[Senate Hearing 110-954]
[From the U.S. Government Publishing Office]
S. Hrg. 110-954
SOVEREIGN WEALTH FUND ACQUISITIONS AND OTHER FOREIGN GOVERNMENT
INVESTMENTS IN THE U.S.: ASSESSING THE ECONOMIC AND NATIONAL SECURITY
IMPLICATIONS
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HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
ON
ASSESSING THE ECONOMIC AND NATIONAL SECURITY IMPLICATIONS OF SOVEREIGN
WEALTH FUNDS AND FOREIGN ACQUISITION
__________
WEDNESDAY, NOVEMBER 14, 2007
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate /
senate05sh.html
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania ELIZABETH DOLE, North Carolina
JON TESTER, Montana MEL MARTINEZ, Florida
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Dawn Ratliff, Chief Clerk
Jim Crowell, Editor
C O N T E N T S
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WEDNESDAY, NOVEMBER 14, 2007
Page
Opening statement of Senator Bayh................................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
Senator Dole................................................. 3
Senator Webb................................................. 4
WITNESSES
David H. McCormick, Under Secretary for International Affairs,
Department of the Treasury..................................... 5
Prepared statement........................................... 40
Alan P. Larson, Senior International Policy Advisor, Covington &
Burling, LLP................................................... 20
Prepared statement........................................... 45
Response to written questions of:
Senator Shelby........................................... 168
Senator Bunning.......................................... 169
Dr. Edwin M. Truman, Senior Fellow, Peterson Institute for
International Economics........................................ 22
Prepared statement........................................... 58
Patrick A. Mulloy, Washington Representative, Alfred P. Sloan
Foundation..................................................... 24
Prepared statement........................................... 85
Response to written questions of:
Senator Bunning.......................................... 172
Dr. Gerard Lyons, Chief Economist and Group Head of Global
Research, Standard Chartered Bank.............................. 27
Prepared statement........................................... 101
Additional Material Supplied for the Record
Table 1.7. Size and Structure of Major Sovereign Wealth Funds.... 176
SOVEREIGN WEALTH FUND ACQUISITIONS AND OTHER FOREIGN GOVERNMENT
INVESTMENTS IN THE U.S.: ASSESSING THE ECONOMIC AND NATIONAL SECURITY
IMPLICATIONS
----------
WEDNESDAY, NOVEMBER 14, 2007
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 2:02 p.m., in room SD-538, Dirksen
Senate Office Building, Hon. Evan Bayh presiding.
OPENING STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. I would like to call the meeting of the
Committee to order. I would like to thank you all for being
with us today. And I would like to begin by thanking Chairman
Dodd for making this hearing possible and for elevating this
important issue to such a priority position. Without the
Chairman's support this could never have happened, and so I
want to express my gratitude to him.
Chairman Shelby, I want to thank you for most especially
your friendship, but also the good working relationship we have
had on so many issues over the years, and it is good to be with
you today.
And Senator Webb, welcome. Senator Webb is one of the
driving forces behind this hearing, and so I am looking forward
to hearing from you today, Jim, and thank you for continuing to
focus on this very important, very important issue.
Senator Webb. Thank you, Mr. Chairman. Good to be with you.
Senator Bayh. I am going to make a brief opening statement
and then hear from my colleagues, and then we will get right to
the witnesses.
The issue of sovereign wealth funds is a significant one.
The number of these funds is growing. Of the 20 largest, 13
were started since 1990. With foreign currency reserves up 140
percent over just the last 5 years, this trend is likely to
continue.
The size of these funds is also growing. There are now
seven over $100 billion in assets, including Abu Dhabi at $625
billion, Singapore at $215 billion, Norway at $322 billion,
Kuwait at $231 billion, China at $200 billion, Singapore at
$108 billion, and Russia now at $127 billion.
These now dwarf in size the multilateral organizations
designed to be the governing architecture of the global
financial system. For perspective, the International Monetary
Fund now holds assets with a market value of just $76.9
billion. The World Bank has just $40 billion on its balance
sheet.
The number and size of these funds is likely to continue to
grow. This is being driven by the increasing price of
commodities, principally oil, trade imbalances and currency
practices by countries that have the effect of increasing their
foreign currency reserves. These situations show no signs of
abating.
This situation presents the United States with both
opportunities and challenges. It is better for the United
States to have capital invested here to create jobs, improve
our productivity growth, keep interest rates low, and our
standard of living high. But sovereign wealth funds are
inherently different than private investors.
As the Chairman of the SEC, Christopher Cox, recently
observed--and I quote--government ownership of companies and
investment funds poses a fundamental challenge to the market
premise upon which the SEC operates. The lack of transparency
that characterizes many sovereign wealth funds undermines the
theory of efficient markets at the heart of our economic
system. In addition, unlike private investors and their
representatives--pension funds and mutual funds, for example--
government-owned entities may have interests other than and
that occasionally will take precedence over profit
maximization.
Just as the United States has interests in addition to
financial ones, so do other countries. Just as we value some
things more than money, so do they. Why should we assume that
other nations are driven purely by financial interests when we
are not? Or are we?
The issue before us, and the subject of this hearing, is
how to strike the right balance of interests. How do we attract
capital from abroad and pursue our financial goals while
reconciling this with other vital national concerns?
To help explore this, we have an extraordinary panel of
witnesses today. But first, we will hear from other members of
the Committee and Senators. Senator Shelby, I would like to
begin with you.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Chairman Bayh.
This afternoon, as the Chairman has pointed out, we are
meeting to examine the dynamic growth of sovereign wealth
funds. A lot of this he has outlined in detail.
I hope this hearing, Mr. Chairman, is the first of several
so that we have an opportunity here at the Banking Committee to
examine fully the range of issues that these funds present to
our economy and to our national security.
As you well know, we are entering to a different economic
world where a lot of wealth has shifted from the United States
and from Western Europe to developing countries like China and
the Gulf States.
There are two unique features of sovereign wealth funds, as
I understand it. First is their size. I have been told that
they hold in excess of $2 trillion, Mr. Secretary, now and
could go to $13 trillion to $15 trillion. This is serious,
serious business. Recent trends indicate that these funds will
continue to grow no matter what we do.
Second, sovereign wealth funds are not private investment
vehicles, as what we have traditionally been involved in. They
are government-controlled entities, as the Chairman pointed
out. Government control introduces the possibility that they
may be used for purposes other than their economic return.
For this reason alone, I think it is important to try to
get a basic understanding of the various funds and their
activities and perhaps their objectives. We need more
information on how they are managed, how they are structured,
and the types of investments they make.
We also need to know more about the objectives that I
mentioned behind their investment activities. What is their
motives here? Are they seeking higher returns, as the Chairman
indicated? Are they also being used as a foreign policy tool,
oftentimes maybe in the long run, against our interests.
Is there a role for global financial institutions such as
IMF, OECD, and the World Bank in dealing with these funds?
Finally, what effects can these funds have on exchange rates,
Treasury securities, and the economic health of this country?
We had better know, and this hearing today will get us going in
the right direction.
But we have to remember, because sovereign wealth funds are
only going to increase in asset size and continue to expand
their global reach, this Committee, Mr. Chairman, has a
continuing responsibility to monitor and understand these
unique and growing investment vehicles. If we let this continue
to grow, we will not be in control of our own economic destiny,
as we have in the past.
Thank you.
Senator Bayh. Thank you, Senator Shelby, for those
perceptive remarks.
Senator Dole, I think we go to you next, as a member of the
Committee. And then, Senator Webb, to you.
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Thank you, Mr. Chairman, Ranking Member
Shelby. I appreciate so much your holding this hearing on
sovereign wealth fund acquisitions and foreign government
investments in the United States.
I appreciate this Committee's recent work on currency
manipulation by foreign governments, namely China, as this
issue has great importance for my home State and its
manufacturing jobs. I agree that today's hearing topic, too, is
of particular relevance to this Committee.
Sovereign wealth funds have existed since the 1950's and
the total number of these institutions has grown dramatically
over the past 10 to 15 years. According to the IMF, there are
currently more than 20 countries--including China, Russia,
Venezuela, and United Arab Emirates--that have these state-
sponsored investment vehicles, and half a dozen or more nations
have expressed interest in establishing one.
Research conducted by Standard Chartered Bank in the United
Kingdom indicates that the total investment by these funds is
estimated at $2 trillion to $3 trillion. Based on current
projections, this is more than hedge funds manage, with $1
trillion to $1.5 trillion, and more than private equity firms
manage with $700 billion to $1.1 trillion.
The IMF estimates or projects that sovereign wealth funds
will continue to accumulate international assets at the rate of
$800 billion to $900 billion per year, which could bring the
aggregate total up to $12 trillion by $2012.
One of the issues that has emerged with these funds is
their transparency and whether they are willing to disclose and
disseminate information. Some of these sovereign wealth funds
already provide information regarding specific investments. For
example, Norway's Government Pension Fund disclosed that it
owns significant stakes in American financial institutions such
as Bank of America, Citigroup, and AIG, as of December 31st,
2006. Unfortunately, other countries such as China and
Venezuela do not make such data readily available.
I am pleased that this issue has captured the attention of
Treasury Secretary Paulson, and I encourage the SEC and the IMF
to continue monitoring sovereign wealth funds and to keep this
Committee fully apprised. I hope that increased disclosure and
transparency will instill a greater sense of confidence and
understanding with regard to these investment vehicles, which
no doubt have significant impacts on the continued integrity of
the United States in international capital markets.
Again, I thank the Chairman, the Ranking Member, for
holding this important hearing and I look forward to hearing
from our witnesses regarding this emerging issue.
Thank you.
Senator Bayh. Thank you very much, Senator Dole.
Senator Webb.
STATEMENT OF SENATOR JIM WEBB
Senator Webb. Thank you, Mr. Chairman, and I appreciate you
allowing me to sit on this hearing today, to be something of an
interloper in your business.
This is a very important hearing. It is a follow-on to a
letter in September that I sent to Treasury Secretary Paulson,
along with you, Senator Bayh, Ranking Member Shelby, and also
the Chairman of this Committee, addressing the importance of
the Committee for Foreign Investment in the United States to
take into consideration passive foreign ownership interests and
assets in the country, including the sovereign investment
funds. The letter urged Treasury to promulgate regulations
broad enough to ensure that potential national security
implications of such investments are appropriately addressed in
the context of ongoing foreign investment in our economy.
Although foreign governments have been investing for years
in the United States through different investment vehicles,
sovereign wealth funds have risen to recent prominence on a
wave of high levels of foreign exchange reserve associated with
increased commodity prices and export led growth. The growth of
these funds demand that we focus on their strategic
implications.
The practice of state capitalism which is a phrase, I
believe, was coined by Dr. Lyons, who will be testifying before
us today, allows sovereign wealth funds to potentially improve
their strategic advantage or to secure access to sensitive
technology from other countries.
Relative to our own security, the Committee on Foreign
Investment in the United States is the primary source of
protection from investment that threatens our national
interest. The increased number, size, and growth potential of
sovereign wealth funds raises the prospect that they may be
structured so as to escape scrutiny in ways not yet
contemplated by current law.
So the question before us really is how we balance the need
for investment with safeguarding our national security assets
in the context of these funds. Our witnesses today are going to
provide us with an opportunity to ensure that we have adequate
regulations and that we seek policy recommendations regarding
the risks of these funds as they may affect not only our market
stability, but also our national security.
I thank you again for inviting me to participate in this
hearing.
Senator Bayh. Senator Webb, thank you, and I am
particularly grateful for your interest in national security
related issues, of which this is one. And you are always
welcome to contribute to the work of the Committee.
We begin today with the Honorable David H. McCormick. As a
matter of fact, you constitute a panel of one, David, so we are
looking forward to hearing from you.
David McCormick is Undersecretary for International Affairs
at the Department of the Treasury, where he oversees policies
in the areas of international finance, trade and financial
services, investment, economic development, and international
debt policy. Until August, he was the President's Deputy
National Security Advisor for International Economics and
previously served as Undersecretary of Commerce for Export
Administration.
In the private sector, Mr. McCormick ran a software company
and was a consultant for McKinsey & Company. He is a graduate
of West Point and holds a Ph.D. from the Woodrow Wilson School
at Princeton University. He is a former Army officer and a
veteran of the First Gulf War.
Mr. McCormick, we thank you for your service to our country
and for you presence here today. We welcome your statement.
STATEMENT OF DAVID H. McCORMICK, UNDER SECRETARY FOR
INTERNATIONAL AFFAIRS, DEPARTMENT OF THE TREASURY
Mr. McCormick. Thank you, Mr. Chairman, Ranking Member
Shelby, Senator Dole, Senator Webb. Thank you for the
opportunity to be with you here today. I very much appreciate
the chance to come and discuss sovereign wealth funds. At
Treasury, we have been increasingly focused on sovereign wealth
funds for more than a year now, and I am pleased to be able to
share with this Committee our views.
As was said by many of your statements, sovereign wealth
funds are not new. The oldest funds date back to the 1950's in
Kuwait and Kiribati. Over the next four decades, these numbers
have slowly grown. By the year 2000, there were 20 sovereign
wealth funds worldwide, managing a total asset base of several
hundred billion dollars.
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 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 trillion to $2.9 trillion.
At the Department of the Treasury, we define a sovereign
wealth fund as a government investment vehicle funded by
foreign exchange assets and managed separately from official
reserves. These sovereign wealth funds generally fall into two
categories. There are commodity funds, which are funded through
commodity exports, owned or taxed by the government. Commodity
funds serve different purposes, including the stabilization of
fiscal revenues, intergenerational savings, and the balance of
payments sterilization.
There are also non-commodity funds, which are established
through the transfers 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 these stand-alone funds.
Now it should be noted that within this group of countries,
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 that increased flexibility in a number of
countries.
