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What to do about sovereign wealth funds

Worrying about sovereign wealth funds has become increasingly widespread. The IHT reports:

These secretive wealth funds - investment funds owned by national governments - have been increasingly investing in the West in the past year, often armed with cash from soaring oil prices and trade.

Several funds have participated in big investments in banks like Citigroup and UBS, which were reeling from thre credit crisis. ... But some people have become concerned about the funds’ growing clout, and this could spur protectionism, chilling the climate for foreign investment in the West even as the global economy slows, analysts say. ... The U.S. deputy Treasury secretary, Robert Kimmitt, this year described wealth funds as a force for good, but said that their rapid growth warranted a vigilant stance by the U.S. government to ensure they remain “a positive influence.”

Law professors Ron Gilson and Curtis Milhaupt propose a solution:

Sovereign wealth funds (SWFs) have increased dramatically in size as a result of increased commodity prices and the increase in the foreign currency reserves of Asian trading countries. SWF assets now roughly equal those in hedge and private equity funds combined. This growth, and the shift of SWF investment strategy toward equities and increasingly high profile investments like capital infusions into U.S. financial institutions following the subprime mortgage problem, have generated calls for domestic and international regulation. The U.S. and other western economies already regulate the foreign acquisition of control of domestic corporations. However, acquisitions of significant but non-controlling positions are not regulated. The danger is that new regulation will compromise the beneficial recycling of trade surpluses accomplished by SWF investments.

In this paper, we situate the controversy over SWF investments in the increasing global trend toward direct governmental involvement in corporate activity, a phenomenon we label the New Merchantilism. We explain why increased transparency of SWF investment portfolios and strategy, the most commonly advanced policy recommendation, does not respond to the chief concern that SWF investments have engendered. We offer a regulatory minimalist response to fears that SWFs will make portfolio investments for strategic rather than economic reasons. Under our proposal, voting rights of SWF equity investments in U.S. corporations would be suspended but reinstated on sale. Thus, SWFs would buy and sell fully voting [shares, while not themselves being able to exercise those votes] rights, thereby assuring that the incentives to make non-strategic investments would be unaffected, while the capacity to exercise influence for strategic motives would be constrained. The paper concludes by assessing the extent to which even a regulatory minimalist response remains both over and under inclusive; however, the limited imprecision does not undermine the effectiveness of the response.