Background Briefing

As the effects of the subprime credit crunch continue to be felt around the world, the new global investors bailing out Wall Street banks are the sovereign wealth funds. These are the investment vehicles of cashed up Arab and Asian governments which are also buying into the mining boom in Australia. While their money is welcomed, are there political motivations behind the investments? Reporter: Stan Correy

Transcript

This transcript was typed from a recording of the program. The ABC cannot guarantee its complete accuracy because of the possibility of mishearing and occasional difficulty in identifying speakers.

Stan Correy: Hello, I'm Stan Correy, and this is Background Briefing.

Something big is happening.

[Crowd cheering...]

Commentator: Liverpool's aiming just as did two weeks ago, to be a team ...

Stan Correy: What's happening at the great Liverpool Football Club in the UK, is part of a multi-trillion dollar global revolution. Its effects are being felt far and wide, from big sporting clubs to mining companies the child care industry in Australia, and previously untouchable Wall Street investment banks.

This is the era of the sovereign wealth funds, the cashed-up investment funds owned by governments in Asia and the Middle East. They're full of oil money, and foreign exchange earned from booming export industries, and they've been causing consternation in Western financial markets.

One of the biggest, Dubai International Capital, wants a stake in the Liverpool Football Club, but there are many others with sights set on iconic corporations, and the circumstances are right.

US NewsReader: The headlines scream 'America for Sale', as Wall Street's biggest banks, battered by losses from the sub prime mortgage mess, go hat in hand to foreign governments, looking for cash. In the last few weeks, countries awash in US dollars, such as Kuwait, Saudi Arabia, Abu Dhabi, China, South Korea and Singapore have ponied up more than $46 billion to buy pieces of Citigroup, Merrill Lynch, Morgan Stanley, UBS and Bear Stearns.

Stan Correy: In the US, it was the financial rescue of struggling investment banks that kick-started the whole debate about sovereign wealth funds. Australia is also at the centre of sovereign wealth mania.

Reporter: The federal government has laid out strict new guidelines for investments in Australia by enterprises owned by foreign governments. The move comes amid official concerns over a flood of cash from government-owned organisations in Asia and the Arab world, looking to invest big budget surpluses. The treasurer, Wayne Swan, says in future the foreign state-owned funds will be subject to assessment against principles designed to protect Australia's national interests.

Stan Correy: What moved the markets and the government was the dramatic entry of Chinese state investors into the takeover battle for the mining giant, Rio Tinto.

Reporter: It's been just three days since Australia's Rio Tinto was swooped on by state-backed Chinese company, Chinalco, and already Chinalco's president has flown in to assure regulators.

Chinalco President [Chinese]

Translation: We are here today in order to explain to our friends in the media, in the government, that our intentions ...

Reporter: Some analysts believe the visit shows he means business in stopping BHP Billiton gaining control of Rio Tinto, and there are reports the Chinese government has told Chinalco there's a $130 billion war chest available to fight BHP.

Stan Correy: The market obsession over sovereign wealth funds has developed in less than six months, and the key word is 'transparency', which means 'we want your money, but we don't know your motives for investment.' For example, is the China Investment Corporation really in charge, or is the Communist Party giving the orders?

The Chinese see unique opportunities to invest, and to learn first-hand about Western-style capitalism.

Australian Chinese corporate lawyer, Thomas Chiu.

Thomas Chiu: I believe the Chinese government, as well as the business people, would take every single opportunity to improve themselves, and at the same time to learn quicker how the Western people operate their banking system and so on. So the best way to do that is to go outside China to work together with the Westerners. So investing in the foreign banking and finance sector, especially during the sub prime crisis, in other words, everything being cheap in the eyes of the Chinese, so for that reason, I believe it is an opportunity for the Chinese to invest and at the same time, to learn.

Stan Correy: In Western markets, everything is cheap, not only 'in the eyes of the Chinese'. The sovereign wealth funds of the Middle East, and even Russia, have the same view.

Following the subprime crisis in the US, 'basket-case' applies not only to Third World companies. Sovereign wealth funds have reversed the natural order in financial markets, according to Mark Thirlwell, the director of the International Economy Program at the Lowy Institute in Sydney.

Mark Thirlwell: They're basically vehicles for government investment, so it's state-owned government investment. And you're right, I think what's really brought them to prominence is this dramatic thing we've seen in the aftermath of the subprime crisis. What we used to think about international financial crises where they happened in developing countries, you know, somebody fell over and then the International Monetary fund came in, lent money to them, bailed them out. This time we're having what's being seen as reverse bail-out; it's the banks in the rich world, the developed world that have been falling over, or at least have been suffering, and the money has been flowing from developing country governments into those banks to recapitalise them. In effect, we're seeing developing country taxpayers bailing out rich country financial systems. It's very different from what we've seen in the past.

