Will sovereign funds reign over EU?

China’s financial clout could block the creation of a global superpower in the metals sector. Stewart Fleming reports on how sovereign wealth funds are re-writing the rules of engagement in international trade.

The Chinese government dealt a blow last week to hopes that European Union member states might easily agree on how to deal with the surging financial power of state-controlled sovereign wealth funds (SWFs). These government-owned agencies currently control assets of about €2 trillion, though some predict that the total will rise to €10 trillion by 2015.

On Friday (1 February) the Aluminium Corporation of China (Chinalco) stunned the City of London by teaming up with Alcoa, the biggest American aluminium company, to launch an unprecedented raid on London’s stock market, sweeping up a $14 billion (€9.56bn), 12%, shareholding in Rio Tinto, the Anglo-Australian mining giant. Industry analysts said the move was partly designed to block the merger mooted in the mining sector between Rio and its huge Australian competitor, BHP Billiton.

BHP yesterday (6 February) increased the value of its bid to $147.4bn (€100.7bn), but that was not enough to persuade the Rio board to bless a friendly tie-up.

Chinalco’s extraordinary decision to team up with Alcoa was interpreted as an attempt to neutralise political opposition to what would otherwise be a wholly Chinese intervention.

The fact that state-controlled Chinalco is being financed by China’s state-owned sovereign wealth fund, China Investment Corporation, is evidence for some of the political motives behind Chinalco’s intervention. High-level government authorisation, it is argued, would be needed to make such a move. There are also reports that China is rushing to draft new competition law which would allow it to oppose mergers between foreign corporations on competition policy grounds.

Given China’s voracious appetite for raw materials to fuel its growth, some of the motivations behind China’s decision to embroil itself in the Rio/BHP shoot-out are easy to fathom.

A merged Rio/BHP would control as much as one-third of the global market in iron ore and could dominate the world markets for copper and aluminium, strengthening its pricing power. Investment bankers Credit Suisse and UBS have forecast that iron-ore producers could try to raise prices this year by 55%.

Attitudes within the EU towards China’s demarche are already diverging. An EU government official who is helping to develop his government’s policy towards sovereign funds argues that further dramatic increases in metals prices could damage Chinese companies and the Chinese economy. In his view Chinese intervention to try and block the merger is perfectly legitimate on economic grounds.

A European Commission official begs to differ. With the Commission working to produce an EU policy proposal for dealing with sovereign funds, he says that this is precisely the sort of government-directed, politically motivated intervention in Western markets which the EU must resist. If the proposed merger raises competition policy issues these should be resolved by competition laws, not thinly disguised Chinese government intervention.

These conflicting positions underscore how difficult it is going to be for the EU to find a policy towards sovereign funds to which all members of the EU can subscribe, not least because sovereign funds themselves come in a variety of shapes and sizes. Some, like those run by China, Russia and some Middle Eastern oil producers, are opaque and secretive. Others, notably Norway’s, are much more open about their policies and activities.

Last weekend Russia signalled that it is going to employ its SWF more actively in international markets.

US Deputy Treasury Secretary Robert Kimmitt is leading the formulation of US policy on SWFs. In a detailed analysis in the January edition of Foreign Affairs, the journal of the authoritative US Council on Foreign Relations, he warned against an upsurge of protectionism directed against SWFs, but demanded that the funds themselves be fair and transparent, not opaque and secretive in their investment policies.

"When national security considerations are involved," he wrote, "investment policies …should be public, clearly articulated, predictable and non-discriminatory." SWFs should, he added, compete fairly with the private sector.

To some eyes, Chinalco’s dramatic intervention fails these tests. It certainly exposes the difficulty of defining what legitimate political or national security motivations might be and deciding when they are in play. Kimmitt wrote that the issue of reciprocity, although not a guiding policy principle, cannot be ignored. "Investment policy decisions are made in a broader political context in which reciprocity, as well as the protection of intellectual and physical property, is taken into account." China, in particular, has been under attack by the EU for protecting its own markets and not adequately defending the intellectual property of foreign investors.

There are growing concerns about the strategic stakes that SWFs are taking in sensitive sectors, worries that some are trying to gain access through shareholdings to politically and commercially sensitive information and intellectual property, and fears that, as they grow, some could have the capacity to destabilise financial markets. But China, in particular, knows that its trump card in trade and investment negotiations is the determination of US and EU companies to get access to its fast-growing market. Such market incentives will make it very difficult for the EU to forge a consensus on what constitutes an appropriate policy response.

• Stewart Fleming is a freelance journalist based in Brussels.

China’s financial clout could block the creation of a global superpower in the metals sector. Stewart Fleming reports on how sovereign wealth funds are re-writing the rules of engagement in international trade.