[Joint House and Senate Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 110-499
DO SOVEREIGN WEALTH FUNDS MAKE THE
U.S. ECONOMY STRONGER OR POSE NATIONAL SECURITY RISKS?
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HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
FEBRUARY 13, 2008
__________
Printed for the use of the Joint Economic Committee
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
SENATE HOUSE OF REPRESENTATIVES
Charles E. Schumer, New York, Carolyn B. Maloney, New York, Vice
Chairman Chair
Edward M. Kennedy, Massachusetts Maurice D. Hinchey, New York
Jeff Bingaman, New Mexico Baron P. Hill, Indiana
Amy Klobuchar, Minnesota Loretta Sanchez, California
Robert P. Casey, Jr., Pennsylvania Elijah E. Cummings, Maryland
Jim Webb, Virginia Lloyd Doggett, Texas
Sam Brownback, Kansas Jim Saxton, New Jersey, Ranking
John E. Sununu, New Hampshire Minority
Jim DeMint, South Carolina Kevin Brady, Texas
Robert F. Bennett, Utah Phil English, Pennsylvania
Ron Paul, Texas
Michael Laskawy, Executive Director
Christopher J. Frenze, Republican Staff Director
C O N T E N T S
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Members
Statement of Hon. Charles E. Schumer, Chairman, a U.S. Senator
from New York.................................................. 1
Statement of Hon. Carolyn B. Maloney, Vice Chair, a U.S.
Representative from New York................................... 4
Statement of Hon. Amy Klobuchar, a U.S. Senator from Minnesota... 6
Witnesses
Statement of David McCormick, Under Secretary for International
Affairs, U.S. Department of the Treasury, Washington, DC....... 7
Statement of Stuart Eizenstat, Partner, Covington & Burling,
former Deputy Secretary of the Treasury and Ambassador to the
European Union, Washington, DC................................. 18
Statement of Douglas Rediker, co-director, Global Strategic
Financial Initiative, The New America Foundation, Washington,
DC............................................................. 20
Submissions for the Record
Prepared statement of Senator Charles E. Schumer, Chairman....... 29
Prepared statement of Representative Carolyn B. Maloney, Vice
Chair.......................................................... 32
Prepared statement of David H. McCormick, Under Secretary for
International Affairs, U.S. Treasury Department Office of
Public Affairs................................................. 33
Prepared statement of Stuart E. Eizenstat, partner and chair of
the International Practice Group, Covington & Burling LLP...... 36
Prepared statement of Douglas Rediker, co-director, Global
Strategic Financial Initiative, The New America Foundation..... 41
DO SOVEREIGN WEALTH FUNDS MAKE THE
U.S. ECONOMY STRONGER OR POSE NATIONAL SECURITY RISKS?
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WEDNESDAY, FEBRUARY 13, 2008
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met at 2:05 p.m. in room SD-106 of the
Dirksen Senate Office Building, the Honorable Charles E.
Schumer (Chairman of the Committee) presiding.
Senators present: Klobuchar, Maloney, Schumer, and Webb.
Representatives present: Maloney.
Staff present: Christina Baumgardner, Ted Boll, Heather
Boushey, Stacy Ettinger, Anna Fodor, Chris Frenze, Nan Gibson,
Rachel Greszler, Colleen Healy, Aaron Kabaker, Tim Kane, Israel
Klein, Michael Laskawy, Robert O'Quinn, Jeff Schlagenhauf,
Robert Weingart, and Jeff Wrase.
OPENING STATEMENT OF HON. CHARLES E. SCHUMER, CHAIRMAN, A U.S.
SENATOR FROM NEW YORK
Chairman Schumer. Good afternoon, everyone. Our hearing of
the Joint Economic Committee on Sovereign Wealth Funds, will
come to order.
I'll make a brief opening statement, as will my Ranking
Member, Vice Chair Maloney, and then we'll get right to our
witnesses.
Anyway, I want to thank everybody for coming. Today the
Joint Economic Committee is having the first hearing of 2008 on
the rise of foreign-government-controlled funds investing large
sums of money in our economy.
The question of the day is whether these huge pools of
investment dollars known as sovereign wealth funds make the
U.S. economy stronger or pose serious national security risks.
I'm not sure we'll answer that question to anyone's
satisfaction today, but at the very least this Committee and
the Federal Government need to spend a great deal of time
thinking about it.
To help us do some of the thinking today we're honored to
have an outstanding panel, including the current Treasury Under
Secretary, David McCormick, a former Treasury Deputy Secretary
under President Clinton and a former Ambassador to the European
Union, Stuart Eizenstat, and a prominent foreign investment
expert, Doug Rediker.
The initial focus of Congress is, correctly, on the
transparency of these funds and whether that is best achieved
voluntarily, perhaps working through international bodies such
as the IMF, or, if that approach doesn't work, through Federal
legislation.
My preference would be for the former, but we may have to
consider the latter.
I'd like to take a few minutes to discuss the broader
economy and why I believe we're faced with such an increase in
investment by sovereign wealth funds in U.S. companies.
It's no secret that our economy is not in good shape now.
There's increasing evidence that a recession will be deeper
than this Administration is willing to admit.
We've spent too much and saved too little as a country and
as consumers. Our national savings rate is just above zero.
Commercial and consumer credit markets have seized; home
foreclosures are rising in both subprime and prime markets; the
value of the dollar has fallen in relation to other world
currencies; job growth is at historic lows, lower than it has
been since January of 2001; and trade deficits are ballooning
to historic highs.
But we also have long-term structural problems in the
economy. The U.S. debt-to-GDP ratio is steeply rising, which is
a reflection of this Adminstration's bad fiscal policy, putting
tax cuts before everything else even during wartime.
Our current account deficit is at historic highs,
approaching a trillion dollars, and this highlights massive
borrowing by the Federal Government to pay for rising defense
and domestic spending.
So it shouldn't surprise us that, as Larry Summers said
last year, the world's greatest power has become the world's
greatest borrower.
Even when the economy was going well there wasn't enough of
our own capital, because we spend more than we save; we import
more than we export; and we consume more than we produce. So as
the economy has slowed, we haven't had the resources to keep it
moving.
Creating a perfect sovereign wealth storm, foreign
countries have benefitted from our unwitting largess. Thanks to
the Bush administration's failure to control the trade deficit,
address currency market manipulation, and bring down oil prices
by reducing our dependence on foreign oil, foreign governments
have a lot of extra money and we do not.
These governments are using their sovereign wealth funds to
go on a buying spree in the United States. The bottom line is
that we're overextended, and there may only be two options,
neither of which is very attractive: We can allow a dramatic
contraction of our economy, or we can allow foreign investment,
in a measured way, to stave off further job loss and keep the
economy humming.
It shouldn't surprise us that the international bargain-
hunters have descended on the U.S. economy. The acquisition of
multibillion-dollar stakes in Wall Street firms like Merrill
Lynch, Citigroup, and Morgan Stanley by Asian and Middle
Eastern sovereign wealth funds, quite naturally, has sparked
increasing interest and concern about their impact on the U.S.
economy.
With domestic credit markets locked up, U.S. businesses
seem to have little choice but to turn to sovereign wealth
funds as a source of much needed capital.
Until recently, much of the criticism has occurred when
money is sent out of the United States, taking American jobs
and moving the abroad. It is contradictory to complain about
similar investments, when they're now being made by foreign
entities, in the United States.
In general, foreign investment has a healthy impact on the
U.S. economy, and I've supported it. It augments domestic
sources of capital and provides much needed capital and
liquidity.
It can also create jobs and improve productivity. However,
where the foreign investor is a government or a government-
controlled fund, we should have concerns about their
motivations.
We have seen plenty of private foreign investors put money
into U.S. companies, without much evidence they're investing
for non-economic purposes.
But it would be perfectly rational to expect a foreign
government-controlled fund to have non-economic motivations.
For instance, foreign governments might have an interest in
controlling strategic assets, securing access to sensitive
information or technology, promoting a political agenda, or
cornering the market on raw materials.
The closer foreign governments come to exercising control
and influence, the greater our concerns. When Dubai Ports World
attempted to purchase major U.S. seaports in 2006, alarm bells
went off.
When it comes to a vital security asset, like a port or
even a basic infrastructure asset like a utility, we are right
to be concerned. For instance, if a Russian sovereign wealth
fund bought a natural gas utility here, alarm bells would be
going off, again, because serious questions and concerns would
be raised about the motivation of the Russian fund in natural
gas. Russia has used natural gas as a political weapon in the
past towards Western Europe.
In this regard, sovereign wealth funds are sometimes their
own worst enemies. Most are not transparent or publicly
accountable, and we know little about their government
structures or fiduciary controls.
So, the bottom line is we don't know if their decisions are
made exclusively on an economic basis. We invited some of the
largest sovereign wealth funds to testify before us today, but
they directly declined or their government embassies in the
United States declined for them.
While managing directors of these funds won't appear in
front of Congress, a number of them have been quoted in the
press recently, attempting to assure lawmakers and the public
that their motivations are purely financial, and they do not
take direction from their governments.
I don't think the American people are yet persuaded. The
funds need to do much more to make their case.
I met recently with the head of China's sovereign wealth
fund. I asked him about the fund's investment policies and its
interaction with government officials, but got no real answers.
I did get this nice glossy brochure, but frankly, if you look
through it, it tells you nothing about those questions.
It is clear that we need to find out more about sovereign
wealth funds, how they are run, what drives their investment
decisions. Sovereign wealth funds should voluntarily provide
information and agree to guidelines that promote good
governance, accountability, and transparency.
Here are some questions that I believe they should answer:
Do sovereign wealth funds report to an independent board of
directors or directly to the government?
Do they disclose their investment goals? If the goals
change, is that made public?
Are directors and the investment management teams selected
on the basis of business qualifications and not political
affiliation? Are their professional qualifications and
experience made public?
Is there a stringent code of conduct that compels members
of the board of directors and management to report any attempts
by the government to influence investment decisions?
Do they disclose publicly, quarterly financial and annual
audited financial statements?
Do they publicly disclose all their portfolio holdings?
I also think we ought to review whether the reforms to the
CFIUS process made by the Foreign Investment National
Securities Act of 2007, FINSA, are sufficient to address the
unique risks associated with investments by sovereign wealth
funds, and if not, propose additional legislation to close any
loopholes.
I'll be taking a hard look at the new FINSA regulations,
due to be published in the spring, in this regard.
Finally, it's important to point out that many of the
countries with the largest sovereign wealth funds still
maintain high levels of protection against investment in their
domestic industries. China and financial services come
immediately to mind.
I hope that Treasury and the U.S. Trade Representative do
better to ensure reciprocal market access for U.S. investors.
Ultimately, we need to maintain a careful balance between
welcoming foreign investment and protecting national and
financial security, as well as market stability.
Sovereign wealth funds need to assuage concerns that they
will manage their investments in terms of political or economic
power objectives. The alternative, I fear, already proposed by
a number of lawmakers and other critics, is restrictions on
sovereign wealth fund investments in the United States.
My hope is that sovereign wealth funds can assure us that
they will behave like other economic actors, and if they do so,
that's all to the good. But until they do so, they should not
get a carte blanche.
[The prepared statement of Chairman Schumer appears in the
Submissions for the Record on page 29.]
Chairman Schumer. Vice Chair Maloney.
OPENING STATEMENT OF HON. CAROLYN B. MALONEY, VICE CHAIR, A
U.S. REPRESENTATIVE FROM NEW YORK
Vice Chair Maloney. Good afternoon. I want to thank
Chairman Schumer for holding this hearing to examine the
benefits and risks of sovereign wealth funds investing in the
United States, and I want to welcome all of our witnesses and
thank them for being here today.
The term ``sovereign wealth fund'' has only recently
entered our lexicon, but these government-controlled investment
vehicles have been around and operating without incident for
decades.
At the moment, these fund are providing much needed capital
to U.S. banks, trying to regain their footing in the wake of
the mortgage crisis. However, the growing market clout of these
funds and the steep rise of their investments in the United
States require that they receive greater scrutiny by Congress.
Bush administration policies have fostered a large amount
of Federal borrowing from overseas, a greater reliance on
foreign oil, and a weak dollar, all of which have created an
environment that is ripe for foreign wealth funds with
extraordinary oil profits or excess foreign exchange reserves
to gobble up American assets at bargain prices.
Governments can have very different motivations than
financial investors, so we would be remiss not to carefully
examine the potential risks from these State-owned investment
funds.
Reform of the Committee on Foreign Investment in the United
States, CFIUS, was triggered by the revelation that the
committee gave the green light to a deal that sold operation of
many U.S. ports to a company owned by the Government of Dubai
without any senior-level or national security review.
With proper implementation by the Administration, the new
reforms will strengthen the system by which foreign investment
in businesses in the United States is vetted for security
concerns, and provides certainty and predictability to the
CFIUS process in order to expand economic activity, create
jobs, and encourage safe foreign direct investment.
I will continue to maintain a watchful eye over the ongoing
implementation process, but I am confident that the Treasury
Department intends to follow the law as I wrote it and have
received assurances that the Department is already adhering to
the new reforms.
I would also like to mention that our antitrust laws and
the review by DOJ's Antitrust Division, protect against
monopolies or a takeover of any sector, whether by a foreign or
domestic entity.
In addition, I welcome the Administration's efforts to work
with the International Monetary Fund to create an international
code of conduct that would include greater disclosure of
sovereign wealth fund activities and their governments.
An important lesson of this summer's mortgage crisis is
that when capital markets become too opaque and risk exposure
is not well understood, the consequences can be devastating for
institutions and individuals.
Greater transparency of foreign wealth funds would be a
welcome development, but it is not enough. Our challenge is to
balance the potential risks to our economic and national
security interests with our desire to maintain an open
investment environment.
