27 April 2011

Sovereign Wealth Funds: Sovereign in their country and special in India too

I have a face-off piece in the Business Standard on the special exemptions (from takeover triggers and FII investment limits) being given to sovereign wealth funds. I find it odd to give special status to those funds which are likely to have a strategic interest in not just a company but the entire economy. Additionally a guest piece in the wsj.com by Tanuj Khosla states "It's difficult to understand why India is making it easier for other sovereign funds to invest in companies here, but doesn't want one of its own". Here are excerpts from my piece:

The Securities and Exchange Board of India (Sebi) and the government are seeking to give special status to sovereign wealth funds (SWFs) when they seek to acquire shares of a listed company. Specifically, the proposal is to exempt SWFs from the ambit of takeover regulations for up to 20 per cent as opposed to 15 per cent for other acquirers. There is also a proposal to allow twice the limit available to other acquirers from a limit of 10 per cent holding per Foreign Institutional Investor (FII), that is to say, an SWF can acquire 20 per cent instead of 10 per cent.

The background to the issue is that the government signed a trade treaty with another government in which it has agreed to these higher numbers. However, the treaty was executive in nature — it was signed by the government as opposed to agreed upon or ratified by Parliament. Given that Sebi regulations (both FII and takeover) are tabled in Parliament, in case of a conflict between a government treaty, which really is a contract signed by the government versus a delegated legislation, it would clearly be the Sebi regulation that would trump a contract, even if it is by the state itself. Sebi has recently put on its website a proposal to be taken up by its board, whether to amend the regulations in line with the treaty and cites the opinion of the attorney general that Sebi is entitled to exempt SWFs, but must do so on a case-by-case basis.

The question of why create a special category of exemption for SWFs begs the question, what are SWFs? There are two answers depending on whom you ask. The first answer is that these funds are arms of the government and deploy surplus sovereign money as investment in various gilts, debt and equity securities of countries across the globe to deliver both returns and strategic benefits. The second answer is that these are surplus funds with no strategic value, and are pooled so that they can be invested in asset classes that deliver higher returns compared to investing in US treasury securities with its low returns. Being sovereign in nature there is little data available about these funds and their objectives. It is, therefore, impossible to answer the question accurately for most countries whether a fund is strategic in nature or is merely a passive investment.

If the answer is the first, then there are dangers attached to foreign governments taking larger stakes in Indian companies and delivering sovereign outcomes. Conspiracy theorists would point to foreign governments trying to reduce outputs of industries that compete with their own industries. Thus, tweaking the rules just for SWFs does not seem appropriate.

If the answer is closer to the second, that they are passive investors, assuming that they provide a high level of transparency and accountability to the world at large about their objectives and source of funds, the issue is less problematic. There are lots of passive international investors who don’t have the benefit of this special class. For instance, a pension fund based out of, say, a state in the US, by its charter will clearly not have any control motives. To treat these obvious passive investments on a lower pedestal compared to SWFs is unfair. If an exemption is given to SWFs that are considered passive, it must also be given to all passive investors including pension funds, social security funds, university fund, mutual funds, charitable trusts and insurance/reinsurance companies. While the law creates un-equals out of equals, there may be strategic merit in signing executive treaties that give special fair treatment to certain countries.

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