In contrast to traditional reserves, sovereign wealth funds
seek a higher rate of return and are invested in a wider range
of asset classes. Their managers emphasize expected returns
over liquidity and many investments are in the form of stakes
in U.S. companies, as has been witnessed in recent months.
Sovereign wealth fund assets are large in their importance,
but very concentrated. While a fraction of global financial
assets, sovereign wealth funds are currently larger--as was
already said--than the total assets under management by either
hedge funds or private equity. However, 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 fund assets, while
the remaining one-third are non-commodity funds transferred
from official reserves.
The rise of sovereign wealth funds clearly has implications
for the international financial system. They bring benefits to
the economy and they also pose concerns.
As reiterated by the President in his May 10th statement,
the U.S. is committed to open investment and advancing open
markets at home and abroad. The United States economy benefits
from open investment, including investment from sovereign
wealth funds. 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. has
derived many benefits in the form of jobs, R&D spending, and
higher wages.
Sovereign wealth funds also have 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
rapidly.
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. Sovereign wealth
funds could provoke a new wave of investment protectionism,
which raises the stakes for the health of the global economy.
Sovereign wealth funds also raise non-security issues
related to the larger role of foreign governments in markets.
For example, through inefficient allocation of capital,
perceived unfair competition with private firms, or the pursuit
of strategic over return-oriented investments, sovereign wealth
funds could potentially distort the market.
Finally, sovereign wealth funds may raise financial
stability issues as actual or perceived shifts could cause
market instability or market volatility.
At the Treasury Department, we are working on a number of
steps to ensure the United States continues to benefit from
open investment while addressing these concerns. First, the new
Foreign Investment and National Security Act, authored by the
Chairman and Ranking Member of this Committee and signed into
law by the President last summer, implemented through the
Committee on Foreign Investment in the United States, ensures
robust review of investment transactions that pose national
security concern. It requires heightened scrutiny of foreign
controlled investments. CFIUS is able to review investments
from sovereign wealth funds, just as it is other foreign
government-controlled investments, and it has and will continue
to exercise this authority to ensure our national security.
Additionally, the new CFIUS legislation reaffirms investor
confidence and longstanding U.S. open investment policy. We
believe the U.S. investment security framework provides a good
model for other countries where protectionist sentiment has
been on the rise and we are actively engaged with these
countries to head off undue protectionist responses abroad.
Second, we have proposed the creation of a multilateral
framework for best practices. The International Monetary Fund
should develop best practices for sovereign wealth funds,
building on the existing best practices for foreign exchange
reserve management. These would provide guidance to funds in
areas such as fund objectives, structure, transparency, and
risk management, while demonstrating to critics that sovereign
wealth funds can be responsible, constructive participants in
the international financial system.
Third, we have proposed the Organization for Economic
Cooperation and Development, OECD, should identify best
practices for countries that receive foreign controlled
investment. I should say that many of the countries that are
the holders of these sovereign wealth funds are also
significant recipients of foreign investment. These practices
should 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.
Meaningful and timely progress has been made. In May of
this year, the Treasury hosted a G-20 meeting of Finance
Ministry and Central Bank officials that focused the first
multilateral discussion on sovereign wealth funds. Just last
month, 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,
Singapore, and the United Arab Emirates, to build support for
best practices. The next day, the IMFC--which is a ministerial
level advisory committee to the IMF--called on the IMF to begin
a dialog to identify best practices for sovereign wealth funds.
Also, at Treasury we have 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 our international affairs team as well as domestic
finance.
We informed Congress in June of some of our thinking on
sovereign wealth funds 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.
We also created a new market room for ensuring vigilant
ongoing monitoring of sovereign wealth funds trends and
transactions. And through the President's Working Group on
Financial Markets, which is chaired by Secretary Paulson, we
continue to discuss and review sovereign wealth funds.
We have also initiated outreach to ensure an ongoing and
very candid dialog with countries that have these sovereign
wealth funds. The Treasury Department will continue its work on
sovereign wealth funds through analysis, through bilateral and
multilateral outreach, so that the United States can shape any
international response to this issue in a way that addresses
legitimate areas of concern while ensuring that the United
States remains open to and welcoming of foreign investment.
Thank you.
Senator Bayh. Thank you, Mr. McCormick.
Senator Crapo, it is good of you to join us. I would give
you an opportunity to make a statement at this time, or you can
waive that, if you would prefer.
Senator Crapo. I will waive that, and let's go ahead with
the witness. Thank you.
Senator Bayh. Thank you.
I think these are 5 minutes rounds. Five minute rounds.
Very good. I will try and keep my first round of questions to 5
minutes. I would ask my colleagues to try and do the same, and
if need be we will be happy to have another round of questions.
Mr. McCormick, I am far from being the longest serving
member of this body, but I have been around long enough now to
have a little institutional memory. So I would like to take you
on just a brief trip down memory lane.
I think it was 2001 when the financial projections for our
country were that we would run surpluses that were of such
magnitude that, in fact, we would pay off our national debt in
fairly short order. There was a big debate at that time that if
that, in fact, happened what would we do with the extra money?
One of the things we heard pretty consistently from this
administration was that well, we should not invest it in the
private economy. I will read you a quote to that effect. I
think it was from the then Chairman of the Federal Reserve,
Alan Greenspan.
This is a quote from his testimony to the Budget Committee.
``The Federal Government should eschew--'' that is Greenspan-
speak ``--should eschew private asset accumulation because it
would be exceptionally difficult to insulate the Government's
investment decisions from political pressures.''
That same year, before that same Committee, then-Secretary
of the Treasury, Paul O'Neill, said ``Government is big enough
and has no business owning private companies.''
My question to you is if it was wrong for the U.S.
Government to invest in our private economy, why is it right
for other nations? And what do we do to protect against the
political influences that Chairman Greenspan warned about?
Mr. McCormick. Thank you, Mr. Chairman. I think it is a
very legitimate question. Through our policy focus, both with
the non-commodity funds, as well as the commodity funds, we
have very active dialogs about how to reduce the accumulation
of foreign reserve, which I noted in my testimony far surpasses
any reasonable level.
Senator Bayh. We wish you good luck with that.
Mr. McCormick. Yes, sir. It is not an easy task.
So my discussion of sovereign wealth funds is by no means
meant to encourage or validate or accept that that is good
policy on the part of the countries that are accumulating these
reserves.
With that said, the fact remains that a very significant
amount of assets have already been accumulated. Under even the
most conservative projections they will continue to accumulate.
And so we are faced with the very real issue that there's a
significant amount of capital out there which is going to be
invested abroad.
Senator Bayh. And as I said in my testimony, we would like
the capital. But I guess, to get back to my question, if we
were concerned about political influences on decisions by our
own Government, why should we not be equally concerned about
political influences on the parts of other governments? And
what can we do to protect ourselves from that?
Mr. McCormick. Mr. Chairman, I think it is an area that we
should monitor very carefully. And by that I mean if you look
at the track record of the sovereign wealth in the United
States to date, it is a track record that has generally been
very responsible investing, long-term investing, and overall a
very stable investment track record. That is not to suggest
that the concern you raise is not a very legitimate one. And so
I think that puts an added responsibility on us, through the
CFIUS process, but also through our ongoing monitoring of this
market and of these developments, to ensure that that is not
happening.
Senator Bayh. You make a good point, that the track record
to date has been a positive one without pernicious influence.
But as all of us have noted, the size of these funds, the
numbers of these funds, are growing very rapidly. And now they
are growing in some countries that view themselves, at least in
part, as competitors of ours, both economically and in other
spheres, which raises a host of different questions.
So I will not continue to ask you about that, but I think
you understand what I am saying. If it is a legitimate concern
on the part of our own Government--for example, I just--one
last point here. We have a big debate about what to do to solve
the Social Security imbalances in our country. We currently
invest, at least as an accounting matter, in Treasury bonds
with the excess fund that are paid in to the Treasury in terms
of Social Security payments. If our Government decided that we
could gain a higher rate of return by, instead of investing in
Treasury bonds, let's say invest in Blackstone or something
like that, a hedge fund, would our Government encourage such a
policy?
Mr. McCormick. Mr. Chairman, you know, it is an interesting
question, in part because within the United States we already
have what many would characterize as a sovereign wealth fund in
the Permanent Fund in Alaska, which is a significant
accumulation that is invested both at home and abroad.
I think one of the things that is interesting about the
discussion on sovereign wealth funds is really there is a whole
continuum of official reserves, which are increasingly being
invested for higher returns in the equity markets; sovereign
wealth funds, as we have just discussed; state-owned
enterprises; and pension funds. And all of these are becoming
much more significant global actors. Some of the same issues
that we are discussing apply to some of those other investment
categories, as well.
Senator Bayh. Well, and as a former Governor with a State
that has a pension fund that does invest in the private
marketplace, I have seen that as a positive development. But
there are policies in place that try and insulate those
investment decisions from political concerns, and I think
legitimately so. And at the national level, when this whole
subject was raised, there have been examples where States only
occasionally--not frequently--have pursued social investing,
shall we call it. And that raised enough alarm bells that it
gave rise to Chairman Greenspan's testimony and several others.
So I raise it as an important issue.
I see my time has expired. I did have a couple of extra
questions, but I will save that for the next round, Mr.
McCormick.
Senator Shelby.
Senator Shelby. Thank you.
Mr. Secretary, I have been looking at a sheet, and I have
marked it up a little bit. I do not know if you have seen it.
It shows the compilation of the estimated size of sovereign
wealth funds in billions of U.S. dollars, and it adds up today
to over $2 trillion. Some people think it will go up $12, $13
billion, could go more. And this is not exactly accurate, but
it is close. About 80 percent of this money is connected to oil
and gas one way or the other. Does that bother you that we have
no energy policy, that we have become more and more dependent
on foreign sources of energy and we are exporting our wealth
and then they want to come back and invest in our company? And
that is good to a point, but to what point? Does that concern
you at times?
Mr. McCormick. Yes, Senator Shelby, it does. I think this
is really what lies behind the President's focus on energy
security and the emphasis that he has placed on that particular
area.
Senator Shelby. Now, you do not have any illusions about
energy security by any of the bills that we have been pushing
and the President has been pushing, do you? You know, whether
it is ethanol or whether it is solar power, all that is good.
But it is not going to make much of a dent in our energy needs,
is it, unless we really conserve energy, all of us, cut down on
our energy consumption 25 percent, or build nuclear power
plants and start walking more? You do not have any illusion
about that, do you?
Mr. McCormick. No, Senator, I do not.
Senator Shelby. OK. So we can look for these sovereign
wealth funds to grow rather than contract, could we not?
Mr. McCormick. Yes, sir.
Senator Shelby. And as they grow, they want to invest
somewhere, and that somewhere is generally the United States or
Western Europe, is it not?
Mr. McCormick. Yes, sir, I think that is true, although I
do think they are also beginning to see the emerging markets as
a very attractive investment area as well.
Senator Shelby. Does it concern you at all that companies'
sovereign wealth funds would like to buy up some of our most
strategic materials? What about iron or coal or oil,
everything, oil companies? Does that concern you?
Mr. McCormick. Yes, Senator, it does. I think the recent
legislation that you and others here in Congress--specific
legislation that you and others have recently passed and the
President has signed is a great step forward in guarding
against that possibility.
Senator Shelby. Could you just highlight some of the
differences here briefly this afternoon with respect to the
management, internal controls, disclosure, and investment
strategies of the different countries? Just pick out several
that have sovereign wealth funds and how they are used.
Mr. McCormick. Well, Senator, what is interesting as you
look at this group of 40 or so is that they fall generally into
two camps: in addition to the commodity/non-commodity
distinction that I made, there are those that have been around
a long time, and those that are relatively new. My experience,
having talked to many of them on both sides of that divide, is
that the ones that have been around for quite some time have
really put in place an investment process, an investment
decisionmaking, a governance structure that is very much like
what we would see in a big private equity fund or a big hedge
fund. The focus, of course, has been in creating
intergenerational wealth, largely, and maximizing returns.
The funds that are relatively new I think are very much in
the process of trying to define how they are going to do
business, and I think therein lies our challenge, frankly, and
our opportunity in terms of developing a coherent set of best
practices that the newer funds might adapt to.
That is not meant to suggest that the transparency and the
clarity within sovereign wealth funds is the same as you would
find in a pension fund or in other areas where there is a great
deal more transparency, and I think that also is our
opportunity, is to get a higher level of governance and
transparency across the entire sovereign wealth fund sector.
Senator Shelby. How do you separate the objectives of a
nation to survive, to expand for their own people, and the
objectives of a sovereign wealth fund which is controlled by
the nation?
Mr. McCormick. Well, Senator, I mean, I think at its core,
we have to acknowledge that they are different. However, the
path that we have been going down----
Senator Shelby. And how are they different?
Mr. McCormick. Well, they are different in the sense that a
private investment vehicle, a private company is designed,
exists for the purpose of maximizing profit. The sovereign
wealth funds can exist solely for the purpose of maximizing
returns, but there is a possibility that they----
Senator Shelby. But it is for the benefit ultimately of the
state, is it not?
Mr. McCormick. It is indeed.
Senator Shelby. OK, as opposed to the shareholders that
you----
Mr. McCormick. Right. Yes, sir.
Senator Shelby. So basically what we are doing in a sense
is exporting our wealth to the world, especially in the energy
areas, and others, and then they are using our wealth to buy
back our companies. Is that correct? You know, money is looking
for its best investment, and the money is going to be invested
somewhere, is it not?
Mr. McCormick. Senator, it is. I would look at that inbound
investment. I would describe that inbound investment I think a
little bit differently.
Senator Shelby. How would you describe it?
