The Hindu Business Line : Conciliation better than confrontation

Members of the G7, especially the US, have failed in their efforts to involve the IMF as an overlord of Sovereign Wealth Funds. Even a mandatory code cannot be enforced by the IMF. In such a context, dialogue with owners of SWFs might work better than diktats.

K. Subramanian

Sovereign Wealth Funds (SWFs) has driven Western governments into a tricky corner. As defenders of capital freedom, they cannot deny them the freedom to enter their markets and avoid the charge of ‘financial protectionism.’ However, they would achieve the objective by creating two classes of capital: one from the West, which is ‘pure’, and the other from the East (SWF), which is ‘tainted.’ The latter could get access only if it adopted “best practices.”

It has led to Orwellian double talk. Western countries, especially the US, treat hedge funds with kid gloves, admire their allocative efficiency and are unwilling to rein them. However, they expect total disclosure by SWFs and burden them with special obligations.

The G7 Ministers discussed SWFs for the first time in October 2007. They acknowledged that SWFs are “increasingly important participants in the international financial system and that our economies can benefit from openness to SWF investment flows.” Their communiqué stated that the IMF, World Bank and the OECD should explore best practices for SWFs in key areas.

Core mission of IMF

The US Treasury Secretary, Mr Hank Paulson, elaborated the idea in his remarks to the International Monetary and Finance Committee (IMFC) of the IMF in October 2007.

He said that a multilateral approach to SWFs that maintains open investment policies is in the best interests of countries that have these funds. He identified the IMF as “uniquely positioned to identify best practices for SWFs.”

He went on to preach how SWFs could be looked upon as “constructive, responsible participants in the international financial system” if they followed them. Indeed, he affirmed the responsibility of developed countries to maintain openness to investment by SWFs!

The US Treasury had set a tough a goal for the IMF on SWFs and, from that time, it became its core mission. On all accounts, the IMF staff went over gear on the issue.

They held a Roundtable with managers of SWFs in November 2007. Views were exchanged and there was no agreement.

Skating on thin ice

The New York Times (February 9, 2008) carried a report that IMF officials involved in drafting the code said that many SWFs were resisting the pressure to embrace even a voluntary code.

The managers of SWFs maintained that their decisions were strictly commercial and that “the West’s demand for regulations is hypocritical in light of failure to regulate European and American banks and hedge funds.” Mr Lou Jewei, Head of China’s CIC, explained in another forum that the IMF’s “effort has run into disagreement over the meaning of transparency and political motivation.”

Much against these hiccups, the IMF staff proceeded with the work. In an article in the IMF Survey Magazine (March, 4), they gave an idea of the work already done by them. They explained their intention to submit a preliminary paper to the Executive Board seeking its approval to proceed with the work in collaboration with SWFs and other stakeholders. They hope to submit the final draft during the Annual Meetings of the Fund/Bank in October 2008.

As can be seen from the IMF staff paper, they skate on thin ice and are engaged in mock battles like officers in Defence Staff Colleges. There has been no worthwhile negotiation with or participation by the owners of SWFs.

On March 21, the IMF issued a press release saying that the Executive Board “gave the green signal for further analysis on the role of sovereign wealth funds (SWFs) in the global economy” and that the Board had endorsed the work programme.

Unfortunately, the press release conveys partial truth and does not reflect the essence of Board discussions. The Board did approve further work but subject to several caveats.

Face-saving device

It is evident from the IMF’s detailed Press Information Notice (PIN No.08/41 dated April 1, 2008) running to four pages, that the going was exceedingly tough for the US and G7 in the Executive Board Meeting. There was no consensus and conflicting views were expressed by most members.

On the issue of transparency and political motivation of SWFs, the PIN reports, “It was recognised, however, that these concerns are not supported by evidence, and the other Director saw the available information as providing evidence that SWFs are driven by risk and return objectives.”

Some Directors took the view that “some aspects of SWF operations, including national security issues, are outside the purview of the Fund and are thus more appropriately addressed by others.”

“Some Directors cautioned that the Fund should not act as de facto regulator of SWFs.” Some questioned whether work on best practices was in the Fund’s core areas of expertise. They noted that the Fund’s focus should be on enhanced market surveillance which should adequately cover hedge fund and private equity fund activities.

In short, what emerges from the PIN is that members of G7, especially the US, failed in their efforts to rush through the item and involve the IMF as an overlord of SWFs. The approval to continue with the work was rather a face-saving device in keeping with the IMF convention and more to avoid embarrassment to the US. Sadly, the G7 and the US have lost their leverage in the IMF.

Long before the IMF was commanded to work on “best practices”, many questioned the utility of the exercise. Given the mood of the owners of SWFs, especially China, there was no hope of even a voluntary code. The irony is that even a mandatory code cannot be enforced by the IMF as no owner of any SWF is a borrower or would ever be.

Two worrisome developments

Two other developments should worry the US. The OECD and the World Bank have broken ranks with the US.

On March 24, Angel Gurria, Secretary-General of OECD, said after a meeting with Chinese leaders, “There should not be any regulation or code applied that unduly restricts the freedom of investment, because we would be doing ourselves a disservice.” “Our hosts agree.” Repeatedly it was publicised that the IMF was preparing a code in cooperation with the OECD. Has the OECD jumped ship?

On April 2, Robert Zoëllick, President of the World Bank, delivered a speech at the Centre for Global Development, Washington D.C. and offered what he called “1 per cent solution.”

He has appealed to SWFs to provide at least 1 per cent of their wealth as equity for African development.

It will amount to $30 billion. It took more than two years and innumerable trips to major capitals before Zoellick could get commitments from past donors for $30 billion for the IDA programme for five years! Referring to SWFs, he said, “Where some see sovereign funds as a source of concern, we see opportunity.”

In a press interview, he said there was little to fear from SWFs because they had already been engaging in sound practices and expanding those investments in Africa would build popular support for them in the US and Europe. Have the Washington Twins fallen out on SWFs?

Despite global shifts and perceptions, the US is not known to give up its objective easily. It will pursue it doggedly in different forums. The agreement with Singapore and Abu Dhabi announced in the press release of March 20 has to be viewed in this light.

What has been agreed is to define “principles” applicable to SWFs and to host countries. The disclosure requirements spelt out and expected of SWFs are total and expect them to bare all.

The obligations listed for host countries are nothing more than what they offer presently to any global investor. The agreement is unbalanced, inequitable and is unlikely to reach finality.

US gameplan

The game-plan of the US is clear. If there is any agreement on “principles” with any one country, Singapore or Abu Dhabi, it will become the template for others.

The US may direct them to adopt it and seek access to its markets. It will deny them to non-signatories and take the moral high ground that its policies are rule-based. It has adopted this strategy while entering into free trade agreements (FTA) with emerging economies.

The strategy is to tame the SWFs. It will fail as discussions in the IMF Board would signify. Zoellick, an unrepentant neo-con, has given them the message: conciliation with the SWFs is better than confrontation, both for the world and the US economy.

(The author has extensive experience in international, trade and finance matters.)

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