Sovereign Wealth Funds-The Newest Danger Facing the U.S. Economy

I.  Introduction

Amidst a global economic ‘credit crunch,’ world economies are desperately seeking dependable sources of investment into their financial institutions, in an effort to regain liquidity into their markets, enabling lending institutions to continue their day-to-day activities. One source of such income is derived from an emerging investment tool known as a sovereign wealth fund (also known as an SWF). This article will briefly explore the development of SWFs, explain the relevance they play in the U.S. and world economy today, raise national security issues that stem from SWFs, and address recent and developing legislation in response to the growing presence of SWFs in the U.S. economy.

Sovereign wealth funds are government investment funds composed of financial assets such as stocks, bonds, real estate, or other financial instruments that are financed by foreign currency reserves.[1] Some experts have referred to SWFs as oil or natural resource funds, because a majority were created with countries excess budgets from exports of oil and natural gas.[2] Many SWFs have developed because of the rising success of emerging economies, specifically in the Middle East and Asia.[3] In recent years, growing concerns have developed over the stake that these state-owned investment funds have in the private market of the U.S. These concerns are echoed by economists and government officials over the national security of the United States, which may be compromised because of the possibility these government owned investments might be securing a stake in vital economic institutions of the country for political rather than financial gain.[4]

II.  Implications of SWFs

Since the recent sub-prime mortgage crisis has stuck at the heart of Wall Street, threatening the collapse of many financial institutions crucial to the economic infrastructure of the United States, SWFs have provided a much needed "cash infusion" into the market.[5] Some of the more prominent investments have been made in Citigroup, Morgan Stanley, and Merril Lynch.[6] One major concern that SWFs pose is the possibility that countries could form an alliance as major shareholders in a US corporation and force the resignation of its corporate officers in an effort to exercise political power.[7] Current estimates of these state owned investments account for nearly $3 trillion globally.[8] Countries across the world have begun to take action in an effort to regulate the unbounded investment of sovereign wealth funds into a significant portion of their financial markets. Some European countries have passed legislation that calls for regulation over SWFs investment into their domestic markets.[9] Accordingly, U.S. government officials are raising awareness about the growing presence of SWFs in the economy.[10] Therefore, it is no surprise that many global economists are calling for legislative reform in the oversight of Sovereign Wealth Funds.[11]

In recent decades, legislation has begun to develop in the Unites States to address the growing concerns presented by SWFs. In 1975 the Committee on Foreign Investment in the United States (CFIUS) was established to examine the national security threats posed by foreign investments into the domestic economy.[12] In 1988, Congress enacted the Exon-Florio Amendment which allows the CFIUS to review any foreign investments deemed a threat to national security.[13] The President may then take any appropriate action with regard to the foreign investment at the recommendation of the CFIUS.[14] Since the enactment of the Exon-Florio Amendment, CFIUS has investigated and ruled on roughly 25 major foreign transactions that implicate a security threat.[15]

However, in the future government scrutiny over these transactions is likely to heighten because of the projected growth of SWFs. Morgan Stanley projects that foreign investments under management of SWFs could reach up to 12 trillion dollars in the United States by the year 2015.[16] It is also predicted that SWFs could exceed the world’s total official reserves as soon as 2011.[17]

Startling predictions like the projected growth of Sovereign Wealth Funds, and recent current events have led to criticism over the inherent weaknesses with current legislation concerning SWFs. For example, in 2006 Dubai Ports World, a state owned company located in the United Arab Emirates negotiated a deal to purchase the management of six major ports in the United States, including New York.[18] Despite intelligence reports raising the possibility of national security risks associated with the management by a foreign government of major ports along the eastern seaboard, CFIUS approved the deal.[19] Public outcry and Congressional pressure eventually prompted Dubai Ports to sell its operations to American International Group (AIG).[20]

