released a communication to the EU Parliament, emphasising the need for a common approach to prevent fragmentation of the single market and to encourage outside investment. The need for clear governance structures and the development of transparency practices by SWFs are at the heart of what the EU Commission sees as best practice principles.
In Britain, the City of London and its financial markets have long welcomed SWF money, and the UK has one of the least restrictive regulatory environments for international direct investment. But some argue that SWFs investing in Britain should sign up to the same standards of disclosure as those that Sir David Walker has mandated for large buyout houses. Walker was successful in getting the state of Qatar to agree that it would comply if it had been successful in its bid for Sainsbury's (which ultimately failed). Discussions are continuing to persuade others to fall into line, and even to join the British Private Equity and Venture Capital Association.
Some response to the growth of SWFs is clearly needed, even if only to assuage public concerns. Technically they may be no more opaque than, say, billionaire financiers, and in reality may be just as concerned to make rational investment decisions. But the scale of the funds, and the political realities, make action inevitable. If that action is focussed on the national regulation of strategic industries (which already exists, of course) and light touch principles-based codes, the net effect for private equity will be positive. Blanket protectionism, on the other hand, could diminish an important (and increasingly needed) source of funds.
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on our services to the private equity industry please contact Simon Witney in our London office 020 7533 2222 or visit our website at www.sjberwin.com.
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