Watching Sovereign Wealth

When the adjectives most often used to describe you are "secretive," "opaque" and "mysterious," you've got an image problem. Such is the predicament of sovereign wealth funds, the government-controlled investment vehicles, often in authoritarian states, that have become the bane of Western politicians. Yesterday, the European Commission became the latest body to propose transparency guidelines for these funds.

But the good news for sovereign wealth funds is that increased disclosure and transparency may actually be a win-win for everyone. A little openness can go a long way.

Market participants and regulators would benefit by gaining some insight into potential contagion risks and concentration issues that could arise when large, nontransparent investors trade assets, causing unexplained price or currency movements and increasing market volatility. The countries in which these funds invest would benefit from greater knowledge about the funds' motivations and investment guidelines. But perhaps most important, citizens of the countries whose funds are being invested would gain a tool to hold their leaders accountable for how these funds are invested. In fact, one of the most unexpected consequences of the rise of sovereign wealth funds may be their role as a catalyst for spreading grass-roots democracy around the world.

Here's how. When even the most secretive sovereign wealth fund makes an investment, it must comply with the disclosure obligations of the countries in which it is investing. So, when the newly formed China Investment Corporation bought into Blackstone last summer, it was compelled to disclose the terms of the deal and other material information as part of Blackstone's regulatory filings in the U.S. That turned out to have some very real consequences back home.

Soon after CIC invested in Blackstone, the holding lost nearly $1 billion in less than a month. Chinese citizens immediately let their political leaders know how they felt about their country's savings being squandered by flooding the Internet and other media outlets with angry criticism.

When it emerged that China Development Bank, having already lost another cool billion in its investment in Britain's Barclays Bank, was considering pouring $2 billion into Citigroup as part of the American lender's January rescue package, Chinese politicians quietly killed the deal. While no official explanation was given, China experts believe that the State Council's rejection of the CDB-Citi investment was driven by fear of taking another highly visible loss and the desire to avoid the resulting political backlash at home. It is not just the public grumbling that was noteworthy, but that Chinese political leaders heard it and apparently reacted.

And it is not just China. Following the flurry of sovereign investment in Western banks over the last several months, people world-wide expressed real concerns, alarmed about foreign government shareholdings in the fragile international banking system.

Multibillion-dollar investments by Singapore's funds in UBS, Merrill Lynch and Citigroup spurred real domestic debate about transparency, corporate governance and government accountability. As one blogger noted: "I am from Singapore, and I think this is scary too... the fact that we are bailing [out] some of the biggest screw-ups in history." Soon Singapore's parliament took note, calling in the finance minister and grilling him on the soundness of injecting these funds into so many distressed banks. Shortly thereafter, Singapore's fund, the Government of Singapore Investment Corporation, announced that it would be more transparent.

Sovereign wealth funds have served as a catalyst for more accountability to a domestic audience before. In the period before the first Gulf War, Kuwait's fund lost an estimated $5 billion, resulting in a highly publicized London-based corruption scandal. Kuwait's investments were made, lost and stolen in regulated European markets boasting strong legal systems and a free press. Members of Kuwait's ruling family were openly called to account in English courts.

Consequently, Kuwait's postwar parliament was able to assert itself. In 1992 it called for oversight of the Kuwait Investment Authority, arguing that it was the peoples' money and that those who managed it were accountable to the Kuwaiti people. To this day, the KIA remains far more open to public scrutiny than its Arab peers and is widely cited as instrumental in fostering political openness in what is arguably the most democratic country in the Gulf.

U.S. lawmakers, the European Union and the International Monetary Fund are now considering how to best advance calls for increased sovereign wealth fund disclosure. They should not forget that the issue need not be framed as a threat to withdraw the privilege of investing in our markets. Many countries with large sovereign wealth funds are tired of being lectured to. They know that, given global imbalances and the funding needs of a capitalist economic system, such threats are unlikely to be effective.

Rather, the push for increased transparency might be better framed as one where the main beneficiaries of disclosure, accountability and prudent investing of "funds for future generations" will likely be those future generations themselves.

Secretive, undemocratic regimes may not readily embrace fund disclosure for the sake of the people they rule over. But it can be assumed that Russia launched its National Wealth Fund earlier this month with high levels of transparency and disclosure in part to insulate fund managers from allegations of theft or other improper conduct should an investment go sour in the future.

As was the case with China, Singapore and Kuwait, investing globally in our markets has already piqued the interest of those who stand to benefit from those investment decisions. It is likely that increased disclosure of a sovereign wealth fund's attempt to invest for the "wrong" reasons would engender criticism not just from the West, but from those with the most to lose. This could begin to break down the distinctions between "the state" and "the people."

The idea that undemocratic governments might consider the voices of their own citizens regarding how their money will be invested may be one of the most underappreciated benefits of sovereign funds' disclosure. It may also be one of the most effective