Again, I'd like to thank our Chairman for holding this
hearing, and I look forward to gaining insights from our
witnesses about the appropriate oversight of sovereign wealth
funds. I yield back.
[The prepared statement of Vice Chair Maloney appears in
the Submissions for the Record on page 31.]
Chairman Schumer. Thank you, Vice Chair Maloney.
Senator Klobuchar.
STATEMENT OF HON. AMY KLOBUCHAR, A U.S. SENATOR FROM MINNESOTA
Senator Klobuchar. Thank you, Senator Schumer, and thank
you for holding this hearing today. I'm looking forward to
hearing our witnesses.
I was thinking as Congresswoman Maloney talked about the
relevance of the subprime mortgage crisis. We've seen it in our
State in a big way in the urban areas, but also now a doubling
of foreclosures in the rural areas, and I would agree with her
that a lot of the way this was handled, and the way these were
marketed, was hidden from a lot of people and it contributed to
that crisis.
As far as the subject for today, I would say that foreign
investments in the United States can, of course, have a healthy
impact on our economy; however, the dramatic increase that
we've seen in the investment from these sovereign wealth funds
raises significant and legitimate concerns that cannot be
ignored, including those related to our national security.
I believe that foreign governments could manage their
investments in pursuit of political or economic power
objectives. The lack of transparency, as was earlier discussed,
combined with the increasing share of investment capital, could
threaten the stability of our financial markets. Sovereign
wealth funds could also perpetuate undesirable underlying macro
economic and financial policies such as China's manipulation of
its exchange rate.
I also think that you can't talk about this without
realizing the failed economic policies of this Administration
and how they have exacerbated the steep rise of these sovereign
wealth funds. The more we're dependent on foreign oil--and
we're spending, what, $200,000, $300,000, $400,000 a minute on
foreign oil--it's contributed to our growing trade imbalance
and to the weakening dollar, and this has created an
environment that is ripe for the investment by these sovereign
wealth funds.
As we look at solutions, I think we have to pay attention
to concerns about the transparency and accountability of
sovereign wealth funds; we have take steps to ensure that there
is a level playing field for investment.
As Senator Schumer noted, in the countries that have the
sovereign wealth funds, they shouldn't be allowed to close off
their markets to American investors.
Finally, we should give careful consideration to the
question of the appropriate level of regulation or reporting
requirements extended to the sovereign wealth funds.
I look forward to hearing the answers from our panelists
along the lines of those suggestions. Thank you.
Chairman Schumer. Well, thank you, Senator Klobuchar.
Now, I want to introduce our first witness. Our first
witness is David H. McCormick, the Under Secretary for
International Affairs at the Treasury Department.
In this capacity, he's principal advisor to the Secretary
of Treasury on international economic issues, and also
coordinates financial market policy with the Group of Seven
Industrialized Countries, so he's very well versed in the
issues we have before us.
Before joining Treasury, Mr. McCormick was the Deputy
National Security Advisor to the President for International
Economic Affairs, and he also served as the Under Secretary of
Commerce for the Export Administration.
Prior to joining the Administration, Mr. McCormick was
president and CEO of Free Markets and president of AREBA, both
software and service companies. In addition, he's a graduate of
West Point, holds a Ph.D. from the Woodrow Wilson School at
Princeton, is a former Army officer and veteran of the first
Gulf War.
Thank you for being here, Mr. McCormick. Thank you for your
service, and you may proceed.
STATEMENT OF DAVID McCORMICK, UNDER SECRETARY FOR INTERNATIONAL
AFFAIRS, U.S. DEPARTMENT OF THE TREASURY, WASHINGTON, DC
Under Secretary McCormick. Thank you, Chairman Schumer,
Vice Chair Maloney, and other Members of the Committee. Good
afternoon.
I very much appreciate the opportunity to appear before you
today to discuss sovereign wealth funds.
At Treasury, we have been increasingly focused on sovereign
wealth funds for more than a year now, and I'm pleased to have
the opportunity to share with this Committee some of our views.
As many of you have just acknowledged, sovereign wealth
funds are not new. The oldest funds date back to the 1950s in
Kuwait and Kiribati.
Over the next four decades, their numbers slowly grew. By
the year 2000, there were about 20 sovereign wealth funds
worldwide managing total assets of several hundred billion
dollars.
Now today, what is new is the rapid increase in both the
number and the size of sovereign wealth funds. Fueled by high
commodity prices and the rapid accumulation of official
reserves, 20 new funds have been created since 2000, more than
half of these since 2005.
Today there are nearly 40 funds managing total assets in a
range of $1.9 to $2.9 trillion. At the Department of Treasury,
we define a sovereign wealth fund as a Government investment
vehicle funded by foreign exchange assets managed separately
from foreign official reserves.
Sovereign wealth funds generally fall into two categories
based on the source of the foreign assets: Commodity funds,
which are funded through commodity exports or it is owned or
taxed by the Government. Commodity funds serve several
different purposes, including stabilization of fiscal revenues,
intergenerational saving, and the balance of payment
sterilization.
Non-commodity funds are the second type, and these are
established through the transfer of assets from official
foreign exchange reserves. Large balance-of-payment surpluses
have enabled non-commodity exporting countries to transfer
excess foreign exchange reserves to stand-alone funds.
Now, within the group of countries with non-commodity
funds, foreign exchange reserves are now sufficient by all
standards of reserve adequacy, and it is our view that greater
exchange rate flexibility is needed, and we are actively
engaged on many fronts, calling for increased flexibility in
these countries.
In contrast, traditional reserves, which are typically
invested for liquidity and safety, sovereign wealth funds seek
a higher rate of return and are invested in a wider range of
assets.
They emphasize expected returns over liquidity, and their
investments can take the form of stakes in U.S. companies, as
we have witnessed in recent months.
Sovereign wealth funds' assets are currently fairly
concentrated. By some market estimates, only a handful of funds
account for the majority of total sovereign wealth fund assets.
Roughly two-thirds of sovereign wealth fund assets are
commodity funds, assets between $1.3 and $1.9 trillion, while
the remaining one-third are non-commodity funds transferred
from official reserves in the neighborhood of $0.6 to $1
trillion.
Sovereign wealth funds' assets may be small, relative to
the $190 trillion stock of global financial assets, with a
roughly $62 million managed by institutional investors, but
they are larger than the total assets under management by
either hedge funds or private equity funds, and they are set to
grow at a much faster pace.
The rise of sovereign wealth funds clearly has implications
for the international financial system. They bring benefits,
but they also raise potential concerns.
On the benefit side, as the President reaffirmed in his May
10 statement, the United States is committed to open investment
and advancing open markets at home and abroad.
The depth, liquidity, and efficiency of our capital markets
make the United States the most attractive country in the world
in which to invest.
And the U.S. economy benefits from that open investment
including investment from sovereign wealth funds.
These benefits come in the form of jobs, R&D spending, and
higher wages. Over 5 million Americans, 4.6 percent of the U.S.
private sector, are employed by foreign-owned firms with U.S.
operations. These 5 million jobs pay 25 percent higher
compensation on average than other jobs in other U.S. firms.
Additionally, foreign-owned firms contributed almost 6
percent of U.S. output and 14 percent of U.S. R&D in 2006.
Foreign-owned firms reinvested over half of their U.S. income,
about $71 billion, back into the U.S. economy in 2006.
As many observers have pointed out, sovereign wealth funds
have the potential to promote financial stability.
They are, in principle, long-term, stable investors that
provide significant capital to the system. They are not highly
leveraged, and they cannot be forced by capital requirements or
investor withdrawals to liquidate positions quickly.
Yet, sovereign wealth funds also raise potential concerns.
Investments in U.S. companies or other firms by sovereign
wealth funds, as with other types of foreign investment, may
create legitimate national security concerns.
Also, sovereign wealth funds could provoke a new wave of
investment protectionism which raises risk for the United
States as well as the global economy.
Sovereign wealth funds raise non-national security issues
related to the larger role of foreign governments in markets.
For example, through the inefficient allocation of capital,
perceived unfair competition with private firms for their
pursuit of strategic over return-oriented investments,
sovereign wealth funds could potentially distort markets.
Finally, sovereign wealth funds may raise financial
stability issues as actual or perceived shifts in their asset
allocations could cause market volatility.
At the Treasury Department, we have been working on a
number of steps to ensure the United States continues to
benefit from investment, while addressing these concerns.
First, we are aggressively implementing the reforms that
strengthen the CFIUS process required by FINSA, and Executive
Order 11858, signed by the President on January 23rd.
I want to be clear that CFIUS reviews the investment
transactions of sovereign wealth funds based on considerations
of genuine national security concerns just as it would for any
other foreign-government-controlled investment.
FINSA protects our national security while keeping
investment barriers low and reaffirming investor confidence and
the longstanding U.S. open investment policy.
Second, we have proposed, in concert with other members of
the G-7, the creation of a multilateral framework for best
practices. The International Monetary Fund should develop best
practices for sovereign wealth funds, building on existing best
practices for foreign exchange reserve management.
These would provide guidance to new funds on how to
structure themselves; it would reduce any potential systemic
risks and would help demonstrate to critics that sovereign
wealth funds can be responsible, constructive participants in
the international financial system.
Third, we have proposed that the Organization of Economic
Cooperation and Development, the OECD, identify best practices
for countries that receive foreign government-controlled
investment. These practices should focus on avoiding
protectionism and should be guided by the well-established
principles established by the OECD and its members on the
treatment of foreign investment.
Meaningful and timely progress has been made. In May of
last year Treasury hosted a G-20 meeting of finance ministry
and central bank officials that included the first multilateral
discussion of sovereign wealth funds.
On October 19th of last year Secretary Paulson hosted a
meeting with the G-7 finance ministers and the heads of
sovereign wealth funds from eight countries--China, Korea,
Kuwait, Norway, Russia, Saudi Arabia, and Singapore, as well as
the United Arab Emirates--to build support for this idea of
best practices.
The next day, the IMFC, a ministerial-level advisory
committee to the IMF, called on the IMF to begin a dialogue to
identify best practices for sovereign wealth funds.
In November, in response to this statement, a first
discussion on policy and operational issues relating to
sovereign wealth funds took place among official-sector
delegates at a roundtable that was hosted by the IMF, and a
separate dialogue is well underway in the OECD on investment
policy with regard to sovereign wealth funds.
At Treasury, we have also taken a number of steps
internally and within the U.S. Government to enhance our
understanding of sovereign wealth funds. Treasury has created a
working group on sovereign wealth funds that draws on the
expertise of both our International Affairs Division, where I
work, and our Domestic Finance Division.
Treasury's new market room is ensuring vigilant ongoing
monitoring of sovereign wealth fund trends as well as
transactions.
Through the President's Working Group on Financial Markets,
chaired by Secretary Paulson, we continue to discuss and review
sovereign wealth funds on a regular basis.
We have also initiated outreach to ensure an ongoing and
candid dialogue with countries that have sovereign wealth
funds.
We are also coordinating actively with Congress, through
staff briefings and committee hearings. As you may know, I
testified before some of you on these issues, for the Senate
Banking Committee, in November.
And in June and December of last year, we provided Congress
with updates on our sovereign wealth fund-related work in an
appendix to our Report on International Exchange Rate Policies,
and we'll continue to provide those updates on a semiannual
basis.
The Treasury Department will continue its work on sovereign
wealth funds--analytically, bilaterally, and multilaterally--so
the United States can shape an international response to ensure
that these legitimate areas of concern are addressed, while
also ensuring that the United States remains open to and
welcoming of investment. Thank you.
[The prepared statement of David McCormick appears in the
Submissions for the Record on page 32.]
Chairman Schumer. Thank you, Secretary McCormick, for your
testimony. Now we'll go to questions. We'll try to limit them
to 5 minutes each, to each of the witnesses.
First, mine is on CFIUS. As you know, we have a CFIUS
process to review certain types of foreign investment
transactions that might raise national security concerns.
And, as you also know, in the wake of the Dubai Ports deal,
I was very much involved in helping Congress beef up the CFIUS
review process.
CFIUS has the responsibility to review certain types of
foreign investment deals that might raise national security
concerns.
Now, we didn't know much about CFIUS before all of this,
but today we don't know much more about it and the review
process than we did 2 years ago.
The fact is that this is still a very opaque government
panel chaired by Treasury. It doesn't have open deliberations
or clear guidelines which deal with the views--which show us
which deals it reviews and which deals it does not.
Obviously, sovereign wealth funds present different types
of concerns than those raised by other types of foreign
investment, particularly in regards to crossing the line
between economic and non-economic motivations that I mentioned.
So, here are my questions: First, do you believe that CFIUS
and its review process can or should be made more open to the
public?
Second, do you believe that there is too much or too little
political pressure based on which deals are or are not reviewed
by CFIUS?
And, third, do you believe that CFIUS is adequately
equipped to address the unique issues presented by sovereign
wealth funds?
Under Secretary McCormick. Thank you, Senator. We, as you
noted in your prepared remarks, are in the process of
implementing the FINSA legislation through a new set of
regulations that are already very consistent in our operation
with the law.
We believe that that legislation was a great step forward
in bringing improvements to our process that allows us to
maintain the open investment posture, but also, first and
foremost, to address national security issues that arise with
any investment.
We think the process that's been established to date and
required by the legislation in terms of the disclosure and the
additional reporting after the fact on these cases to Congress
is appropriate, and we think that the ongoing dialogue that
we've had with Congress and many of your staffs on our
implementation of CFIUS is also a very important step forward
and a very important dialogue.
In terms of political pressure our view is that we are able
to implement our decisions on CFIUS cases, as we have been
mandated to do, with our focus exclusively on national
security, and I believe that I can say to you today that I
think we have operated in that spirit, both before and after
the passage of the legislation.