Stan Correy: After the wave of 1980s privatisation, the theory was that government was out of the economy. That's no longer the reality. In the past six months, massive state-owned investments companies from China, Dubai, Russia and elsewhere, have been buying up Western assets.

Immediately there've been calls for these mysterious, opaque investment funds to be regulated. This has a familiar ring to it. In the late 1990s, Third World countries screamed loud about another family of mysterious and opaque investment funds, the hedge funds. The difference is that hedge funds are private players, not government owned. Attempts to regulate them failed completely.

Mark Thirlwell.

Mark Thirlwell: Developing countries for example, used to worry a lot about hedge funds. They used to say, 'We don't like hedge funds, they're not transparent.' And famously, the prime minister of Malaysia was blaming hedge funds as part of the Asian financial crisis. But the rich world view of that tended to be much more benign, it was 'Oh no, no, these are just market instruments; we don't worry about the supply side, how you deal with all this stuff, is you get your own policies right at home.' Now, if you like, the boot's on the other foot, and the rich countries are saying, 'Actually maybe now that we're the recipient of investors out of there, we're not worrying about transparency and control issues, actually then we do want to regulate the supply side of the international financial market.'

Stan Correy: Mark Thirlwell says the double standards has been well and truly noted by the new sovereign wealth funds.

Mark Thirlwell: I certainly think from the point of view of those countries which are hosting the sovereign wealth funds, they'll think some of this commentary is a bit rich. I think they'll all say, 'Well wait a minute, it's OK if it's Western capital flowing in one direction, you're all relaxed about that, but now when the money is flowing in the other, you suddenly want to bet a bit more onerous on restrictions.' Now the line that's being delivered in the West is, 'Well look, the difference here is that it was private capital before, now this is state-owned capital. If it was your private investors doing this, but where it's governments, you think that government risk is different.' But again, you can quite happily see a developing country response saying, 'Well you tell us that, but we think there's a Wall Street/Treasury complex or whatever, and because there's not transparency, how do we know that there isn't?' So you can see that there's a sort of a comeback there.

Stan Correy: And the Chinese have responded with a bureaucratic counterpunch to Western criticism, by way of the People's Bank of China, that's China's central bank. Here's a reading of what the People's Bank of China said.

Reader: Countries like the United States and those in the EU also strengthened their scrutiny over investments made by sovereign wealth funds from emerging economies. This has led to escalating trade frictions, which will bring negative impacts on the healthy development of the world economy and the orderly correction of global imbalances.

Stan Correy: If you cut through the diplomatic language, what the People's Bank was saying is, 'Lay off, if you want our money, you have to play by our rules'.

Last week, the European Union sent one of their big guns to China, Trade Commissioner, Peter Mandelson.

Mandelson had already indicated that the EU wants a code of practice for the government funds. He met with the head of the CIC, the China Investment Corporation, Lou Jiwei. It was all very friendly, on the face of it. Lou Jiwei told the EU that the CIC was not interested in politics, only in making money.

Announcer: Welcome to the 38th Annual Meeting of the Members and Constituents of the World Economic Forum. Our scene is the power of collaborative innovation. We need more collaboration in the world, we need more creativity and more innovations in the world.

Stan Correy: I January, the World Economic Forum was held in Davos, Switzerland.

The session on sovereign wealth funds was packed out, whereas the presentation on hedge funds was poorly attended. Interest reflecting the amount of funds available.

The panel on sovereign wealth funds was chaired by Martin Wolf of The Financial Times.

Martin Wolf: We're going to start with the people with the money, because that's where it should start, I think. Then we're going to talk to the people who are the intermediaries for the money, and then finally we're going to talk to the people who are the policy makers; I think it will be pretty obvious to you what that order is. Just to remind you, this has become a very, very big topic, two and a half trillion dollars and counting, and it could clearly rise massively. It's become one of the fascinating features of our world that in the age of global capitalism, state-owned funds have become such significant players, and very recently they have become not only significant, but very helpful players. Instead of having to bail out banks ourselves, we have these kind people bailing out our banks for us, which I have to say I'm quite grateful for.

