Jeremy Warner's Outlook: Concern grows over sovereign funds

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The Independent Online

Nasdaq has given potential bidders for its 31 per cent stake in the London Stock Exchange until the end of the week to come forward with their final offers. At least two sovereign wealth funds – Singapore's Temasek and the Qatari Investment Authority – have registered an interest.

They may be joined by Borse Dubai, which would likewise be backed by government money. Their interest underscores the growing importance of these funds in global capital markets. Collectively, sovereign wealth funds are already one of the biggest buyers of corporate, property and debt securities in the world, and they threaten to dwarf all others once China properly joins the party.

To date, China's presence in the capital markets has largely been confined to purchases of US Treasuries, which in turn is essentially a foreign exchange operation designed to support the country's trade surplus with the US. That's likely to change over the years ahead. Encouraged by the success of sovereign wealth investors such as Tem-asek, China has already invested substantially in the US private equity house Blackstone. It has also established a separate fund to mirror other sovereign investors in overseas markets.

Other factors too are driving the Chinese into more commercial investment overseas. The yield on US Treasuries is tiny compared with what can be earned on higher-risk assets. What's more, the Chinese face massive portfolio losses on these holdings once their currency is allowed to appreciate against the US dollar. All round, it makes sense to diversify into alternatives.

Both in Europe and the US, there has been growing political concern about the power of the sovereign wealth funds. Nobody was that bothered as long as they confined their purchases to smaller companies in relatively unimportant industries. Yet increasingly they are in the market for rather bigger fish, including what many would consider to be strategically or nationally important companies.

In Britain, with our open-doors policy to foreign investment, we are particularly vulnerable to their ambitions. Yet Britain is also the least vocal in expressing alarm. Public policy with regard to takeovers in Britain focuses almost exclusively on whether they are likely to damage competition. That's rarely the case with sovereign wealth fund investment.

On the Continent and also to some extent in the US, which has rules and vetting procedures to govern foreign investment, a less laissez-faire approach is adopted. With growing concern over homeland and energy security, who's to say they are wrong? There are a number of issues for public policy to address here. One is lack of reciprocity. The Qataris and others seem perfectly welcome to come shopping here, but it is virtually impossible for any British interest, let alone a government-controlled fund, to buy anything over there.

Private equity has been much criticised over the past year for lack of transparency, but it has got nothing on some of these sovereign wealth funds, many of which are as transparent as deepest mud. State ownership of the means of production was something which Britain rightly eschewed many years ago as far as its own government is concerned. Should we really be allowing our best companies to be effectively renationalised, and renationalised to boot by a foreign power?

To be fair, some foreign wealth funds are more transparent and independent of their governments than others. The model is Temasek, one of the first and latterly a big investor in Standard Chartered and Barclays. There are published accounts, established rules and governance procedures, and, though the board is packed with government cronies and has a habit of pursuing investments with a particular strategic importance to Singapore, the fund is none the less at root commercially driven and relatively independent of political interference.

It has also been phenomenally successful, having grown its assets from Singapore from $350m 32 years ago to $164bn today. That's an annual rate of return of 18 per cent. Some of the newer sovereign wealth funds of the Middle East and the emerging markets fall a long way short of these standards.

Much higher public interest tests should be applied to these funds than we have seen to date. Britain's politicians have so far turned a blind eye, but what happens when Dubai, or maybe the Chinese, bid for Rolls-Royce, or Gazprom, a kind of sovereign wealth fund all of its own, takes a pop at Centrica? Temasek is one thing. The Singaporeans can hardly be regarded as a threat to anyone. China, Russia and the oil-rich nations of the Middle East may be quite another.

Has the Bank been asleep at the wheel?

Few are going to have any sympathy with the whingeing City bankers who insist the Bank of England should be doing more to help them through the present credit crunch. It is not entirely true to say the markets were the cause of the present turmoil. Central bankers with their policy of exceptionally easy money after the terrorist atrocities of 9/11 must bear a large part of the blame. But the immediate problem with liquidity is a market-driven phenomenon and it is therefore basically down to the markets to sort it out.

The Bank of England has so far been notable by its absence in the crisis that has enveloped credit markets, in marked contrast to the US Federal Reserve and the European Central Bank, both of which have flooded the markets with cheap money to tide the banking system over. Both of them have also repeatedly commented on events. The Bank of England has done neither. The lights are on, but there appears to be no one there.

This has prompted growing outrage among practitioners in the London market. Of course, the Bank should not be expected to rescue markets from the consequences of their own folly, but it does have a statutory duty to maintain financial stability, as well as limit the damage any instability might do to the wider economy.

The nub of the present problem is that the money markets have essentially closed. Uncertainty over where liability for the losses being sustained in high-risk lending might lie has caused a breakdown in trust between banks, which have become reluctant to lend to one another.

This has caused the commercial paper market, a key driver of the liquidity boom of recent years and a vital source of credit to many companies, to seize up. Both the ECB and the Fed appear to have been more helpful than the Bank in trying to get it working again. Yet they haven't yet succeeded. The Bank may therefore be justified in staying its hand. What is required is not a free ride of cheap money, but for banks to start trusting each other again. Alliance & Leicester tried to clarify its exposure yesterday with a relatively detailed statement. In the long run, this kind of transparency is likely to do a lot more good than flooding the system with cheap money, which is great for banking profits but possibly not much else.

A careful reading of the Bank's framework for open market operations shows that actually there is nothing to stop it following the lead set by the Fed and the ECB. The framework deliberately allows open market operations around base rate in circumstances where the money markets in effect become closed. The fact that the Bank has not yet chosen to do so is instructive. Rightly, the Bank has taken the view that the markets don't yet need it.

"Yet" may be the operative word here, for the banks can gain access to this liquidity by increasing their reserves with the Bank of England. As it happens, today is the first overt opportunity the banks have had since the crisis began to avail themselves of this facility. Their reserve requests were lodged last night, and we'll know the result this morning.

In the meantime, the Bank of England Governor, Mervyn King, can at least take comfort as he begins the Monetary Policy Committee's monthly meeting that if he was ever minded to raise rates again, he now won't have to. The three-month interbank rate is around 100 basis points higher than the Bank's base rate. The markets have done the work for him.

j.warner@independent.co.uk

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