We think that the legislation does allow us to
appropriately deal with cases that involve sovereign wealth
funds in the event that there is an issue of national security,
and we also believe that the added rigor required by the
statute in terms of the higher level of sign-off is
appropriate, and we are executing as has been mandated by----
Chairman Schumer. How about on openness? I mean, we still--
it's still an opaque process. Are your regulations going to
require it to be more open, allow us to know more about which
firms and which deals are reviewed, which are not, and why?
Under Secretary McCormick. Well, Senator, we have new
reporting requirements, after the fact, to Congress, as you
know.
I think it's a very sensitive issue to offer more
transparency in the midst of a case, to explicitly get to the
second question you raised, because I think the more that those
deliberations are open, the more there's a risk of the
potential decisions being politicized which, I know, is not the
intent of the legislation and certainly not our intent within
the Treasury Department.
We come at our implementation of the legislation and each
specific case with a very clear sense of our mandate from you
which is to start, first and foremost, with the issue of
national security and make a determination of whether there is
in fact a national security issue, and that is the way we've
implemented it.
Chairman Schumer. Now, the other question with sovereign
wealth funds of course is: Are decisions being made on an
economic basis or an non-economic basis--which you really
didn't address that much in your testimony.
So, let me ask you this: Why should we be confident that
these funds won't pursue other goals, now if not in the future,
because they are owned by governments--and run by governments
which are not solely economic entities, and they are not even
primarily economic entities; isn't greater transparency exactly
the sort of thing that could give both the Congress and the
American people more confidence in the motivation of sovereign
wealth funds?
Under Secretary McCormick. Yes, Senator, I think your point
is a very fair one. So, I think our starting point in all of
this is that we do have a history of sovereign wealth fund
investment, and that sovereign wealth fund investment has been
long-term, stable, and commercially driven up to this point.
But I don't think we should just accept with blind faith
that the investment would be that way in the future, and that's
why there is a legitimate policy issue here.
We think that a set of best practices that includes greater
transparency on the things you mentioned, on objectives of the
fund, how decisions are made ultimately, how risk is managed,
how we ensure a degree of separation between the government and
the investment committees of these funds is critical.
We think the IMF, through a multilateral effort, is the
best way to achieve that and also to achieve the buy-in of the
sovereign wealth funds who would actually implement these best
practices.
Chairman Schumer. You think legislation might be necessary,
if the IMF process doesn't work?
Under Secretary McCormick. Well, Senator, I'm hopeful that
the process we're undertaking will work.
Chairman Schumer. But if it doesn't?
Under Secretary McCormick. Well, I hope that's not the
case, Senator. The reason I say that is I think we have an
alignment of interests here between the sovereign wealth funds,
between the countries that are the recipients of that
investment, and that alignment is to keep our markets open
because that's in their interest as well as ours, and to give
confidence to investment recipients that those investments
truly are commercially driven.
Chairman Schumer. Thank you.
Vice Chair Maloney.
Vice Chair Maloney. Thank you. I would like to ask you
about the legislation that gave the Treasury Department the
power to define ``foreign control,'' and how are you planning
to define ``control'' in the new regulations for
implementation?
Under Secretary McCormick. Congresswoman, we have defined
``control'' as the power to determine important matters
affecting the U.S. company in which the foreign company is
invested.
That definition is a functional one rather than a bright
line. And by that, I mean that we look at a number of factors
in terms of determining whether control does, in fact, exist.
The current regulations assume a presumption that a share-
holding of 10 percent or less--or of less than 10 percent--is
not control.
But we actually look at a whole series of factors and, in a
number of cases, have determined that control does, in fact,
exist with investment lower than 10 percent.
Those other factors include: Board participation; they
include committees; they include minority rights, so we look at
that whole set of factors in determining whether the investment
is indeed passive or whether control exists.
We have not published the new regulations, as you
mentioned. They will come out later this spring. I would expect
that our general approach to control would remain very
consistent with that.
Vice Chair Maloney. And when will you publish them?
Under Secretary McCormick. Ma'am, they're due later this
spring.
Vice Chair Maloney. Later this spring. Now, the
Administration has come out and said that they support
voluntary guidelines and a voluntary code of conduct. How soon
will such guidelines be available, and even assuming that
they're successful negotiations of these guidelines, how in the
world are we going to enforce them? Your comments on that, and
why should we put our faith in an as-yet-to-be-written
voluntary code of conduct that has no enforcement?
Under Secretary McCormick. Well, I think, Congresswoman, it
starts with the premise that I made earlier which is we believe
it's in the best interests of the investors and the investment
recipients to create more clarity around best investment
practices and transparency around the process.
We think getting the sovereign wealth funds to be active
participants in that is a very important part of striking the
right balance in this whole thing.
Vice Chair Maloney. But the news reports that I've been
reading there they're pushing back; they think they're
unnecessary; they're saying they're not going to adhere to
them, and they're just brushing them off.
But I'd like to ask you about a comment from former
Secretary Larry Summers. He's suggested that one way to avoid
these sovereign wealth funds from exerting control or
influencing management would be to have them invest through an
intermediary. Do you think that's workable? What's your comment
on that idea?
Under Secretary McCormick. Well, I think, as Larry Summers
has spoken out about this a number of times and, as I
understand his remarks, is supportive of the voluntary best
practices idea, whether the funds invest through an
intermediary or whether they invest directly, the investments
could be passive or have control.
So, through the CFIUS implementation we can look through
the structure of the investment to ensure that if control is in
place that we do an active national security review to ensure
that no national security interests are at stake.
Vice Chair Maloney. Do you think it's possible to prohibit
sovereign wealth funds from participating in or influencing
management decisions once they own a stake in a company? And do
you think you should continue with the 10-percent passive
ownership? Are you going to put that into regulation? Or how do
you stand on that?
But many people are concerned. My constituents raise--once
they are stakeholders and they have a voice at the table, they
can influence management; they can influence direction.
Under Secretary McCormick. Congresswoman, the definition,
again, that we use is the ability to determine key decisions
around the direction of the company. The 10-percent rule, as
you referred to it, is a general guideline, and if there are
other factors that give the acquiring company or the investing
company greater ability to determine decisions, then that may
in fact constitute control, and we've acted in that way in
previous cases.
Vice Chair Maloney. Are you concerned that these emerging
sovereign wealth funds could deliberately or inadvertently
cause market disruptions?
Under Secretary McCormick. Congresswoman, as I said in my
prepared remarks, I think that's a legitimate issue for us to
ask. I think that conversation and many of the points you raise
need to begin with the fact that we've looked at this very
carefully and that has not been the case up until this point.
And so our challenge as policymakers is to ensure that we
guard against that possibility in the future, but understanding
that we do not have evidence that sovereign wealth funds have
invested for anything other than commercial purposes.
Chairman Schumer. Thank you, Vice Chair Maloney.
Senator Klobuchar.
Senator Klobuchar. Thank you. Mr. McCormick, earlier you
talked about national security as a guide. Ambassador
Eizenstat, who is here with us, has stated that our definition
of national security as far as it is used when discussing the
impact of sovereign wealth funds remains largely undefined.
To what extent could we develop a more clear definition of
what investments impact national security so that we wouldn't
have murky transactions like the one in 2006 when Dubai was
looking at the U.S. port investments?
Under Secretary McCormick. Senator, we think that the
definition we use in the CFIUS process is the appropriate
starting point for how we think about a particular transaction.
And I think there is a case to be made that we need to take
care not to broaden that definition to the point where we
expand it and ultimately risk sending a message that we're not
open to investment.
Right now, the definition we have is questioning whether
indeed the transaction can jeopardize national security.
It's not specific in terms of the types of sectors or the
types of categories because the CFIUS Committee needs to have
the liberty to look at each transaction on a case-by-case basis
and ask themselves the fundamental question on whether in fact
national security is at risk.
As I mentioned in my remarks, sovereign wealth funds do
raise issues that go outside that definition of national
security in terms of non-commercial investment behavior which
we need to guard against, but in our view, CFIUS is not the
best way to do that.
Senator Klobuchar. It just seems to me--as we have seen
such a change in our national security and the kinds of threats
to our national security, do you think that CFIUS has changed
with the times?
Under Secretary McCormick. Congresswoman, given a lot of
interest and input from Congress and a lot of good work that I
think has happened over the last couple of years, I do think
CFIUS has evolved dramatically, and I think that if you talk
about national security or national interest in the broader
sense of the words I think we need to take care not to forget
that, ultimately, remaining open to investment and ensuring
that investment comes into the United States is a critical
component of our national prosperity.
Senator Klobuchar. And I think it can do very good things,
but my concern is--I was just thinking of our recent stimulus
package where, you know, we pumped $150 billion into the
economy in order to ward off a recession and sovereign wealth
funds now account for almost $3 trillion of investment in the
United States and we're looking at that number growing to, I
think it's $10 to $15 trillion in the next 5 years.
Abu Dhabi's fund alone is almost five times the size of our
recent stimulus package. Do you think that there is ever a
point at which we would not only oversee and investigate these
investments, but we would also look at capping the overall
amount of sovereign wealth funds in our economy?
Under Secretary McCormick. Congresswoman, I start with, I
think, a recognition as I know you do that the global economy
has changed dramatically and that a continued flow of
investment from country to country is an important driver of
our economic prosperity. That capital that comes from sovereign
wealth funds within the overall scheme of the global economy--
as I said, there's $190 trillion of financial assets--is still
a relatively small mark, and even if the projections that we
see, which one might question, because they are very
significant growth rates over the next 4 or 5 years, even if
those are true, sovereign wealth funds would still be a very
small percentage of financial assets.
Now, those assets will flow to places that are open and
attractive for investment, so one of the challenges is that we
have those sovereign wealth funds invested in the United States
and have some of the issues I have raised as concerns.
Another issue is that they don't invest in the United
States, and we don't have a climate that continues to attract
investment from that asset class as well as lots of others. So
that's the balancing act that we collectively need to strike.
Senator Klobuchar. Well, you know, we have some sovereign
wealth funds that have been around forever--Kuwait, Norway--and
they have decades of investment experience. But then you have
all these startup funds. I think there's one in Saudi Arabia
and also a startup of a fund with at least $6 billion in
assets.
As these funds gain popularity as a higher-risk investment
vehicle, do you think there should be anything done to oversee
the startup of these new funds?
Under Secretary McCormick. Well, you've touched on what I
think is one of the real challenges. There are some 40
sovereign wealth funds, and you have some that have been around
for 30 years, are very sophisticated in terms of their
investment practices, very sophisticated in terms of how they
think about the market, a long track record of commercial
investment, and then you have some that are brand new with
enormous chunks of money.
And so as we collectively think about how we address that,
what we're really trying to do is move some of those new funds
up the continuum in terms of how they think about best
practices, and help solidify and clarify some of the best
practices that are already existing in some of the more mature
funds, also impose new best practices where there's just things
that aren't where they need to be.
So, you've hit on something that's very clear which is that
we need to help some of those new funds in terms of how they
think about their investment practices.
Senator Klobuchar. Thank you.
Chairman Schumer. Senator Webb.
Senator Webb. Thank you, Mr. Chairman.
Mr. McCormick, I assume you would agree with the notion
that irrespective of the size of the investment, investment
from different countries with different political systems
potentially make us more vulnerable as a nation?
Under Secretary McCormick. Senator, I think the answer to
that would be yes, and even to be more precise, some of the
connections between the investor and the government in some of
those countries raise legitimate questions.
Senator Webb. With respect to governments, for instance,
you mentioned in your testimony Kiribati and Kuwait. I've been
to Kiribati and I've been to Kuwait, and it's not exactly China
in terms of the vulnerability of this country to the strong
investment patterns of their governments.
That would seem to me to be inarguable.
Under Secretary McCormick. I think different countries do
raise different investment questions.
Senator Webb. Right. And so one of the concerns that I and
a number of other people have, which Senator Bayh, I think,
addressed very well in a piece recently in the Wall Street
Journal, is that this isn't simply a snapshot process in the
way that we are dealing with one investment or another, but it
is potentially a cumulative process that could affect the
freedom of the U.S. Government to act in certain situations
down the road. Wouldn't you agree that that's a potential
danger here?
Under Secretary McCormick. Our CFIUS mandate is to look at
each case in a very clear way and ask the question, as you just
zeroed in on, on whether there is indeed a national security
issue associated with that transaction.
But I do think it's a legitimate question or need to
periodically step back and look at the broader investment
patterns which we do on a periodic report to Congress that
addresses some of the more fundamental questions of how all
this fits together.
Senator Webb. Particularly with respect to countries that
may have different viewpoints on issues that relate to the
national strategy of the United States.
Could you describe the conditions under which the U.S.
Government directly invests in American corporations?
Under Secretary McCormick. Senator, to my knowledge the
Federal Government, with, I think, some rare exceptions in
history, does not typically----
Senator Webb. Because it would be a conflict of interest,
it would be assumed to be a conflict of interest. How about the
U.S. Government directly investing in foreign corporations?
Under Secretary McCormick. Not typically the case.
Senator Webb. So you would agree, I would think, that this
is something of an anomaly when we're inviting foreign
governments to do something that our Government itself does not
do?
Under Secretary McCormick. Senator, I think we went back
and forth in the last hearing, and I did call out that there
are some exceptions at the State level.
Senator Webb. But that's not what we're talking about here.
Under Secretary McCormick. The Alaska Permanent Fund, for
example, is characterized by most analysts as a sovereign
wealth fund, but as a general rule of thumb, I think your
assessment is correct.
Senator Webb. OK, thank you, Mr. Chairman.
Chairman Schumer. OK, thank you, Mr. McCormick, for your
testimony. We're going to continue to pursue this issue.
Vice Chair Maloney. May I ask him about one thing?
Chairman Schumer. Please go ahead, Ms. Vice Chair.
Vice Chair Maloney. May I ask just one question about a
company? There's been several press reports on the Hu-Wai
Technologies buying 3M Corp, 3C Corp, and I know that it was
under CFIUS review.
