Soverign Wealth Funds - Swiss Bank Assoc

May 2008

Sovereign Wealth Funds A Position Paper by the Swiss Bankers Association

Sovereign Wealth Funds A Position Paper by the Swiss Bankers Association

Contents Executive summary........................................................................................................................................... 2 1. Background................................................................................................................................................ 3 2. The economic importance of the free movement of capital for Switzerland......................... 5 3. Drivers of sovereign wealth funds, development prospects........................................................ 6 4. Is the Swiss banking sector strategically important?...................................................................... 7 4.1 Importance of the banking sector … ........................................................................................... 7 4.2 … and when is it threatened? ........................................................................................................ 8 5. Does Switzerland need a set of defensive powers? ......................................................................10 5.1 Legal provisions to prevent undesirable holdings and takeovers in the banking sector .....................................................................................................................12 5.2 Subsequent objections to a foreign holding that was originally approved?...................14 5.3 Do sovereign wealth funds threaten financial market stability?.........................................15 5.4 Restraint in international coordination......................................................................................16

Impressum Publisher, typesetting and printing: Swiss Bankers Association, Basel This broshure is available in German and English. © Schweizerische Bankiervereinigung 2008

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Executive summary The Swiss Bankers Association (SBA) adopts a free market approach to potential investment by foreign sovereign wealth funds (SWFs) in Switzerland and welcomes the Federal Council’s statement that it sees no need for legislative action. The SBA sees the growth of SWFs and their assets as a reflection of a shift in emphasis in the global economy. As long as they are commercially rather than politically motivated, inflows of capital surpluses from emerging and developing countries promote competition and prosperity. Switzerland is especially reliant on open markets and the free movement of capital, as for a long time it has invested significantly more capital in other countries than other countries have in Switzerland. At the end of 2007 these net assets amounted to some CHF 650 billion, plus a further CHF 80 billion in the form of foreign exchange reserves. These assets generate annual flows of CHF 60-70 billion into Switzerland in the form of investment income in the balance of payments – around 12% of gross national income. Sovereign wealth funds currently have a worldwide investment volume of more than USD 3 trillion. The largest funds are in the Middle East, Singapore, China, Norway and Russia. Some USD 90 billion of their assets is invested in western financial institutions, with USD 80 billion placed since 2007. Primarily due to the continuing rise in commodities prices and the increasingly professional management of foreign exchange reserves, the assets managed by SWFs could reach USD 7 trillion by 2012 and USD 10-15 trillion by 2015. Further investment in the financial sector is a stated aim of the major funds. The Swiss banking sector is unquestionably of strategic importance for the Swiss economy and must be protected, at the political level if necessary, against any potential threats. However, careful analysis is required to ensure that foreign sovereign wealth funds do indeed represent a genuine threat and justify political intervention. A hasty or unjustified political response would threaten capital inflows into Switzerland and raise the prospect of retaliatory action by other countries. We believe that the defensive options currently in place are adequate, particularly in the banking sector. In any event it is ultimately the debtor country and not the creditor country that is in the stronger position. Swiss banking and stock market law provides for a number of defensive measures against undesirable holdings and takeovers. Qualified holdings must be disclosed to the Swiss Federal Banking Commission (SFBC), with a supplementary licence also required from the SFBC where such holdings are foreign-controlled. There is no scope for rejecting or revoking this licence on political or economic grounds, however; this is only possible where there is a breach of the guarantee of irreproachable business conduct, in other words only in exceptional cases. A firm could in theory use the provisions of company law to impose a voting rights restriction and ‘seal itself off’ to some extent from any undesirable investors (not just foreign ones) in the future. In reality, however, this option ceases to be viable as soon as the firm becomes dependent on the capital of these investors.

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The requirement for a guarantee of irreproachable business conduct in respect of controlling shareholders must be met not just at the time the licence is granted but on an ongoing basis. In the event of any subsequent breach of the guarantee, the licence can and must be reviewed. Furthermore, SWFs do not pose any greater a threat to financial market stability than other asset classes such as foreign exchange reserves or hedge funds. There are no obvious steps that Switzerland needs to take; rather, a close watching brief should be kept. Under no circumstances should Switzerland attempt to go it alone: the watchword at international level is restraint.

1.

Background

The announcement that the Government of Singapore Investment Corporation (GIC) is to acquire a stake in UBS AG has finally sparked debate in Switzerland on the possible need for political intervention with regard to foreign sovereign wealth funds. The Swiss Bankers Association (SBA) welcomes this discussion and supports a free market position. In particular, we are in agreement with the Federal Council statement of 30 January 2008 that no legislation appears to be required.1 The International Monetary Fund defines sovereign wealth funds (SWFs) as “special investment funds created or owned by governments to hold foreign assets for long-term purposes”. 2 Sovereign wealth funds are not the same as state-owned enterprises (SOEs), although the latter (can) also invest in foreign firms. Interestingly, perhaps the most controversial recent cases involving foreign holdings, such as Dubai Ports 3 and China National Offshore Oil Corporation (CNOOC)/Unocal Oil Company (USA), concerned not SWFs but SOEs. The two are often almost indistinguishable in terms of function, however, and the following discussion relates to both types of institution unless otherwise stated. Sovereign wealth funds have been around for a long time, but they have returned to the fore, particularly for banks, in the wake of the turmoil on the financial markets. In total there are approximately 40 major SWFs and SOEs engaged in similar activities, with an investment volume of USD 3.1 trillion, including:

Kuwait Investment Authority Temasek Holdings (Singapore) Abu Dhabi Investment Authority (ADIA) Government of Singapore Investment Corporation Government Pension Fund – Global (Norway) China Investment Company Ltd.

