Oxford SWF Project

By Ashby Monk

The Oxford SWF project is a source of open discussion and engagement on the topic of SWFs. As such, we welcome and indeed seek out all views and opinions on the subject. Today, we offer the ninth instalment of our segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Yu-Wei Hu of the OECD. While Dr. Hu’s views are his own, his perspective helps to further debate and facilitate understanding.

Ashby Monk: Thanks for joining us today, Yu-Wei. What is the OECD’s interest in SWFs? How does the project at the OECD differ from the project at the IMF?

Yu-Wei Hu: Thank you for your invitation to participate in this exciting debate.

The OECD is interested in issues relating to SWFs largely due to the potential impact of investment from SWFs on national economies within (key) OECD countries as well as that on the global economy, which has been highlighted by the recently intensified attention and debate on this subject – particularly against the background of the current global financial turmoil. In saying so, the OECD is an appropriate organisation to address these issues in that it has long been regarded as a foremost inter-governmental body in developing and setting international accepted rules on across-border investment and capital movements.

Upon the request from the G7 finance ministers in the autumn 2007, the OECD and the IMF started to work on the SWFs issues albeit from different but complementary perspectives. The OECD mainly focuses on the recipient countries, specifically on providing guidance for these countries towards investment from SWFs. Main topics in which the OECD is interested and has worked on include a) SWFs and recipient country investment policy; b) SWFs and public pension reserve funds; c) SWFs and state-owned enterprises.

In contrast, the IMF’s work concentrates on the SWFs themselves, i.e. developing a voluntary code of conduct for SWFs in the areas of legal framework, governance structure and investment strategies. This was reflected by the recent release of the General Accepted Principles and Practices (GAPP) of SWFs in Santiago in October 2008.

Ashby Monk: Based on your extensive research on the Chinese pension systems, I wonder if you have some insight as to why the CIC has attracted so much attention in the West vis-à-vis other Chinese investment funds.

Yu-Wei Hu: Yes, in addition to the CIC the Chinese government also owns and controls several other big investment vehicles, e.g. the National Social Security Fund (NSSF) and SAFE (State Administration of Foreign Exchange) Investment Company. However, it is the CIC which has received the most media coverage and political attention since its creation in 2007. I think there are three reasons for it.

First, it is a new and large SWF. It is new in that it was created just one year ago, therefore no record of history is available to evaluate its performance and particularly its real objectives and investment strategies. It is large, as reflected by its mere size of USD 200bn assets under management and its potential to expand to a much larger fund given China’s fast growing foreign reserves (which is currently approaching to USD 2 trillion).

Second, owing to the fact that the CIC is wholly owned by the Chinese government, the Western countries – particularly the United States are worried that the Chinese government may use the CIC to achieve their geopolitical strategy, thus threatening the national security and interests of the West.

Thirdly, if we look at this issue from a broader perspective, I think this concern in fact lies on the traditional West’s perception on China as a potential threat. In other words, the CIC is just one of the many Chinese things Western politicians are suspicious about.

Ashby Monk: In terms of investment policies, governance and financial decision-making, how is SAFE different from CIC different from the NSSF?

Yu-Wei Hu: As noted in a recent OECD paper (Blundell-Wignall, Hu and Yermo 2008) and by Prof. Clark earlier in this series, there are different types of government-controlled investment vehicles, which is also the case for China. The three major ones in China are SAFE, CIC and NSSF, which, however, demonstrate differences in several areas.

In terms of legal framework, the SAFE is a governmental department within the Chinese central bank and in charge of administering and managing foreign reserves. However, it is noted that in 1997 the SAFE Investment Company was established in Hong Kong, and its principal objective is to invest in (overseas) equities, largely due to dissatisfaction of the government on the conservative investment strategy, i.e. mainly on treasury bonds in the past.

The CIC was established in the same purpose as the SAFE Investment Company but different in the sense that it reports directly to the State Council, rather than the central bank. Meanwhile, it has an independent legal status as an incorporate entity, i.e. not a governmental department. Its board of directors consists of senior officials from various ministries, and the Ministry of Finance is playing a much bigger role than others. In terms of investment strategy it is relatively aggressive for two reasons. First, it has a real pressure to pay back huge amount of interests to the Ministry of Finance, which is approximately USD 9bn annum. Second, good profits earned by its wholly owned subsidiary, i.e. Central Huijin Company allow the CIC to focus on fundamental and long-term investment.

As China’s strategic pension reserve fund the NSSF was created in 2000. Although supervised by both finance and labour ministries the National Council of Social Security Fund (NCSSF) – administrator of the NSSF reports directly to the State Council. Therefore the NCSSF is equivalent to the ministerial level. NSSF’s investment strategies were initially rather conservative; however, in recent years it has started to invest in risky assets, including equities, foreign assets and now it is also considering investment in private equities.

Ashby Monk: The CIC reports directly to the State Council. This seems to be an idiosyncratic hierarchy within Chinese political establishment. Why do you think this is?

Yu-Wei Hu: It is idiosyncratic in the sense that it should be currently the only firm in China which directly reports to the State Council. Although in China there are many other large state-owned financial institutions or enterprises, where heads of these firms are frequently considered as equivalent to the ministerial level (indeed most of them were senior government officials), they are normally subject to supervision of relevant governmental agencies which in turn report to the State Council, e.g. the China Banking Regulatory Commission (CBRC) on regulation and supervision of the Chinese banking industry, including the largest state-owned banks.

On the other hand, this arrangement, however, might be sensible due to the crucial importance of a well-functioning CIC for the performance of China’s huge stock of foreign reserves (particularly if more reserves are transferred to the CIC in the future) and potential relationship with the outside world.

Ashby Monk: Some have suggested that CIC’s human resources policies have left it without the industry’s top talent. What’s your view?

Yu-Wei Hu: According to the current governance structure of the CIC, all members of the top management – including the chief investment and chief operation officers, were senior government officials, and mainly form the Ministry of Finance and the central bank. However, it was noticed that rather than relying on junior government officials the CIC is recruiting from the wider job market for its various key positions, e.g. investment, analysis and research. It is at least a good start at the right direction for this new institution which I believe will try to attract the talented candidates – if not for the top management team, though.

Ashby Monk: How has the recent financial turmoil affected the CIC?

Yu-Wei Hu: The CIC so far has two well-known investments in the US market, one in Blackstone Group and the other one in Morgan Stanley. However, due to the current global financial crisis both investments have suffered significant losses. This has prompted criticism in China regarding CIC’s investment strategies and risk management mechanism, which therefore is likely to lead to a hold-off of further large investment abroad in the near term. Meanwhile, the sensitivity of buying the US or other Western financial institutions by SWFs at this moment could also arouse further protectionist reactions. Thus, the CIC alongside other SWFs might be more sensible to take a wait-and-see position on its overseas investments in the near term, although it was noticed that the CIC is considering slightly increasing its shareholding in Blackstone.

As far as I’m concerned loss per se is not a problem particularly given that the CIC is a long-term institutional investor, and it should be more concerned about the fundamental values of a firm and less about the temporary market volatility. However, what most matters is whether the internal decision making process is prudentially and professionally sufficient, i.e. not influenced by factors other than financial considerations. Unfortunately in terms of governance structure, transparency etc the CIC underperforms when compared to some other SWFs. It is hoped, however, that the active participation of the CIC in the IWG of SWFs and the recent release of the Santiago Principles will help it in becoming a “world-class investment institution” as being committed by the CIC.

Ashby Monk: Thanks, Yu Wei, for taking time out of your busy schedule to chat with us today. We really appreciate getting the Chinese perspective on these issues.