Mr. McCormick. I would describe that as in many ways the
lifeblood of what has allowed companies in the United States to
grow, to capitalize, to invest in R&D, to create higher-paying
jobs. So investment as a general rule, as I know you know,
Senator, has been a very critical part of our prosperity, and
this sovereign wealth fund investment can also be a critical
part of our future prosperity, but if and only if it operates
within our markets in a way that is consistent with market
fundamentals and market-driven investment decisions.
Senator Shelby. I know you have a portfolio over at
Treasury, and we set up CFIUS for Treasury to head that up, but
you are not alone. But I hope that you will be very careful as
you look at sovereign wealth funds' investments in this country
as to who they are, what they are investing in, and the long-
term repercussions for this country, our workers, and our
companies.
Thank you, Mr. Chairman.
Senator Bayh. Thank you, Senator Shelby.
Senator Webb.
Senator Webb. Thank you, Mr. Chairman.
Mr. McCormick, I want to understand your views and the
administration's views in terms of any level of concern that
you have about this concept. I did not quite get that from your
testimony. Do you have concerns, national security concerns?
Mr. McCormick. Senator, the national security concerns that
I think can exist from a sovereign wealth fund investment, a
state-owned enterprise, or other investments, we believe can be
addressed through the legislation that this Congress has
passed.
Senator Webb. So you believe under current policy there is
no cause for national security concerns about the nature of
these investments?
Mr. McCormick. Well, Senator, I would say it a little bit
differently, which is I believe that any given transaction from
a sovereign wealth fund could pose very severe national
security consequences. I believe the legislation that you have
passed allows us the authority to deal with that appropriately.
Senator Webb. How would you characterize the relationship
between the United States and China? Adversary? Competitor?
Ally?
Mr. McCormick. I guess, Senator, I would characterize that
as one of constructive engagement across a number of areas, and
also a relationship that is tense and where we have lots of
disagreement in other areas.
Senator Webb. You would agree that in areas where two
countries of the size and global interests on the United States
and China, if there are disagreements that one country would
want to be able to use leverage against the other?
Mr. McCormick. As a general rule, yes, Senator, I think
that----
Senator Webb. I assume you would agree that there is--or
maybe not. But I would assume you would agree that there is a
difference when you look at an investment that actually is made
by a foreign government and particularly into direct areas of
the economy as opposed to, say, something like a T-bill?
Mr. McCormick. Yes, Senator, I agree there is a difference.
I would describe this as a continuum, so on the one end would
be investment in T-bills and official reserves. Then you could
see passive investment in the equity markets, and all the way
up to a controlling investment in an individual company.
Senator Webb. So in a situation that would likely--or can
generally occur with this type of investment, I would think
that, on the one hand, we could get ourselves into a situation
nationally where we are dependent on certain levels of
investment--there are sort of three areas of concern. One is
that we would be dependent on a certain level of investment
which would give another nation a form of quiet leverage. You
have another situation with respect to the potential of access
to sensitive information depending on what the investment is.
And then, third, just due to the liquidity of our markets,
which you commented on, there could conceivably be overt
leverage in a situation where we would be having a
confrontation with a country like China.
Would you care to comment on that?
Mr. McCormick. Yes, Senator. I think just as you were on
your second point in particular, access to sensitive
information, sensitive technology, that was--I want to
reinforce the point I made earlier, which is that I believe the
CFIUS legislation that the Congress passed allows us to address
that very direct national security concern. And I think those
other areas of potential risk that you identify are legitimate
ones and ones we need to monitor very carefully to ensure that
that is not the case.
Senator Webb. How would we resolve a situation if that were
to occur? Given the construct of the law and of our
governmental policies right now, what would we do?
Mr. McCormick. Regarding market instability, Senator?
Senator Webb. Both forms of leverage, if we were to find
ourselves in a situation of some tension, not necessarily even
military tension but tension between ourselves and China in a
situation where these types of investments were growing.
Mr. McCormick. Well, Senator, I think a characteristic, for
better or for worse, of a global economy and one that is as
integrated as ours is, is that we are dependent--and other
countries are dependent--on this inflow of foreign capital. And
this becomes the basis for growth and continued investment
within the private sector of those respective countries.
I think if you looked at the distribution of the investment
in the United States today, one of the things that would be
most telling is the diversity of that investment and the degree
to which we truly are the investment destination for the world.
Senator Webb. But we do not do this, right?
Mr. McCormick. Excuse me, sir?
Senator Webb. The U.S. Government, do we have these types
of sovereign wealth funds? You mentioned one example in Alaska.
Mr. McCormick. We have that one----
Senator Webb. As a National Government, we do not have this
policy.
Mr. McCormick. We do not.
Senator Webb. OK.
Thank you, Mr. Chairman.
Senator Bayh. Thank you, Senator Webb.
Mr. McCormick, as my opening comments indicated, I think it
is good for our country to attract capital investment into our
society. We need to do that in a way that does not compromise
our other interests, and the reason for my quoting Chairman
Greenspan is that I could not help but think that some people
who now are desirous of this kind of investment would pitch a
fit if our own Government was doing the same, and, therefore,
we do not. But we do have State investment funds, as you
pointed out, in Alaska, Indiana, and elsewhere, but we have
built-in protections that insulate that from political
decisionmaking and so forth. And so it seems to me that is what
we need to do in this instance as well, and so we can get the
benefit without the downside, and that is what I would like to
ask you a couple of extra questions about.
You mentioned the work of the G-7 in terms of promoting
transparency and best practices for sovereign wealth funds. Is
it your opinion that those should be purely voluntary? Is that
enough to protect the national interest? And whether voluntary
or involuntary, if they are violated, what should the
consequence for that be in terms of allowing sovereign wealth
funds that do not follow best practices to continue to invest
in our country?
Mr. McCormick. Senator, to begin with, I think that----
Senator Bayh. Is your microphone on, Mr. McCormick? The
little red button. OK. You might pull it a little closer.
Mr. McCormick. Senator, as we review the current state of
sovereign wealth funds, I think the starting point is that we
believe there is a common objective here for most of the
players involved, which is the free flow of investment. The
sovereign wealth funds desire markets where they can maximize
their return, and the investment destinations want to remain
open to that foreign investment.
Senator Bayh. Life is easy if everybody plays by the rules,
but what do we have if they do not?
Mr. McCormick. At the G-7, I think there was agreement that
some of the areas we outlined previously in the testimony and
in our discussion are areas of concern. As I described earlier,
on the national security front, we feel like we have the
appropriate authorities to deal with that issue from a
sovereign wealth fund or another investor in the United States.
Senator Bayh. So you are satisfied with having voluntary
best practices?
Mr. McCormick. Well, Senator, for the national security
dimension of this, whether it is voluntary or not, if there is
a sovereign wealth fund investment or any investment in the
United States that raises a national security concern, we
believe we have the authorities to deal with that
appropriately.
The issues that could be raised that would be dealt with by
best practices that we do not have a legal authority necessary
to deal with are non-commercial intent, so investment for non-
commercial reasons.
As I said before, the track record on this to date has been
very positive, but we need to monitor it very carefully. And if
we begin to see evidence that sovereign wealth fund investors
are not investing in a market-determined way, then I think that
would raise additional concerns.
Senator Bayh. Well, let me give you an example. One of the
largest of these funds is now Russia's, and their behavior
toward some other countries using energy as a leverage I think
can best be described as thuggish. They are making substantial
investments in some of the Balkan nations, perhaps as part of
their intent to influence policies in those countries. When you
have a country that has behaved like that, are voluntary
guidelines enough?
Mr. McCormick. Well, Senator, it remains to be seen. We
have initiated a conversation on this. We have asked the IMF to
take a leadership role. The IMF is now beginning to do that,
and I think it will be a very telling process to determine what
those best practices might be and how the sovereign wealth
funds begin to work together, along with the investment
destinations, to try to develop those.
There are other areas where these types of best practices
have really had a positive effect, and we are optimistic they
could be very helpful here as well.
Senator Bayh. As Chairman Cox mentioned in his statement,
for American investors in America and American-operated
companies, they are not entirely voluntary. I mean, we have
mandatory standards of transparency and those sorts of things.
I would encourage you to think carefully about what the
consequences should be for non-American investors investing in
our economy who choose to not play by the best practices. My
guess is that if there are no consequences, we should not be
too surprised if some decide that the rules are just simply
inconvenient and they do not abide by them, and in this area I
think that is probably not satisfactory.
Let me ask you one other question. My time on this round is
up, and I will return to Senator Webb. I did have just a couple
more.
You mentioned the IMF, and I think, you know, continuing to
push on the currency manipulation front is a good one. I
encourage you in that effort. I know the report due October is
a little bit overdue. We are going to be interested to see if
we actually made any tangible progress or whether we are just
continuing to jawbone them.
But here is my question: The IMF is a good organization,
but as a part of their charter, maintaining stable currencies,
you know, market-based currencies, is a part of what they do.
They have not had much impact on these countries that are
maintaining artificial exchange rates. Why should we expect
them to be any more effective in this area when they have been
ineffective in the area of exchange rate policy?
Mr. McCormick. Well, Senator, I think it would be fair to
say and I think the new leadership at the IMF recognizes that
it is a very dynamic time for the IMF when they really do need
to reinvent themselves and define their mission for the next
coming decades. And a critical part of that in the view of the
United States is taking a very aggressive posture on currency
surveillance and implementing the recently designed
surveillance program that is being put in place--I know the
Managing Director is committed to that--and taking on issues
like sovereign wealth funds, which is an issue that is ideally
suited in my view for the IMF to play a leadership role.
Senator Bayh. I am going to turn to Senator Webb. I would
only observe that redefining their mission and, quote, taking
on an issue, that is all well and good. But if they are not
able to do anything about it, if people simply do not abide by
the rules, well, that is not enough. And that is what we need
to think carefully about, whether that organization, as well
intentioned as they might be, is capable of being effective.
Senator Webb.
Senator Webb. Thank you, Mr. Chairman.
Mr. McCormick, I have one other question, and I would like
to presage it a little bit with looking back on a different
kind of institutional memory. We went through a period in the
1980's where particularly with the competition against Japan,
we saw as a result of their ability through MITI to develop an
economic strategy for their companies, that policies were put
in place, underpricing, dumping, designed to sort of unfairly
diminish the abilities of American companies, whether it was
pianos or guitars or motorcycles or cars, whatever. That kind
of pales in comparison to what possibly could be the result of
these practices if they go out of control because, on the one
hand, Japan is an ally, and on the other, China particularly is
a competitor, you know, at a minimum.
But we are having a--we are seeing a new phenomenon here in
many ways, and that is that you have Government wealth entering
a direct competition with private corporations in a way that,
when I go back in my mind and look at what the Japanese were
doing at that time, when you can concentrate your wealth, you
can drive out competitors in the same business. You know, just
totally serendipitously this morning in the Financial Times,
there was an article--I do not know if you saw it or not--which
discussed the--David Rubenstein of the Carlyle Group was
talking about the potential of these types of investments
taking down the predominance of American corporations that are
in the same business, saying that these types of funds over the
next decade could challenge the predominance of U.S. buyout
firms because of the explosion of wealth and the ability to
concentrate it, so you can compete in a way with very, very
deep pockets that corporations cannot.
Would you have any thoughts on that? Actually, I would be
interested in hearing from our witnesses on that point, too.
Mr. McCormick. Well, Senator, I think it is a legitimate
concern whether the degree to which these funds are so well
capitalized allows them to invest in non-market ways based on
non-market principles--in other words, investing more than the
market would determine, and in doing so gain some advantage. It
would not be an advantage in terms of its returns because it
would have paid above market for the asset, but in terms of
some political advantage.
So I think that is something we have to monitor very, very
carefully, and I do not mean to suggest that the past is a
flawless predictor of the future, but what we have seen here
are very, very focused investors trying to maximize returns
that have been largely managed by investment professionals,
often not from the country themselves, invest in a passive way.
And the question, I think, that certainly we are
contemplating, what steps should we take, working with others
in the international community, to ensure that that is largely
the kind of investment that we see going forward. And that I
think is going to require a collection of actions, some
multilateral, some bilateral, which I tried to describe
earlier.
Senator Webb. Thank you.
Thank you, Mr. Chairman.
Senator Bayh. Thank you, Senator Webb.
Mr. McCormick, I just have one last area of inquiry, and it
has to do with the letter that was sent by Chairman Dodd and
Senator Shelby and myself and Senator Webb about this sort of
in-between area, where someone takes a minority interest stake
in a company; it is not yet 51 percent, so they do not have
absolute control; and yet it is possible that they exercise
some considerable influence over the affairs in the company.
So my question to you is: First of all, what does the
Department plan to do in response to the issue we raised? Are
you contemplating anything in this area? That is No. 1.
No. 2, isn't it possible that the significant minority
owners can exercise that kind of influence? And if the answer
to that is yes, well, what do we do when it is short of 50.1-
percent ownership stake?
Mr. McCormick. Thank you, Senator. As you know, Exon-Florio
allows the president to take action in situations where there
is a demonstration of control. But the line, the red line in
terms of what defines control--let me say it differently. There
is no hard and fast red line in terms of what defines control.
Control will be identified based on an evaluation across
several different factors. Those factors would include
ownership, voting rights, board seats, and so forth, which,
when viewed in their totality would be demonstrative of a
party's ability to significantly influence major decisions for
the company.
There has been a presumption----
Senator Bayh. The ability to influence major decisions. And
so you take all those factors together and the question is: Can
they influence major decisions of the company?
Mr. McCormick. Yes, Senator. There has been a presumption
up until this point that a passive investment was one that was
roughly at the 10-percent level or below. But there may even be
instances when there is a 10-percent investment that the--
because of other factors, that there is actually the ability
for control.
