The opportunities for more cross-border GCC investments within the MENA region itself, as well as other emerging market regions, could be a good strategic response to the growing scrutiny over SWF investment in Western markets, says Alessandro Bruno. The Case of the Middle East and the Growing Shiite-Sunni Rift
Investment Thesis:
True “sustainable” investment has at least three dimensions: economic, environmental, and social. With the conspicuous exception of Norway’s Government Pension Fund – Global, Sovereign Wealth Funds (SWFs) have paid relatively little attention to the latter two dimensions. We believe that the embrace of Sustainable Investment (SI) approaches by the SWFs, particularly those in the Persian Gulf region, could pay important economic, social, environmental and even political dividends.
More specifically, SWFs in the Persian Gulf region should consider making strategic, cross-border investments which are explicitly targeted at job-creation and economic and social development within the region. Historically, major SWF investments have tended to be either global or purely domestic. A third, mid-range category of SWF investments holds considerable promise: cross-border, intra-regional investments with a strong job-creation and social development focus.
Such investments could go a considerable distance towards mitigating the Sunni-Shiite conflict, thereby helping create a more stable and attractive investment climate in the region. This would not only benefit the overall investment programs of the SWFs themselves, but also those of Western investors. The latter impact would also have the collateral benefit of creating new reputation capital for the Gulf SWFs, and potentially mitigate some of the suspicion with which they are currently viewed by the West.
Background and Context:
Sovereign Wealth Funds have been one of the hottest topics in both financial and political circles since early 2007. While the definition of SWFs remains somewhat imprecise and even controversial, they are frequently defined as funds controlled by governments invested in international securities against which the government does not have any liabilities. This differentiates them from other government-controlled investment entities such as public pension funds.
Following the surge in the price of oil, most oil-rich countries, which are especially concentrated in the Middle East, have accrued significant amounts of foreign reserve surpluses. Consequently, the scale, risk appetite and impact of SWFs have all increased exponentially over the past few years. In the face of the credit crisis and the bail-out of several major western banks by SWFs, they have been praised especially by financial actors, as forces of financial stability and saviors for troubled banks. Among the Western financial institutions which received life-saving financial transfusions from SWFs in 2007 are: UBS, Citibank, Barclays, Merrill Lynch, and Morgan Stanley. Table 1 below summarizes the investable asset bases of four of the largest SWFs in the Gulf region:
At the same time, however, major multilateral institutions such as the OECD and the IMF, as well as the international investment community, have also shown increasing concern about the real or potential lack of independence of SWF operations from government policies, and the possibility of “politically motivated” investments by SWFs. The International Monetary Fund is currently drafting a code of conduct for SWFs (Generally Accepted Principles and Practices), which will primarily focus on the transparency and independence of their governance structures and behavior.
In this short Issue Brief for Innovest clients, we shall argue that, while “political” investments in the western capital markets might not be desired by the Western investment community and regulatory bodies, in other regions such as the Middle East, strategically-targeted, “political” cross-investments between countries can be a source of both political and economic stability in the region. This would actually benefit most of the stakeholders in those jurisdictions, as well as Western investors and corporates.
The Global Trend Towards Sustainable Investment
There is a powerful, worldwide trend among major institutional investors to incorporate “sustainability” or “ESG” (environmental, social, and governance) concerns – notably climate change – into their global investment strategies. Recent evidence indicates that, in addition to other less tangible benefits, risk-adjusted returns can also be improved by including sustainability factors.
By far the most far-reaching aspect of this trend has been its rapid recent growth beyond the narrow “socially responsible investment” niche into the mainstream investment world. Among the most recent examples of this “mainstreaming” phenomenon:
• Over 380 leading global financial institutions, with more than $55 trillion worth of managed assets, have formally expressed strong concern about climate change as an investment risk through the global Carbon Disclosure Project.
• Over 400 major institutional investors, with over $15 trillion in assets, have recently pledged formally to integrate sustainability considerations more directly into their investment strategies by publicly adopting the UN Principles for Responsible Investment.
• Over 20 institutions from seven countries, with over $2.4 trillion in combined assets, have already invested in investment research in this area through the Enhanced Analytics Initiative.
To date, however, with the conspicuous exception of Norway’s Government Pension Fund – Global, the world’s SWF’s have been conspicuous by their absence from participation in this global trend. This may be an ideal opportunity to change that.
The Potential Stabilizing Role of the GCC SWFs
The urgency of subduing the Shiite-Sunni quarrel at both regional and domestic levels is such that in Saudi Arabia, King Abdullah has risked his own legitimacy, challenging the dogmatic Wahabi clerics. The emerging sectarian struggle in an area holding most of the world’s known oil reserves is a grave geo-political and economic concern. However, as worthwhile as the interfaith dialogue recently launched by Saudi Arabia could be, it must also be buttressed by investment and economic growth.
Significant political and economic changes have recently swept across the Persian Gulf countries. The princes of the Gulf have taken small but symbolic steps to suggest that they are trying to earn greater legitimacy with their populations, including the election of women parliamentarians in Saudi Arabia and semi-democratic elections in Kuwait. The economic changes, particularly as far as capital markets are concerned, have been even more significant. Many Gulf countries and companies are now open to foreign investment. Saudi Arabia has embarked on a privatization process, and the smaller princedoms of the UAE and Bahrain have made attracting foreign investment one of their main priorities. Libya has also adopted market reforms easing foreign investment, opening up to trade and removing domestic barriers to resource allocation. This suggests that economic cross-connections driven by SWFs could be increasingly effective policy tools which could contribute to political stability and sustainable economic growth in such historically volatile regions.