Stan Correy: One of the 'kind people' on the panel was Bader Al Sa'ad, the managing director of the Kuwaiti Investment Authority. It's the oldest sovereign wealth fund, having begun in 1953. One of the scare campaigns is how can people in the West trust Kuwaitis, Chinese, Russians, to make non-political investments? In capitalism, you're supposed to only think of the bottom line, not what the party committee or the royal family thinks is in their best interests. But Bader Al Sa'ad says 'Don't fear us, we're just like Western capitalists.'

Bader al Sa'ad: For 55 years, we never politically enforced decision for our investment. All our investment has been on commercialised basis. We look onto the bottom line, we don't look to anything else. Also we have been passive in all our investment. We haven't played an active role, we haven't been an activist in all our shares. So I think all these fears which have been created these days about the sovereign wealth funds have no basis and has no real case to build on.

Stan Correy: Bader al Sa'ad, the managing director of the Kuwaiti Investment Authority. At Davos, the case for regulating sovereign wealth funds was put by the former US Treasury secretary, Larry Summers. Summers' view is popular in Western capitals, that there needs to be a code of practice, and if the sovereign funds don't agree, they must have something to hide.

Larry Summers: I'm baffled by why the sovereign wealth funds don't get together and put an end to all this discussion by agreeing on some piece of paper that says 'We're under no circumstances going to speculate in currencies, we're always going to be a long term investor. We're never going to use our sovereign wealth fund to pursue any national, political objective', and list five principles to which you're going to abide, say you've never done otherwise, and you've now been prepared to state your intention not to do the things that raise concerns in the future.

Stan Correy: Larry Summers, speaking at the World Economic Forum in Davos.

There's an eerie similarity in current financial commentary about sovereign wealth funds to the early days of the subprime meltdown. The initial response was, 'Don't upset the markets because the money, or liquidity, will stop flowing around the world.'

The people pushing that line were generally the investment bankers, and they should know. It was the investment bankers who instigated the financial meltdown.

As the markets were crashing and the sovereign wealth funds were hovering, late last year the English comedians John Bird and John Fortune offered this insightful take on events.

Interviewer: So George Parr, you are an investment banker?

George Parr: I am, yes.

Interviewer: And as such, you have your fingers right on the pulse of the financial market.

George Parr: Yes, very much so, yes.

Interviewer: And during the summer, there's been a great deal of turbulence and...

George Parr: Volatility. Volatility in the marketplace.

Interviewer: Volatility, yes.

George Parr: Yes, tremendous.

Interviewer: Yes, and what has caused that?

George Parr: Well you have to remember two things about the market. One is that they are made up of very sharp and sophisticated people, and the second thing you have to remember is that the financial markets, to use the common phrase, are driven by sentiment.

Interviewer: What does that mean?

George Parr: What does that mean? Well, things let's say, are just going along as normal in the market, and then suddenly, out of the blue, one of these very sharp and sophisticated people says, "MY GOD, SOMETHING AWFUL IS GOING TO HAPPEN!! WE'VE LOST EVERYTHING. OH MY GOD, WHAT ARE WE GOING TO DO??"

Interviewer: 'Shall I jump out of the window??'

George Parr: 'SHALL I JUMP OUT OF THE WINDOW?? LET'S ALL JUMP OUT OF THE WINDOW!!"

Interviewer: 'SELL!!'

George Parr: WE'VE GOT TO SELL, SELL, SELL!!

Interviewer: Sell!!

George Parr: Yes, precisely. And then a few days later, this same sophisticated person says, 'You know, I think things are going rather well.' And everybody says, 'Actually, I agree with you. Do you know, I think we're rich. We're rich.'

Interviewer: Rich. Buy, buy, buy.

George Parr: Buy, buy, buy, yes. And that's what we call market sentiment.

Interviewer: But yes, surely we are exaggerating just a bit, aren't we?

George Parr: Well, I don't know, I mean in the middle of August this year when the market absolutely plunged in London, a well-known city firm, State Street Global Markets, issued a statement which said, and I quote: 'Market participants don't know whether to buy on the rumour and sell on the news; do the opposite; do both; or do neither, depending on which way the wind is blowing'.

Interviewer: Yes. This is the kind of rigorous analysis that companies will pay huge salaries for.

George Parr: Yes, exactly. And a few days later when the markets have gone up a little bit, the Senior Equities Advisor from ABN Amro Morgan said, and I quote: 'We're back to happy days again.'

Interviewer: Well, no price is too high for that kind of mature wisdom.

George Parr: Certainly not. And these sorts of people are paid millions of pounds in bonuses.

Interviewer: Yes, of course.