So our challenge here is to really review each case on a
case-by-case basis and do that in a way that identifies whether
there is a controlling interest, but to also do that in a way
that does not create so much uncertainty around transactions
that you have ultimately created an incremental burden or
chilling effect on investment.
Senator Bayh. Well, let me give you a recent for instance.
I do not know how much you followed the recent change in the
CEO position at Citigroup, which their largest shareholder is a
Saudi prince who has apparently a 4-percent ownership stake,
significantly below the 10-percent threshold that I gathered
that we normally would assume would be passive. And according
to published reports, he played a very active role in bringing
about a change in the leadership of that company.
Now, I am not being critical of him. It may have been
exactly the right thing to do. But, you know, there is an
example of someone with a 4-percent stake who, I think by your
definition, he apparently exerted influence over a significant
development at that company.
Does he have a controlling interest in the company? Most
people would ordinarily say at 4 percent, no, but it is hard to
say he did not exert some significant influence over a major
decision. So what do you do in a case like that?
Mr. McCormick. Well, Senator, obviously all this is within
the context of national security, so----
Senator Bayh. That is the largest private financial
institution in our country.
Mr. McCormick. Senator, as I said, all this is viewed
within the context of national security, so if the ability to
significantly influence decisions that could come at the
expense of the national security of the United States, then
control in that case would go into CFIUS and go through the
appropriate review to ensure that that security interest can be
mitigated or the transaction is not approved.
Senator Bayh. Well, one of the--and, again, you have been
very patient here today, Mr. McCormick, and I know you are just
here by yourself taking all these questions. But one of the
things I think Chairman Shelby alluded to and, in fact, the
CFIUS law spoke to was that in today's world--and you look at
the Russian behavior as an example, and there are some others--
the definition of ``national security interest'' is broader
than it used to be. You will see the Chinese going around the
world acquiring what they view as strategic energy interests,
and it is not impossible that financial positions might be used
in a similar vein.
And so we just need to see the world that is evolving and
be ever mindful that in some non-traditional areas in today's
world and tomorrow's world, they may, in fact, implicate
national security interests where 20, 30 years ago, perhaps it
was not the case.
Senator Webb, is there anything else you would like to
touch upon before we let this good man go?
Senator Webb. No. Thank you very much, Mr. Chairman.
Senator Bayh. Mr. McCormick, thank you very much.
Mr. McCormick. Thank you, Senator.
Senator Bayh. As I said, I appreciate your service to our
country.
Mr. McCormick. Thank you.
Senator Bayh. We have a very distinguished second panel. If
it is all right with you, gentlemen, I would like to introduce
all of you together, and then, Mr. Larson, I think we will
start with you, then Mr. Truman, and just move in that
direction down the table.
Ambassador Alan Larson is senior international policy
advisor at Covington & Burling where he counsels clients on
issues of international business and public policy. He joined
the Foreign Service in 1973 and retired in 2005 as Under
Secretary of State for Economic, Business, and Agricultural
Affairs. During his tenure, he served as Ambassador to the OECD
in Paris and in numerous posts as an economic officer in
Washington and at missions in Jamaica, Zaire, and Sierra Leone.
He earned the rank of Career Ambassador in 2004 and was honored
with the Secretary of State's Distinguished Service Award in
2005. Ambassador Larson is currently Chairman of Transparency
International USA. He holds a Ph.D. in economics from the
University of Iowa. There seems to be a great interest in all
things Iowa these days, Dr. Larson, so we are glad that you are
here representing that fine State--at least in part.
Dr. Edwin ``Ted'' Truman is also with us today. Ted Truman
is a senior fellow at the Peterson Institute for International
Economics in Washington, D.C. He served as Assistant Secretary
for International Affairs at the Treasury Department from 1998
to 2001. Previously, he led the International Finance Division
of the Federal Reserve Board and staffed the Federal Open
Market Committee. Dr. Truman has been a member of a number of
multilateral working groups on economic and financial issues
and has published widely on international and sovereign
investments. He holds a B.A. from Amherst and a Ph.D. from
Yale. Dr. Truman, thank you for joining us.
Next is Patrick Mulloy. Mr. Mulloy, you are no stranger to
this Committee. It is a pleasure to welcome you back once again
to share your perspective. Pat Mulloy served on the bipartisan
U.S.-China Economic and Security Review Commission from 2001 to
2006, including a period as Acting Chairman. The Commission
reports to Congress on the national security implications of
our economic relations with China. Mr. Mulloy also served as
Assistant Secretary for Market Access and Compliance in the
Department of Commerce's International Trade Administration. He
spent 15 years on the staff of the Senate Banking Committee,
including as chief international counsel and general counsel.
Mr. Mulloy is currently the Washington representative for the
Alfred P. Sloan Foundation, which funds studies and programs
regarding the competitiveness of American industry and
citizens. He is also an adjunct professor of international
trade law at both Catholic University and George Mason
University. A native of Pennsylvania, he holds a J.D. from
George Washington University Law School and an M.A. from Notre
Dame. Mr. Mulloy, welcome back. We are sorry about the Fighting
Irish's football team this year, but there is always next year.
Dr. Gerard Lyons, welcome. Dr. Lyons is chief economist and
head of Global Research at Standard Chartered Bank in London.
Although based in the U.K., he travels extensively, visiting
the bank's operations and clients in Asia, Africa, and the
Middle East. He has held senior positions at a number of major
financial institutions. Dr. Lyons is an expert on the world
economy, the international financial system, macroeconomic
policy, and global markets, and is invited to speak frequently
on these topics. Originally from London, he obtained an M.A.
from the University of Warwick and a Ph.D. from the University
of London. Dr. Lyons, we are grateful for your presence here
today.
Mr. Larson, why don't we begin with you. Technically, we
are supposed to limit our comments to 5 minutes. If you need to
run over a little bit, that is OK, but you could also submit--
if it is a much longer statement, feel free to submit that for
the record.
STATEMENT OF ALAN P. LARSON, SENIOR INTERNATIONAL POLICY
ADVISOR, COVINGTON & BURLING, LLP
Mr. Larson. Thank you very much, Senator Bayh, Senator
Webb. It is a pleasure to be here. I would like to submit a
longer statement for the record, and to summarize it, I would
just begin by confirmation my name is Alan Larson, and when I
was a Career Ambassador and an Under Secretary of State for
Economic Affairs, I often used to deal with policy with respect
to investment and inward acquisitions. Today, in my current
private sector position, I sometimes get involved as an advisor
on inward investment acquisitions, including some transactions
that involve entities with foreign government ownership. So I
have seen it from both the public and private sector side.
My testimony summarizes how foreign investments and
acquisitions can benefit the United States by putting to work
here capital that supports investment, growth, job creation,
innovation, and competitiveness in our own economy. And I think
all speakers have touched on that point.
In addition, foreign investments can mitigate the
disruptive effects of global imbalances. They can transform
foreign entities into stakeholders in the U.S. economy,
stakeholders who prosper when our economy prospers.
There are a number of reasons why foreign entities may want
to invest in the United States. My testimony goes into those. I
am just going to touch on three here.
One is that some foreign government pension funds want to
invest in assets that are diversified across sectors, across
countries, and across different types, and in that they are
like lots of other investors everywhere.
Second, as we have already discussed, some countries are
very dependent on a single resource, such as oil, and they have
economic reasons for wanting to diversify across investments in
other countries in other sectors.
And, third--not conclusively--many foreign governments,
including some of our closest allies, own operating businesses.
We have discussed that that is not the American philosophy, and
I agree with the American philosophy, but the fact is that some
countries do have foreign-owned entities or foreign-owned
enterprises, and we sometimes go abroad in trying to leverage
the expertise that they have developed in their home market.
As has been discussed, these trends look very likely to
continue to grow. As we know, high oil prices and current
account surpluses provide some of the financial fuel for the
rapid growth of these types of investments and acquisitions.
Studies suggest that these surpluses are likely to continue and
that a strong energy policy, even if we were to adopt a
stronger one, and great progress in rectifying international
imbalances, even if we were able to achieve that, are not going
to dramatically change this picture.
Many of the speakers today rightly have emphasized the
importance and the issue of transparency of Government
investment entities. I think it is important that the G-7 has
been prodded by the U.S. Government into leading an
international exercise. It is designed to identify best
practices on transparency, and that these best practices would
be strongly recommended to Government investment entities. It
is also important that the G-7 has asked the OECD to lead a
similar exercise with respect to transparency on the part of
investment-receiving countries so that their investment
policies are transparent and that they avoid a lurch into
protectionist policies.
Here in the United States, we have followed a clear policy
of welcoming foreign investment while maintaining effective
tools to allow us to scrutinize any transactions that might
raise national security concerns. I think that the recently
enacted Foreign Investment and National Security Act of 2007 is
a robust tool for addressing any national security issues
involving foreign acquisitions, including those by Government-
owned entities or sovereign wealth funds.
FINSA mandates that the executive branch will focus on
those acquisitions that raise national security concerns. I
think it rightly does not look at economic factors or
industrial policy considerations that could distract FINSA and
lead away from--and dissipate resources on issues that are not
crucial for national security.
I think that FINSA also requires--or, excuse me, I have
lost my place here.
The acquisitions that do not result in control correctly
lie outside the jurisdiction of FINSA, and this gets very much
at the important point that Senator Webb and you, Senator Bayh,
were raising. When there is not control, there is not, in my
opinion, a risk that foreign persons might direct, determine,
or decide core business policies in ways that raise national
security concerns. I think this language is important. Is it
influence? Is it the ability to direct, determine, or decide
what the business strategy is going to be?
Again, I think that it would be important, if we want to
protect national security, to keep our eye on those
transactions that could result in foreign influence--in foreign
ability to direct, determine, and decide these decisions.
Whenever an entity that is controlled by a foreign
government makes an acquisition in the United States that falls
within FINSA--and, therefore, within the scrutiny of CFIUS--
this law already mandates that there is a presumption that the
transaction will go into a second-stage review or an
investigation. I think that is also an important safeguard.
These transactions that involve Government-controlled entities
are going to be looked at very, very carefully, and I think
that is what Under Secretary McCormick was underscoring as
well.
It is my understanding that the executive branch is
mandated to promulgate regulations by next April in terms of
the implementation of FINSA and that these regulations may
address, update, and clarify the factors that the Government is
going to consider when determining whether an acquisition would
result in control by a foreign entity and the factors that the
Government will consider in determining whether a foreign
entity is, in fact, controlled by a foreign government.
Therefore, I think this is a very important process that will
take place between now and April and that in writing these
regulations, it is going to be important for the executive
branch to look carefully at other control tests that have been
used and look carefully at some of the considerations that have
been raised thus far in this hearing.
I think it is important, as well, that FINSA gives those
agencies with security responsibilities an appropriately strong
voice; it also gives the executive branch flexibility in
defining when national security concerns are present, and this
gives the administration the flexibility to recognize that
national security may be touched by different considerations
this year than it appeared that national security was touched
by 10 years ago. This is an important aspect of the law, in my
judgment.
I think that Congress and the administration should alertly
monitor the new developments we are discussing today. But I
think it is also important to recognize that Congress and the
administration have worked together to put in place an
effective law and an effective policy to address national
security issues that may arise and that these equip us to
address a future where foreign investments and acquisitions may
well play a larger role in the American economic landscape.
Thank you.
Senator Bayh. Thank you very much, Mr. Larson.
Dr. Truman.
STATEMENT OF EDWIN M. TRUMAN, SENIOR FELLOW, PETERSON INSTITUTE
FOR INTERNATIONAL ECONOMICS
Mr. Truman. Thank you, Chairman Bayh, Senator Webb. It is a
pleasure to appear before you here this afternoon.
In my longer written testimony, which I have submitted for
the record, I make five main points.
First, sovereign wealth funds and related vehicles for
external or cross-border investments by governments have been
around for a long time, are growing in relative importance, and
are here to stay.
Second, the existence and growing importance of these types
of vehicles raise profound questions about the structure and
functioning of the international financial system, as was
reflected in the introductory comments by various Senators.
Third, the continuation of these trends does not currently
pose a threat to U.S. national or economic security, in my
view, that cannot be dealt with under existing laws,
procedures, and regulations.
Fourth, it would be desirable to consider possible
improvements in the U.S. statistical information base on
foreign-government-related investments in our country.
Fifth, the U.S. Government should continue actively to
encourage foreign governments with large cross-border
investments to develop and follow a set of best practices with
respect to managing those investments in their interests, in
our interests, and in the interests of the stability and
openness of the international financial system.
The scoreboard on existing sovereign wealth funds, which I
have developed with my colleague Doug Dowson, provides a
starting point for the development of such a set of best
practices for sovereign wealth funds.
In the remainder of my oral testimony, I will touch on my
fourth point and elaborate a bit on my fifth point.
In my view, consideration should be given to improving our
statistical information in this area. I summarize in my written
testimony my understanding of the nature and limitations of our
current data. It would be useful to know about, one, the data
that are currently available or not available on U.S. assets
and liabilities of governments and government-owned and -
controlled entities, broken down by the nature of those
entities; two, the costs and complexities for the United States
of expanding the collection of such information; and, three,
the prospects for encouraging similar efforts in other
countries.
Now, turning to my fifth point, what should be done to make
the world safer for sovereign wealth funds? In my view, large
sovereign wealth funds--at least it got a laugh out of Mr.
Larson. Large sovereign wealth funds should increase
significantly their accountability to----
Senator Bayh. People laugh at my testimony all the time,
Dr. Truman. Don't take it personally.
Mr. Truman. No, I was intending--I thought I might get a
laugh. It is rare that my laugh lines get laughs.
Senator Bayh. Well, good.
Mr. Truman. In my view, large sovereign wealth funds should
increase significantly their accountability--and I would like
to stop and emphasize the issue is not just the question of
transparency. It really is a question of accountability.