Has that been completed, or is it still under CFIUS review?
Under Secretary McCormick. Congresswoman, if you'll forgive
me, I really am not able to comment on a specific case.
Vice Chair Maloney. But is it still under review? That's my
question?
Under Secretary McCormick. What I can confirm there is that
both parties have acknowledged publicly that the case is in
review.
Vice Chair Maloney. OK, thank you.
Under Secretary McCormick. Thank you.
Chairman Schumer. Thank you, Mr. McCormick.
Now let's call our next two witnesses, Stuart Eizenstat, as
well as Douglas Rediker.
Chairman Schumer. Our first witness is Stuart Eizenstat. He
is a partner at the law firm of Covington & Burling. He has had
a lengthy and distinguished career in public service as Deputy
Secretary of the Treasury under the Clinton administration;
Ambassador to the European Union; Under Secretary of Commerce
for International Trade; and as Chief White House Domestic
Policy Advisor to Jimmy Carter. In his role as Special
Representative of the President and Secretary of State on
Holocaust-Era Issues he successfully negotiated major
agreements with many of the European countries covering
restitution payments.
He regularly writes on issues regarding international trade
and international law and economics, and is a graduate of the
University of North Carolina and Harvard Law School.
Douglas Rediker is currently co-director at the Global
Strategic Finance Initiative at the New America Foundation, an
initiative that addresses the fast-changing relationship
between global capital flows, financial markets, foreign
policy, and national security.
Before joining the foundation, Mr. Rediker spent over 16
years in Europe where he served as senior investment banker and
private equity investor for some of the world's leading
financial institutions including Salomon Brothers, Merrill
Lynch, and Lehman Brothers.
More recently he was a London-based partner in a private
equity firm where he was jointly responsible for establishing
and managing the group's European operations. In addition, he
has served on the board of directors of several companies, and
written regularly on issues regarding international trade and
economics.
We are going to ask each of you to limit your statements to
5 minutes because we have a vote coming up at 4:30--I believe
it is at 3:30--and then we will ask questions. So Ambassador
Eizenstat, your entire statement will be included in the
record.
STATEMENT OF AMBASSADOR STUART EIZENSTAT, PARTNER, COVINGTON &
BURLING; FORMER DEPUTY SECRETARY OF THE TREASURY, AND
AMBASSADOR TO THE EUROPEAN UNION, WASHINGTON, DC
Ambassador Eizenstat. Thank you, Mr. Chairman, and
colleagues for holding this important hearing.
Permit me to say at the outset that the challenges provided
by the some $3 trillion in sovereign wealth funds from China
and Russia to the Gulf States and Saudi Arabia are as much a
reflection of our own economic problems as they are about
sovereign wealth funds themselves.
Their remarkable growth and their decision to invest more
broadly in a portfolio beyond the investments by their central
banks and treasury bills is a reflection of our own growing
dependence on expensive foreign oil and our massive Current
Account deficit.
All of us need to be spending as much time and energy, if
not more, on dealing with these structural economic problems as
on the consequences of the problem. In effect, we should look
at sovereign wealth funds as recycling the U.S. petro dollars
and our appetite for products from China and emerging markets.
I am a strong believer in the importance of the free flow
of capital around the world and the value of foreign direct
investment in creating jobs and adding to creativity and
innovation in our economy.
For sure there is a difference between private foreign
investment and that of sovereign wealth funds and their close
cousins State-owned enterprises. But even there the distinction
is not always as clear as it may seem.
For example, many European companies have some government
ownership through Golden Shares, and many European governments
now are trying to create so-called national champions to better
compete in the global marketplace.
We need to be careful that in dealing with sovereign wealth
funds we don't deter the free flow of international capital. I
believe that sovereign wealth funds do bolster the U.S. economy
and that on balance they are a significant net plus for our
economy.
If we take the ``welcome'' sign off, they will invest their
growing wealth elsewhere in the world. At the same time, there
are legitimate concerns that need to be addressed heavily
revolving around the need for transparency and good governance.
This in my opinion does not mean that they must divulge all
their holdings and investments, but rather that they need to be
transparent in their governance, their relationship to their
governments, their processes, their goals, and determining
whether they obtain subsidized government financing on
individual deals which would create an unfair advantage over
U.S. or other private foreign corporations who have to rely on
private credit markets for competing for the same acquisitions.
We have a legitimate interest in assuring that sovereign
wealth funds have a purely commercial, not political or
national security, interest in their investments in our
country.
Beyond transparency and good governance, there are
certainly a limited number of matters in which national
security is implicated by sovereign wealth funds or State-owned
enterprise acquisitions. But in a globalized world economy in
which we no longer have a monopoly on hardly any product, it is
important that national security not be defined so broadly that
it is used as a pretext to deter foreign investment.
Mr. Chairman and Members of the Committee, I would urge
Congress at this point not to legislate or to pressure
regulators to heavily impose regulations on sovereign wealth
funds. The reason is that Congress has reasonably and recently
provided the executive branch with the means to deal with
genuine national security threats from sovereign wealth funds
or state-owned enterprises in the form of last year's
bipartisan Foreign Investment and National Security Act, FINSA,
which Chairman Schumer was clearly a leader in developing.
We should give the CFIUS process under this new legislation
time to work through these sovereign wealth investments before
we come to any further conclusions.
Moreover, it is critically important that Congress not take
unilateral action. It is vital that we try to develop
multilateral principles.
For example, Europe has similar concerns as we do with
sovereign wealth funds and State-owned enterprises. As just one
example is Russia's Gazprom expressing interest in acquiring
energy assets in the UK and elsewhere in Europe, eliciting a
strong response from government leaders and from EU officials.
The Bush administration has wisely agreed to a multilateral
approach. The IMF, as we've said, is directly working now with
major sovereign wealth funds on developing a set of Best
Practices which they hope to have completed by April.
The OECD is doing the same with host countries and their
report will be ready at roughly the same time. In addition, the
Government Accounting Office is examining sovereign wealth
funds and, as we've noted, Treasury will have its regulations
out in the spring on the new FINSA law.
We should let these activities play out, and in particular
see how sovereign wealth funds react to the IMF effort to
develop a set of principles focused on transparency before we
consider anything beyond voluntary principles.
In short, as I've stated in more detail in my testimony, I
firmly believe we can both protect our national security and
remain open to the vast majority of sovereign wealth funds
investments in the United States, most of which do not
implicate national security.
One example: The purchase, for example, by Dubai of
Barney's hardly touches on national security. For sure there
are going to be some highlight cases which do, but by and large
most of these investments really do not touch national security
interests, and we have to be very careful that we distinguish
those that do not from those that might.
[The prepared statement of Mr. Eizenstat appears in the
Submissions for the Record on page 36.]
Chairman Schumer. Thank you, Ambassador.
Mr. Rediker.
STATEMENT OF DOUGLAS REDIKER, CO-DIRECTOR, GLOBAL STRATEGIC
FINANCIAL INITIATIVE, THE NEW AMERICA FOUNDATION, WASHINGTON,
D.C.
Mr. Rediker. Thank you, Mr. Chairman, Madam Vice Chair, and
Members of this Committee for the honor of addressing you.
I am particularly pleased to be invited to speak before you
because I was born and raised in New York City which I believe
puts me in very good company here today.
Chairman Schumer. What high school did you go to, Mr.
Rediker?
Mr. Rediker. Fieldston.
Chairman Schumer. Fieldston? Hmm, very nice.
Mr. Rediker. Thank you.
[Laughter.]
Mr. Rediker. As a general matter, I believe that both U.S.
and global economies are strengthened by the free flow of
investment capital and increased liquidity that open markets
provide.
As significant providers of capital to these markets,
sovereign wealth funds have thus far been a positive influence
in U.S. and global markets.
Recently, significant capital injections by sovereign
wealth funds in several major financial institutions have been
a stabilizing force at a time of market uncertainty and
volatility.
Capital flows from sovereign wealth funds benefit U.S.
investors, companies, and workers not only in the financial
services sector but more broadly, as increased liquidity
results in higher stock and asset prices and lower risk
premiums.
It is indisputable that funds from foreign governments,
whether in the form of central bank reserves or through
sovereign wealth funds, have contributed to more benign
financing conditions in this country than would have otherwise
been the case.
While I believe that continued investment by sovereign
wealth funds is positive and should be encouraged, I also
believe that the nature and scale of these investment funds
warrants continued vigilance and oversight by Congress.
Especially when compared with other industrialized nations,
I believe that this country's national interests are relatively
well protected and well regulated.
National security and market integrity are already
protected, not only by CFIUS and FINSA legislation, but also
through existing laws which prohibit, restrict, or require
disclosure from foreign investors in areas as diverse as
securities trading, export controls, ownership of media and
communications assets, and the broad protections afforded by
our antitrust laws.
There are of course some areas that warrant particular
attention. I believe the U.S. Government should continue to
support calls for increased sovereign wealth fund disclosure.
Transparency would benefit the markets by calming suspicions
aroused by lack of information and would increase the
likelihood that markets would be alert to concentration issues
and potential contagion risks.
Transparency should be part of a broader code of Best
Practices adopted in a collaborative effort by sovereign wealth
funds. I do not support calls to impose mandatory disclosure
obligations as a prerequisite for investing in U.S. markets as
I believe these would be ineffective and potentially
counterproductive.
These funds should recognize the benefits of smooth,
functioning markets and financial stability and may also
embrace the opportunity to judge their own returns against
relevant indices, and even their peer group, as well as to
demonstrate that they are investing in a manner consistent with
the best interests of the people of the countries that they
govern.
Within the United States, I believe that the investment
environment for sovereign wealth funds should be as clear and
predictable as possible. In particular I suggest that specific
guidance be provided regarding the interpretation of control
which would require a formal CFIUS review.
One of the most compelling lessons I learned during my
career in finance was that investors abhor uncertainty which
discourages investment by injecting unquantifiable risk into an
investment decision.
If a sovereign wealth fund complies with all relevant laws
and regulations and is later subject to unforeseen scrutiny and
delay, it is likely that that investment decision will be
negatively impacted.
Over the past decade, international capital markets have
transitioned away from U.S. domination to being truly global in
scope and leadership. Sovereign wealth funds are but one
manifestation of the past decade's shift towards a truly multi-
polar global financial marketplace, a marketplace where the
sources, intermediation, and destinations of capital outside of
the United States have grown at a tremendous pace.
Those who seek alternatives to invest in and trade through
U.S. financial markets now have multiple options to choose
from.
When addressing sovereign wealth funds it is imperative
that this Committee take into account the crucial issues of
this country's national and economic security, financial market
integrity, and the continued competitiveness of our capital
markets.
As part of that effort, I believe that professionally
managed sovereign wealth funds with some $3 trillion of capital
to invest, who agree to abide by the rules that we set for
investing in this country, should be encouraged to do so.
Thank you.
[The prepared statement of Mr. Rediker appears in the
Submissions for the Record on page 40.]
Chairman Schumer. Well, thank you both for your excellent
testimony.
I guess my first question is to both of you. You heard my
opening remarks where I stressed both the benefit that these
investments have in the United States, particularly given our
economic situation where we don't have a wealth of capital and
we have a need for it, but also the call for transparency in a
variety of ways.
The reason for transparency is just to make sure we are not
crossing the economic line and getting into political
involvement, which a government-owned fund might naturally have
the inclination to do.
First, I laid out a number of things that were measures of
transparency. Do you generally agree with those? Disagree? Tell
me what you think.
And do you think the funds now are transparent enough is, I
guess the second question I would ask in relation to that:
Ambassador?
Ambassador Eizenstat. I generally agree. I think
transparency is absolutely crucial because transparency also
gets to the issue of governance. We want to know the
relationship that these funds have to their governments, to
ministries. We want to know whether the boards of directors and
the management of sovereign wealth funds are in fact as they
are; for example, with Gazprom, which is really a State-owned
enterprise, are really government ministers or are they private
individuals? All the issues of governance can get--we can get
to through the issue of transparency.
I really hope that sovereign wealth funds understand that
transparency is also in their interest as well. That is because
it will cool tempers here. It will increase their own levels of
governance. And this is also important.
Now one other thing on transparency, Mr. Chairman. When you
come to an individual transaction the question is--and
transparency is a way to find it out--is the government
subsidizing the particular acquisition in question?
Is it providing below-market financing? Which if it does is
unfair competition with private foreign corporations or with
U.S. companies trying to acquire the same asset. That is a very
important issue.
Now in terms of models, Temasek is a sovereign wealth fund
that publishes annual reports. They have since 2004. And you
know, they have a good track record. Others do not. So I think
that this exercise with the IMF is terribly important, and it
should be as much in their interest as it is in ours.
Chairman Schumer. Mr. Rediker.
Mr. Rediker. Thank you, Mr. Chairman.
First of all in terms of the question: Are they transparent
enough now? Well, obviously many are not. In the case of the
Norway they are. Temasek does a very good job. But I think that
if there is a malicious motivation on the part of a sovereign
wealth fund or State-owned enterprise, there is no level of
transparency either we on a bilateral basis or the IMF could
impose on them that would actually cause them to disclose
something that they were not willing to disclose if they really
have a motivation to hide it.
So even a fund like that of Norway, which does an excellent
job, almost too much information, does not disclose its
derivative positions. If a country, like Russia for example,
that we did not believe was looking out for our best interests
wanted to comply with a code of best practices, but still
wanted to hide something, they could do it.
So I think we should not get--I certainly agree that we
should be pushing them for increased transparency and
disclosure, but let's not make believe that that is going to
solve all of our ills.
Chairman Schumer. It would certainly be a lot better to
have it than not.
Mr. Rediker. One hundred percent. And I would encourage it.
Chairman Schumer. I could understand if there were a
nefarious purpose, but if there's a nefarious purpose I suppose
the foreign government could disguise its investment with an
individual and not do it through a sovereign wealth fund.
