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London’s Nick Garrott on Sovereign Wealth and Foreign Investor Developments

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London and City Hall

This interview will appear in the 4Q Y2013 (January 2014) issue of the Sovereign Wealth Quarterly.

Nicholas Garrott is an International Macroeconomist and Advisor to the Mayor of London – Greater London Authority.

1. How has the relationship between the London Government, and by extension UK government, changed with sovereign wealth funds since the 2008 crash?

This is a substantive issue, and there has been a large swing in public sectorial opinion on sovereign wealth funds – there was a marginally negative sentiment a decade ago, questions were asked by the Treasury, and Parliamentary Commissions were convened on the subject: Who were they? What were their long term objectives? Could they be trusted? Was the money “clean,” or should we be concerned about possible human rights records?

The outcomes were broadly inconclusive; no one was quite sure whether [SWFs] were a good or a bad thing, so inward flows remained largely unchecked, though investment opportunities outside of London were hardly forthcoming. Traditional bank and corporate investment vehicles remained the preferred choice for local and regional (Regional Development Agency) levels of government.

London was rather unique at a UK level in having an accommodating attitude to funding origination, of which SWFs make up a major element of the global base – either directly or indirectly. A couple of examples include the UAE sovereign fund backed DP World £1.5 billion investment in London Gateway and the Qatari fund backed QNB funded construction of the Shard.

There is an increasingly nuanced supranational, organisational relationship framework with SWFs developing, including information sharing, engagement with Bretton Woods institutions or with savvy private sector institutions.

Whilst these London projects both predate the 2008 banking crash, it is true that attitudes nationally towards sovereign funds have changed significantly. Sovereign wealth funds were originally, to paraphrase Donald Rumsfeld, ‘known’ unknowns; experts knew what they were, but there were political implications to their involvement in UK government backed projects. Post 2008, when many banks were exposed as operating a tad below public expectations, the heat of public questioning came off SWFs and alternative funds and was placed firmly on more traditional financial services.

To go off on an economic history tangent – this realisation was inevitable, and the psychological groundwork to accepting the key role that sovereign funds could play in future funding efforts already existed.

The UK, despite not having an existing active sovereign fund, has an historical parallel: the Crown expenditure, a key component from the creation of the burgeoning Elizabethan nation state through British economic decline in the 1870s. The formation of a formal empire, large navy and other aspects of a global power were leveraged off a public fund broadly created through a state pooling of revenues from commodity sales in various crown and Imperial funds. These receipts were then reinvested nationally and internationally.

There had been a psychological break among the British public and government at large, unable to legitimize the idea of foreign investment in the immediate post war era – pushed by consensus Keynesianism and the collapse of Empire. The possibility that sovereign controlled funds could own UK firms and infrastructure led to initial reticence and fears of undue foreign influence. Sovereign investment was far less acceptable than international corporate investment. These initial fears have subsided and are manifestly no longer the case in 2013 as evidenced by the increasing lengths to which the UK government will go to court sovereign fund interest. Domestic banks failed to give support for national infrastructure prior and post the 2008 crash. Their support has also been limited in funding large development projects and increasing the capital base. SWFs offer the possibility of filling the funding gap that is slowing national policy delivery.

The Sovereign Wealth Fund Institute must be commended on boosting the profile of all investing public sector funds – and drawing large public pension funds into their analytical mix. Their work tracking the totemic growth of the SWF space, defining what constitutes a sovereign fund and spotlighting emerging SWFs has shifted the political narrative.

2. Why have banks and traditional foreign investors failed to step up to the funding challenge for large projects in London/UK?

There has been an historic underinvestment in the capital base of industry and commerce in the UK when compared to European competitors and the US. In the UK, gross fixed capital as a percentage of GDP rate runs at 14% as a 10 year average compared to France’s 20%, Germany’s 18% and the US’s 16.3% (2002-2012 World Bank). Banking money has spent decades flowing abroad, where returns are potentially higher. UK capital markets under-perform in creating and sustaining domestic investment; management is historically uninterested in boosting the domestic capital base, and the bond market is not open to government infrastructure products which makes funding on project by project basis a struggle.

This is alongside a very poor history of government support for strategic infrastructure in general. Indeed, though London currently hosts the largest infrastructure project in Europe (Crossrail), this was a project first proposed in 1948. It took the personal political clout of the very popular Mayor Boris Johnson alongside the 2012 Olympics to get the project off the starting blocks.

As before, this relates to historical economic issues, the Empire took precedence in the psychology of business and government from the 1870s – external outflows replaced significant levels of Victorian inward investment. The failure to achieve a recipe for growth post WW2 cemented poor practice.

The attraction for SWFs from a political position is that many of them are keen to make investments that are, in part, declarative statements for domestic and international political reasons. The style of capital investment that combines a message with a business case – which punctuated the various industrial revolutions in the West – has returned. London is more than happy to support that.

That said, if there were to be any official IMF/World Bank style Sovereign Wealth Fund Centre established, its natural home would, of course, be London.

3. Where do you see the sovereign fund space going in the future – engagement with government and from a supranational perspective?

Superlative SWF Institute analysis alongside long term IMF research suggests that there has been exponential growth in both the number of SWFs and the total amount of assets they have under control, from a dozen with a few hundred billion dollars in assets in the 90s to the 80+ today with $6 trillion in assets. This is to be expected given the broad success the SWFs have enjoyed.

