Vol 5 (2008) - Issue 5

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Sovereign Wealth Funds to the (International Corporate) Rescue?

For many insolvency practitioners, it probably seems like only yesterday that they were remarking to colleagues about the excess liquidity in global markets. Indeed, for a time it seemed as if bankruptcies were a thing of the past as even companies with the heaviest of balance sheets were able to get refinancing when crisis hit. In a few short months, however, the seemingly endless pool of capital flowing from hedge funds and private equity firms seems to have all but dried up.

One source of financing, however, remains as robust as ever: sovereign wealth funds (SWFs). SWFs made headlines recently when, on 15 January 2008, the governments of Singapore, Kuwait and South Korea provided most of the USD 21 billion lifeline extended to Citigroup and Merrill Lynch, two Wall Street heavy hitters that had just lost vast sums in the ongoing ‘subprime’ crises. This was hardly the first foray of foreign government-managed funds into the US marketplace. Indeed, since August of 2007, when the sub-prime mess first began unfolding, such funds have wagered almost USD 69 billion on the recapitalisation of the world’s largest investment banks.Perhaps the best known SWF intervention came in 1991 when Saudi Arabia’s Prince Alwaleed bin Talal acquired a 15% stake in Citibank at the absolute bottom of the market. Citibank’s poor real-estate investments put it on the brink of insolvency and the Prince’s cash injection came at a much-needed time and, in the 17 years since, has proved to be a savvy investment.

In general terms, SWFs are assets held by governments in another country’s currency. All countries have foreign exchange reserves (typically in dollars, euros or yen). When a country, by running a current account surplus, accumulates more reserves that it feels it needs for immediate purposes, it can create a sovereign fund to manage those 'extra' resources.Sovereign funds have existed since at least the 1950s, but their total size worldwide has increased dramatically since 1990. It is estimated by the IMF that the funds, in aggregate, have grown from USD 500 billion in 1990 to USD 3 trillion today, and are projected to grow to USD 10 trillion by 2012, driven largely by the high price of oil and the current account deficits being run by many Western countries with emerging market manufacturers like China. Beyond investing in financial houses, these funds have spread into the telecom, technology, aerospace and even gambling sectors. At first glance, they would seem to be a godsend: a quiet, long-term investor that does not place nearly the same level of pressure that hedge and private equity funds might on management to turn the company around. Yet, from a bankruptcy perspective, these funds raise a number of potential concerns.

First, the lack of direct intervention into management while possibly a boon to existing managers, may, in the long run, be counter-productive. By acting as last-minute 'white knights', these funds may be forestalling the natural economic process of 'creative destruction' of inefficient companies. Private equity and hedge funds (usually) save companies from destruction too, but they exact a heavy price for this rescue: the ruthless pursuit of efficiency and profitability. SWFs, thus far, have shown no appetite to this kind of direct involvement.

The bigger potential problem stems from what economists like to call 'incentives', that is, the motivations that drive the behaviour of market players. For typical investors, and certainly for hedge and private equity funds, the incentives are clear: maximising return while minimising risk. While the current credit crisis shows us that these players are not always successful in balancing the risk/reward equation, there is no doubt about their aims to do so.