1 2 3

Current investment volume USD 250 billion USD 108 billion USD 875 billion USD 330 billion USD 322 billion USD 200 billion

Established 1953 1974 1976 1981 1990 2007

Press statement of 30 January 2008 Working paper by Max Castelli, UBS DP World, a company owned by the Dubai government, attempted to take over the London-based Peninsular and Oriental Steam Navigation Company (P&O). P&O operated key ports in New York, New Jersey, Philadelphia, Baltimore, New Orleans and Miami. The US government blocked the transaction to prevent DP World from operating strategic infrastructure elements such as ports, ostensibly for security reasons.

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Sovereign wealth funds have a total of USD 79 billion invested in western financial firms, and there is an additional USD 12 billion from Chinese investment vehicles. Of this USD 91 billion, USD 80 billion has been invested since 2007. 93% of the investments in financial firms stem from Singapore, China, Abu Dhabi, Kuwait and Dubai. Major holdings of SWFs/SOEs in western banks: Bank

SWF/SOE

Barclays Standard Chartered Deutsche Bank Citigroup

Temasek Temasek Dubai Abu Dhabi GIC Korean Investment Corp. Kuwait Investment Authority Temasek China Investment Corp. GIC Qatar Investment Authority

Merrill Lynch Morgan Stanley UBS Credit Suisse

Investment in USD bn 2 8 2 7.5 6.9 2 3.4 4.4 5 10 0.5-2?

Year 2006 2007 2007 2007 2007 2007 2007 2007 2008 2008

Sovereign wealth funds are more than just another asset class: the lightning growth of SWFs and their assets is in fact a reflection of a shift in emphasis in the global economy. Just as the norm in recent decades was for western companies and portfolio investors to invest in emerging and developing countries, meaning that capital flowed from ‘North’ to ‘South’, it is now logical from an economic point of view that the present capital surpluses in the ‘South’ will seek out investment opportunities in the ‘North’. In some cases this is through privatesector investment (such as Mittal with Arcelor or Tata with Jaguar/Land Rover), but since many emerging and developing countries do not (for various reasons) have privately owned companies of a sufficient size to invest significantly in industrialised countries, this role is increasingly being performed by SWFs. Provided that these investments are for business or ‘technical’ (see section 3) reasons, there is absolutely nothing wrong with them – on the contrary, ‘recycling’ this capital into western companies brings economic benefits for all parties. Fighting against this investment under these circumstances is tantamount to sealing oneself off from competition and globalisation. It is protectionist and hence ultimately detrimental to prosperity. As long as investment decisions are commercially rather than politically motivated, the fact that the funds are stateowned should have no bearing whatsoever. Every country has its own ideas about how to address the SWF issue, and there are also international initiatives (Financial Stability Forum, IOSCO, OECD, Business Europe) to ensure a minimum level of coordination. At the present time, activities are focused on the following points: • • •

Fears that countries, as owners of SWFs, invest in companies with a view to acquiring ‘know how’ (intellectual property, patents, etc.) Danger of foreign investment in companies that are directly or indirectly involved with issues of national security ‘Political’ investments that create dependencies (in the energy sector, for example)

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• •

Lack of transparency in the investment policy of SWFs Reciprocity: how can countries that invest in foreign companies via SWFs be prompted to adopt a less restrictive policy with regard to foreign investment in their own country (e.g. China)?

On 31 January 2008 the Federal Council resolved to closely monitor the continued development of SWFs and comparable investors. It decided that no legislation is required for the time being. In the event of any privatisation plans, the Federal Council reserves the right to check that the rules regarding ownership structure and market conduct are observed. According to the Federal Council, however, key infrastructure areas in Switzerland are predominantly publicly owned or protected against takeovers by private or foreign investors through special legal provisions. As a result, the Federal Council considers the risks to Switzerland posed by SWFs to be fairly low.4

2.