There is an increasingly nuanced supranational, organisational relationship framework with SWFs developing, including information sharing, engagement with Bretton Woods institutions or with savvy private sector institutions. Whether this growing awareness remains broadly unofficial or attains some official status is less significant than the fact that the general experience of operating a SWF successfully is shared effectively – which promotes not just the awareness and integrity of SWFs globally, but reduces instability risks (both political and economic) in emerging economies and guards against dangerous commodity bubbles like we saw in the 2000-2010 period.

That said, if there were to be any official IMF/World Bank style Sovereign Wealth Fund Centre established, its natural home would, of course, be London. And we would make every effort at a city and national level to support this.

Intriguing macro-economic effects of having a sizeable SWF in an economy over the long term are gaining more and more support among economists. The positive trends observed are that, when compared to nations without a fund, they keep inflation low, there are beneficial lending considerations and they help to counter exchange rate fluctuations. This is clearly a major reason behind the rapid uptick in SWF numbers globally over the 2000s.

There is increasing support in non-commodity based economies to have some form of fund structure as both a macro hedge and a superior instrument for national investment policies. These sidestep one of the primary difficulties of pluralist democracies, breaking the short-termism of the 5 year cycle.

Moreover, against the current backdrop of the global boom in [hydraulic fracturing] for shale gas, we have realised the possibility of commoditising or re-commoditising many economies. In the UK, where we were facing the end of North Sea Oil, there is pressure on the government to create a SWF with the tax proceeds from shale commodity sales, a plan that never reached fruition in the 1980s during the North Sea boom.

Indeed if the industry does take off, there is the possibility of the UK’s first sovereign fund of the post war era – a nuanced, directed, green focused fund which would arguably boost productivity and competitiveness across the economy. This would take the investment and regulation costs of ‘greening’ the economy off the tax payer and offset it against profits accrued by such a fund.

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Will CalPERS Double its Allocation to Private Equity?

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Yu Ben Meng, the new Chief Investment Officer of the California Public Employees Retirement System (CalPERS), detailed a picture on why the institutional investor needs to augment its allocation to private equity. [ Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view content. ]

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Minutes Describe Fed Expecting to End Balance Sheet Reduction by Year-End

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The U.S. Federal Reserve board released minutes from its January 2019 meeting. There was a split among board members whether any interest rate increases would be necessary for this year. In addition, these officials chatted about ceasing the reduction of bonds on the central bank’s balance sheet before the end of 2019. Board members are keeping an eye on the stock market and current credit spreads. The Federal Reserve started reducing its bond portfolio in October 2017, a measure of quantitative tightening (QT). The US$ 3.8 trillion pool of bonds held by the central bank’s balance sheet is a topic of concern for U.S. fixed income investors.

Minutes of the Federal Open Market Committee
January 29-30, 2019

An excerpt from the minutes details that “Participants commented that, in light of the Committee’s longstanding plan to hold primarily Treasury securities in the long run, it would be appropriate once asset redemptions end to reinvest most, if not all, principal payments received from agency MBS in Treasury securities. Some thought that continuing to reinvest agency MBS principal payments in excess of $20 billion per month in agency MBS, as under the current balance sheet normalization plan, would simplify communications or provide a helpful backstop against scenarios in which large declines in long-term interest rates caused agency MBS prepayment speeds to increase sharply. However, some others judged that retaining the cap on agency MBS redemptions was unnecessary at this stage in the normalization process. These participants noted considerations in support of this view, including that principal payments were unlikely to reach the $20 billion level after 2019, that the cap could slightly slow the return to a portfolio of primarily Treasury securities, or that the Committee would have the flexibility to adjust the details of its balance sheet normalization plans in light of economic and financial developments. Participants commented that it would be important over time to develop and communicate plans for reinvesting agency MBS principal payments, and they expected to continue their discussion of balance sheet normalization and related issues at upcoming meetings.

Following the discussion, the Chairman proposed that the Committee communicate its intentions regarding monetary policy implementation and its willingness to adjust the details of its balance sheet normalization program by publishing a statement at the conclusion of the meeting. All participants agreed with the proposed statement.

STATEMENT REGARDING MONETARY POLICY IMPLEMENTATION AND BALANCE SHEET NORMALIZATION
(Adopted January 30, 2019)

After extensive deliberations and thorough review of experience to date, the Committee judges that it is appropriate at this time to provide additional information regarding its plans to implement monetary policy over the longer run. Additionally, the Committee is revising its earlier guidance regarding the conditions under which it could adjust the details of its balance sheet normalization program.5 Accordingly, all participants agreed to the following:

The Committee intends to continue to implement monetary policy in a regime in which an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve’s administered rates, and in which active management of the supply of reserves is not required.
The Committee continues to view changes in the target range for the federal funds rate as its primary means of adjusting the stance of monetary policy. The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.”

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Vision Fund Investors Display Stress on Frothy Market Valuations

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Led by Masayoshi Son, Japan-based SoftBank Group Corporation continues to run the gargantuan Vision Fund scooping up exciting technology investments, both big and small globally. Armed with a roughly US$ 100 billion warchest, the Vision Fund has been disrupting both suppliers of capital and the industries that receive it. Are the big-money limited partners of the Vision Fund the technology backers of last resort? Two of the major backers of the Vision Fund are Saudi Arabia’s Public Investment Fund and Abu Dhabi-based Mubadala Investment Company. SoftBank has invested billions into tech companies like Compass, Katerra Inc, WeWork Cos., Coupang, DoorDash, and Uber Technologies. For example, a beneficiary of the Vision Fund, Katerra is a manufacturer of modular building parts, in which many people question the company’s profitability and business model. Uber is driving toward its initial public offering. SoftBank recently participated in an investment round in Clutter, a storage company.

[ Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view content. ]

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