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To Be or Not to Be: Sovereign Wealth Funds Face Increasingly Complex Legal Challenges

Letter from Thomas F. Holt, Jr., F ‘77 
Co-head of SWFI and Senior Fellow, Center for Emerging Market Enterprises
Partner, K&L Gates LLP


Dear Readers,

Not long ago, my colleague Eliot Kalter and I embarked on a series of interviews with senior managers of sovereign wealth funds (“SWFs”) located in Asia and the Middle East as part of the Fletcher School’s Sovereign Wealth Fund Initiative.  At one meeting, we were surprised when a senior official at one of the world’s larger SWFs told us that his agency, in fact, was not a sovereign entity at all.  Rather, he said, his organization was a private concern investing in overseas companies and assets, albeit using foreign reserves as its exclusive source of funding.  To say the least, this had the effect of significantly curtailing that day’s discussion.  Nevertheless, the senior official’s statement was thought provoking and, in many ways, encapsulates a basic and very profound tension confronting SWFs as they continue to deploy their vast reserves throughout the globe.  Whether a SWF is viewed as a governmental agency or body, or as some other category of foreign investor, may lead to vastly different legal and regulatory results in recipient countries or, as is becoming more significant, before arbitral tribunals.

The importance of defining a sovereign wealth fund is the topic of “Reflections on the legal nature of SWFs: public or private investment beasts?” by Eliza Malathouni.  In her article, Ms. Malathouni states the blunt fact that “the law treats private entities differently from public entities.”  In essence, when a SWF seeks a purely commercial objective – maximizing return on investment – it is likely to be viewed from a legal and regulatory standpoint as a garden-variety, foreign direct investor.  On the other hand, when a SWF’s investment appears to be strategically driven, it can be an entirely different ball game.  However, as Ms. Malathouni points out, this analysis tends to be overly simplistic and fails to acknowledge the variation in structure and objectives of different SWFs. 

The article by K&L Gates LLP partners Fred M. Greguras and Michael J. O’Neil, entitled “M&A in the United States: What Chinese Companies Need to Know about Exon-Florio Review in the Clean Technology and Other Business Sectors,” (see Bulletin sidebar) focuses on the legal and regulatory hurdles that Chinese companies face when investing in U.S. concerns.  While it is not news that Chinese companies are stepping up investments in the U.S., recent developments have shown that at least some of these companies are receiving substantial support from the Chinese government in the form of commitments of foreign reserves.  This is an outgrowth of China’s broader “going out” strategy announcing in July 2009 by Premier Wen Jiabao.  Coupled with increased investment in clean technology, many Chinese companies can expect to run the gauntlet of the Exon-Florio review process. 

Not unsurprisingly, the proliferation of bilateral investment treaties (“BITs”) to facilitate foreign direct investment and its concomitant emergence as a “regime,” has significant implications for SWFs.  In his article entitled “Regime Changer?  Sovereign Wealth Funds and the International Investment System,” David G. Fromm of the Fletcher School considers the challenges faced by SWFs seeking the productions afforded by the BIT regime.  This is an important topic and we are likely to see more about the intersection between SWFs and BITs in the future. 

We are fortunate to have a contribution this month from Professor Jeremy Leong of the Singapore Management University, School of Law.  In his article, “Domestic Constraints on Sovereign Wealth Fund Investment Activity,” Professor Leong suggests a course correction in how cross-border capital flows and SWFs might best be controlled.  Professor Leong points out that focusing on whether a SWF’s investment is commercially driven or strategically driven from the point of view of a recipient state is largely beside the point.  Instead, a more pragmatic approach would be to focus on how domestic legal and structural factors within the states of the SWFs themselves might offer a more reliable constraint on SWF behavior.  The change in factual circumstances wrought by the financial crisis, as well as the largely ineffectual efforts of the International Monetary Fund to formulate international standards for SWFs, favors a change in approach.  Professors Leong’s article is both thoughtful and timely. 

As SWFs expand the reach of their investments, interesting questions as to their legal status under U.S., U.K. and Chinese laws come into play.  In “FCPA and Other Anti-Corruption Concerns Facing Sovereign Wealth Funds,” by K&L Gates LLP partners Luke Cadigan, Robert, Hadley, Elizabeth Robertson, and Amy Sommers, the authors consider possible legal exposure for SWFs under three of the most significant anti-bribery laws:  the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and the People’s Republic of China’s Antibribery Laws.  The status of SWFs as either governmental entities or “private” investors again comes to the fore.  How a SWF and its business activities will be characterized may be critical to assessing the risk of exposure to these laws.  Moreover, apart from strictly legal liability, SWFs must be aware of the very real reputational damages that can result from a failure to take steps to prevent and ultimately address bribery allegations. 

Last, the fund profile included in this month’s Bulletin is that of the New Zealand Superannuation Fund (“NZSF”), arguably among the most transparent of large, sovereign investors.  The NZSF, established in 2003 to manage government pension liability and invest pension assets, enjoys the highest ratings for accountability and governance.

In closing, I would simply note that the breadth and quality of this month’s contributions fall squarely within the mandate of the Fletcher School to provide SWF stakeholders with tools and resources to prudently manage their external relationships.  I thank all of this month’s contributors and, as always, welcome our readers’ comments and suggestions.  

With best regards,

Thomas Holt, Jr.

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