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The last few weeks have seen the emergence of impressive cross-border deals initiated by Sovereign Wealth Funds targeting distressed banks in the US as well as in other developed countries, such as Switzerland.

One of the deals that has provoked a lot of debate is the acquisition of $5-billion stake in Morgan Stanley, which has faced large write-downs due to the sub-prime problem. The investment has been made by the China Investment Corporation (CIC), the i nvestment vehicle of the Sovereign Wealth Fund set up by Beijing only last September.

It is noteworthy that a blue-blooded investment bank, such as Morgan Stanley, should have turned to China for recapitalisation. Market observers are familiar with the high degree of credibility that Morgan Stanley carries.

The Morgan Stanley Composite Index (MSCI) is an indicator of where a country’s stocks figure in the global investment market. It is a mark of the depths to which the US’ financial companies have fallen and China has risen that China’s investment fund is rescuing a paragon of market values.

The Morgan Stanley deal represents the coming of age, within a very short time of its being set up, of China’s investment vehicle. There has, of course, been criticism by rivals that this would lead to Morgan Stanley gaining an advantage in its own investment banking field.

The CIC has acquired legitimate strength by the deal, which entitles it to argue that Morgan Stanley, an investment giant, is its ally.

As a result of the deal, Morgan Stanley will also be in a position to offer renminbi-denominated products to various mainland-based corporates. This is a tremendous advantage to the investment bank.

With the CIC’s acquisition of Morgan Stanley’s shares, there have been other significant developments, which go to show that the CIC is going to play an important role in the Chinese securities business.

China knows how to take risks on a calculated basis in the global deals market. The CIC has been given the mandate to earn higher returns on $200 billion sequestered from the distressed enormous foreign exchange reserves. The tough choices before the managers of the Fund are illustrated by its recent decision, which has got both bouquets and brick-bats. Global financial newspapers state that large dealings involving billions of dollars are still ahead, in view of the fact that the Fund has still to organise its staff. The Fund, however, has to seize the unique opportunities arising in the context of credit crisis in the developed world.

The Financial Times (December 21, 2007) reports that only in late November, Lou Jiwei, Chairman of China’s new Sovereign Wealth Fund, had said publicly that it would take at least a year before the Fund was fully operational.

Incidentally, the Chairman of CIC is a US-trained lawyer who has taken upon himself the job of setting up the Corporation and running it.

The fact is the Chinese have taken seriously the mandate to obtain higher returns to the country’s high foreign exchange reserves through investments.

Observers point out that in spite of the temptation of many prospective investments abroad, the CIC has also been using its funds to recapitalise the massive state-owned agricultural banks of China and take over certain investments, which shows the company is controlling the stakes in many of the country’s largest banks. Does this hold a lesson for India’s policy-makers also to use their forex reserves locally as well?

The CIC has been given a huge degree of autonomy, but at the same time its final decisions are approved by political leadership. It has not been smooth sailing for the CIC in operating its new investment vehicle. It is under pressure to invest much of its funds as quickly as possible. It is, at the same time, expected not to overpay for any investment vehicle. The markets are volatile and returns are not assured.

There have been critiques of some of its investments inside Beijing. One of the largest deals by China even before the CIC was established was the investment in Blackstone.

Unfortunately for China, Blackstone’s shares have fallen about a third of the IPO prices. Thus, the CIC has lost more than $600 million as a result of this transaction. Further, Blackstone’s deals are so organised that China’s stake cannot be sold for four years.

In this context, it is fair to note that so far as Morgan Stanley is concerned, the CIC has avoided this difficulty. It has got equity units that will pay a 9 per cent return until August 2010. Then its stock will convert into common shares. The experience of the problems of Blackstone may have perhaps guided the CIC into taking a more cautious stand in acquiring the stake in Morgan Stanley.

The age of Sovereign Wealth Funds has truly arrived. There had been expectations that the political authorities in the US may not welcome aggressive action by these funds. But, given the institution’s heavy losses, there was no escape from such investments.

The CIC and its aggressive transactions make us wonder whether and when India will try a similar move. For this, the CIC’s Indian counterpart should get a similar degree of freedom. Opportunities of the type that the CIC negotiates will also bring risks. It cannot be a risk-less investment if the Sovereign Wealth Fund expects to get a good return.

I believe policymakers in Delhi and Mumbai are already putting the finishing touches to the India version of the CIC. I hope they do not put too many hurdles in the path of the investment vehicle they are trying to evolve. Ultimately, the investor will be guided by the returns he gets and no amount of hefty accounting restrictions can make for the success of an institution, such as Temasek or the CIC.

A reflection on the personalities involved in the acquisition of Morgan Stanley is in order. The political personality chairing the CIC is a communist but trained in the US, particularly in laws relating to securities. Can we imagine a member of a Left party presiding over a similar investment vehicle and taking bold decisions to acquire stake in an American company?

The manner in which the Chinese are utilising American-trained financial expertise to turn the tables on the US’ distressed giants is an object lesson to India’s political bureaucracy.

The success of deals such as the CIC’s with Morgan Stanley will have to be determined over time. This very much depends on the way the markets turn out. The CIC’s problems and the returns are both giant-sized, in keeping with the magnitude of the funds at its disposal and its responsibilities.

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