Keeping Reins on Foreign Investments

Few people outside the financial world knew anything about sovereign wealth funds (SWFs) until a few years ago. Today, they are one of the biggest headline grabbers, representing an enormous pool of capital: $2 trillion today and perhaps $15 trillion by 2015. Last year these funds grew at a remarkable rate of 18 percent.

The sources of these trillions of dollars are the gargantuan trade deficits the U.S. and other nations maintain with countries like Kuwait, China, Norway, Saudi Arabia, Singapore and others. As we consume much and save little, these countries, especially those capitalizing on record-high oil prices, must do something with the surplus dollars they have accrued.

The profitable assets of stable and industrialized countries are alluring investment opportunities.

From our perspective, SWFs are capable of supplying a much-needed influx of capital into our traumatized financial markets and propping up a struggling U.S. economy. A recent Washington gathering with the Chinese official in charge of Beijing's $200 billion SWF attracted representatives from every invited New York financial firm, not to mention a few uninvited guests, as well.

Economics teaches that the investor seeks to maximize profit, but some doubt whether that applies to foreign governments whose geopolitical interests can extend beyond their checkbook balances.

What if a SWF uses its investments in a crucial American industry -- telecommunications, banking or energy -- to gain leverage over American policy? What if a foreign government seeks to accumulate voting rights on corporate boards or insulate stagnant industries from innovations the free market demands?

It is important to remember that SWFs never have engaged in this sort of behavior. They have acted like traditional investors, seeking to maximize profits, not meddle in other countries' politics.

Nonetheless, there has been a growing backlash against these funds-- just recall the controversy over Dubai-owned DP World's proposed management takeover of several major U.S. ports in 2006 or China's bid for UNOCAL in 2005. Some of these countries' autocratic tendencies and disregard for human rights only augment fears of a breach of American economic sovereignty.

While there are legitimate concerns about ensuring the long-term viability of vital American industries, blanket exclusion of these funds is not the right way to address them.

The proper long-term response is to increase domestic saving, balance the federal budget and reduce the trade deficit. In the short term, reasonable, prudent measures can relieve our anxiety.

This month the Committee on Foreign Investment in the U.S. (CFIUS), which vets foreign direct investment for national security threats, will extend its right to investigate foreign investments in less than 10 percent of a company.

Other proposed measures include: greater transparency, denying SWFs a controlling interest in a corporation, excluding SWFs from having voting rights on corporate boards, further strengthening CFIUS' national security-review capabilities. Also, the World Bank has suggested that SWFs devote 1 percent of their assets to investment in Africa.

Establishing codes of conduct linked to tax exemptions for SWFs has also been discussed. But such conditions are vague and provide foreign countries with lots of latitude. Like private equity groups before them, SWFs recognize the potential backlash their secretive image could cause. In England, 25 private equity firms have signed on to a British code of conduct and there are reports that at least one SWF is prepared to follow suit.

The United States should pay close attention to what occurs across the Atlantic, because the pace of investment is picking up, and we can't afford to be left behind. The U.S. will simply have to work its way through this challenge in the years ahead.

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