Transparency is a means to accountability. Accountability is
what we are after. Accountability first to the citizens of the
countries involved; second, to our citizens and Government as
well as to those of other countries; and, last, not least to
participants in international financial markets.
The most promising way to increase the accountability of
these activities is through the establishment of a standard or
a set of best practices for international investments in
general and for sovereign wealth funds in particular. For
sovereign wealth funds, best practices, in my view, should
cover four broad categories: structure, governance,
transparency and accountability, and behavior.
As I said earlier, to aid in the development of a set of
best practices for sovereign wealth funds, my colleague Doug
Dowson and I have developed a scoreboard for 32 sovereign
wealth funds in 28 countries, which are listed in Table 1 in
the testimony before you.
The scoreboard includes 25 elements grouped into four
categories, and I want to emphasize that at least one sovereign
wealth fund receives a positive score on each element, so I am
not asking--maybe I should be, but I am not asking any--the
collectivity to do anything that somebody else does not do, at
least one other person does not do.
Table 3 attached to the testimony summarizes our results.
Out of a possible 25 points, the highest score of 24 is
recorded by New Zealand's Superannuation Fund, followed closely
by Norway's Government Pension Fund at 23 points. The Abu Dhabi
Investment Authority--ADIA--and its Investment Corporation--
ADIC--in the United Arab Emirates record 0.5 points. The
average is 10.27 points. Six of the ten largest sovereign
wealth funds score at or below the average, including two of
the three largest funds at the bottom of the table. One of the
two is the Government of Singapore's Investment Corporation,
called GIC. At the same time, Singapore's Temasek Holdings
scores considerably above the average. I can answer more
questions about this if you would like.
I endorse the Treasury's effort to encourage countries with
sovereign wealth funds collectively and cooperatively to
establish a set of best practices for those investment
vehicles. The G-7, as you have heard, has embraced this
approach to reinforce the global framework governing cross-
border investment. The willingness of the Fund and the World
Bank and the OECD to promote dialog on identifying best
practices is also encouraging.
In the end, however, it will be the governments of
countries that the sovereign wealth funds and their related
activities that must decide that it is in their individual and
collective self-interest to participate in those efforts. It is
in our self-interest to facilitate that process.
Thank you very much.
Senator Bayh. Thank you, Dr. Truman.
Mr. Mulloy.
STATEMENT OF PATRICK A. MULLOY, WASHINGTON REPRESENTATIVE,
ALFRED P. SLOAN FOUNDATION
Mr. Mulloy. Chairman Bayh, let me begin by thanking you,
Chairman Dodd, Ranking Member Shelby, and Senator Webb for
providing me the opportunity to testify today. I want to note
that the views I will present are my own and not necessarily
those of any of my employers. I also want to assure the
Committee that I have no client, except the public interest, on
these matters and have never been paid by any company or
government or any other entity to advise it on foreign
investment matters. I commend the Committee for holding this
important hearing, and as an alumnus of the Committee staff, I
am really honored to be here.
Senator Bayh. It is good to know that there is life after
the Banking Committee.
[Laughter.]
Mr. Mulloy. It was terrific while I was here, let me assure
you.
Senator, in May of this year, you had me up before the
Committee to talk about China's exchange rate practices, and in
my testimony then, we talked about the provisions of the 1988
trade bill and the responsibilities given to Treasury in that
bill--20 years ago almost--to identify countries that are
underpricing their currencies to gain trade advantage. I told
you in that hearing that Treasury had completely failed to
carry out those responsibilities. I think one of the reasons we
are here today to talk about sovereign wealth funds flows
directly from the failure of Treasury to carry out those
responsibilities given it by the Congress.
In June of this year, the Acting Under Secretary of the
Treasury Clay Lowery made a speech in San Francisco to talk
about sovereign wealth funds, and he said that these are
Government investment vehicles which are funded by foreign
exchange assets. So where do you get the foreign exchange
assets to fund these? Trade surpluses are a big help.
So there are two aspects of these things:
One are the commodity funds, put together by the oil
producers, and so they run trade surpluses because we are
dependent upon imports of oil from them because we really do
not have a good energy policy.
But the second part of this which Mr. Lowery identified
were non-commodity funds. He said these are established through
transfers of assets from official foreign exchange funds. In
October of this year, the McKinsey group did a study on foreign
sovereign funds. McKinsey told us that the Asian central banks
will have $3.1 trillion in foreign reserve assets. It did so at
the end of 2006. The study then went on to say, to put that
amount in perspective, ``it is twice as many assets as global
hedge funds manage and twice the size of global private
equity.''
Now, these are huge amounts, and they are growing rapidly.
China's central bank right now has over $1.3 trillion in
foreign currency reserves. Japan has $875 billion. The central
banks of Hong Kong, India, Malaysia, Singapore, South Korea,
and Taiwan together have another $1 trillion.
Now, the McKinsey study says--now, how are they able to
accumulate these vast amounts of foreign exchange reserves? And
the report put out by McKinsey says ``exchange rate
management.'' McKinsey tells us that these governments have had
these large current account surpluses, and they like it. So in
order to maintain the money coming in, they intervene in
currency markets to keep their currencies underpriced against
the dollar. That way, they get the surpluses. We get the cheap
goods. They get the money to put in sovereign wealth funds.
Now, it is very interesting. The McKinsey study said on
page 78, ``For Asia''--and it is not just China; it is Asia--
``the system has ensured the success of its export-led growth
model and continuous and growing current account surpluses.''
Then the McKinsey study says, well, OK, what is the downside
for the United States? They said the good side is we get a lot
of good, cheap goods, and we get them invested in our Treasury
to help us keep our interest rates down. What is the downside?
They say we have a dollar, a higher dollar, which is propped up
by the Asian central banks, which hinders our ability to
export, particularly to Asia. We are getting some relief now on
the euro because the euro is falling in value--I mean, is
raising in value against the dollar. But we cannot--with Asia,
they prop up the dollar. It harms our ability to export, and it
knocks out our domestic industries that are competing against
imports. It is a very--and then they say there are hazards for
our country to be overreliant on foreign capital. I think these
sovereign wealth funds are part and parcel showing that it is
dangerous to be so overreliant on foreign capital.
Now, what are some of the problems? Senator Webb talked
about strategic--that they can invest for strategic purposes.
Mr. Lyons, who is here today, wrote a paper on that called
``State Capitalism: The Rise of Sovereign Wealth Funds,'' and
talked about strategic investments in telecommunications,
energy, the financial sector, or even to get intellectual
property rights that they do not develop but that they can
buy--that we develop or others develop.
Two, what is another problem? And, Senator Bayh, you talked
about this. Chairman Cox of the SEC made a major speech up at
Harvard at the Kennedy School a couple of weeks ago, and he
made the point you made. We have not wanted to have our own
Government owning large chunks of our economy, and the road
that we are on now, we are going to have foreign governments
owning large chunks of our economy.
Now, Mr. Cox said at least if our own Government owned
portions of our economy we could presumably try to influence
our own Government to carry out our wishes. Here is what he
said about the foreign governments. If the owner, on the other
hand, is a foreign government, ``the national interests a
foreign government will advance will presumably be its own.''
OK. That is so clear.
Now, Warren Buffett, who I like very much--I follow him and
I pay attention to what he tells me. He wrote an article in
Fortune magazine in October of 2003 entitled, ``Why I'm Not
Buying the Dollar: America's Growing Trade Deficit is Selling
the Nation Out From Under Us.'' Selling the Nation out from
under us. He says we are behaving like a rich family that has a
farm and we are no longer earning our way in the world and we
sell off portions of the farm to foreigners every year to
maintain a lifestyle we are no longer earning. That, he said,
is the trade deficit. He said it was imperative that we take
``action to halt the outflow of our national wealth.''
In 2005, he writes a letter to his shareholders, and he
refers to the United States as moving toward ``sharecropper
society.'' In other words, we are going to be working for other
people because they are going to own us.
The Washington Post then put out an editorial in August of
2005 at about the same tine CNOOC was trying to buy Unocal, and
the Post said Buffett's vision of where we are headed was
``distressingly plausible.'' And the editorial then went on to
say ``the country is living beyond its means, spending more
than it earns, and relying on foreigners to supply the
difference.''
Senator Bayh. Mr. Mulloy, I am loath to interrupt, because
I like you and I like Warren Buffett, we are a little bit over,
and I would like to explore this with you in response to
questions.
Mr. Mulloy. OK. I will make three key points.
One, we need an energy policy to reduce the outflow there.
Two, we have to understand these other Asian countries in
particular are following mercantilist trade practices, and we
need to address those. The bill reported by this Committee on
exchange rates was very important. And in the provision that
you have talked about, making these underpriced currencies and
illegal export subsidy that should be countervailed, that is
very important to get in that bill that you reported out of
this Committee.
The third thing is, Senator Webb, keep an eye on that CFIUS
process at the Treasury. There is going to be rulemaking,
notice and comment rulemaking. The interests of the foreign
governments and foreign investors are going to be all over that
process, and I think a countervailing effort has to be made by
this Committee to stay on top of that process, because Treasury
in the past did not operate CFIUS the way you intended, and you
had to amend it.
So those are my key points, and I thank you very much
again, Senator, for the opportunity.
Senator Bayh. Mr. Mulloy, thank you very much.
Again, Mr. Mulloy, I apologize for intervening but I have
some--part of having the gavel means trying to keep things more
or less on schedule.
Mr. Mulloy. I understand.
Senator Bayh. Although, as you know, it is the Senate and
we do tend to fall beyond. So thank you very much.
Yes, Dr. Lyons.
STATEMENT OF DR. GERARD LYONS, CHIEF ECONOMIST AND GROUP HEAD
OF GLOBAL RESEARCH, STANDARD CHARTERED BANK
Mr. Lyons. Good afternoon, Senator Bayh, Senator Webb,
members of the Committee. It is my pleasure and honor to appear
before you today and offer views on sovereign wealth funds.
Thank you for inviting me here to Washington to participate. I
commend the Committee for devoting time to this examination of
this issue.
I am going to offer brief oral testimony but I have,
respectfully would request my written statement that covers the
biggest 22 sovereign wealth funds be entered into the record.
I would like to talk about three areas. But before I do
that, I should stress that sovereign wealth funds are both
stakeholders and shareholders of Standard Chartered. Indeed, I
met and sat with some last week when I was in the Middle East,
so hopefully I'll give you some fresh thoughts.
But there are three areas I would like to talk about.
First, the composition. Second, their possible impact on
financial markets. And third, the strategic aspects of
sovereign wealth funds that I think stresses the need for
common ground rules.
First, in terms of composition, really I just want to
reinforce the points already made. They are in the written
paper. It is not just the size of these funds, which are $2.2
trillion and possibly more, in our view. It is difficult to
contemplate fully how much or how big these funds will plump.
In qualitative terms, they clearly are going to grow and
therefore become far more important.
It is not just the size, as I say. Chairman Bayh listed
what I call the super seven funds in his opening statement. But
there is also the openness and transparency of these funds. One
can differentiate between the funds. Some of them appear to be
very transparent. They include Norway, Singapore's Temasek,
Alaska, Malaysia and Canada's Alberta. Those funds provide
detailed information on their size, returns achieved, and their
portfolio composition. And many companies have seen these as
investors without any apparent issues to date. One has to ask
if these funds find it possible to provide such information and
continue to perform as sovereign wealth funds, why cannot
others?
In contrast, there are other, secretive, funds. They
include the UAE funds, China, Qatar, Brunei, Venezuela, Taiwan,
Oman, and Kuwait. And while secrecy in itself does not mean the
funds will be a bad investor, in the global investor
environment where transparency and accountability are seen as
important positives, such opaqueness should be discouraged and
openness clearly encouraged.
Second is their possible impact on the financial markets. I
would stress that the source of these funds comes from four
different areas. One has already been stressed, namely the
movement in commodity prices. Second is the growth in foreign
exchange reserves. And just to put that in perspective, a
decade ago Asia held one-third of global currency reserves. Now
it holds two-thirds. The bulk are still in dollars, although I
would stress that, in my view, passive diversification from the
dollar is already underway.
In addition to commodities and FX reserves, the third is
clearly the investment performance. And fourth is what I would
call the discretionary factor, how much a government wants to
put into these funds. That is particularly important when one
considers the new Chinese fund where, whilst in my view foreign
exchange reserves in China will grow significantly--probably to
$2 trillion by early 2009--it is not yet clear how much of that
increase in reserves will be allocated to new funds.
Senator Bayh. What was your third factor, Dr. Lyons?
Mr. Lyons. Sorry, the investment performance of the funds.
Basically how much money they are making.
They also will grow relative to other types of investors,
as has already been stressed. I think it is important to
appreciate that in other parts of the world sovereign wealth
funds are viewed as a force for good, particularly in emerging
markets. And that is partly because of where I believe
sovereign wealth funds are expected to invest their money. I
would stress four particular areas, two of which come into the
category of state capitalism, as Senator Webb mentioned in his
opening statements.
In terms of where I expect the funds to invest their money:
one, I do expect them to take bigger stakes in equity and bond
markets across the emerging world. That makes sense in economic
and financial terms. Second, I do expect them to feed more
money into alternative investments such as hedge funds and
private equity. And the third and fourth area which I would
include under state capitalism, I believe that they will boost
strategic links with countries that have not fully shared in
globalization's success or, indeed, regions that have been
shunned by the West. Africa comes immediately to mind. Although
I would stress if a country wants to take a stake in such
regions or areas, they do not have to just do it through
sovereign wealth funds. And finally, I think they will take
strategic stakes in sensitive areas within developed countries
if, clearly, they are allowed to.