Stan Correy: English comedians, John Bird and John Fortune.

Whether in the satirical or real world, market sentiment can be based on either rigorous analysis or fear of the unknown. There are still lots of unknowns with sovereign funds and this seems to be driving current sentiment.

A recent survey in the US about the influence of sovereign funds confirmed this, as reported by CNBC.

Anchor: Dan, I found this really shocking, almost half of the people surveyed think sovereign wealth investments are bad for the economy, I mean it's not surprising they think it's bad for national security, bad for the economy?

Dan: Well it's really quite striking. I think you've had this general sentiment across our country for several years now, where there's a protectionist attitude. Just look at the trade votes going on in the United States Congress. Both Republicans and Democrats being much more wary about free trade deals. But with sovereign wealth funds there's an extra element to this case, and that is, do the American people think that these foreign government, whether it be in the Middle East or China, have the financial and economic interest of the American people foremost in their mind? And they are quite sceptical that they don't.

Stan Correy: The Bush Administration hasn't really developed a coherent strategy to respond to public fears about sovereign wealth funds. They know American financial institutions need the money. But it's an election year and while Administration officials want to calm the markets, Congressional committees are in a protectionist mood.

Chairman: First of all, welcome everyone here this morning to this hearing on the state of the economy in capital markets.

Senator Bayh : Thank you, Mr Chairman. Secretary Paulson, I want to follow up on something you said the President said. I think it is very important that our country remain a safe and secure place for capital investment, from abroad, including from sovereign wealth funds. To date, the experience has been a very positive one. The investments have been passive. But recent behaviour by the Russian government, China's relentless pursuit of economic advantages in any number of levers to attain that does give some pause.

Henry Paulson: So I think the real question we're getting at is are the investments coming in to our country driven by market forces or are they being driven by political forces, and that's where the focus is, and being vigilant there, that's why the focus on best practice is transparency, and so on. There has been in this country for some time, and in many countries in the world, a concern about foreign investment. I can remember back to the '70s, the '80s, I remember when Japanese companies were buying the Rockefeller Center or golf courses, or investing and there was this huge concern. So there is a concern in our country that I think has been for a long time somewhat unfounded, and there is a concern in many other countries that will try to hold back foreign investment.

Stan Correy: US Treasury Secretary, Henry Paulson, responding to concerns in Congress about sovereign funds.

The political pressure flows through to the corporate regulators. In the United States, the Securities and Exchange Commission, the SEC, has copped a lot of criticism for being flat-footed in its response to corporate disasters. Enron being the biggest example. With sovereign wealth funds they've got in early, flagging an interest before there's even any evidence of a problem.

The Director of Enforcement with the US Securities and Exchange is Linda Chatman Thomsen. I met Linda Chatman Thomsen when she was visiting Melbourne for an Australian conference on corporate regulation.

Linda Chatman Thomsen: Well I think the issue of sovereign wealth funds has captured a lot of people's attention, not just securities regulators, in part because they are growing funds. Some estimate the amount in sovereign wealth funds will be measured in many trillions of dollars in the next few years, so I think it's a growing investment vehicle that people are focused on.

Stan Correy: Linda Chatman Thomsen acknowledged the problem for corporate regulators is that they don't have any evidence yet of malpractice with sovereign wealth funds.

Linda Chatman Thomsen: And the issues from an enforcement perspective, which are largely sort of theoretical thinking about what could arise, are fundamentally two. One is sovereign wealth funds like other large institutional funds or traders, may engage in illegal trading, etc, those are issues that someone may want to look at, and we would certainly look at it if we had evidence, but that's the potentiality, if you will. One of the things we would worry about is sovereign wealth funds using their market power to gain information illegally, and using that information. So that's one issue that's out there.

Stan Correy: There's another problem for regulators: getting information from the governments who own the funds. And there's the matter of different jurisdictions. That is, the different rules and regulations in different countries.

Linda Chatman Thomsen: As the world and securities markets go more and more global, we need to worry about how we cooperate with other jurisdictions to gather information, and we're concerned that if we're going to a foreign jurisdiction to get information, and the issue we're investigating is a sovereign wealth fund that is essentially controlled by that jurisdiction, how much help are we going to be able to get, and there's a conflict there, potentially. And effective law enforcement in global markets requires all of us to cooperate, and so that's another issue that we're worried about.

Stan Correy: Is there evidence though, that the sovereign wealth funds have actually done much to I think hurt the integrity of the markets?

