Gulf sovereign wealth funds exercise financial muscle

Surging oil prices have given Middle East producers renewed financial muscle. More worryingly for some Western leaders, they are showing a confidence, bordering on brazenness, to exercise that strength by buying up stakes in key industries throughout the world at a time when the financial power of Western banks has been neutered by subprime and the credit crisis.

The most recent and visible of the conduits for those investment outflows, the sovereign wealth funds (SWF) are accused of being opaque with their financial reporting and investment strategy, and of pursuing political as well as commercial ends. The government of Abu Dhabi even felt compelled to write reassuring letters to finance ministers around the world, explaining that it is investing merely for financial gain, not power and influence. There is, apparently, no empire building by stealth going on.

The six nations of the Gulf Cooperation Council (GCC), namely Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, earned $381 billion from their oil and gas exports in 2007 and a further $26 billion from gas, according to the Institute of International Finance (IIF). If the oil price stays at about $100 a barrel, they will reap a cumulative windfall of almost $9 trillion by 2020, says the McKinsey Global Institute, compared with a combined GDP of just $800 billion last year.

The GCC added $215 billion to its stock of foreign assets in 2007, divided between the regionÆs central banks, its SWFs, and its hereditary ruling class. Their total foreign assets now amount to around $2 trillion. They have been using this cash aggressively, have been acting quickly and have become a dominant force in global stock markets.

Take a recent example. In June, the Qatar Investment Authority (QIA), a ú30 billion SWF set up three years ago to invest profits made from the worldÆs largest gas field, bought a near-8% stake in Barclays Bank, BritainÆs third-largest. The investment was made by spending ú1.7 billion ($3.9 billion) on a maximum 7.7% holding as part of BarclaysÆs ú4.5 billion capital raising. At the same time, Challenger, an offshore vehicle set up by QatarÆs Prime Minister to invest family wealth, intends to spend ú533 million on a 2.3% share of the bank.

The QIA also bought 7 million shares in J Sainsbury at an undisclosed price in a move that took the Qatari shareholding in the UK supermarket chain from 25% to just under 25.3%. This followed a failed takeover bid last November, which left the QIA with estimated losses of more than ú1 billion on its original investment in Sainsbury. At the same time the London Stock Exchange led the FTSE 100 risers on speculation that the QIA had increased its 15.1% stake in the stock exchange operator.

There had been rumours earlier in the year that the QIA was planning to buy a stake in Royal Bank of Scotland (RBS). And the QIA had also attracted notice with its acquisition of 1% to 2% of Credit Suisse, as part of a drive to build up a $15 billion portfolio of Western bank assets.

Shortly after the Credit Suisse deal, the European Commission (EC) approved proposals for SWFs to be requested to adopt a voluntary code of conduct requiring certain standards of corporate governance and disclosure, and expressed a fear that these funds were being used as an implement of geopolitical strategy.

Yet, European and US banks have been busy courting Middle East SWFs to bail them out. For instance, the Kuwait Investment Authority (KIA) contributed $5 billion to a capital-raising package for Citigroup and Merrill Lynch in January, and the Abu Dhabi Investment Authority (ADIA), which is the worldÆs biggest SWF with assets of about $800 billion, pumped $7.5 billion into Citigroup last November. In difficult times, politicians have encouraged these moves.

Of course, for the SWFs, the purchases have been a great opportunity to build holdings in a banking industry viewed as having strong long-term growth potential, at a time when shares are relatively cheap and political concerns quite muted.

New kids on the block
In February the QIA said that it had $15 billion to spend on overseas financial institutions over the next two years. The ú30 billion fund itself is expected to double in size by 2010. But, the QIA is only one of several with huge financial clout.

Some of these funds have been around for a while. Kuwait first set up a fund to invest surplus oil revenues in 1953, while ADIA was established two decades later, but both have normally been conservative, hands-off investors. The difference has been the arrival of the new kids on the block, with a more aggressive, ambitious agenda fuelled by massive spending powers. In addition to QIA, a range of Dubai government-linked vehicles such as Istithmar and Dubai International Capital (DIC), as well as Abu DhabiÆs Mubadala Development Company are keen to buy strategic stakes in companies or even full control.

In May, Saudi Arabia announced that it too would set up an SWF, reflecting healthier finances due to the rise in oil prices over the past five years and perhaps less anxiety about encountering international criticism. The government is also keen to modernise and expand its financial services sector.

It will start relatively small. Mansour al-Maiman, the secretary-general of the Public Investment Fund (PIF), an arm of the Saudi finance ministry, told the Financial Times that the new fund is expected to have authorised capital of SR20 billion ($5.3 billion) at its launch, and will aim to build up a diversified portfolio of investments in order to maximise long-term rates of return. He said that although the PIF will own the investment vehicle, the SWF will have its own independent management team. Interestingly, he suggested that it will behave in a similar way to NorwayÆs $350 billion General Pension Fund, recognised as the most transparent SWF, which would signal a significant shift away from the regionÆs usually opaque dealings.

Observers reckon, however, that the Saudi fund is more likely to function like the Government of Singapore Investment Corporation (GIC), which provides little detail about its operations beyond indicating the total value of its portfolio and the countries where it operates.

While nervous Western governments express at best ambivalence, at worst hostility to this shift in financial power relations, Gulf SWFs have also been looking east, especially toward the booming economies of Asia. Late last year, the QIA announced that it planned to raise its Asian allocation to 40% of the fundÆs investments, and in mid-February, DIC said it plans to invest $5 billion into China, India and Japan over the next three years, while the KIA has also hinted that it will increase its Asian investments. As Istithmar pointed out at the beginning of the year, Asian countries are generally more welcoming to SWFs.

This story first appeared in a Middle East Report that was published together with the July issue of FinanceAsia magazine.