That leads on to the third and final aspect, which is the
strategic aspect of these funds. I think this is very much in
the case of trying to head off future problems rather than
addressing the issue that is really big at the moment. In the
paper I submitted, I said that my big concern is that these
funds will see an opportunity to acquire strategic stakes in
key industries around the globe, whether it be
telecommunications, energy, the media, the financial sector, or
indeed to secure intellectual property rights in other fields.
Whilst that can be viewed in a sinister way, I would also
stress that it makes a lot of economic sense. If one is a low
value-added country like China, then it makes sense to try and
leap a few years by acquiring strategic assets that give access
to intellectual property rights. Basically, countries will want
to move up the value curve quickly. Of course, there may be
other non-economic factors at play there. Also, buying into
overseas firms will make sense for countries which are not
thinking possibly of setting up sovereign wealth funds.
Reverse nationalism is an area that I think is already big,
and that is basically the need to acquire strategic commodities
and resources around the world. Not just energy but maybe hard
metals and, indeed, soft commodities.
Despite that, I would argue a protectionist backlash
against sovereign wealth funds would be damaging for global
trade. I would reinforce some of the points already made about
the need for sovereign wealth funds to be encouraged to adopt
the best practice of open funds like Norway. I would also
stress countries in the West to press for what I call the level
playing field approach, to encourage the opening up of markets
from which sovereign wealth funds emanate.
I think this is a particularly important point when we look
at sovereign wealth funds. One of the reasons why I think they
have become such a big issue is because of the imbalance to the
global economy. For the global economy to become more balanced,
it is not just a case of currency adjustment that is needed.
One needs to see high savings regions like Asia and like the
Middle East move away from export-led to domestic-led growth.
Indeed, that is in their best interest as well, given their
demographic profiles.
As they move toward domestic driven growth, part and parcel
that process will be the opening up and deepening and
broadening of their financial sectors. I think that is
something that needs to be stressed. And that is a multi-year
process which I think will address many of the issues here.
And of course, I would say and reinforce the point made
that we need to try and improve the governance and transparency
of sovereign wealth funds and to promote an investment
framework that is fair and commercial driven.
So finally, I would say the sovereign wealth funds debate
is a further sign of the shift in the global economy, the shift
in economic and financial terms. In recent years, there has
been much talk about the need for global policy form to change.
Whether they will change remains to be seen, but even if they
do change, whether they will be effective again remains to be
seen. But in this particular area, it is an opportunity for
countries in the West to work with emerging economies,
particularly those from where the big funds come, to basically
get some ground rules and a common code of practice.
I would stress that the more sovereign wealth funds invest
strategically, that would be a concern. Yet, as long as the
investments by these funds are for commercial reasons and not
for political purposes, then these funds should be accepted.
But as clearly stated, there is lots of issues within that.
Senator Bayh. Thank you very much, Dr. Lyons.
Perhaps I should pick up where you left off. As I said at
the beginning, and Mr. Mulloy was going on--I think
appropriately so--and you mentioned as well, some of the forces
that are leading to the reserves that enabled these funds to be
created. It seems as if the macroeconomic factors are not going
to be changing any time soon. So this phenomena is likely to
continue.
So we want to see these dollars recycled into our economy.
That is beneficial to us. But we want to insulate ourselves
from any political agenda on the part of countries that have
the sovereign wealth funds. So I would like to focus with all
of you on that, perhaps, Mr. Larson, starting with you, and
then Dr. Truman, and then Dr. Lyons. I am not leaving you out,
Mr. Mulloy. I had another question for you, but my first two
questions to you three gentlemen--maybe we can just go in
order.
No. 1, should the best practices that we envision for these
funds be entirely voluntary? And if they are, I think, Dr.
Truman, you emphasized--and I think appropriately so--the
notion of accountability. So if the best practices are
voluntary, what should the accountability be if the best
practices are not followed?
Mr. Larson. Thank you very much.
I do think that the international effort to develop best
practices and get them adopted is an important one. My
government career over 32 years was negotiation and I know that
some of these can take a while. And I think that I would not
want to offer undue hope that this will be quick and easy.
Having said that, I want to come back to the ``what if''
because I think that insofar as these entities are making
acquisitions in the United States that have security
implications, national security implications, that the law that
Congress has put in place and the process that the CFIUS
agencies run allows them to demand information with respect to
a specific transaction, about the reasons why the investment is
being made, whether it is political, whether it is----
Senator Bayh. Will the CFIUS process serves as a backstop
to the voluntary nature of the best practices?
Mr. Larson. I think it is a safety net, sir, yes.
Senator Bayh. Is there any inconsistency in your mind about
why we would not insist upon adherence to best practices from
global investors when, for publicly held companies in our
country, we would probably not countenance such a thing,
voluntary standards?
Mr. Larson. Well, I think there is a difference.
Senator Bayh. In other words, if the SEC just said you
know, the reporting requirements and that kind of thing, that
is just best practices and you can follow it if you want to.
And if you do not, the marketplace will do with you what it
will?
Mr. Larson. I am glad you asked that question, because let
me zero in on some of the things that Chairman Cox said. I
agree with the requirements that the SEC levies, and I do think
that they protect investors and give confidence to investors. I
agree with his comments that we have had, as Americans, a
strong and correct desire to make sure that government is not
conflicted as between its role as an owner of a company and its
role as a regulator of an industry. And that was one of the
things, I think, that was at the core of some of the remarks
that the Chairman made in his speech at Harvard.
It is, in my judgment, a different set of issues that we
face when we have foreign companies or entities and possibly
government-owned entities making investments in the United
States. And that is why the structure of the Foreign Investment
National Security Act, I believe, took the form that it did.
And it gave the executive branch tremendous authority to
scrutinize, review, and if necessary prevent those acquisitions
that would jeopardize national security.
Senator Bayh. I have only got 56 seconds left before I turn
to Senator Webb, so I apologize. But I think you put your
finger on an important point I wanted to make, which is I hope
that the--and I was very grateful for the Under Secretary's
comments and presence today. A lot of this will depend upon the
zeal with which they enforce the new law.
In the past, it has been the perception of some that it has
been largely a laissez faire interpretation of the regime that
was in place. And perhaps they will have a bit more rigor going
forward which, I think, would give a lot of people confidence
in the fact that the appropriate framework may already be in
place. But it is going to be dependant upon how they choose to
enforce it. I guess that is what I--and some of us are going to
be looking to see do they mean business here or is it going to
be just kind of an anything goes attitude yet again.
And I apologize, Dr. Truman--thank you. I hated to
interject, but I want to get to Senator Webb.
Dr. Truman, should it be voluntary? If not, how is
accountability provided?
Mr. Truman. Well, I would--let me turn on the microphone,
excuse me.
I would go the same place where Al Larson started from. In
some sense, in terms of the national security dimension, we
have a mechanism that--I would come at it the other way.
From the national security dimension, you have things that
prevent--whether or not you have best practices. Right? Some
foreign government comes in, buys something, does not tell us,
we can throw them out of the country after the transaction is
made, right, and have mitigation agreements and so forth and so
on.
So the best practices, in some sense, has to do with the
other things we are concerned about, right? The citizenship
elements. Do we know what they are doing? Do we--what kind of
things they are buying, whether they are passive investments,
whether they--and so I think that is a--I would it the other
way around.
You have the first line of defense, in some sense, is for
government's own investments, is the CFIUS, whatever
abbreviation you now call it.
And the second would be a set of best practices. I think to
be successful the principle should be--as it is often called--
comply or explain. If you have a significant number of
countries who are following essentially the best practices,
then the system--right--public opinion has a lot of leverage, a
lot of leverage over countries and entities that are not
following those best practices.
You can do it, if I may put it that way. You and your
colleagues can do it. The newspapers can do it. And public
opinion, since this is also in the interest of the people in
the countries themselves, can do it.
Senator Bayh. If I could just interject, please go ahead
and then I want to get to Dr. Lyons. But I am going to need to
get to Senator Webb. Two of the reasons that we are here
today----
Senator Webb. Mr. Chairman, it is not a problem. I am
interested in hearing this, as well.
Senator Bayh. Thank you, Senator.
Two of the reasons we are here today, Doctor. No. 1, the
line between what constitutes a national security interest and
what constitutes an economic or financial interest may not be
quite as clear and bright as we would all like it to be. Part
of that is a process of interpretation.
Dr. Lyons alluded to other countries perhaps having a
strategic interest in acquiring our intellectual property,
which if our national economic comparative advantage is going
to be by being a more highly innovative economy and our
intellectual property is bought for a few cents on the dollar,
that has some potentially pretty significant ramifications for
our country.
So that is just one example.
Mr. Truman. I accept fully that these lines are not easy to
draw.
Senator Bayh. The second thing was what some of us would
call the relaxed attitude of the administration on enforcing
the previous regime.
Mr. Truman. We can discuss it. I favor a narrow approach
personally. My judgment, and it is a matter of judgment and I
understand it is a matter of judgment for a narrow definition
of national security. But I recognize that there are other
issues involved. There are issues involved whether you are a
government-owned corporation or entity or not, about
proprietary information and so forth and so on. Those are
issues which extend, it seems to me, in the continuum extend
from government to non-government and it is a very complicated
issue.
I think it is appropriate that we have laws and rules and
regulations in this area. I would note that, just to come back
on the publicly held corporations, I mean it is true that
outside of CFIUS itself, there are rules and regulations in
terms of publicly owned entities that require certain
disclosures when large--or even relatively small stakes--are
accumulating, including your friend the Prince, the Saudi
Arabian Prince. That had to be disclosed.
So it is not as if we do not--but on the other hand, I
think it is in the interest of the countries involved, right,
as well as our own, right, that there be more disclosure and
accountability, including to the countries involved.
I say in my testimony that, in some sense, if this money is
wasted, right, the biggest--which is one risk, right? You
pursue non-economic objectives, right? And even if they are
overall national security objectives and it is wasted, in some
sense you get nothing on either dimension, right? Then the
people who really pay are the citizens of the country involved.
And there are a lot of examples where that has happened
already, whether it is Nigeria or Ecuador or appearing to be
happening in Venezuela. So in that sense, accountability, in
some sense, the biggest risk, in some sense, is to the
countries' wasting their money. You can have issues about where
the money came from in terms of the foreign exchange reserves.
But at least as far as the commodity funds, it was dug out of
the ground, right? And then the wealth became below ground,
became above ground, and if it ended completely wasted, in some
sense, the country in a longer term sense is much worse off.
And that also can have national economic and security
implications for the United States if Venezuela, for example,
implodes as a consequence of this process.
Thank you.
Senator Bayh. Dr. Truman, thank you. Dr. Lyons, I would
love to hear from you, but I have run substantially over.
Senator Webb has been very courteous, but I would like to turn
to him and then maybe in a second round get back to you.
And I have not forgotten you, Mr. Mulloy. Do not worry.
Senator Webb.
Senator Webb. Senator Bayh, I would actually like to hear
from Dr. Lyons on your question, if you do not mind. I did not
anticipate we were going to get that long of an answer from Dr.
Truman when I yielded a few minutes, but I would like to hear a
little more if Dr. Lyons would care----
Senator Bayh. You were almost Senatorial in your response,
Dr. Truman.
Mr. Lyons. Rather than repeat the comments that have
already been made, and which I agree with, maybe just three
different perspectives or three perspectives that reinforce.
One is, obviously this Committee is looking at things from
a U.S. perspective. I would very much certainly encourage the
Committee to try and view this in the multilateral basis and
try and export best practice. If it is seen that the U.S. is
putting up some blockages, justified or whatever, then the
money from sovereign wealth funds will simply go elsewhere. I
think it is therefore important to work with these funds to
basically have best practice.
And best practice is only going to be adopted if the funds
see it as being in their best interest, as well.
Senator Bayh. Well, we want the money and we would
encourage them to follow best practices. The question is what
do we do when they do not?
Mr. Lyons. Which leads on to China. It is interesting, I
agree with the points about China's currency. When I go to
China, it is very clear that financialism is how they approach
all aspects of policy, including the currency. China, although
it is one country, is a multitude of different economies, some
of which are booming, some of which--Western Central China,
Northeast part of China--have clearly been held back.
And Hu Jintao, the President, when he gave his policy
speech earlier this year, was saying that even though China was
growing strongly--indeed rapidly--it is not generating enough
jobs at the moment for urban workers. It needs 25 million a
year and it is currently generating 9 million to 11 million a
year.
So when one looks at it from a Chinese perspective, they
are almost very fearful of allowing their currency to
appreciate more aggressively. And therefore, they approach
financialism.
But what I find interesting is, in my view, the way the
U.S. approach changed in recent years, rather than just
focusing on the currency debate with China, but trying to
package it as part of the need for China to open up and deepen
its financial markets. I think that met with more reception in
China, and I think that is the right way to proceed.
But I think it is inevitable that China will not allows its
currency to appreciate too aggressively, but certainly one
should encourage them to try and appreciate it further. But the
point is that they will continue to accumulate reserves. We can
all debate the speed at which they do so.
And the final point I would make about security, I think
there is widespread global agreement about protecting areas of
defense security. As you pointed out, it is very difficult
beyond that. And indeed, in the U.K., in the Enterprise Act,
the U.K. Chancellor, the Finance Minister, talked about areas
of sensitivity, again far more vague.
But I think the important point is that for any investors,
they need to know where the line in the sand is. And if one is
to protect areas outside the defense, then that is in any
country's--clearly in any countries' interest if they wish to
do that--or agreement rather to do that. But I think it is
important to actually know where those lines in the sand are.
But ultimately, I think we should be working closely to try
and get best practice. But I think it will take time, actually,
because many of these funds have only really come under
scrutiny and under public domain in the last year. The more
they are in the public domain, under public scrutiny, then
hopefully the more progress there will be.
Senator Webb. Thank you, Mr. Chairman.
I would like to request the Chair reset the clock, since
that was not in response to my question. I would like to have a
few minutes here.
Senator Bayh. The clock has been reset.