Linda Chatman Thomsen: I think what I identified and what I continue to identify were the potential risks, not specific, actual actions. If we had actual cases, we would be bringing those, but I don't believe there is a sovereign wealth funds case out there at this point.

Stan Correy: Linda Chatman Thomsen, director of enforcement with the SEC in Washington, DC.

The pressure to regulate or scrutinise investments by sovereign wealth funds is also building in Australia. Australian governments have had long experience dealing with Chinese government enterprises.

And with the election of Kevin Rudd, a Mandarin-speaking prime minister, the China relationship will be highlighted even more.

The Prime Minister spoke about this and the emergence of sovereign wealth funds at a recent press conference.

Kevin Rudd: I believe it's a good thing to sit down with our friends in the Chinese leadership and try and think through some strategic horizons. So for the next 10 to 20 years, On China's long-term resource and energy needs, and what this country has to offer. Principally the decision-makers in this process, of course, will be our large resource companies, I understand that. And China's corporate sector as well.

But there is a role for government in mapping out longer-term strategic approaches, so that we know where the Chinese government's coming from, and they'll know where the Australian government's coming from. I think that's very important in a context of ensuring that our national interests are appropriately advanced.

Stan Correy: The Australian government's new guidelines are among the first in the Western world specifically aimed at sovereign fund investments, but the Prime Minister says applying them would depend on which fund was investing.

Kevin Rudd: The problem we have, whether it's with China or other sovereign wealth funds for example, whether they come from Singapore or the United Arab Emirates, or other state-owned enterprises from around the world, is that it's not a case of one size fits all. Therefore, assessing each proposal requires the application of the criteria which the Treasurer has released and the definition of the national interest, against the particular factual circumstances of that firm. You can't make a broad generalisation.

Stan Correy: Kevin Rudd's comments got immediate international attention.

The new investment guidelines released by Treasurer Wayne Swan focus on national security, concentration of control, and making sure that an investor's operations are independent of the relevant foreign government.

There has been some criticism. And just as in the United States, it's the bankers who are cautioning government. The chief executive of the ANZ Bank, Michael Smith, spoke at a China business summit in Sydney.

Michael Smith: In this environment of tight liquidity and scarce financial capital, there is a welcome role for sovereign funds. They now hold much of the new wealth which is being generated in the world. Australia needs to think carefully in considering the policy on sovereign funds, and about what is, and what isn't, in the national interest.

Stan Correy: Michael Smith was speaking in mid-February as ANZ shares plummeted 6% as a result of the bank's exposure to the subprime crisis in the US.

Australian banks have welcomed investment from Chinese state funds. And the Chinese State Administration of Foreign Exchange (or SAFE) has been buying small holdings of shares in three Australian bank, including the ANZ.

This is a significant development, because SAFE represents a second Chinese state investment arm, in competition with the China Investment Corporation.

[Lion dance music...]

Stan Correy: Over the past ten days, there's been a lot of shuffling of top treasury officials around the world. US. and European union officials have met with executives from sovereign wealth funds.

The main concern is over the political motives behind their investments in battered Western stocks. In the US, this centres on the China Investment Corporation. The fear is that unknown party bureaucrats in Beijing could be the new rulers of Wall Street.

Australian Chinese lawyer, Thomas Chiu thinks that's unlikely.

Thomas Chiu: The Chinese never would have the ambition to control the whole world. Now one or two examples in front of us is we all know that eating good food is something that you and I enjoy, we like to eat in Chinatown and so on, but you never find Chinese food industry would be so prosperous and welcomed like McDonald's, like KFC. The Chinese never could do it, because I'm not saying the Chinese wouldn't have the talent to do it, but the Chinese would not have the ambition or the aggression to develop a world franchise like that. And you name those franchises in China, I would say 60% of them from overseas. Among the 60% a majority of them from America.

Stan Correy: It's an interesting kind of analogy, because in America in the moment, people are seeing the China Investment Corporation as a bit like a McDonald's, a financial McDonald's taking over their country. But you're saying that's not necessarily the Chinese way?

Thomas Chiu: I don't think that's the Chinese way, let's wait and see. And people try to compare China today with Japan 20 years ago, and they say they're similar, and eventually we haven't seen the Japanese taking over America. Remember when the Japanese bought the Rockefeller Centre, and a lot of business in the Gold Coast? I mean where are these Japanese investments? So the Chinese have been very cautious about overspending, and modesty is the philosophical belief among the Chinese business people, I mean most of them.

Stan Correy: Thomas Chiu.