Mr. Rediker. Absolutely. But I encourage increased
disclosure and transparency. But I would echo my colleague's
comment here which is that it is far more effective if they
believe it is in their interests as well. And I think that that
is entirely consistent with the undertakings of the IMF----
Chairman Schumer. I think you may find that I generally
believe most of the countries have purely economic purposes.
You take a small gulf oil state which has tons of money and no
place to invest it on its own, obviously they want to have a
good rate of return.
There are other countries--I mean Russia would be the most
obvious--where the government relishes using economic threat
and has. China is a little further over. And you know, you
get--I can have the luxury, which say Mr. McCormick does not,
of sort of speculating about these countries, but obviously it
goes into the decision.
My final question to each of you is:
Since the IMF guidelines will be voluntary, what do we do
if there are nations that do not wish to abide by them? I think
most will, because as I agree with both of you it is in their
interests, particularly if their motivations are good, but what
do you do if a country says no?
Ambassador?
Ambassador Eizenstat. This is a very difficult question.
First, I hope that most will. But if hypothetically some do
not, it seems to me then you get into two types of investments.
One is that I would be less concerned even for a sovereign
wealth fund that does not abide by voluntary guidelines if they
are investing in real estate, and a hotel, and a retailer,
where there is really no national security interests.
However, if they decide to invest in anything that
implicates the CFIUS process, then CFIUS could have a
presumption against acceptance and make it clear, because I
think as Mr. Rediker said, and Dave McCormick, certainty is
very important. They should have the knowledge that if they do
not abide by these rules, if they are not good international
citizens--and we talk about a globalized economy. A globalized
economy also means accountability and responsibility by
emerging markets and developing markets to play by
international rules. That is what WTO rules are all about.
So I think that in those circumstances they should know
that there is at least a presumption when they're in the CFIUS
process and touch on national security interests that would be
a presumption against such investments.
Mr. Rediker. I would certainly agree with everything that
Ambassador Eizenstat said. I would point out, though, that in
general if an investor sovereign wealth fund is investing
solely in a passive capacity, then it does not trip into many
of these whether it's CFIUS or the other disclosure or approval
processes.
ADIA, for example, out of Abu Dhabi has been a model
investor for many decades and has not been the most forthcoming
in the area of transparency, but has not raised its investment
in any area that has caused us any national security or market
concerns.
So I think that the existing process, as Ambassador
Eizenstat said, should take into account whether they are being
forthcoming, and whether they are being transparent if it falls
into a CFIUS review process, but otherwise I think the market
has functioned reasonably well in nonvoting passive stakes and
we should not be terribly concerned about it.
Ambassador Eizenstat. Let's remember, if I may say, Mr.
Chairman, there really are two things that trigger CFIUS, and I
was involved on the government side and sometimes now on the
private side. There are two things.
One is the issue of control which, as David McCormick said,
is not mechanical. There is a presumption on 10 percent, but
the real issue is you could have 1 percent and if you control
the board, if you control management, if you have a say-so over
the budget, if you have say-so over acquisitions or
divestments, then you move from passive to control. So control
is one.
And then the national security link is the second. If you
don't touch either of those, which is the case in most of these
investments, then the issue of opaqueness becomes less of a
problem.
It would be desirable, but I would not say it should create
a necessary presumption against the investment.
Chairman Schumer. Thank you both for what you're proposing.
Aside from the national security, which is separate and apart,
there is sort of a scale of push and pull between control and
transparency, or ``influence'' is a better way to put it, based
on what the Ambassador said, influence and transparency.
The more influence you have, the more transparency you
need; the less, the less. It is interesting.
Vice Chair Maloney.
Vice Chair Maloney. Thank you, Mr. Chairman.
The CFIUS process is voluntary, as you know, and its main
thrust--as you both said--is national security, homeland
security. But Ambassador Eizenstat, you raised another issue
that is incredibly important. And that is, competitiveness,
market and financial security for our own firms to be able to
compete against government-subsidized entities.
I know since I've read many CFIUS cases it is very hard to
determine what percentage is influenced by a government.
Oftentimes they incorporate in different countries, all over
the place. One right on top of the other. And you really have
to have a subpoena to figure out who really owns it.
But even in the cases where foreign governments were buying
stakes in our own American firms, I was wondering were American
investors given the same opportunity to buy in at the same
terms? I never saw that discussed in detail.
But I think that something that you raised is: If a foreign
government is subsidizing a shell company to compete and buy
properties that are not related to national security, they have
a tremendous advantage that can undercut the competitiveness of
American businesses. And my question is:
Aside from the national security--CFIUS is taking care of
that--this competitive advantage that they have, and what kind
of safeguards should we put there? I believe this is a separate
question from CFIUS which is primarily national security and
security concerns.
But buying Barney's for example, that is obviously not a
national security concern, but if the government is subsidizing
it then an American cannot in any way compete in buying it.
What protections do you think we should have for American
commerce just in the competitive atmosphere of government
subsidy, government-sponsored enterprises buying up real estate
and companies in America? Or stakes, important stakes, passive
stakes in companies in America?
Ambassador Eizenstat. This is a very difficult and
appropriate question. Again, within the CFIUS domain, CFIUS can
and does have a great capacity to bore into the governance of
companies, to look at shell companies and so forth.
Vice Chair Maloney. I am very aware of that. I have
followed that, and they can get to the shell companies. But
those that are not part of national security, that is the
concern in my question.
Ambassador Eizenstat. I understand, and it is an
appropriate question. I think that there really is not a
vehicle for dealing with that other than perhaps putting some
oversight or public pressure when such a transaction occurs.
To the extent that there is competition between a State-
owned enterprise that is subsidizing that transaction, or a
European national champion that is making that acquisition on a
private company, then the private company would probably have
to go to the Congress and urge that Congress look at that and
insist on some kind of a level playing field.
But there is currently no structure to deal with that. In
terms of whether legislation should be necessary, I would
prefer to see if there are not some other ways to deal with
that. But it certainly is a very vital question and one that we
should look at more closely.
Vice Chair Maloney. But it is not something that a business
person or company can go to Congress with, because it usually
happens very quickly. You pick up the paper and find out that a
foreign entity, a sovereign entity has bought a major company
or a major stake, and it is not clear whether Americans were
given an opportunity to compete for it, and certainly they
cannot compete if it is government subsidized.
Ambassador Eizenstat. But there the market is taking care
of it in a sense if--and again hypothetically let's say
Barney's--decides that they do not want to auction themselves
and get a better price, and turn down a foreign acquirer, even
one that is subsidized, that is their market decision.
If they were wise, perhaps, and again I am using this only
hypothetically, they would say, well, let's see what better
deal I can get in the market from another company. And then you
would have a more transparent process.
So if a company is willing to sell itself even to a foreign
entity that is subsidized, that is its decision and the
marketplace will basically bear that out that no national
security implications. They might be wise again to have a more
transparent process where they give other bidders the
opportunity, but I would be prepared by and large to let the
market take care of that.
Vice Chair Maloney. But obviously American companies cannot
compete if it is government-sponsored and government-
subsidized.
Mr. Rediker, would you like to respond?
Mr. Rediker. Yes, please, Madam Vice Chair. I think I am
not sure I understand the concept of ``subsidy'' here. Because
my focus on this general issue would be when we have a Barney's
transaction, for example, a competing bidder from the United
States would likely look to its bankers and to the capital
markets to provide leverage in the credit markets to enhance
its return on its equity.
The real issue here is that sovereign wealth funds with
several trillions of dollars under management do not need to
access those credit markets. So I am not sure that it is the
subsidy that would be my concern; rather, it would be the fact
that sovereign wealth funds have a lot of liquid capital to
invest in equity right now without regard to the market turmoil
which would affect those in the private sector that are usually
more subject to the volatility of those capital markets to
finance the returns on those investments.
Vice Chair Maloney. Well, I think that you have raised an
important point, Ambassador Eizenstat, and I do not think that
there is anything out there to really level the playing field
for American firms.
I note that under the CFIUS process, which only kicks in
when it is a national security concern, they can spend a year
looking at the shell company and finally figure out that the
shell company is owned by the government and then turn it down.
You do not have anything like that in the regular commerce
that is not part of national security. So what do you think we
should do about it, if anything? If you leave it to market
forces, then our businesses that are not subsidized would just
be beaten out of the market.
Ambassador Eizenstat. Well, I mean at this point, with the
exception of very few cases, I have not really heard of U.S.
companies who are complaining that they are being beaten by
these kinds of subsidies, outside of a CFIUS context.
If it became more of an issue, it is something Congress
could look at, but I think at this point I am prepared to let
the market take care of itself and let the company to be
acquired make the decision about whether it is getting a better
deal.
Also, there are many other factors beyond the question of
sovereign wealth funds. For example, a U.S. company may wish to
be acquired by another U.S. company in terms of technology,
management teams, expertise. Most of these sovereign wealth
funds are not in a position to be able to control any kind of a
sophisticated U.S. company, at least without being passive
investors and allowing U.S. management to participate.
So I think the market by and large will sort that out.
Vice Chair Maloney. Well, my time has expired.
Chairman Schumer. Well, I want to thank both witnesses.
This hearing has explored the issue, I think, in a careful and
thoughtful way. We have a ways to go, obviously. This is a new
area. There are dangers, but there are dangers to doing
nothing; there are also dangers to doing too much, as you both
pointed out; and we are going to have to thread that needle.
And so far I think we are off to a pretty good start.
So I thank both of you, as well as Secretary McCormick and
my colleague, Congresswoman Maloney, as well as Senators Webb
and Klobuchar. The hearing is adjourned.
[Whereupon, at 3:28 p.m., Wednesday, February 13, 2008, the
hearing was adjourned.]
Submissions for the Record
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Prepared Statement of Senator Charles E. Schumer, Chairman
Good afternoon and thank you all for coming. Today the Joint
Economic Committee is having the first hearing of 2008 on the rise of
foreign government-controlled funds investing large sums of money in
our economy.
The question of the day is whether these huge pools of investment
dollars, known as sovereign wealth funds, make the U.S. economy
stronger or pose serious national security risks. I'm not sure that we
will answer that question to anyone's satisfaction today, but at the
very least, this Committee and the federal government needs to spend a
great deal of time thinking about it.
To help us do some of that thinking today, we're honored to have an
outstanding panel including: the current Treasury Undersecretary, David
McCormick, a former Treasury Deputy Secretary under President Clinton
and former Ambassador to the European Union, Stuart Eizenstat, and
prominent foreign investment expert, Douglas Rediker.
The initial focus of Congress is correctly on the transparency of
these funds and whether that is best achieved voluntarily working
through the IMF, or if that doesn't work, through legislation. My
preference would be for the former, but we may have to consider the
latter.
I would like to take a few minutes to discuss the broader economy
and why I believe we are faced with such an increase in investment by
sovereign wealth funds in U.S. companies.
It is no secret that our economy is in bad shape now. There is
increasing evidence that a recession will be deeper than this
administration is willing to admit:
We have spent too much and saved too little as a country and as
consumers (our national savings rate is just above zero).
Commercial and consumer credit markets have seized.
Home foreclosures are rising in both subprime and prime markets.
The value of the dollar has fallen in relation to other world
currencies.
Job growth is at historic lows since January 2001.
And trade deficits are ballooning to historic highs.
But we also have long-term structural problems in the economy. The
U.S. debt-to-GDP ratio is steeply rising, which is a reflection of bad
fiscal policy putting tax cuts before everything else, even during
wartime.
Our current account deficit is at historic highs, approaching one
trillion dollars, and this highlights massive borrowing by the federal
government to pay for rising defense and domestic spending.
So it shouldn't surprise us that, as Larry Summers said last year,
``the world's greatest power has become the world's greatest
borrower.''
Even when the economy was going well, there wasn't enough of our
own capital because we spend more than we save, we import more than we
export, and we consume more than we produce. So when the economy
slowed, we didn't have the resources to keep it moving.
Creating a perfect sovereign wealth storm, foreign countries have
benefited from our unwitting largess. Thanks to the Bush
Administration's failure to control the trade deficit, address currency
market manipulation, and bring down oil prices--foreign governments
have a lot of extra money, and we do not.
These governments are using their sovereign wealth funds to go on a
buying spree in the United States.
The bottom line is that we're overextended and there may only two
options--neither of which is very attractive.
1. We can allow a dramatic contraction of our economy;
2. Or we can allow foreign investment, in a measured way, to stave
off further job loss and keep the economy humming.
It shouldn't surprise us that international bargain hunters have
descended on the U.S. economy.
The acquisition of multibillion dollar stakes in Wall Street firms
like Merrill Lynch, Citigroup and Morgan Stanley by Asian and Middle
Eastern sovereign wealth funds, quite naturally, has sparked increasing
interest and concern about their impact on the U.S. economy. With
domestic credit markets locked up, U.S. businesses seem to have little
choice but to turn to sovereign wealth funds as a source of much-needed
capital.
Much of the criticism until recently has been when money is sent
out of the United States, taking American jobs and moving them abroad.
It is contradictory to complain about similar investments when they are
now being made in the U.S.
In general, foreign investment has a healthy impact on the U.S.
economy, and I've supported it. It augments domestic sources of capital
and provides much-needed capital and liquidity. It can also create jobs
and improve productivity.
However, where the foreign investor is a government or a
government-controlled fund, I have concerns about their motivations. We
have seen plenty of private foreign investors put money into U.S.
companies without much evidence that they are investing for non-
economic purposes. But it would be perfectly rational to expect a
foreign government-controlled fund to have noneconomic motivations.
For instance, foreign governments might have an interest in
controlling strategic assets, securing access to sensitive information
or technology, promoting a political agenda, or cornering a market on
raw materials. The closer foreign governments come to exercising
control and influence, the greater my concerns.
