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The truth about Private Equity and Sovereign Wealth Funds
Fiction:
Through their investments in private equity firms, SWFs are seeking to sneak into U.S. capital markets through the back door.
Fact:
Actually, the situation is quite the opposite. American companies such as Citigroup and Merrill Lynch have openly welcomed and solicited direct investments from SWFs, and the front pages of newspapers document these transactions in minute detail.
SWFs invest in private equity funds in exactly the same way as state pension funds – as limited partners – not through any back door. They commit capital according to fund guidelines and receive their share of profits distributed by the fund to its limited partners. As private equity fund investors, SWFs are not afforded any more rights or any more control over portfolio companies than any other limited partners, including all of the major U.S. public pension funds.
Fiction:
SWFs can secretly control U.S. companies when they invest through private equity.
Fact:
SWF investments in PE are made to obtain the same superior returns PE funds have provided for 20 years to other investors, including public employee pension funds, teacher pension funds, fire and police pension funds, university endowments, and foundations.
More importantly, SWFs that invest directly in private equity partnerships are limited partners — minority owners with no voting rights and no role in management decisions, such as determining what companies to buy or how to operate them. In short, there is no legal opportunity for SWFs to exert control over the companies in which PE funds invest.
Critics point to the fact that some SWFs have taken equity stakes in PE firms as evidence in support of this fiction. But in these cases, they are minority investors with no ownership or managerial rights. In fact, several large state public pension funds have made similar equity investments, but no one suggests that they are secretly controlling American companies or hiding beyond a veil of secrecy, suggesting that this attack on SWFs is less about facts and more about exploiting fears.
Fiction:
SWFs investment occur under the radar with little regulatory control or oversight.
Fact:
Federal regulation of foreign investment in the U.S. is vigorous, especially in instances involving potential national security concerns.
The Committee on Foreign Investment in the United States (CFIUS), an inter-agency panel chaired by the Department of Treasury that includes the Department of Defense and Homeland Security, reviews foreign investments, including those by SWFs, that involve national security implications and in which foreign investors exercise control. As mentioned above, limited partners exercise no control over private equity funds in which they invest.
Separately, the U.S. and others have been pressing SWFs to adopt the International Monetary Fund (IMF) voluntary code providing guidelines for accountability and transparency to ensure that SWFs are investing from an economic and not political posture.
In addition, various government agencies have their own regulations that apply to specific transactions involving foreign investors. For example, both the Federal Communications Commission and the Departments of Defense and Transportation set limits and prohibitions on various types of foreign investment through PE funds on transactions over which they have jurisdiction.
So, not only does CFIUS look at investments by SWFs into the PE sponsors, but other regulators also police foreign ownership of particular portfolio companies indirectly through the funds.
Fiction:
The expansion of Sovereign Wealth Funds investments reflects the growing political ambitions of the nations that are creating the funds.
Fact:
Conspiracy theories are rarely grounded in reality. Here’s the reality: America is spending its money overseas – buying oil from the Middle East and apparel, electronics and other consumer goods from Asia.
As a result, these countries hold billions of dollars worth of U.S. currency and U.S. treasuries and their bank accounts are bulging. So they simply want to find a safe and profitable place to invest some of these funds.
Companies in the U.S. - whether banks, PE firms, or other businesses - sometimes offer attractive opportunities. There is no vast foreign conspiracy to use PE funds as a backdoor way to take over the American economy and undermine national security.
Fiction:
Current U.S. regulation of both the private equity industry and foreign investment make the United States vulnerable to foreign control.
Fact:
This is a scare tactic. Two analysts for the Congressional Research Service said that the notion that a country will “buy up” a key commodity or sector for its own purposes is “seen as unlikely because no SWF has sufficient capital”; it is “difficult to purchase sufficient companies”; and there is a “risk of retaliation.”
Critics also say that SWFs are to be feared because they can create market instability. To the contrary, unlike many U.S institutional investors, such as mutual funds, SWFs are long term investors with patient capital and are not subject to redemptions that would force them to unload investments, thus roiling markets.
Fiction:
Foreign investment in the U.S. economy is a new phenomenon.
Fact:
Foreign investment in the U.S. is as old as American capitalism. Our economy is open to and has thrived on investments from all over the world. Foreign investment supports U.S. jobs, R&D and U.S. manufacturing. U.S. companies and workers would be at a severe disadvantage to foreign competitors if we erected unnecessary barriers that hindered foreign investment in the U.S.
Fiction:
Sovereign wealth funds (SWFs) are different and more dangerous than other foreign investors in the U.S. because they could use their stakes to undermine our competitiveness.
Fact:
This is a fear not a fact. SWF investment has been a boon to the U.S. According to an October 2007 report from the McKinsey Global Institute, SWFs have provided vastly expanded liquidity in the markets.
“Higher liquidity has expanded access to financing for companies and other borrowers around the world and has lowered the cost [lower interest rates] of raising funds. The resulting additional investment and consumption has likely been a factor in the robust economic growth rates seen over the past five years.”
McKinsey estimates that the additional liquidity provided by SWFs has lowered U.S. long term interest rates by 1.3 percent. CFIUS has a strong track record for reviewing – and blocking, where appropriate - foreign investments that may impose on U.S. national security interests.