Incidents like the Dubai controversy have led to reform in Congress concerning foreign investments, including SWFs. In 2007 Congress passed the Foreign Investment and National Security Act.[21] The Act requires the Executive Branch to make specific inquiries into the effects of commercial transactions that raise national security threats.[22] It also lays out several factors to use when making a decision to take action.[23] In addition to legislative reform, international debate over the controversy of Sovereign Wealth Funds (SWFs) caused the leading SWFs of the world to meet in early September of 2008, where they agreed to draft a voluntary code of conduct.[24] Still, it is important to realize that the world today is a global economy. Accordingly, economists also believe adopting a policy of protectionism that restricts foreign investment opportunities could restrain economic growth in the United States.[25] In addition, the U.S. could steer foreign investments towards other countries, as well as causing retaliatory policies against American’s investing abroad.[26] Thus, the U.S. is placed in a difficult position, sometimes being forced to pit economic concerns against those of national security.

III.  Conclusion

With the emergence of Sovereign Wealth Funds (SWFs), the U.S. is presented with unique challenges that have caused many leading economists and government officials to rethink basic principles of capitalism and free market that have laid the foundation of economic prosperity in this country. Therefore, in an ever-increasing global economy it is important to weigh the risks and benefits of allowing SWFs to have such a large financial stake in the U.S. economy.

End Notes:

[1] Lee Hudson Teslik, Sovereign Wealth Funds, Council on Foreign Relations, January 18, 2008, http://www.cfr.org/publication/15251/.

[2] Andrew Rozanov, Who Holds the Wealth of Nations?, State Street Global Advisors, August, 2005, http://www.ssga.com/library/esps/Who_Holds_Wealth_of_Nations_Andrew_Rozanov_8.15.05REVCCRI1145995576.pdf.

[3] Id.

[4] Teslik, supra note 1.

[5] Asset Backed Insecurity, The Economist, January 17, 2008, http://www.economist.com/finance/displaystory.cfm?story_id=10533428#top.

[6] Id.

[7] Teslik, supra note 1.

[8] Id.

[9] Germany approves law against some foreign investment actions, International Herald Tribune, August 20, 2008 available at http://www.iht.com/bin/3-col.php?id=15465294.

[10] Lawrence Summers, Funds that shake capitalist logic, Financial Times, July 29, 2007 available at http://www.ft.com/cms/s/2/bb8f50b8-3dcc-11dc-8f6a-0000779fd2ac.html.

[11] Id.

[12] 50 U.S.C. Appendix 2170

[13] Id.

[14] Id.

[15] Edward Graham and David Marchick, US National Security and Foreign Direct Investment, May 2006, available at http://www.petersoninstitute.org/publications/chapters_preview/3918/02iie3918.pdf.

[16] Stephen Jen, How Big Could Sovereign Wealth Funds be by 2015, Morgan Stanley, May 3, 2007, http://www.morganstanley.com/views/perspectives/files/soverign_2.pdf.

[17] Id.

[18] Reuters, AIG to buy Dubai company’s U.S. ports, USA Today, http://www.usatoday.com/money/industries/2006-12-11-dubai-ports_x.htm (December 12, 2006).

[19] James Carfano and Daniella Markheim, After Dubai Ports: Getting CFIUS Reforms Right, The Heritage Foundation, May 17, 2006, http://www.heritage.org/research/nationalsecurity/wm1081.cfm.

[20] N. King Jr. and G. Hitt, Dubai Ports World Sells U.S. Assets, The Wall Street Journal, December 11, 2006, http://online.wsj.com/article/SB116584567567746444.html.

[21] James Jackson, The Exon-Florio National Security Test for Foreign Investment, April 8, 2008, http://www.fas.org/sgp/crs/natsec/RL33388.pdf.

[22] Foreign Investment and National Security Act of 2007, Pub. L. 110-49, 121 Stat. 246 (July 26, 2007), http://www.uslaw.com/us_law_article.php?a=320.

[23] Id.

[24] Krishna Guha, Sovereign funds sign up to code of conduct, Financial Times, September 9, 2008, available at www.ft.com.

[25] Carfan and Markheim, supra note 19.

[26] Carfan and Markheim, supra note 19.

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