When Dubai Ports World attempted to purchase major U.S. seaports in
2006, alarm bells went off. When it comes to a vital security asset
like a port or even a basic infrastructure like a utility, we are right
to be very concerned. If a Russian sovereign wealth fund bought a
natural gas utility here, alarm bells would be going off again because
serious questions and concerns would be raised.
In this regard, sovereign wealth funds are their own worst enemies.
Most are not transparent or publicly accountable, and we know little
about their governance structures or fiduciary controls. So the bottom
line is that we don't know if their decisions are made exclusively on
an economic basis.
We invited some of the largest sovereign wealth funds to testify
before us today, but they directly declined or their government
embassies in the U.S. declined for them.
While managing directors of these funds won't appear in front of
Congress, a number of them have been quoted recently in the press
attempting to assure lawmakers and the public that their motivations
are purely financial and that they do not take direction from their
government.
I am not yet persuaded. They need to do much more to make their
case.
I met recently with the head of China's sovereign wealth fund. I
asked him about the fund's investment policies and its interaction with
government officials, but got no real answers. I did get this nice
glossy brochure, but it does not really tell me anything.
It is clear we need to find out more about sovereign wealth funds--
how they are run, what drives their investment decisions. Sovereign
wealth funds should voluntarily provide information and agree to
guidelines that promote good governance, accountability, and
transparency. Here are some questions they should answer:
Do sovereign wealth fund officials report to an independent board
of directors or directly to the government?
Do they disclose their investment goals? If those goals change,
is that made public?
Are directors and the investment management team selected on the
basis of business qualifications and not political affiliation? Are
their professional qualifications and experience made public?
Is there a stringent code of conduct that compels members of the
board of directors and management to report any attempts by the
government to influence investment decisions?
Do they publicly disclose quarterly and annual audited financial
statements?
Do they publicly disclose all their portfolio holdings?
I also want to review whether the reforms to the CFIUS process made
by the Foreign Investment and National Security Act of 2007 (FINSA) are
sufficient to address the unique risks associated with investments by
sovereign wealth funds--and if not, propose additional legislation to
close any loopholes. I will also take a hard look at the new FINSA
regulations due to be published in the spring.
Finally, it is important to point out that many of the countries
with the largest sovereign wealth funds still maintain high levels of
protection against investment in their domestic industries. I hope that
Treasury and the U.S. Trade Representative do better to ensure
reciprocal market access for U.S. investors.
Ultimately, we need to maintain a careful balance between welcoming
foreign investment and protecting national and financial security, as
well as market stability. Sovereign wealth funds need to assuage
concerns that they will manage their investments in terms of political
or economic power objectives. The alternative I fear--already proposed
by a number of lawmakers and other critics--is restrictions on
sovereign wealth fund investments in the United States.
My hope is that sovereign wealth funds can assure us that they will
behave like other economic actors, and if they do so that's all to the
good. But until they do so, they shouldn't get carte blanche.
__________
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Prepared Statement of Representative Carolyn B. Maloney, Vice Chair
Good afternoon. I would like to thank Chairman Schumer for holding
this hearing to examine the benefits and risks of sovereign wealth
funds investing in the United States. I want to welcome our witnesses
and thank them for testifying here today.
The term sovereign wealth fund has only recently entered our
lexicon, but these government-controlled investment vehicles have been
around and operating without incident for decades. At the moment, these
funds are providing much needed capital to U.S. banks trying to regain
their footing in the wake of the mortgage crisis. However, the growing
market clout of these funds and the steep rise of their investments in
the United States require that they receive greater scrutiny by
Congress.
Bush Administration policies have fostered a large amount of
federal borrowing from overseas, a greater reliance on foreign oil and
a weak dollar--all of which have created an environment that is ripe
for sovereign wealth funds with extraordinary oil profits or excess
foreign exchange reserves to gobble up American assets at bargain
prices.
Governments can have very different motivations than financial
investors, so we would be remiss not to carefully examine the potential
risks from these state-owned investment funds. Reform of the Committee
on Foreign Investment in the United States (CFIUS) was triggered by the
revelation that the committee gave the green light to a deal that sold
operation of major U.S. ports to a company owned by the government of
Dubai without any senior level review.
With proper implementation by the Administration, the new reforms
will strengthen the system by which foreign investment in businesses in
the United States is vetted for security concerns, and provide
certainty and predictability to the CFIUS process in order to expand
economic activity, create jobs, and encourage safe foreign direct
investment. I will continue to maintain a watchful eye over the ongoing
implementation process, but I am confident that the Treasury Department
intends to follow the law as I wrote it, and have received assurances
that the department is already adhering to the new reforms.
I welcome the Administration's efforts to work through the
International Monetary Fund to create an international code of conduct
that would include greater disclosure of sovereign wealth fund
activities and governance. An important lesson of this summer's
mortgage crisis is that when capital markets become too opaque and risk
exposure is not well understood, the consequences can be devastating
for institutions and individuals. Greater transparency of sovereign
wealth funds would be a welcome development, but it may not be enough.
Our challenge is to balance the potential risks to our economic and
national security interests with our desire to maintain an open
investment environment.
Mr. Chairman, thank you for holding this hearing and I look forward
to gaining some insights from our witnesses about the appropriate
oversight of sovereign wealth funds.
__________
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Prepared Statement of David H. McCormick, Under Secretary for
International Affairs, U.S. Department of the Treasury
Chairman Schumer, Vice-Chair Maloney, Ranking Member Saxton,
Senator Brownback and Members of the Committee, good afternoon. I very
much appreciate the opportunity to appear before you today to discuss
sovereign wealth funds. This is a timely hearing on a very important
topic. At Treasury, we have been increasingly focused on sovereign
wealth funds for more than a year now. I am pleased to be able to share
with the Committee some of our views.
history and context
First, some history: sovereign wealth funds are not new. The oldest
of these funds date back to the 1950s in Kuwait and Kiribati. Over the
next four decades, their numbers slowly grew. Three of the largest and
most respected funds--the Abu Dhabi Investment Authority, Singapore's
Government Investment Corporation, and Norway's Government Pension
Fund-Global--were founded in 1976, 1981, and 1990, respectively. By the
year 2000, there were about 20 sovereign wealth funds worldwide
managing total assets of several hundred billion dollars.
Today, what is new is the rapid increase in both the number and
size of sovereign wealth funds. Twenty new funds have been created
since 2000, more than half of these since 2005, which brings the total
number to nearly 40 funds that now manage total assets in a range of
$1.9-2.9 trillion. Private sector analysts have projected that
sovereign wealth fund assets could grow to $10-15 trillion by 2015. Two
trends have contributed to this ongoing growth. The first is sustained
high commodity prices. The second is the accumulation of official
reserves and the transfers from official reserves to investment funds
in non-commodity exporters. Within this group of countries, foreign
exchange reserves are now sufficient by all standard metrics of reserve
adequacy. For these non-commodity exporters, more flexible exchange
rates are often necessary, and Treasury actively pushes for increased
flexibility.\1\
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\1\ Russell Green and Tom Torgerson, ``Are High Foreign Exchange
Reserves in Emerging Markets a Blessing or a Burden?'' Office of
International Affairs Occasional Paper No. 6, U.S. Department of the
Treasury, March 2007.
---------------------------------------------------------------------------
So what are sovereign wealth funds? At the Department of the
Treasury, we have defined them as government investment vehicles funded
by foreign exchange assets, which manage those assets separately from
official reserves.\2\ Sovereign wealth funds generally fall into two
categories based on the source of the foreign exchange assets:
---------------------------------------------------------------------------
\2\ U.S. Department of the Treasury, ``Sovereign Wealth Funds,''
Appendix 3 of the Semi-Annual Report to Congress on International
Economic and Exchange Rate Policies, June 2007.
Commodity funds are established through commodity exports, either
owned or taxed by the government. They serve different purposes,
including stabilization of fiscal revenues, intergenerational saving,
and balance of payments sterilization. Given the recent extended sharp
rise in commodity prices, many funds initially established for fiscal
stabilization purposes have evolved into savings funds. In the case of
commodity funds, foreign currency typically accrues to the government
and does not increase the money supply and create unwanted inflationary
pressure.
Non-commodity funds are typically established through transfers
of assets from official foreign exchange reserves. Large balance of
payments surpluses have enabled non-commodity exporting countries to
transfer ``excess'' foreign exchange reserves to stand-alone funds. In
the case of non-commodity funds, foreign exchange assets often derive
from exchange rate intervention, which then increases a country's money
supply. Monetary authorities take additional steps to lower the money
supply and stave off inflation by issuing new debt, but there may be a
cost associated with this if the cost of the new debt is more than the
returns that the government earns on its foreign exchange assets.
In contrast to traditional reserves, which are typically invested
for liquidity and safety, sovereign wealth funds seek a higher rate of
return and may be invested in a wider range of asset classes. Sovereign
wealth fund managers have a higher risk tolerance than their
counterparts managing official reserves. They emphasize expected
returns over liquidity, and their investments can take the form of
stakes in U.S. companies, as has been witnessed in recent months with
increased regularity.
However, sovereign wealth fund assets are currently fairly
concentrated. By some market estimates, a handful of funds account for
the majority of total sovereign wealth fund assets. Roughly two-thirds
of sovereign wealth fund assets are commodity fund assets ($1.3-1.9
trillion), while the remaining one-third are non-commodity funds
transferred from official reserves ($0.6-1.0 trillion).
To get a better perspective of the relative importance of sovereign
wealth funds, it is useful to consider how they measure up against
private pools of global capital. Total sovereign wealth fund assets of
$1.9-2.9 trillion may be small relative to a $190 trillion stock of
global financial assets, or the roughly $62 trillion managed by private
institutional investors. But sovereign wealth fund assets are currently
larger than the total assets under management by either hedge funds or
private equity funds and are set to grow at a much faster pace.
In sum, sovereign wealth funds represent a large and rapidly
growing stock of government-controlled assets, invested more
aggressively than traditional reserves. Attention to sovereign wealth
funds is inevitable given that their rise clearly has implications for
the international financial system. Sovereign wealth funds bring
benefits to the system but also raise potential concerns.
benefits
A useful starting point when discussing the benefits of sovereign
wealth funds is to stress that the United States remains committed to
open investment. On May 10, 2007, President Bush publicly reaffirmed,
in his Statement on Open Economies, the U.S. commitment to advancing
open economies at home and abroad, including through open investment
and trade. Lower trade and investment barriers benefit not only the
United States, but also the global economy as a whole. The depth,
liquidity and efficiency of our capital markets should continue to make
the United States the most attractive country in the world in which to
invest.
In 2006, there was a net increase of $2.5 trillion in foreign-owned
assets in the United States, while U.S. net international investment
abroad increased by $2.2 trillion. International investment in the
United States fuels U.S. economic prosperity by creating well-paid
jobs, importing new technology and business methods, helping to finance
U.S. priorities, and providing healthy competition that fosters
innovation, productivity gains, lower prices, and greater variety for
consumers. Over five million Americans--4.6 percent of the U.S. private
sector--are employed by foreign-owned firms' U.S. operations. Over 39
percent of these five million jobs at foreign-owned firms are in
manufacturing, a sector that accounts for 13 percent of U.S. private
sector jobs. These five million jobs pay 25 percent higher compensation
on average than jobs at other U.S. firms. Additionally, foreign-owned
firms contributed almost 6 percent of U.S. output and 14 percent of
U.S. R&D spending in 2006. Foreign-owned firms re-invested over half of
their U.S. income--$71 billion--back into the U.S. economy in 2006. A
disproportionate 13 percent of U.S. tax payments and 19 percent of U.S.
exports are made by foreign-owned firms. Without international
investment, Americans would be faced with painful choices regarding
taxes, spending on government programs, and their level of savings and
consumption. Foreign investors' economic interests become more
dependent on the health of the U.S. economy--giving the investor an
incentive to support U.S. economic interests.
As many observers have pointed out, sovereign wealth funds have the
potential to promote financial stability. They are, in principle, long
term, stable investors that provide significant capital to the system.
They are typically not highly leveraged and cannot be forced by capital
requirements or investor withdrawals to liquidate positions rapidly.
Sovereign wealth funds, as public sector entities, should have an
interest in and a responsibility for financial market stability.
potential concerns
Yet, sovereign wealth funds also raise potential concerns. Primary
among them is a risk that sovereign wealth funds could provoke a new
wave of investment protectionism, which would be very harmful to the
U.S. and global economies. Protectionist sentiment could be partially
based on a lack of information and understanding of sovereign wealth
funds, in part due to limited transparency and clear communication on
the part of the funds themselves. Concerns about the cross-border
activities of state-owned enterprises may also at times be misdirected
at sovereign wealth funds as a group. Better information and
understanding on both sides of the investment relationship are needed.
Were protectionist pressures to lead to greater restrictions on
international investment, this would weaken the United States. The
United States could lose out to other countries in the competition for
international investment and the benefits it brings. U.S. businesses'
worldwide operations could suffer. The United States is the world's
leading foreign investor. If the United States imposed new
restrictions, other countries could impose restrictions on U.S.
investors, jeopardizing the benefits generated in the United States by
U.S. businesses that operate globally. Protectionism could raise
questions about whether we have faith in the dynamism and productivity
of the U.S. economy. Foreigners invest in the United States because
they have faith in our future and believe our economy will provide them
a good return. The United States has long welcomed international
investment--and has used this capital to create new U.S.-owned
businesses, expand existing businesses, and grow our economy.
Protectionism could also damage the U.S. relationship with major allies
such as Western Europe, Canada and Japan, which account for 90 percent
of international investment in the U.S.
Second, transactions involving investment by sovereign wealth
funds, as with other types of foreign investment, may raise legitimate
national security concerns. The Committee on Foreign Investment in the
United States (CFIUS), which is chaired by Treasury, conducts robust
reviews of certain investments that could result in foreign control of
a U.S. business to identify and resolve any genuine national security
concerns. The Foreign Investment and National Security Act (FINSA)
became effective on October 24, 2007, and strengthened the CFIUS
process. CFIUS is able to review investments from sovereign wealth
funds, just as it would other foreign government-controlled
investments, and it has and will continue to exercise this authority to
ensure national security.