The China Investment Corporation, the CIC, appears to have a modest investment strategy, at this stage.

One theory doing the rounds is that the Ian Chalmers: hasn't quite worked out its strategy. In fact, one of its big investments has already been a disaster, the purchase of a $3 billion stake in the American private equity firm, Blackstone.

Blackstone was listed on The New York Stock Exchange last year. Since then, CIC's investment has fallen 30% in value.

In Sydney's bustling Chinatown, that's probably not seen as good business. In his office in the middle of Chinatown, Colin Hawes studies Chines banking law and corporate governance for the UTS School of Law. Chinese banks have also failed, and Colin Hawes says that while the China Investment Corporation may have several functions, they're all aimed at domestic economic stability.

Colin Hawes: It has several functions, and some of them are related to China's domestic economy, such as saving the banks, and some of them are more related to helping China expand internationally, for example, helping to finance Chinese companies that are going overseas, that's a second function of this China Investment Corporation. And then a third function is to invest for example, in investment banks and other investment funds overseas, to make a return on that investment, which I assume will be used at some point for China's domestic needs. And so what we've been hearing about most recently is that those two other functions, one is helping to finance Chinese companies abroad, for example, indirectly you could say that the China Investment Corporation was involved in the Chinalco purchase of part of Rio Tinto, through financing that Chinese company. And the other thing that we've heard a lot about recently is the China Investment Corporation buying shares in troubled US investment banks, for example, Morgan Stanley I think had some shares purchased by the China Investment Corporation, several billion dollars of shares purchased by that corporation. So those are the other functions of that China Investment Corporation, so you can see it has several different functions and not necessarily functions that go together very well. But they all have an ultimate purpose of trying to help the Chinese domestic economy, either in the short term or the long term.

Stan Correy: Colin Hawes.

It was the Chinalco purchase of 12% of Rio Tinto, just over a month ago, that really kickstarted the debate here about the national interest and foreign government control of Australian resources.

Chinalco is a state-owned enterprise, ultimately controlled by the China Investment Corporation, a sovereign wealth fund.

Chairman: Thanks very much for making time to be here today. We have with us, Yaqing Xiao, President of Chinalco.

Stan Correy: At a press conference in Sydney, reporters tried to get a clear answer from Chinalco President, Xiao Yaqing about the relationship between the Chinese government and a Sate-owned company like Chinalco.

Karen Snowden: Karen Snowden from Radio Australia. Mr Xiao, hello. Would you explain if you would, for an Australian audience, the company's relationship with the Chinese government. And a second question, if I may: Why a personal visit to Australia? Who do you see is the most important audience of your meetings? Thank you.

[Language...]

Translation: First of all, Chinalco enjoys a very good relationship with the Chinese government. Well we are a state-owned company, but we put our shareholders and actually are very diversified. We have lists of subsidiaries in New York Stock Exchange, Hong Kong Stock Exchange, Shanghai Stock Exchange, and also we are engaged in multiple metals businesses, including aluminium, copper and titanium

While to precisely describe our relationship with the Chinese government, basically the government tells us and all the other Chinese companies that you make your commercial decisions, you enjoy autonomy in making those decisions based on market principles, but you have to wherever you invest , wherever you have your corporate activities, you have to abide by the rules and regulations of the local community.

To answer your second question, we're here today in order to explain to our friends in the media and in the government, that our intentions, and what we have done and why we have done it, and we have other investments in Australia, and we plan to do more.

Stan Correy: Chinalco President, Xiuao Yaqing, speaking in Sydney. Chinese executives may be a little bemused by all the attention on their relationship to the Chinese government. In fact, we've had Chinese state investors funded by Chinese state banks in Australia for quite a long time.

Colin Hawes again.

Colin Hawes: They might assume, because they have such a close relationship with their government organisations, they might assume that it's similar in Australia and that big companies here can just make a phone call to Canberra to somebody they know in the government and get things sorted out. And so they might be a bit surprised if, for example, a large investment is not approved by the government, even after the company itself was very enthusiastic about it, because usually in China it would work the other way around: the company would first make sure it would be OK with the government, before they made a real strong deal with the foreign investor.

There have been cases in China where some provincial companies have had the approval of their local governments, but then the central government has overturned it as not in the interest of China. So shows it's a slightly complex situation in China as well. But on the other hand, Australia being a relatively small population, and a relatively unified system of government, I think they would assume that the big companies like Rio Tinto would have already made some informal inquiries with the government before they allowed them to get involved in the company. So that might be a shock to them if they find that their investments are not approved.