Even at an oil price of “only” USD 70/barrel, the Gulf Cooperation Council states (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and UAE) can expect unprecedented revenue (into the trillions of dollars) over the next decade. This gives them extraordinary investment clout abroad. It also gives the GCC a powerful investment opportunity, which has a real chance to affect the very nature of the region’s economy and society, by promoting diversification away from oil, as well as social transformation through the employment and training of locals in a greater variety of industries. In other words, the GCC SWFs’ investment philosophy will have significant worldwide and regional repercussions.
While their domestic investment has focused largely on improving hard physical and industrial infrastructure, outbound foreign investment has concentrated on gaining a foothold in the world’s principal capital markets and targeted industries such as aerospace, real estate and high technology. The GCC sovereign funds have, however, paid less attention to emerging markets, particularly those that share their same language, customs, and culture in the Middle East and North Africa. One of the main problems afflicting the region, in spite of the various pockets of intense oil-derived wealth, is youth unemployment. Left unchecked, it remains the primary destabilizing element in the region, because of its vulnerability to ideological and potentially violent forms of social protest, which often take on religious hues in the MENA region. The tensions that linger from the Iraq war and the Lebanese political crisis, combined with the hegemonic challenge posed by Iran in the region, can only grow as destabilizing ingredients. Characteristically, governments remain the largest employers in the region. The GCC’s sovereign funds should not simply seek to replace the state in offering essential services; they should consider investing to help support emerging private sector companies, so as to reduce the employment burden on the state itself. Abu Dhabi is already using private capital to finance water and power projects, and the model could be exported and supported through SWF’s.
Sovereign funds may prove to be the ideal tool to catalyze a greater diversification of the region’s economy, based on private rather than public sector leadership, carrying with it the promise of an improvement of living standards for the entire population of the MENA region. The SWFs have at least five major advantages denied to virtually all other major institutional investors:
- Exponential growth rates
- An infinitely long investment horizon
- An extremely broad vested interest in the overall health of entire national economies and societies
- A lack of financial liabilities to offset their revenues
- A very short, efficient decision chain
These unique assets provide a unique set of capabilities which could and should, we believe, achieve much wider objectives and benefits than is currently the case.
Some Early Progress
One ambitious example of what we have in mind is Saudi Arabia’s planned USD 6 billion SWF to finance domestic projects designed to maximize employment and training in general, and youth employment in particular. This provides an excellent and recent example of a domestic initiative which could be replicated and scaled up on a regional basis. The opportunities for more cross-border GCC investments within the MENA region itself, as well as other emerging market regions, could be a good strategic response to the growing scrutiny over SWF investment in Western markets. The Western ambivalence and occasional antipathy towards sovereign funds in the GCC region militate in favor of more of this kind of “South-South” cooperation. Not surprisingly, Libya's USD 100 billion sovereign fund is primarily targeting investment in other emerging market areas such as Asia and South America. It should be encouraged to seek opportunities in the emerging markets of the Middle East as well.
Kuwait has already used its sovereign wealth fund to make a cross-border strategic investment in Syria. The Kuwait Investment Authority (KIA) has discussed launching a joint venture investment fund with the Syrian government to invest in Syria, which has continued to open its economy to foreign investment over the past decade despite the imposition of US sanctions. A Kuwaiti-Syrian holding already owns 10% of the Damascus Four Seasons hotel, which has been very profitable. In addition, in June 2008, it was also announced that Syria and Qatar set up a venture with share capital of $500 million to invest in property in Syria. The concrete prospects of peace with Israel are expected to boost market reforms in Syria even further.
Having historically been focused on either purely domestic or international investments, Gulf States now increasingly realize the investment opportunity to help develop the Muslim world, to overcome the sectarian rift, and to invest in the economic, social, and environmental infrastructure necessary for the region’s economic growth.
In the environmental sphere, Abu Dhabi’s USD 15 billion+ commitment to the ambitious MASDAR environmental technology initiative (including the creation of the world’s first carbon-neutral city) provides a compelling example of what can be accomplished with a “sustainability-enhanced” investment orientation. While MASDAR currently has a domestic focus, it could ultimately become an engine of technological development, employment, and forward-looking skills development for the entire region. On the social side of the sustainability ledger, in neighboring Dubai, investments improving the living standards of international workers could help minimize labor problems and bottlenecks which could otherwise threaten the emirate’s spectacular growth boom.
Conclusion
In the face of continued political crises in the Middle East, the GCC sovereign wealth funds and their oil revenues can play a significant political and economic stabilizing role in the region. We would advocate that the Gulf SWFs pursue three bottom lines (economic, environmental, and social) with their investment strategies, expanding their almost exclusive focus on only the first of the three. Such investments could decrease the overall investment risk profile of the region, and increase the scale and scope of the economic opportunities, for Gulf and Western investors alike.
Consequently, we believe that the attempts by western transnational institutions such as IMF and OECD to depoliticize the SWFs and to transform SWFs into pure economic players are not fully justified, and might deprive the investment community from the stabilizing roles that such funds could play in their own regions.
Any regulatory pressure on the SWFs by Western regulators and multilaterals, while attempting to depoliticize their investments in the international capital markets, should also permit or ideally encourage SWFs to make investments aimed at increased stability and long term economic, social and environmental progress in their home regions.
Alessandro Bruno is Research Analyst at Innovest Strategic Value Advisors.
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