As we take our work forward on sovereign wealth funds, Treasury is
also considering non-national security issues related to potential
distortions from a larger role of foreign governments in markets. For
example, through inefficient allocation of capital, perceived unfair
competition with private firms, or the pursuit of broader strategic
rather than strictly economic return-oriented investments, sovereign
wealth funds could potentially distort markets. Clearly, both sovereign
wealth funds and the countries in which they invest will be best served
if investment decisions are made solely on commercial grounds.
Finally, sovereign wealth funds may raise concerns related to
financial stability. Sovereign wealth funds can represent large,
concentrated, and often non-transparent positions in certain markets
and asset classes. Actual shifts in their asset allocations can cause
market volatility. In fact, even perceived shifts or rumors can cause
volatility as the market reacts to what it perceives sovereign wealth
funds to be doing.
policy response
Treasury has taken a number of steps to help ensure that the United
States can continue to benefit from open investment while addressing
these potential concerns.
First, we are aggressively implementing reforms that strengthen the
CFIUS process, reflected in FINSA and Executive Order 11858, issued by
the President on January 23. We are proceeding steadily through a
vigorous drafting process for new regulations which will become
effective later this Spring following public notice and comment. One of
the reforms codified by FINSA, which we have already implemented, is an
elevated level of accountability within CFIUS for review of foreign
government-controlled transactions. I want to be clear that CFIUS
reviews the investment transactions of sovereign wealth funds, based on
the consideration of genuine national security concerns, just as it
would for any other foreign government-controlled investment. FINSA
protects our national security while keeping investment barriers low
and reaffirming investor confidence and the longstanding U.S. open
investment policy.
Second, we have proposed that the international community
collaborate on the development of a multilateral framework for best
practices. The International Monetary Fund, with support from the World
Bank, should develop best practices for sovereign wealth funds,
building on existing best practices for foreign exchange reserve
management. These would provide guidance to new funds on how to
structure themselves, reduce any potential systemic risk, and help
demonstrate to critics that sovereign wealth funds can be responsible,
constructive participants in the international financial system.
Third, we have proposed that the Organisation for Economic Co-
operation and Development (OECD) should identify best practices for
countries that receive foreign government-controlled investment, based
on its extensive work on promoting open investment regimes. These
should have a focus on avoiding protectionism and should be guided by
the well-established principles embraced by OECD and its members for
the treatment of foreign investment.
We have already seen meaningful progress along these lines. On May
12-13 of last year, Treasury hosted a G-20 meeting of Finance Ministry
and Central Bank officials on commodity cycles and financial stability,
which included perhaps the first multilateral discussion of sovereign
wealth funds among countries with these funds and countries in which
they invest. Following a period of extensive direct bilateral outreach
with sovereign wealth funds, Secretary Paulson hosted a G-7 outreach
meeting on October 19, 2007 with Finance Ministers and heads of
sovereign wealth funds from eight countries (China, Korea, Kuwait,
Norway, Russia, Saudi Arabia, Singapore, and the United Arab Emirates)
to build support for best practices.
On October 20, 2007, the International Monetary and Financial
Committee--a ministerial level advisory committee to the IMF--issued a
statement calling on the IMF to begin a dialog to identify best
practices for sovereign wealth funds. On November 15-16, 2007, the IMF
hosted a roundtable meeting for sovereign asset and reserve managers.
In response to the IMFC statement, the IMF added a special session on
policy and operational issues relating to SWFs for official sector
delegates. This marks the beginning of an important process in the IMF.
IMF Managing Director Dominique Strauss-Kahn opened the roundtable
meeting and underlined that some form of agreement on best practices
for the operations of SWFs could help maintain an open global financial
system.\3\ A separate dialog is well underway in the OECD on investment
policy issues with regard to SWFs, building on the discussions on
Freedom of Investment, National Security, and ``Strategic'' Industries.
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\3\ IMF Convenes First Annual Roundtable of Sovereign Asset and
Reserve Managers, IMF Press Release, November 16, 2007. http://
www.imf.org/external/np/sec/pr/2007/pr07267.htm
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Fourth, Treasury has taken a number of steps internally and within
the U.S. Government to enhance our understanding of sovereign wealth
funds. Treasury has created a working group on sovereign wealth funds
that draws on the expertise of Treasury's offices of International
Affairs and Domestic Finance. Treasury's new market room is ensuring
vigilant, ongoing monitoring of sovereign wealth fund trends and
transactions. Through the President's Working Group on Financial
Markets, chaired by Secretary Paulson, we continue to discuss and
review sovereign wealth funds. We also have initiated bilateral
outreach to ensure an ongoing and candid dialog with countries with
significant sovereign wealth funds and their management.
Treasury is actively coordinating with Congress through staff
briefings and committee hearings. As you may know, I testified on these
issues before the Senate Banking Committee in November. Also, in June
and December of last year we provided Congress with updates on our
sovereign wealth fund-related work in an appendix to the Report on
International Economic and Exchange Rate Policies, and we will continue
to provide updates on a semi-annual basis.
The Treasury Department will continue its work on sovereign wealth
funds through sound analysis and focused bilateral and multilateral
efforts to help ensure the United States shapes an appropriate
international response to this issue, addresses legitimate areas of
concern, and together with other countries, remains open to foreign
investment.
Prepared Statement of Stuart E. Eizenstat, Partner and Chair of the
International Practice Group, Covington & Burling LLP
Chairman Schumer, Vice-Chair Maloney, Ranking Member Saxton and
Members of the Committee, good afternoon. Thank you very much for
holding this important and timely hearing.
During the Clinton Administration I was fortunate to hold several
positions that brought me into frequent contact with issues of inward
investment into the United States: I was the US Ambassador to the
European Union, Under Secretary of Commerce for International Trade,
Under Secretary of State for Economic, Business and Agricultural
Affairs, and then Deputy Secretary of the Treasury. Since my government
service I have been the chair of the International Practice Group at
Covington and Burling, LLP where I have engaged in this issue from the
private sector.
I am honored to participate in the Committee's discussions and hope
that my experience and contributions will be helpful to the Committee's
deliberations.
The question posed in the title the Committee has given this
hearing, whether Sovereign Wealth Funds (SWFs) strengthen or imperil
the US economy, is the critical question in the SWF debate. Permit me
to say at the outset that the challenges provided by the some $3
trillion in SWFs, from China and Russia to the Gulf States and Saudi
Arabia, are as much a reflection of our own economic problems as they
are about SWFs themselves. Their remarkable growth and decisions to
broaden their portfolio beyond the investments of their central banks
in Treasury bills, is a reflection of our growing dependence on
expensive foreign oil and our massive current account deficit. This
Committee and the Congress, and all of us, should be spending as much
time and energy on dealing with these structural economic problems as
on the consequences of those problems. In effect, SWFs are recycling
U.S. petro-dollars and our appetite for products from China and
Emerging Markets.
In addition, I am a strong believer in the importance of the free
flow of capital around the world, and of the value of foreign direct
investment (FDI) in creating jobs in the United States, and adding
creativity and innovation to our economy. There is a difference, for
sure, between private foreign investment and that of SWFs and their
close cousins, State Owned Enterprises (SOEs). But even there, the
distinction is not always as clear as it may seem. Many European
companies, for example, have some government ownership through ``golden
shares''. Moreover, many European governments are trying to create
``national champions'' to better compete in the global marketplace. We
need to be very careful that in dealing with SWFs, we do nothing to
deter the free flow of international capital.
I strongly believe that SWFs do bolster the US economy, and that on
balance they are a significant net plus for the U.S. economy. If we
take off the ``welcome sign'', they will invest their growing wealth
elsewhere in the world. At the same time, there are legitimate concerns
about SWFs that need to be addressed. These heavily revolve around the
need for ``transparency'' and good governance. This, in my opinion,
does not mean that they must divulge their holdings and investments,
but rather that they should be transparent in their governance, in
their relationships to their governments, in their processes, in their
goals, and in determining whether they obtain subsidized government
financing on individual deals--which would create an unfair advantage
over U.S. or foreign corporations who must rely on the private credit
markets for competing for the same acquisitions. We have a legitimate
interest in assuring that SWFs have a purely commercial, not a
political or national security, interest in their investments in the
U.S.
Beyond transparency, there certainly are a limited number of
matters in which national security risks are implicated by SWFs and
SOEs acquisition. But in a globalized world economy, in which the U.S.
does not have a monopoly on products, it is important that national
security not be defined so broadly that it is used as a broad basis to
deter foreign investment.
I urge Congress not to seek legislation or to pressure regulators
to impose heavy regulations on SWFs at this stage. The reason for this
is that Congress has wisely provided the executive branch--in the form
of last year's bipartisan Foreign Investment and National Security Act
(FINSA)--the means to deal with genuine national security threats from
SWFs and SOEs. In my opinion we already have the legislative tools
necessary to effectively address any national security concerns raised
by SWF investments, and we should give the CFIUS process the time to
work through SWF/SOE investments on a case by case basis.
Moreover, it is critically important that Congress not take
unilateral action. It is vital that we try to develop multilateral
principles. Europe, for example, has similar concerns with SWFs/SOEs;
for instance, Russia's Gazprom has expressed interest in acquiring
energy assets in Europe. The Bush Administration has wisely agreed to
support this multilateral approach. The IMF is now working directly
with all the major SWFs on developing a set of ``best practices'',
which they hope to have completed by April. The OECD is doing the same
exercise with host countries, and their report will be ready in roughly
the same timeframe. Moreover, the Government Accounting Office is
examining SWFs and their report will be an important touchstone. We
should allow these activities to play out, and, for example, see how
the SWFs react to the IMF effort to develop a set of principles focused
on transparency.
the benefits and concerns of the ``new'' sovereign wealth funds
The benefits of foreign investment into the US are well known. Such
investments support economic growth and job creation; they help keep
domestic industry competitive; they grease the wheels of the
international economy by helping to right financial imbalances; and, as
we have seen since last summer as SWFs began investing heavily in the
US financial industry, foreign investments can be ready sources of
assistance to distressed sectors, in this case bolstering the US
economy while providing a needed vote of confidence in the US financial
system at a difficult time.
Moreover, we know that SWFs are not recent innovations The first
versions beginning in the 1950s and 60s with states as diverse as
Kuwait, Kiribati and Norway establishing national investment vehicles,
many of which have long invested in the US. SWFs have a strong record
of making long-term investments, with a generally passive involvement
in the management of the companies in which they invest.
Most SWF and SOE investments raise no national security risks.
For instance, the acquisition of Barney's, the U.S. retailer, by
Dubai, hardly impacts on national security. CFIUS approved the sale of
IBM's PC division to Lenovo (which our firm handled), which is partly
owned by the Chinese government. Further, SWFs' recent investments in
U.S. and European financial institutions have been for small stakes,
well under 10%, with no board seats or management voice. It is
important to recognize that the control test--which can trigger CFIUS
review--is not a mechanical test of 10% voting shares. There are a
variety of factors to consider, such as whether the SWF/SOE has the
right to appoint members of the board of directors; the right to
appoint or veto members of management; the right to approve the
corporate budget; the right to approve of new investments and
divestitures. Generally, SWFs/SOEs have not insisted on this level of
control.
Even if a SWF or SOE transaction presents some risk to national
security, CFIUS has proven well-equipped to analyze the risk and
negotiate appropriate measures to mitigate that risk. If, for some
reason, CFIUS determines that the risk cannot be satisfactorily
mitigated, the President has the power to block the transaction.
There are some different factors at work in the recent emergence of
SWFs. The amount of money under SWF management is greater than it has
ever been. Fueled in some cases by high commodity prices (as is the
case for the Persian Gulf, Russian and Norwegian funds) and in others
by trade surpluses ``unequalled as a percentage of the global economy
since the beginning of the 20th century'' (as for East Asian SWFs) SWFs
are thought to control as much as $3 trillion in assets--greater than
the global stock of assets invested in either hedge funds or private
equity. Even so, SWFs account for no more than 1.3 percent of the
world's financial assets.
And, the number of SWFs are increasing, with some new entries
representing perhaps the biggest challenges for US regulatory review.
There are now more than 40 major SWFs, with as many as a dozen
established since 2005. Given the size and number of the new players in
the SWF world, some measure of anxiety was expected and prudent.
The timing of the emergence of SWFs also sharpened fears. The 2008
Presidential campaign has begun, memories of two highly politicized
bids by foreign government owned companies for key US assets were still
raw (CNOOC's bid for Unocal was in 2005, the Dubai Ports World
controversy erupted in 2006), and news of SWFs came just as Congress
was completing its legislative overhaul of the US investment screening
mechanism--the Committee on Foreign Investment in the United States
(CFIUS) codified in FINSA--a task that was precipitated by the CNOOC/
Dubai Ports World events but took on new urgency once SWFs appeared.
governance and transparency--the critical swf reforms
If there has been an underlying theme for most of the concerns
verbalized about SWFs it the assertion that these funds, as a whole,
are nontransparent, and consequently policymakers cannot be sure what
drives the funds' investments, divestments, and other behaviors. It is
asserted that that SWFs may be political or intelligence-gathering
tools out to harm the United States, rather than profit maximizers.
And, it is disquiet emanating from this alleged feature of SWFs that
has led many of those otherwise positively disposed toward free capital
movements--including Treasury Department officials, capital markets
regulators, and some in the think tank community--to question whether
some regulation is needed. Senior government officials from Robert
Kimmitt and Clay Lowery at Treasury to Chris Cox, the Chairman of the
SEC, to experts like Ted Truman at the Peterson Institute, have raised
a number of legitimate concerns:
whether the governments subsidize individual transactions;
the potential for imprudent investments to increase risks for
market stability;
whether they have a political agenda, such as Gazprom has
exhibited in Ukraine, Georgia and elsewhere;
whether there is a risk of insider trading;
whether there is a risk for corruption, if government officials
are directly involved from countries with a record of corrupt
activities;
whether there is a risk of leakage of sensitive technology to
countries which are not allies of the U.S.
