The Rebalance author Mercy Kuo regularly engages subject-matter experts, policy practitioners and strategic thinkers across the globe for their diverse insights into the U.S. rebalance to Asia. This conversation with Odette Lienau – Professor of Law at Cornell University, where she also co-directs the International Law/International Relations Colloquium, as well as the author of Rethinking Sovereign Debt: Politics, Reputation, and Legitimacy in Modern Finance – is the 77th in “The Rebalance Insight Series”.
What is the role of sovereign wealth funds (SWFs) in bolstering markets and economies?
SWFs have a range of institutional structures and purposes, so it tends to be an oversimplification to speak of them all at once. However, these government investment vehicles are generally funded by foreign currency but remain separate from official reserves, with the goal of generating high returns to maximize a country’s long-run wealth and interests. There is no uniform requirement of transparency for SWFs, so we do not always know where they invest. However, one potential benefit is that SWFs may enable countries that are dependent on a narrow source of income, such as natural resource exports, to diversify their revenue base. They can also be used when a country has amassed high reserves in a particular foreign currency and would like to diversify this holding. Such diversification may allow countries with SWFs to better weather the ups and downs of the global economy.
Of course, the relative independence and minimal public oversight of these funds also can raise concerns about the degree to which SWFs are truly being managed in the public interest, as opposed to in the interests of managers or their government or business allies. There may also be apprehension about international political or geostrategic implications when such significant pools of funds are controlled by a government, even indirectly. The 2008 Santiago Principles (for SWFs) offer a code of conduct to allay these fears, but they are purely voluntary.
Central Huijin Asset Management, a subsidiary of China’s main sovereign wealth fund – China Investment Corporation (CIC) – has been buying shares to strengthen China’s stock market since 2015. Please assess.
To the extent that Central Huijin’s actions are undertaken to promote the interests of the central government in a strong stock market, rather than in order to generate returns for its own portfolio, this will be viewed by many as problematic. It could be seen as part of a general trend toward loyalty to the central leadership in CIC and its subsidiaries. This might be a particular issue if Central Huijin seeks to invest in other countries – including the U.S. – especially given that investments in many sectors require the agreement of the target investment’s home country.
What is the impact of SWFs on a country’s market governance and growth?
It is hard to empirically assess this on a broad level because of the lack of transparency I mentioned earlier. However, there are several potential ramifications. To begin with, an actively investing SWF can increase the availability of funds in a market, making it easier to raise capital. In addition, SWFs have the capacity to be long-term investors, given that their managers are less likely to be beholden to volatile and short-run stock price metrics. This can help to smooth out investment and promote sustained, stable growth, as SWFs are arguably less likely to either invest or withdraw funds with a focus on short-term profits.
Finally, SWFs can – and, I would argue, should – take the lead on conscientious investing, acting in ways that are socially, politically, and environmentally responsible. This would be very much in line with a mandate to invest in the long-run public interest, and they could demonstrate to investors more generally that this kind of investing is consistent with generating returns. Such commitments could be aligned with the Equator Principles (on Project Finance) and the 2012 UNCTAD Principles on Responsible Sovereign Lending and Borrowing, for example, to the extent that SWFs are active in these areas. Of course, if SWFs invest overseas more than in their domestic market, such benefits might remain concentrated in foreign markets.
With infrastructure revitalization as a high priority for the Trump presidency, should the United States set up its own sovereign wealth fund?
There does appear to be bipartisan support for infrastructure investments in the broader population. It remains to be seen whether Mr. Trump’s campaign statements will go far beyond the inauguration, particularly with a Republican-controlled Congress generally hostile to public funding of such projects. Even if infrastructure investment does become a political reality, I would hesitate to recommend establishing a SWF at this point. I think there would be widespread and well-founded concern that a U.S. SWF in the current political context would display many of the pathologies of the form. As is well-documented, President Trump has been reluctant to divest himself of his business holdings or place them into a trust independent of his family members’ control or involvement. To the extent a Trump-led executive branch were to have significant control over any U.S. SWF or over appointing the managers of a SWF, it would have to be monitored carefully to ensure independence from undue political pressure and to encourage maximum transparency.
Identify two major sovereign debt challenges facing the incoming U.S. administration.
Broadly speaking, there are two main sovereign debt challenges for any country, though they are made more pressing by the U.S. position in the global financial system.
The first issue or challenge is how to use borrowed funds wisely. There is certainly a place for debt finance, particularly with the low borrowing rates right now and the U.S.’s excellent credit rating (thus far). The key is to invest these funds in ways that generate long-run benefits for the population writ large, whether that be through infrastructure, education, research support, or the like. This is the more general, perennial challenge of finding the right balance of borrowing, taxes, and short vs. long-term spending.
The second challenge involves the reform of the sovereign debt restructuring regime. Given the shadow cast by recent distressed debt/vulture fund tactics in U.S. courts and beyond, and the ongoing or emerging debt problems of a number of countries, improving the debt workout mechanism is essential. The reform of market or contractual approaches is an excellent step, though it is purely forward-looking and so does not deal with the very significant outstanding global debt stock.
A more coordinated international response, ideally with the statutory authority to act retroactively, would be preferable, but it is unclear whether the incoming administration has the interest or willpower to undertake such a project. Certain approaches – in particular, a multilateral treaty system or a reform keyed to changing the IMF Articles of Agreement – would require the involvement of the incoming administration. Other approaches, including a shift in the internal policies of the international financial institutions or a change in New York state law (which is the governing law for many sovereign debt contracts), would not necessarily involve the U.S. federal government. Perhaps those alternatives might be a place to begin.