Having said that, they've already experienced that problem in the United States at least a couple of times with attempted takeovers of American companies.

Stan Correy: The Chinese have what they call a 'socialist market economy'. This may be a contradiction in terms to the free marketeers in the West, but it's the reality. Colin Hawes explains the structure.

Colin Hawes: All the state-owned companies, as far as I'm aware, the top executives are also members of the Communist Party, and within the companies themselves, they all have Communist Party committees, and they are supposed to comply with Communist Party policy. So it would be as if in an Australian company, the chief executive had to be a member of the Labor Party and comply, and the company had to comply with all the Labor Party rules. It's that kind of connection, if you like, in China.

Having said that, the government's policies themselves, the Chinese government's policies, have changed dramatically in the last, probably 15 years, certainly since 2001 since the time of Jiang Sa Min, the previous leader. Basically they've been welcoming businesspeople into the party, including private entrepreneurs and companies that are privately managed also have set up Communist Party committees, and they're developing relations with the government, not because they are political as such, they don't want to necessarily be all socialist or communist, but because it's a good way for their business to develop.

Stan Correy: Colin Hawes is describing a very different concept of 'arm's length' to the one we understand in Australia.

Colin Hawes: It's almost like the government itself is a kind of Meta-corporation. It's like a government that wants to encourage business and to make its economy really successful, because that's the way the government can keep the trust of the people and stay in power obviously. So it's a different Communist party from what it was 15 to 20 years ago. They have different priorities. In the Communist party constitution itself, it says the top priority is economic development, which is not what it used to say back in the 1950s and '60s. So when people talk about, say, a Chinese government enterprise taking over foreign companies as if this is some kind of communist invasion, it's not like that any more.

Stan Correy: The CIC, the China Investment Corporation, is still a work in progress, and it's being followed closely. In 2007, the CIC had $200 billion to spend, most of which it spent in China. However, it is predicted that in a few years, the CIC will have access to at least $1 trillion to invest.

[Language...]

Stan Correy: Passing through Sydney ten days ago was Zheng Xinli. He's the deputy director of the Policy Research Department in the Central Committee of the Chinese Communist Party. He is just one of the many bureaucrats who have a say in the way Chinese money is invested overseas. His speech in Sydney didn't refer to sovereign wealth funds, it concentrated on the booming trade between China and Australia. But in December, he was interviewed by a Chinese news service, and he said the following:

Reading: The China Investment Corporation should look for big multinational companies, including banks and investment firms with stable operations and good development momentum and buy their stocks in the Stock Market.

Stan Correy: The trillion dollar question is, who's controlling this cash? Is it senior party officials, like Zheng Xinli? And does that matter, if Mr Xinli is only concerned with making a profit, like any Western CEO?

[Lion dance music...]

Stan Correy: There are alternative critiques of the sovereign fund phenomenon, that broaden and challenge our first impressions.

One critique says the more difficult issues for Western economies will not come from sovereign wealth funds, and that the current mania is a bit of a smokescreen for a more threatening problem.

And that is the expansion of what Wall Street calls, emerging market multinationals. They might be state-owned like Chinalco, or they could be privately owned with strong links to the government. Think of Russian Energy and mining multinationals, some of them have small investments in Australia.

Mark Thirlwell of the Lowy Institute in Sydney.

Mark Thirlwell: The interesting thing is the focus has been just on the sovereign wealth funds and in fact the focus probably needs to be a lot broader, and these are just one vehicle for investment that's coming out of developing countries. You'd assume that some of the same issues are held for example by state-owned companies. Again if we think of some these big countries, whether it's their resource companies, some of the manufacturing companies, they're not private companies as we'd understand them, they're still fully state-controlled. So the difference between for example sovereign wealth funds taking a stake in your economy and a big state-owned company taking a stake in your economy, for all the issues that we've been talking about for national security or strategic issues, it's seems to me that there's no big distinction there. So in effect, the debate probably needs to be a bit wider. Sovereign wealth funds are the sexy issue of the moment, but in fact the broader issue is probably Well how do you deal with big investment flows coming from economies which are basically still state controlled.

Stan Correy: What you're saying there is rather than just concentrate say on the China Investment Corporation which is the new Chinese sovereign wealth fund, it's not the only organisation; we've just seen Chinalco, which is the aluminium company. So is one of the problems though there, is that it's very difficult to know where the connections are between all those different organisations within the Chinese economy?

