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SEC Chairman Cox Highlights Rise of Sovereign Funds

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U.S. Securities and Exchange Commission Chairman Christopher Cox focused on the risks and opportunities encompassed in sovereign or government-owned commercial investment funds such as those of Abu Dhabi, Norway, Saudi Arabia, and Kuwait in his speech at the American Enterprise Institute's Legal Center on December 5, 2007. He revealed that today, the world's sovereign wealth funds are significantly larger than all of the world's hedge funds combined. And, given the current trajectory, they could grow as large as $12 trillion over the next eight years. The Abu Dhabi Investment Authority, Norway's Government Pension Fund, and Saudi Arabia's wealth fund each currently have more than a quarter of a Trillion dollars in assets to invest. Kuwait, Singapore, Russia, and Hong Kong also each have sovereign wealth funds totaling more than $100 billion in assets. Domestic government funds include the Alaska Permanent Fund (a $40 billion fund) that has diversified its oil income into stocks, bonds, and real estate. The permanent funds of Texas, originally oil based, are today mostly financial portfolios. Thus, he stressed, the issue is not so much foreign ownership as it is government ownership of the investment funds.

Interestingly, he opined that the impact of these giant investment vehicles will likely be more pronounced in economies outside the U.S. because of the massive size of the U.S. economy and U.S. securities trading compared to other nations. The U.S. economy is bigger than the next four largest economies of the world put together. That includes Japan, China, Germany, and the UK -- combined. Further, as examples, the entire economy of Russia is roughly the same size as the gross state product of Texas, and California's economy is over twice the size of India's.

Using the traditional viewpoint that government's role should be limited and generally to enable growth of private enterprise, Cox discussed decades of efforts to ensure rule of law, property ownership, regulating markets, and protecting economic freedom. Meanwhile, however, global consolidation of capital markets has been taking place with borderless trading gradually becoming the norm, and associated diversified risks and lowered transaction costs, raising the specter of world-wide growth even beyond continental growth patterns. Amidst all this euphoria, has become the reality that the regulator in some countries is also a major investor!

As an example, he cited PetroChina, which recently surpassed ExxonMobil as the world's largest company by market value, which has offered just 12% of its shares to the public, with 88% of its ownership remaining with the Chinese government. This phenomenon can be observed in many of the world's countries, and could be a growing trend. Of the 20 largest publicly traded companies in the world, eight are state-owned sovereign businesses.

However, the Federal, State and Local governments' role in the U.S., even today, is only about 30% of the economy, and Federal revenues totaled less than 5% of GDP in the early 1930s.

Chairman Cox claimed that neither international law nor the Foreign Sovereign Immunities Act renders these funds immune from the jurisdiction of U.S. courts in connection with their commercial activity conducted in the United States. Today, when a foreign private issuer is suspected of violating U.S. securities laws, SEC works with overseas regulatory counterparts, but in this case, the foreign investor is also the regulator, making it awkward for the foreign entity to sue itself, or help the SEC to crack down -- a major conflict of interest, to say the least. An extension of those conflicts of interest is that the opportunity for political corruption increases. Individuals with government power in those entities also possess enormous commercial power and exercise control over large amounts of investable assets, thus magnifying the risk of their transformation for personal gain.

When government is the majority or sole shareholder would it seek to maximize value of shares, or rather geo-political benefits? Transparency may also be a casualty in those countries and institutions where there is a "culture of silence" and the ability of journalists and citizens to inquire into government affairs, or to criticize the conduct of government is severely limited.

Investor confidence hinges on perceived information parity. If an estimated 100 million retail customers in America who own more than $10 trillion in equities and stock funds in U.S. markets come to believe that they are at an information disadvantage when they compete head to head in markets with government, confidence in the capital markets could collapse, and along with it, the market itself, Cox added. However, he warned that debates in parliaments around the world about sovereign wealth funds and sovereign business are provoking a new round of protectionism.

Given that most sovereign funds are represented on the Boards of multilateral agencies, such as the IMF and the World Bank, it is hard to imagine that their deliberations will provide any greater clarity than we have at present. Hence, it is an area ripe for analysis and recommendations from think tanks and policy researchers. Chairman Cox called for more generalized agreement about the kinds of strong fiduciary controls, disclosure requirements, professional and independent management, and checks and balances to prevent corruption that will help protect both investors and markets.