Senator Webb. Again, I would like to thank you for holding
the hearing and to all the witnesses, I was very interested in
all your testimony. I found it to be very illuminating. I took
a lot of notes, a lot of things to think about.
From my perspective, I would just like to make it clear
that the concern that I have, and I think a lot of people who
see this the way that I do, is not foreign investment. It is
foreign government investment. And that is something that is
quite different.
And when we are talking about the individual transactions
or the individual direct business activities that are going to
be examined, there is another piece of that. And that is
whether, in the aggregate, we might reach a tipping point with
respect to one nation or another. It is a different kind of
thing. In some cases, the economic and the non-economic factors
tend to merge, just as the commercial and the political can
tend to merge.
As I was listening to the testimony, one thought was going
through my mind. And that is I do not think we have really yet
come to grips philosophically with what is going on here. Dr.
Lyons, you created a couple of terms here that I think are
applicable. Mr. Mulloy, you talked about a sharecropper society
in which that is basically the definition of colonialism, quite
frankly, that somebody else owns the assets and somebody--
another group of people does the work. One group gets the labor
and the other group gets the profit.
But somewhere in here with this notion of state capitalism,
we are emerging, in some cases, to a new form of national
power. Very clearly, with the countries that are our
competitors. It is a very unique situation to be in. It is
almost--we went through colonialism and then we had socialism
and then we had fascism with the government sort of
accommodating large scale industry. And now we have state
capitalism, and I think that is a very good term.
When it comes to nations that are in competition with us on
a number of other fronts that affect a clear definition
national strategy, we have to look at that. And we have to look
at that not only in terms of individual transactions but the
vulnerabilities that they are bringing to our ability to
articulate our policy around the world. We can understand how
this began. We can understand the inception of this, with the
nations--particularly in Asia--having accumulated so much
capital--or excuse me, so much money--that they want to invest
and that is healthy when it is properly designed, that they do
so in our country.
But I am just sort of curious. I would like to hear Dr.
Lyons and Mr. Mulloy particularly, in the time that I have
address this philosophical environment that we are moving into.
Mr. Lyons. I completely agree with the comments of Senator
Webb. I think it is not just foreign investment. It is a
differentiation between private foreign investment and state
investment.
One phrase used in the U.K. is the Wimbledon effect, which
relates to the first point about private investment. Basically,
the feeling in England or Britain is that we have the best
tennis tournament in the world. But Britain rarely ever wins
it. But that is not the point. The important point is that the
tournament takes place in London with all of the associated
benefits.
The phrase is used, the Wimbledon effect, not so much for
tennis but more because of the city of London. The city of
London is seen as one of the world's major financial centers.
But the ownership, a very small part of it, is in British
hands. Lots of it is international hands. And the important
point is that that is the right thing. As long as you have the
right legal framework, you have the right environment, then it
does not really matter who owns the companies, who owns the
business, as long as it takes place in London.
And I think that is the right approach. But as you say in
your comment, it refers to the private sector part of the
foreign investment.
When it comes to government involvement, it is a very
difficult ball game for all the reasons we mentioned before.
Governments approach things not just in terms of maximum short-
term, maximum long-term return, it is maybe not to maximize
returns for investors. It is very much a different set of
criteria.
The interesting aspect is that this does not really just
mean sovereign wealth funds. If one looks--let's take China as
an example. China is investing heavily in Africa, not through
China's sovereign wealth fund but through CMOOC or Petrol
China. Indeed, one can argue China's Development Bank, Chen
Yuan, the president there, have taken stakes overseas in
Barclay's, et cetera.
Now all of this is justifiable in economic terms but all
these different parts of China's ink, you could say, link back
to the government. So when one starts to look at it in a
government perspective, whether at different incentives
structures, than it does actually have a profoundly different
aspect. And therefore, it becomes very difficult to get the
common ground rules to apply in that flavor.
The important point, I would argue, is maybe to try and
step back and encourage China to open up its financial sector
even further, one of the points I was making, and try and work
with them so they see it as in their best interests to adopt
the principles that we in the West see as in our best interest,
as well.
Mr. Mulloy. Senator, thank you for the question.
Being on that China Commission for 6 years and reading the
press clips that the staff would prepare for us every weekend--
magazine articles, newspapers, everything--you begin to form
some impressions of what you think is happening here. China was
a great society, a great economy. They had a bad 200 years.
They want it back. They tried communism and a collectivist
economic approach. It did not work. Deng Xiaoping came in, in
1978, and he said, ``We need to have the Westerners, the
foreign investors help us build our economy.'' And they
provided all kinds of incentives and strategies to make that
happen. And we have gone along, and many other foreign
corporations have done so as well.
So there has been tremendous technology transfer,
tremendous knowledge transfer. We have not fully grasped what
is happening here, and we have no counter strategy. I am not
out to demonize the Chinese. I mean, what the heck? If you were
them, you would be doing the same thing. But they have a
strategy, and we do not have any counter strategy.
This is an article by Peter Navarro that appeared March
13th. He is a business professor at the University of
California, and he has written some books on China. He said,
``China may invest its equity funds strategically to
established controlling interests in U.S. companies and thereby
gain influence over decisions ranging from the offshoring of
production and technology transfers to lobbying against U.S.
legislation to promote fair trade with China.''
Now, let me just give you another one. This is from Inside
U.S.-China Trade, September 12, 2007. There is an article here
called ``Multinational Firms Begin Campaign to Derail China
Trade Legislation.'' That is your bill, Senator. He said all
the major exporters, importers, and firms with investments in
China are all meeting to figure out--and they are being put
together by the U.S.-China Business Council, the Retail Leaders
Association, ECAT, Chamber of Commerce, Business Roundtable. It
is a lobby. It is a lobby----
Senator Bayh. It is always nice to be taken seriously.
Mr. Mulloy. I mean, really, it is an amazing situation.
So this is what I think we need to understand. There is a
strategy. The U.S. Government, we need to really think and do
some serious effort to have the committees of the Congress look
into some of these things and begin to put together, just like
we put together the 1988 competitiveness and trade bill, a new
globalization bill to prepare us for this different kind of
international economic competition that we are now in. And I
think that is very important for the country to be doing,
Senator, and thank you for the question.
Senator Webb. Well, thank you both for your responses. I am
not one who is attempting to demonize China, either. I think
that what we have seen over the past 36 years with China, being
able to aggressively pursue relations with them, it has been
very healthy. It is something that we probably should be
thinking about with Iran. We have been able to bring them into
the international community. At the same time, we have to
recognize their size and the potential and the fact that they
are a competitor, and we need to address those situations in a
way that prevents us from further vulnerability, and that was
my motivation--one of my motivations in asking for the hearing,
and, Mr. Chairman, I thank you very much for having held it.
Senator Bayh. Thank you very much, Senator.
Mr. Mulloy, I think you addressed it. I was going to ask
you about--oh, as long as we have the energy situation that we
do and the trade situation that we have, and as I think Dr.
Lyons pointed out, even the conscious currency policies that
some countries have designed to promote domestic stability, we
are going to continue to face the phenomenon that we are
dealing with here today, and the question is: How do we
responsibly deal with that? As I said at the outset, how do we
get the advantages of the investment, but insulate ourselves
from political pressure or an agenda on the part of other
countries that may have interests other than our own.
And so with regard to the piece of legislation you
mentioned, I would much prefer to have global currency markets
establishing the value of respective currencies. But as long as
some countries choose to pursue industrial policies, we have to
think carefully about what the consequences of those are, and
then act in accordance with our own interests.
Dr. Truman, you look like you are volunteering an answer.
Mr. Truman. If you will permit, Mr. Chairman, I just wanted
to say on the record I agree 100 percent about this issue of
the Government role, and I have said in my own writings--and I
think the issue, if I may turn Gerard Lyons' phrase on its end,
is state capitalism, the question is how much of it is state
and how much of it is capitalism. That is essentially the issue
that we have to try to sort out.
I would like to make one point on the question of the
linkage of this to the imbalances. I agree with are living
beyond our means, and that is a big problem. But let's say we
magically went back to a current account deficit or a small--
balance or small surplus or deficit. There actually still would
be a case for a lot of cross-border investment because it is
diversification. And it may not be so important for the United
States, which actually has a lot more in terms of Government-
owned, Government-managed--I mean, CalPERS and so forth and so
on, and various Government-owned pension funds. We actually do
have a lot of that, though it is structured in a way which is
transparent and accountable and so forth and so on.
And that makes sense, even for the United States, which has
a lot--we can diversify a lot within the country. It makes a
lot more sense for Singapore to have a lot of diversification
outside.
So even if we were in current account balance, in some
sense, given the different governmental structures of the world
we have, even if we had current account balance and then built
up an extra $10 trillion worth of--or net of $3 to $5 trillion
worth--$2.5 trillion worth of debt over the last 24 years. The
existing say $14 trillion on both sides would still be there,
and in some sense raise all the same questions, right? Because
we have different--because we would have our $14 trillion
abroad, most of which was managed by private investors, right?
And they would have their $14 trillion in the United States, a
lot of which--of which a much more significant fraction was
managed by governments. And that is the issue that you are
raising, and I think it is a profound issue, and we cannot go
remaking their governments. We can try to persuade them that
our system works better, and my guess is that is what is going
to happen over the next 25 years in some sense, just as with
central planning. But the diversification motivation is still
there, and we in some sense still have the same problem even in
the absence--I agree with you entirely--of this overhang of
living beyond our means that we have been living with for the
last whatever number of years you want to pick.
Senator Bayh. Well, a lot of good issues have been raised
here today, and, gentlemen--yes, Mr. Mulloy, you raised your
hand.
Mr. Mulloy. I agree that we are in a bind now, that we need
to get these best practices, and I agree probably the best way
is to have a good CFIUS process that is quite aggressive and
what we think the best practices are. And I do not think that
will happen, Senator, without strong oversight from this
Committee on the rulemaking and other things that go on in
Treasury.
Senator Bayh. This Committee with the assistance of Senator
Webb.
Mr. Mulloy. Yes.
Senator Bayh. Well, I think that is a good point, and,
again, I want to thank all of you. I think there were some
excellent points raised here today, and the first one being
that there is a difference between foreign investment on the
part of individuals or private entities and government-
sponsored entities. That is No. 1.
No. 2, a good CFIUS process can backstop voluntary best
practices. One of the hard parts about that is when is it a
national security interest and when is it a financial or an
economic interest and how do you differentiate one from the
other and so forth.
I suspect that these imbalances will last for a while. You
are right, it would make sense from a portfolio theory
standpoint to diversify investments in any event, but I suspect
what is happening today--and Mr. Mulloy would probably agree--
is that we are at least temporarily maintaining a higher
standard of living for us at the expense of our children and
grandchildren, is what is happening here. And I do not think a
great nation does that for long.
But that is a topic for another day and another panel, and
until then I want to thank all of you for your time. Dr. Lyons,
you have come a long way. We are grateful to you. And, again,
thank you for your service to our country through your presence
here today.
We stand adjourned.
[Whereupon, at 4:10 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ALAN P.
LARSON
Q.1. Please discuss the potential, if any, for systemic risk
when Sovereign Wealth Funds invest in private equity, hedge
funds, or regulated financial institutions.
A.1. Sovereign Wealth Funds (``SWFs'') invest capital that has
accumulated in countries with financial surpluses. Their
investments in financial institutions in the United States put
that capital to work in our country. As a general matter, such
investments reduce the systemic risk that would otherwise arise
if capital surplus countries hoarded their surpluses.
Periodically, the international financial system comes
under stress as a result of an excess of ill-considered
investments in particular sectors, countries or instruments.
The latest example of this phenomenon is the international
financial disruption resulting from ill-considered investments
in poorly understood sub-prime mortgage securities.
The sub-prime crisis resulted from, by and large, decisions
by financial institutions in the United States. The sub-prime
crisis elevated international systemic financial risk.
Fortunately, the stability of the international financial
system has been bolstered, and systemic risk has been reduced,
by investments of ``patient capital'' from SWFs. The
investments made by SWFs in financial institutions whose
capital base had been badly eroded by investments in sub-prime
investment vehicles have been stabilizing.
Q.2. Beyond choosing to invest through Sovereign Wealth Funds,
what other means could countries with large current account
surpluses employ? Are such other means more or less desirable
than using Sovereign Wealth Funds?
A.2. Countries that accumulate current account surpluses could
dispose of those surpluses in a variety of ways. The citizens
of these countries are, of course, the persons in a position to
decide which approach best serves their goals and objectives.
Most countries with large surpluses choose to devote part
of those surpluses to the modernization of public
infrastructure, including roads, ports and airports as well as
social infrastructure such as health and education. Such
investments make sense so long as they are well-targeted and
subjected to rigorous cost-benefit analyses.
Countries with surpluses could choose to distribute a
portion of those surpluses to their citizens in the form of
grants or reduced taxes. Putting a larger share of the
surpluses into the hands of the private sector is appealing.
At the same time, the citizens of some countries take the
view that at least a portion of government surpluses should be
invested in a way that creates returns for future generations.
They believe that, after a certain level, the benefits of
public sector investments or direct grants to citizens can be
diminishing. These countries have chosen to invest part of
their surpluses in funds or investment companies.
Q.3. Federal Reserve Chairman Bernanke has stated that he
believes inflows of foreign capital into our markets,
particularly to purchase Treasury bills and other dollar-
denominated assets, have helped to keep interest rates low. In
other words, the globalization of capital flows has benefited
our economy by suppressing interest rates and maintaining the
value of the dollar. Do you believe that Sovereign Wealth Funds
can affect the value of the dollar or our domestic interest
rates?
