Xinxin Li, of the G7 Group recently sent me a report on China’s newly created sovereign wealth fund. G7 Group is a New-York-based research and consulting group partially owned by Xinhua that gives especially good information of the activities of various major governments and their impacts on financial markets. He has allowed me to quote the following:
1) The Ministry of Finance has issued RMB 600bn STBs, the first batch of the approved RMB1.55 tn (equivalent to $200 bn), to finance the new CIC. It is expected to receive another RMB100 bn by the end of September and the balance before year-end.
2) A seven-person executive team has been formed, representing all the interested parties. The Chairman of the Board is the vice secretary general of the State Council (China's Cabinet) Lou Jiwei, who invited the current deputy head of the National Social Security Fund (China's national pension fund) Gao Xiqing to be the CEO of the CIC. The team also includes vice finance minister Zhang Hongli, the head of Central Huijin, Xie Ping, and a representative from the NDRC. The PBoC is supposed to send a deputy governor to join the team, but the appointment is still pending. A possible candidate is the current deputy governor Su Ning.
3) This structure reflects the inter-ministerial nature of the CIC: it is not only a SWF seeking high investment returns, but a coordinator among different government agencies on China's overseas investment.
4) The CIC will have three major departments in terms of investment functions. Central Huijin, the former investment arm of the PBoC, will be integrated into the CIC and continue to capitalize domestic financial firms. Another existing institution, China Jianyin Investment, will mainly operate in the area of managing domestic assets and disposing of non-performing loans. In addition, the CIC will establish a new department for overseas investment. The takeover of Central Huijin and Jianyin will make the CIC a big agency with about 1000 employees.
However, the CIC is quite different from what the global market was expecting, in terms of investment strategy and the pace at which it will operate overseas. At the initial stage, it will focus on domestic issues rather than picking where it left off, so to speak, seeking overseas ventures similar to its Blackstone investment. Why? - Seemingly, its investment strategy is very flexible with only two criteria: its foreign currency investments cannot be exchanged back into RMB; and it must be profitable. However, this ambiguity gives other government agencies excuses to tap into the CIC's foreign reserves, and lobbyists already are lined up at the door of Lou Jiwei's office. - Very likely, the CIC will cooperate with the State Assets Supervision and Administration Commission (SASAC) and invest in 16 state-owned enterprises to fund their overseas expansion plans. - The CIC has domestic policy responsibilities, e.g., pushing forward restructuring and capitalization of domestic financial firms. As expected, it will inject up to $60 bn to two state-owned banks: the Agricultural Bank of China and China Development Bank. Consequently, its available funds for foreign investment will be sharply reduced. - At the same time, the CIC has to compensate the PBoC for its previous capitalization of domestic financial firms though the Central Huijing. The PBoC is asking a "reasonable" price -- RMB500 bn ($67 bn). This means, the CIC will limit its overseas investment further to roughly $70 bn. - But the CIC is unlikely to use even this limited capital for overseas direct investment (ODI). The State Council made it very clear that, "given its initial stage and the sensitive timing of the international financial market", the CIC will mainly outsource its foreign reserve management to the State Administration of Foreign Exchange (SAFE) and specialized financial institutions, at least in the short-term. - Its portfolio will include non-dollar currencies, foreign stocks and high yield bonds, but strategic investment in commodities is not a priority yet.
All of a sudden, the CIC appears to be embracing a very conservative and gradualist investment strategy, in contrast to its audacious investment in Blackstone. The unstated reasons behind this shift are both external political pressure and domestic criticism on the Blackstone deal. - During German Chancellor Merkel's visit to China at the end of August, Chinese officials promised her that the CIC had no intention of buying a strategic stake in a big western company in the near future. Clearly, that was a response to the growing worries from European countries about potential takeovers by foreign SWFs. Many US officials also expressed the same concerns in their visits to China. - Furthermore, Blackstone's share price has dropped below $24, or 20% below the CIC's purchase price. This has aroused public criticism and political backlash. Some critics accuse the CIC of recklessness, poor execution and bad-timing. Others wonder why the investment was approved before the CIC had either a basic investment strategy or a risk management framework.
Having the head of the NSSF run CIC seems to be a good choice since the NSSF is very well regarded as a professionally managed fund. It's name is a bit of a misnomer since most social security in China comes from local funds which are much less well run, and the NSSF serves as a backup fund in case a local fund fails (and most of those are insolvent). Having NSSF run the show means that the Central Government is probably less interested in foreign investment than in dealing with the huge pension headache which is about to come up. NSSF is considered to be very professional and woefully undercapitalized.
What will be interesting is to see how this new agency interacts with SASAC. One logical thing to have happen is to have CIC act as the "shareholder" of the SOE's and have SASAC operator as the "regulator" of them. Then again, a lot will depend on somewhat murky politics. As with every other move, Chinese moves in this area is a fascinating experience in corporate governance and finance which is much more complex than some economic modelers like to think.
The other thing this might do is to cut the linkage between Central Huijin and the Finance Ministry.
One other thing to bear in mind is that some of the discussion about CIC has been skewed toward what Wall Street was interested in. If CIC makes direct investments overseas, then this means a lot of commissions and fees to Wall Street and so that was the aspect that much of the financial press was interested about. What seems to be the case is that the Chinese Central Government has some other pressing priorities.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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Comments (1) for "China's sovereign wealth fund"
- 9/19/2007 9:39 PM
December, 2007