Tellingly, SWFs have followed these debates and concerns and appear
to have made recent investments with political sensitivities in mind.
As I mentioned, the recent SWF investments in the financial sector have
explicitly and invariably been non-controlling minority investments,
have not included any board seats for the SWFs or powers to control
management, budgets, or new acquisitions or divestitures, and have
generally been below 10% voting shares.
Further, some SWFs have already responded to calls for greater
openness.
I hope that SWFs will take steps to be more transparent. Even in
the short run, increasing transparency produces benefits not just for
the host states, but for the SWFs themselves. Real transparency
promises to ease the acceptance of SWF investments as host states come
to understand SWFs' investment strategies and management structures,
and can be assured that commercial rather than political interests
control investments, and that SWFs do not receive unfair subsidies that
may make competitive bidding with private entities difficult. Finally,
SWFs will very likely come to understand that adopting some measures of
transparency and other robust regulation for themselves is the best way
to avoid more heavy-handed regulation from both the US and other
investment recipients.
Across the Atlantic, Joaquin Almunia, the EU Commissioner for
Economic and Monetary Affairs, has explicitly suggested such a quid pro
quo, stating that there were ``good reasons'' to ask funds about their
investment strategies and holdings, and if they do not provide such
information ``we can find good reasons to `react' in some cases, where
these funds try to invest . . . in strategic sector[s] or . . .
specific industries.''
unilateral rules may harm the u.s.
My contention that SWF-specific legislation is not needed at this
juncture comes not just from my hope that over time many SWFs will
become more transparent of their own accord. Rather the imposition of
unilateral rules on US investment for SWFs may harm the competitive
position of our economy. After all the United States is only one of
many markets in which SWFs can choose to invest. As former Secretary of
State Colin Powell noted, ``capital is a coward,'' and unilateral rules
in the US that are not matched by similar regulations in other
potential host states may adversely impact our ability to attract FDI
and consequently may diminish our competitiveness. It is worth
remembering that the majority of SWF money that has been invested into
the US is actually recycled US dollars resulting from our oil
dependence (for the Middle Eastern funds) and mass current account
deficit (for the East Asian funds). It seems far better to have this
money recycled here, than to be moved elsewhere.
the way ahead--multilateral discussions and the ``new'' cfius
The necessity for a global solution that evens the playing field
between potential recipients of investments provides one of the
guideposts to the most effective future direction for US policy on the
SWF issue. Fortunately such a multilateral approach is underway. Last
fall, the Treasury Department, along with finance ministries from the
rest of G8 and those of several states owning leading SWFs asked the
International Monetary Fund and the Organization for Economic
Cooperation and Development to begin working on best practices.
The IMF process, which is focused on best practices for the SWFs
themselves, is due to issue its recommendations in April. Though the
IMF will likely touch on several aspects of reform, it seems evident
that a central focus of the guidelines will be on enhancing SWF
transparency in order to increase the number of SWFs that publish
annual accounts and provide outsiders some insight into governance and
investment strategies. In a hopeful sign, some SWFs including
Singapore's Temasek, are closely assisting the IMF efforts.
Working alongside the IMF, the OECD's Investment Committee has
begun working on best practices for host countries, and in particular
the processes of host country review of SWF investments. The OECD
report is due in March. The OECD's primary concern is that some
recipient states may overreact to SWFs and erect needless procedural
barriers to SWF investments which may chill wider FDI flows. Though
still being drafted, the OECD rules will likely borrow from best
practices in some of its members, including the US CFIUS process.
The CFIUS process, newly vested with enhanced transparency and
predictability, provides the other guidepost for effective domestic
response to SWFs. Though as this Committee knows the CFIUS regulations
are due to be released in April, even before the rules are finalized it
is clear that FINSA's improvements on CFIUS are significant and
important. Its enhancements include a greater clarity for foreign
investors, a result of new transparency regarding the factors CFIUS
considers in moving a transaction from a 30-day review to a 45-day
investigations, alongside the requirements that CFIUS issue public
guidance on the types of transactions that have been reviewed and that
have raised national security concerns. Moreover, the law's provision
for a ``lead agency or agencies'' for the government entity with
greatest equities in a transaction promises to instill discipline in
CFIUS and lead to more routinized review processes. Finally, the law
requires the involvement of senior-level officials in major CFIUS
actions including with respect to certifications provided to Congress
and decisions not to investigate transactions involving foreign
government ownership.
We should rely on the wisdom of FINSA and take solace from the
CFIUS process and its recent ability to quickly clear transactions--
such as the sale of IBM's personal computer business to Lenovo. That
the review processes were transparent and efficient, simultaneously
promoting both open investment and national security, suggests that the
current tools--set to be improved further after the release of the
CFIUS regulations--can effectively address SWF investments.
I counsel Congress to withhold judgment on the necessity for
further legislation until both the CFIUS regulations are published and
can be assessed in practice, and the IMF and OECD have delivered their
reports.
history, transparency and nuance--the key to effective regulation of
swfs
If the past is prologue, history does not suggest that most SWFs
will engage in politically motivated investments. SWFs have been long-
term, stable and passive investors. Though they may be less risk averse
than central banks solely investing in T-Bills, most SWFs are run with
profit in mind. Quickly unwinding positions, or investing for political
as opposed to financial gain, could be as damaging to SWFs (if not more
so) as to host countries. Most SWFs have been mandated to secure
healthy returns and many have received political and public rebuke at
home for unsuccessful investments. Further, SWFs are aware of the
growing political sensitivities regarding their investments and most
would be loathe to upset host governments for fear of wearing out their
welcome.
Even if history and the structure of SWFs suggest that we have
little to fear, the current approach adopted by the Bush Administration
should be lauded. Unilateral, protectionist regulations have not been
contemplated, neither has the Administration raised the potential for
imposing reciprocity as a test for SWF investments. In some quarters
this has been a commonly suggested response to the SWF influx and asks
the reasonable question why the United States should allow unfettered
access to its assets to state-backed SWFs when those states to not
allow commensurate access to their assets. A successor of mine as
Deputy Treasury Secretary, Robert Kimmitt, made the Administration's
rejection of reciprocity clear in his recent Foreign Affairs piece:
raising reciprocity as a barrier to SWFs ``is not on the list'' of
policy proposals. He argues correctly that the benefits the United
States receives from foreign investment are irrespective of whether or
not other countries provide US investors similar rights.
Indeed, instead of unilateral restrictions, constructive
deliberation on a multilateral basis is critical so as to ease bona
fide concerns regarding investors' intentions and fund transparency,
while ensuring that host states remain open to receiving the benefits
SWF investments can bring--benefits that include both domestic
financial stability in distressed sectors and wider global stability as
the world's major economies become ever more interdependent.
To that end, transparency coupled with nuance are key. Clearly
there should be some limits to SWF acquisitions. However, these
prohibitions should be clear, narrowly focused and few and far between.
Broad prohibitions are not needed, and with nuanced review that takes
into account the transparency of a particular investor and the
magnitude of specific investments (differentiating between controlling
and passive stakes), there is little reason that our aim of protecting
national security cannot be consistent with opening up the vast
majority of the American economy to SWF funds. Relying on the CFIUS
process makes per se rules even less needed, given that appropriate
protections can be negotiated on a case-by-case basis, ranging from
insisting that investors establish an arm's length proxy relationship
to handle sensitive investments, to striking nuanced mitigation
agreements of the kind the Government has forged with scores of foreign
investors.
It is my view that a chorus of support for moderated, thoughtful
reaction to SWFs must be developed now, before SWFs become a political
third-rail and the United States loses out in attracting both needed
funds and in retaining the mantle of the world's most dynamic economy.
Thank you. I will gladly respond to any questions.
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Prepared Statement of Douglas Rediker, Co-Director, Global Strategic
Finance Initiative, The New America Foundation
Thank you Mr. Chairman, Madam Vice Chair and members of this
committee for the honor of addressing you today.
By way of introduction, I spent most of the last seventeen years
working as an investment banker and private equity investor based
primarily in London, England. This experience, I believe, gives me a
somewhat different perspective on Sovereign Wealth Funds and the role
that they play in today's international capital markets. Currently, I
co-direct the Global Strategic Finance Initiative at the New America
Foundation. The New America Foundation is a non-profit, post-partisan
public policy institute in Washington D.C.
Over the past several months, few issues in international finance
have generated as much discussion and comment as have Sovereign Wealth
Funds. I commend you and your colleagues for the informed and balanced
views that you have expressed and the questions that you have posed on
this important subject.
As a general matter, I believe that both the U.S. and global
economies are strengthened through open markets. Overall, economic
health is bolstered and fortified by the free flow of investment
capital and increased liquidity that open markets provide. As
significant providers of capital to these markets, Sovereign Wealth
Funds have thus far been a positive influence in U.S. and global
markets. Most recently, significant capital injections by Sovereign
Wealth Funds in several major financial institutions have been a
stabilizing force, potentially averting a significant market downturn
at a time of high market uncertainty and volatility.
Capital flow from Sovereign Wealth Funds benefits U.S. investors,
companies and workers not only in those specific cases involving
investments in our financial services sector, but more broadly, as
increased liquidity results in higher stock and asset prices and lower
risk premiums, especially of riskier, less liquid assets. A recent
estimate quantified the potential gross capital inflows from Sovereign
Wealth Funds over the next 5 years to global equities at $1 trillion
and $1.5 trillion to global debt markets, increasing to $3.1 trillion
and $4.6 trillion respectively over the next decade.\1\
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\1\ Steffen Kern, Deutsche Bank, September 10, 2007.
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While I believe that continued investment by Sovereign Wealth Funds
should be encouraged, I also believe that the nature of this investment
on this scale warrants continued oversight by Congress. Your vigilance
should ensure the continued competitiveness and smooth functioning of
our financial markets, while also protecting both our national security
and the integrity of these markets.
It is to this Committee's credit and to others in the U.S. Congress
and the Administration that when compared with other industrialized
nations, the United States' national security interests and financial
market integrity are relatively well regulated. Last year's revised
CFIUS/FINSA legislation, as well as existing provisions under U.S.
Securities and Exchange, Antitrust, Export Control, and other similar
legislation and regulation, protect and regulate both our national
security interests and potential acquisition targets from improper
takeover approaches or material investments from foreign state
investors.
There are, however, areas that could benefit from some improvement.
In particular, I believe that the U.S. Government should continue to
support calls for increased disclosure and transparency of asset mix,
investment guidelines, currency composition and geographic
diversification by Sovereign Wealth Funds. Such increased disclosure
would benefit the markets in many ways and could calm suspicions borne
of lack of information. Increased transparency would be more likely to
alert the market to concentration issues and potential contagion risks.
While increased disclosure and transparency is in everyone's
interest, I would not recommend making disclosure a mandatory pre-
requisite for investment in our markets. To do so, would likely be
counterproductive and ineffective. I believe that any insistence on
transparency should be part of a broader code of best practice, adopted
in a collaborative effort by Sovereign Wealth Funds and the IMF,
motivated by a collective desire for financial stability and smooth
functioning of the markets. Sovereign Wealth Funds may further welcome
the opportunity to judge their own returns against relevant indices and
their peer group, as well as by the opportunity to demonstrate that
they are investing in a manner consistent with the best interests of
the people of the countries they govern.
Within the U.S., I believe that the investment environment for
Sovereign Wealth Funds should be clear and predictable. Regulations
regarding when a CFIUS review is warranted should be as express and
explicit as possible. For example, I suggest that regulatory guidance
be provided regarding the interpretation of control as opposed to that
of the more amorphous concept of influence.
In my years in investment banking and capital markets, one of the
most compelling lessons I learned was that investors abhor uncertainty.
Uncertainty discourages investment by injecting unquantifiable risk
into an investment decision. I believe that it is imperative that
Sovereign Wealth Funds and other foreign investors understand that
their investment is welcome in the United States. Furthermore,
investors should know precisely on what terms they are welcome.
If a Sovereign Wealth Fund complies with all relevant laws and
regulations and then is subject to unforeseen scrutiny or delay, their
investment decision will be negatively affected. To ensure that the
U.S. maintains its role as the most open, transparent and welcoming
capital market in the world, the U.S. should not discourage any
investment made in compliance with the law.
Over the past several years, international capital markets have
transitioned away from US domination to being truly global in scope and
leadership. Sovereign Wealth Funds are but one manifestation of the
past decade's shift toward a truly multi-polar global financial
marketplace--a marketplace where the sources, intermediation and
destination of capital and financial expertise outside the U.S. have
grown at a tremendous pace.
Competing centers of global finance and capital now exist not only
in Europe, but also in Asia and the Middle East. Those who seek
alternatives to invest in, and trade through, US financial markets now
have multiple options to choose from.
When addressing the issue of Sovereign Wealth Funds, it is
imperative that this Committee take into account crucial issues of
national and economic security, financial market integrity as well as
the continued competitiveness of our capital markets.
In that context, I believe that professionally managed Sovereign
Wealth Funds, like other foreign investors, should be encouraged to
invest in the U.S. in virtually all asset classes. The U.S. Treasury
has made it a priority to ensure that the United States continues to be
the most attractive place in the world to invest and should be
applauded for this effort. As a complement to this effort, we should
ensure that we spell out unambiguous ``rules of the game'' for all
investors--domestic and international. Assuming they abide by those
rules, Sovereign Wealth Funds, which today represent perhaps $3
trillion of investment capital, should be welcomed as a major part of
that effort.
Thank you.