A.3. Chairman Bernanke is correct in asserting that foreign
investment in the United States tends to lower interest rates
and to support the value of the dollar in relation to other
currencies. SWF investments in the United States have had this
positive effect on our economy. Recent SWF investments in U.S.
financial institutions have supported the capital base of these
institutions, indirectly bolstering credit, growth and job
creation.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM ALAN P.
LARSON
Q.1. Do you have any evidence or reason to believe that
sovereign wealth funds have invested based on, or shared,
inside government information?
A.1. When sovereign wealth funds invest in the U.S. economy,
the most important information relates to the firm or industry
sector that is the target of the investment. In the
transactions with which I am familiar, the foreign investors
relied on investment banks and industry experts to assist the
due diligence that guided their investment decisions. In my
experience, SWFs and the governments whose money they invest do
not have inside government information on U.S. firms or on the
industries in which those firms operate.
Q.2. Do you have any evidence or reason to believe that
countries have manipulated markets for gain in their sovereign
wealth funds? For example, using the regulatory powers of the
state to move market prices.
A.2. In the transactions I know about, sovereign wealth fund
investors have not benefited from market manipulation. The SWF
investors I know seek to comply with U.S. laws and regulations.
Their home governments have not manipulated--nor do those
governments have the power to manipulate--the international or
U.S. markets in which the SWF invests.
Q.3. Do you have any evidence or reason to believe that
sovereign wealth funds have used or had access to national
intelligence or other state assets for their investment
decisions?
A.3. I have not encountered instances when SWFs have used
national intelligence to guide their investment decisions.
Under the new Foreign Investment and National Security Act
of 2007, the CFIUS process will benefit from analyses by the
Director of National Intelligence. I would encourage DNI to
include in its analyses an assessment of whether a foreign
investor has had access to national intelligence in making
their investment decisions.
Q.4. Do you have any evidence or reason to believe that
sovereign wealth funds have been used as a policy tool similar
to how some state-run companies have been, most prominently in
Russia?
A.4. SWFs differ significantly one from another. The ones with
which I am most familiar operate commercially and are
independent from government policy and government direction of
their investment decisions. The SWF investments in the United
States with which I am familiar have been used to advance
commercial objectives, not the home government's policy
objectives. The Foreign Investment and National Security Act of
2007 provides the U.S. Government with tools, which it should
use, to investigate any proposed SWF acquisition when there is
reason to believe that a foreign government might try to use
that acquisition, to the detriment of the national security of
the United States, to advance a national policy objective.
Q.5. Have there been any destabilizing effects of sovereign
wealth funds, such as shifts of large amounts of capital?
A.5. Investments by SWFs have, on balance, promoted financial
stability. They have recycled capital to the United States. In
2007, SWF investments bolstered the capital stock of fragile
U.S. financial institutions.
Most SWFs have a track record of being long-term commercial
investors. Most SWFs have made diversified, minority
investments. I am not aware of any instances where SWFs have
shifted large amounts of capital in a manner that is
destabilizing.
Q.6. We have CFIUS to look at foreign control for national
security reasons. What do we have to look at political and
economic security concerns of sovereign wealth (or other
foreign) investments?
A.6. Congress was correct, in my judgment, in writing the
Foreign Investment and National Security Act of 2007 in a way
that keeps the focus of CFIUS investigations on possible
threats to national security. Consistent with the President's
broad responsibilities to protect national security, CFIUS has
the flexibility to investigate potential national security
threats that might arise from economic or political factors.
Some countries have engaged in screening of foreign
investment based explicitly on economic criteria such as a
``net economic benefits.'' Congress was wise, in my view, to
shun this approach. Markets rather than government policymakers
are best placed to determine whether investments have a sound
economic basis. The United States correctly has refrained from
``picking winners and losers'' and from designating ``national
champions.'' The same American philosophy lies behind our
decision not to have the Government decide, on economic or
political grounds, which foreign investments to permit to take
place.
Q.7. What tools do we have to monitor these investments?
A.7. I believe that the government's intelligence capabilities
and its oversight of mitigation agreements provide the
executive branch with tools it needs to monitor these
investments. Congress has increased funding for agencies to
monitor compliance with the mitigation agreements. The
Executive Branch is obligated to report to the Congress on its
oversight of mitigation agreements and should promptly inform
the Congress if additional tools or resources are needed.
Q.8. China has been very active in traditional and economic
espionage in this country. Are you worried they are using that
information either to make investments or to pass information
to companies they invest in?
A.8. The U.S. Government should actively use its counter-
intelligence capabilities to defend against traditional or
economic espionage. If there is reason to believe that a
proposed acquisition by a foreign investor could be used to
engage in espionage, that concern would be grounds for a
rigorous CFIUS investigation. If the investigation confirms
that a serious threat exists, CFIUS should take appropriate
action to address the threat.
Q.9. The IMF is looking into voluntary best practices for
sovereign funds. What other options do we have to learn more
about what the funds are doing?
A.9. The IMF's work to develop a code of best practices is
likely to expand information about the governance of SWFs,
increase the transparency of their operations, provide a better
understanding of the differences among SWFs, and offer greater
clarity as to their investment strategies and methodologies.
When an SWF makes an acquisition that falls under the
jurisdiction of the laws of the United States, our laws and
regulations give the United States adequate tools to learn what
we need to know about what the fund is doing. I recommend that
we place primary reliance on U.S. law to address the policy
needs of the U.S. government.
Q.10. How can we leverage these investments in U.S. markets to
get other countries to open their markets to U.S. private
investment?
A.10. The Government of the United States should, and does,
actively work to open foreign markets to U.S. private
investment. The government uses a number of tools, including
the negotiation of Bilateral Investment Treaties, to accomplish
this. In addition, the World Bank has been an effective
advocate in persuading foreign countries to reduce barriers to
foreign investment. Country after country has come to see that
private foreign investment brings a great boost for economic
development and that barriers to such investment should be
reduced or eliminated.
Using specific investment transactions as leverage to
promote reciprocity in the provision of investment
opportunities to foreign countries is neither necessary to
encourage liberalization abroad, nor is it in the interest of
the United States. We have adopted an open investment policy in
the United States because it is in our own economic self-
interest.
Q.11. Do countries with sovereign funds investing in the U.S.
allow similar investments from U.S. private or government
investment?
A.11. Each country that has established an SWF maintains a
somewhat different policy towards foreign investment. In many
cases, countries whose SWFs seek to invest in the United States
have been quite open to foreign investments. Singapore, for
example, has negotiated a Free Trade Agreement with the United
States that has an investment chapter providing significant
investment opportunities for U.S. firms. There also are
substantial U.S. investments in Norway, Canada and those Middle
Eastern countries which have government-owned investment
companies.
In other cases, of course, U.S. companies still face
significant investment restrictions in countries that are the
home of sovereign wealth funds. The U.S. Government should make
strong efforts to persuade these countries to open their
investment markets.
Q.12. Are there any sovereign wealth funds being used to
enhance the lives of the wealthy elites, while the general
population suffers?
A.12. The SWFs with which I am familiar are directed to make
investments that will provide broadly shared benefits for the
citizens of their countries. Some government-owned investment
funds are investing in order to finance pension benefits of
their citizens. In other cases, SWFs have been accumulating
assets for future generations, but the governments have not yet
distributed the earnings of SWFs.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM PATRICK
A. MULLOY
Q.1. Do you have any evidence or reason to believe that
sovereign wealth funds have invested based on, or shared,
inside or government information?
A.1. No. However, Chairman Cox of the FCC raised concerns about
such issues in his Oct. 24th speech at the Kennedy School of
Government at Harvard University.
Q.2. Do you have any evidence or reason to believe that
countries have manipulated markets for gain in their sovereign
wealth funds? For example, using the regulatory powers of the
state to move market prices.
A.2. No.
Q.3. Do you have any evidence or reason to believe that
sovereign wealth funds have used or had access to national
intelligence or other state assets for their investment
decisions?
A.3. No. I have no evidence, although it would not surprise me
if they did.
Q.4. Do you have any evidence or reason to believe that
sovereign wealth funds have been used as a policy tool similar
to how some state-run companies have been, most prominently in
Russia?
A.4. No. I have no evidence of that.
Q.5. Have there been any destabilizing effects of sovereign
wealth funds, such as shifts or large amounts of capital?
A.5. Not that I am aware of.
Q.6. We have CFIUS to look at foreign control for national
security reasons. What do we have to look at political and
economic security concerns of sovereign wealth (or other
foreign) investments?
A.6. You are correct. The CFIUS process currently examines the
national security concerns of foreign acquisitions of
controlling influence of U.S. companies. I think the Executive
Branch interprets ``national security'' in the law governing
the CFIUS process too narrowly. I believe that political and
economic security concerns could be addressed in the CFIUS
process if the Executive Branch carried out its CFIUS
responsibilities in the manner intended by the Congress.
Q.7. What tools do we have to monitor these investments?
A.7. I am not aware that the U.S. government monitors foreign
sovereign wealth fund investments or other foreign government
investments in the United States. I believe the sole exception
would be if such monitoring was agreed to as part of a CFIUS
review of a foreign acquisition. Congress should enact
legislation making the activities of foreign government
controlled investment in the United States more transparent.
Q.8. China has been very active in traditional and economic
espionage in this country. Are you worried they are using that
information either to make investments or to pass information
to companies they invest in?
A.8. The recently released Defense Department Annual Report to
Congress entitled ``Military Power of the People's Republic of
China 2008'' states on page 8 that, ``Officials from the FBI
have identified China as running an aggressive and wide-ranging
effort aimed at acquiring advanced technology from the United
States.'' Thus, it would not surprise me if China targeted
gaining access to key technologies as part of their government
investment decisions in the United States.
Q.9. The IMF is looking into voluntary best practices for
sovereign funds. What other options do we have to learn more
about what the funds are doing?
A.9. The IMF codes, if developed and agreed upon, would not be
binding on IMF member nations. Member nations of the OECD are
also using that organization to examine and discuss the
national security concerns raised by sovereign wealth fund
investments. While I believe these multilateral efforts can be
helpful in highlighting key issues and recommending best
practices for such funds, I believe that the United States
Government, perhaps after evaluating the IMF and OECD work
products, should pass legislation imposing what it considers
``best practices'' on sovereign wealth funds. That way we would
know what we think are the best practices could be enforced.
Q.10. How can we leverage these investments in U.S. markets to
get other countries to open their markets to U.S. private
investment?
A.10. China is desirous of making investments in the U.S., but
as the February 2008 report by GAO entitled ``Foreign
Investment: Laws and Policies Regulating Foreign Investment in
Ten Countries'' makes clear, China prohibits foreign
acquisitions in key industries and sectors of its economy. For
example, CNOOC, which wished to purchase Unocal in the summer
of 2005, could not itself be purchased by an American investor.
We might with China enter into some kind of reciprocal
investment agreement to gain leverage to open China's market to
U.S. investment. We should not, however, waive our own national
security concerns just in the interest of ensuring more open
investment opportunities for U.S. firms abroad.
Q.11. Do countries with sovereign funds investing in the U.S.
allow similar investments from U.S. private or government
investment?
A.11. I refer you to the GAO report, ``Foreign Investment: Laws
and Policies Regulating Foreign Investment in Ten Countries'',
dated February 2008. GAO did this report at the request of
Senator Richard Shelby, the ranking member on the U.S. Senate
Banking Committee. It is a very good review of the foreign
investment policies followed by a number of key nations.
Q.12. Are there any sovereign wealth funds being used to
enhance the lives of the wealthy and elites, while the general
population suffers?
A.12. While I have heard allegations along these lines, I have
not studied the matter thoroughly. I do think that many of the
trade policies being followed in the WTO and other bodies tend
to focus on benefits for small groups within many societies and
not for the populace of the countries as a whole. That is why
within the U.S. and many other nations there is a growing
resistance to ``globalization'' as it is now proceeding.
Q.13. Mr. Mulloy, I understand there is a relationship between
China's accumulation of dollar-denominated assets--its $1.4
trillion war chest--and its efforts to keep the Yuan
undervalued against the dollar. According to a recent survey of
18 exchange-rate studies by the Peterson Institute, the Yuan
remains 40% undervalued, in spite of the dollar's recent fall
against other currencies whose exchange rates are more market
determined. China's accumulation of reserves and its
deliberate, trade distorting policy to keep the Yuan
undervalued are two sides of the same coin. I applaud Chairman
Dodd and Senator Shelby for moving legislation out of this
Committee to address the problem, and I hope they are able to
persuade our Majority Leader to give it the priority it
deserves. My question to you, Mr. Mulloy, is what effect would
this legislation have on sovereign wealth funds, and what is
the danger of Congress failing to use the tools it has
available to address currency?
A.13. On pages 4 and 5 of the prepared testimony I submitted to
the Committee when I testified on November the 14th. I quoted
from a McKinsey and Company report entitled, ``The New Power
Brokers'', which examines sovereign wealth funds. That McKinsey
Report tells us, on pages 77 and 78, that China and other Asian
countries have accumulated huge dollar reserves through trade
surpluses with the United States. It further tells us that
exchange rate management, i.e. keeping the dollar overvalued by
intervention in foreign exchange markets, has been part of
their trade strategy, and has permitted them to acquire the
dollars they have put in their sovereign wealth funds. As I
noted on page 11 of my prepared testimony, the United States
must craft trade policies to address the mercantilist trade
practices being used by China and/or other Asian partners. I
mentioned the Banking Committee bill to address currency
manipulation in my testimony and strongly supported its
passage. I also made other recommendations on pages 13 through
15 of my prepared testimony that we consider other legislation
to combat China's IMF illegal currency practices. Their
underpriced currency, as Chairman Bernanke noted in a December
2006 speech in Beijing, acts as an export subsidy. We should
have a law to permit our industries to be able to bring
countervailing duty cases against such a subsidy as you,
Senator Bunning, along with many other of your colleagues have
proposed.
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