Mark Thirlwell: Well let's just come back to the critique that's been there particularly for example in the United States, which is the big thing that they're calling for is transparency, because it's not always clear who owns which part of the economy, it's not clear what the objectives of investment incentives are. So that comes back to one way of making people feel more comfortable about that is making it more transparent. So I think that is part of it. But I think the other part of it goes back to the thing we were discussing right at the beginning, it's the way that the world economy now works is different to the way we used to think it worked, and in particular, the rise of big emerging markets, which aren't run on the same basis as the way that our own economies are run, that are run by a quasi-state controlled system. People call it state capitalism, for example. How does a market capitalist society like ours interact with a state capitalist society when the rules of both sides are slightly different. You need to find some kind of common ground so that both sides are happy with the same rules, and one of the issues that clearly comes out for example is reciprocity. Should feel that yes, we're happy to take foreign investment into our economy, but only on the grounds that our companies, our investors, are free to have the same kind of investment with flows going in the other direction.

Stan Correy: Another alternative critique of sovereign funds is provided by Stephen Davidoff, Professor of Law at Wayne State University in Detroit. He's also known as the Deal Professor, after the name of his daily column on corporate takeovers in The New York Times.

Davidoff's theory is that it's not the poor investment bankers who should worry about Chinese or Arab bureaucrats running their businesses, it's the faceless bureaucrats who should be worrying about the Western bankers.

Stephen Davidoff: Crisis begets opportunity as the old Chinese saying goes. These sovereign wealth funds have the capital and would be making investments no matter what. The fact that they're making these high profile investments now is the opportunity, but these investments would be coming no matter what, into various types of industry. However I think there's a clue here. Why this widespread investment in financial firms? Why are financial firms going to sovereign wealth funds? Our capital markets globally are efficient enough that Morgan Stanley, Citibank, can obtain this capital from other people, from hedge funds perhaps, from pension funds, from other banks, from merely issuing stock out to the public. They've all deliberately chosen to go to sovereign wealth fund. There's a reason why here, and perhaps because sovereign wealth funds will not be very questioning investors, they're unlikely to launch a contest to overthrow their board, or otherwise interfere with their management, and they could present business opportunities. But again this is the type of soft problem it's hard to monitor.

Stan Correy: Stephen Davidoff is posing a big question here: who's fooling who?

Stephen Davidoff: Ah, who's fooling who? And these are the smartest players out there, they've been in the financial markets for a hundred years, that they're going to sovereign wealth funds signals something broader perhaps, either they're selling the capital most cheaply to the sovereign wealth funds? Perhaps. Or they think these will be the investors that they want in their company, and if that's the case, why do they want them as investors?

Stan Correy: Professor Steven Davidoff.

Is there any evidence that investment bankers are fooling the foreign state-owned investment funds? China experts have told Background Briefing that there's a lot of talk in China that the new CIC operation might be ripped off by savvy Western investment bankers, and talked into buying stakes in their troubled institutions at an inflated price. After all, that's already happened with CIC's investment in the private equity firm, Blackstone. And while foreign government controlled investment funds may be a scary thought, Steven Davidoff reminds us of that elephant in the room, the private hedge fund.

Stephen Davidoff: Don't take your eye off on the other ball, hedge funds are a big phenomenon, they provide important liquidity to the market, they're gradually becoming publicly available to shareholders. I know they are in Australia and they do pose systemic risk issues, that have yet to be grappled with. And we saw that with the collapse of long term capital management back in 1998 which threatened the stability of the global financial system. Sovereign wealth funds pose their own problems, but unfortunately, so do hedge funds, still.

Stan Correy: And one final thought on the very complex problem of sovereign wealth and hedge funds. Remember, hedge funds are private organisations who disclose very little information. If a sovereign wealth funds wants to escape all the regulations that are being proposed around the world, why not turn into a hedge fund? That's the idea of an English financial commentator, Felix Salmon. Here's a reading of what he said.

Reader: Let's say I open up a hedge fund in London, or Connecticut. It's a private fund, I need to disclose very little, and I sell a 95% stake to Abu Dhabi, which also puts in $50 billion or so for me to invest. At that point, I'm a sovereign wealth fund in all but name, but you just try to include me in any proposed legislation.

Stan Correy: Background Briefing's Coordinating Producer is Linda McGinniss. Research and website by Anna Whitfeld. The technical operator is Mark Don. Supervising producer this week is Chris Bullock. Executive producer is Kirsten Garrett. I'm Stan Correy and this is Background Briefing on ABC Radio National.

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Sovereign Wealth Fund Radar

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Stan Correy

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Stan Correy