The economic importance of the free movement of capital for Switzerland

Switzerland has a long tradition of free capital movement. Capital circulated (relatively) freely in both directions here long before similar liberalisation took place in other countries. One exception to this was the 1970s, when the foreign exchange markets had to seek a new balance following the collapse of the Bretton Woods fixed exchange rate mechanism. Massive capital volumes flowed into Switzerland and the Swiss franc, pushing up the value of the currency and creating real problems for the export and tourism industries. A raft of measures were implemented to restrict inflows of capital: in addition to a requirement to disclose foreign exchange transactions, these also included a ban on interest payments and a commission on foreign-owned assets. The measures were not completely abolished until the beginning of the 1980s. The measures were initially passed as emergency legislation, with the ordinary laws subsequently being amended accordingly, i.e. Art. 8 of the Banking Act (capital export controls) and Art. 16i of the Central Bank Act (capital import controls). These provisions were only removed when the monetary system was completely reformed in 2004. The Swiss National Bank (SNB) also has a wide range of monetary policy tools at its disposal to act against undesirable movements in the Swiss franc even without the aid of controls on capital movement. Such steps are unlikely to be necessary as a result of investments by individual SWFs, however, but at most if these investments trigger a general broad inflow of capital into Switzerland. Switzerland is generally reliant on open markets and the free movement of capital, and for a long time it has invested significantly more capital in other countries than other countries have in Switzerland. At the end of 2007 these net assets amounted to around CHF 650 billion, made up of CHF 350 billion in direct investments and CHF 300 billion in portfolio investments. On top of this come foreign exchange reserves of CHF 80 billion. These assets currently generate annual flows of some CHF 60 billion into Switzerland in the form of investment income in the balance of payments5 – equivalent to around 12% of gross national income. This increases the prosperity of our country. The income does not – as is The Swiss Federal Department of Economic Affairs will monitor the continued development of SWFs and submit a further report to the Federal Council before the end of the year (press statement of 30 January 2008). 5 Source: SNB balance of payments, investment income section; in its position paper the Federal Council refers to a figure as high as CHF 70 billion. 4

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the case with SWFs – flow into a single pot: it benefits (in line with their asset positions) private households, institutional investors, companies and the state. Foreign assets can also – if they are needed here – be brought back to Switzerland (e.g. to finance key infrastructure projects on a private-sector basis or to pay pension benefits to future generations). Conversely, as the Federal Council statement made clear, “foreign investors are in principle welcome in Switzerland, as borne out by the high volume of foreign capital invested in the country (2006: CHF 266 billion). They keep our economy competitive and create jobs here. The same also applies to investments by state-owned funds. Many of these funds have a long-term investment horizon and therefore help to provide a sustainable supply of capital for the economy. As a consequence, Switzerland is reliant on there being no restrictions between international financial markets ...”6

3.

Drivers of sovereign wealth funds, development prospects

Sovereign wealth funds are created when countries have surplus revenues and reserves and their governments feel it would be advantageous to manage these assets with a view to future liquidity requirements and as a way of stabilising irregular revenue streams.7 The surplus revenues and foreign exchange reserves invested in SWFs generally come from the sale of oil, gas or other natural resources. Most SWFs are found in countries that export oil or have commodities reserves and generate revenues from their sale. In countries such as Chile, Botswana or Kiribati 8 the sale of natural resources such as copper, diamonds or mineral commodities provides the basis for SWFs. However, SWFs are also fed from general household or export surpluses that a government invests in a fund of this type. Countries – China among them – are increasingly transferring official central bank reserves into SWFs. Previously, central banks had invested these reserves in liquid government paper and precious metals, primarily gold. Sovereign wealth funds are increasingly operating as largely independent companies and adopting a systematic and professional portfolio management approach. Two factors in particular play a role in the accumulation and management of national financial assets over a longer period: Firstly, the finite nature of natural resources – mining and exporting them will sooner or later result in them being exhausted or at the very least make mining them no longer economically viable. The situation is similar with regard to maintaining international competitive advantages for domestic companies or sectors of industry – they cannot be guaranteed for the long term either. Governments therefore face the challenge of weighing up the interests of the various generations and converting current revenues from the sale of resources or other export goods into a long-term source of income. Secondly, the international commodities markets are subject to major price fluctuations. Natural commodities are comparatively risky assets and consequently offer strong incentives for diversification. Federal Council press statement, op.cit. The remarks in this section and some of those in section 5 are based on the Deutsche Bank Research study “Sovereign wealth funds – state investments on the rise” of 10 September 2007 8 Former British colony of the Gilbert Islands in the Pacific, with major phosphate deposits 6 7

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Supporters of SWFs point to a number of potential advantages that can be gained by transferring state-owned financial assets into this type of fund: •

•

•

•

Intertemporal stabilisation: Sovereign wealth funds can help protect an economy against market volatility. In such cases the fund acts as a liquidity pool that is filled up in periods of favourable commodities prices and reserve inflows and can be drawn on in periods of low prices or reserve shortages. Diversification: Countries that export oil or other commodities are frequently exposed to considerable concentration risk. In view of the finite nature of natural resources and the danger of capital being misallocated, this risk is particularly severe if the sale of natural resources leads to a higher real exchange rate, thereby impairing the competitiveness of other economic sectors. Concentration risks can be reduced by diversifying state-owned assets through international investments across a broad range of financial stocks. Risk/return optimisation: Governments should seek to optimise the risk/return profile of sovereign assets. According to Deutsche Bank Research, conventional reserve management by central banks – which generally invest in short-dated, firstclass government bonds and money market instruments – has generated returns of 1% per annum over the last 60 years. By contrast, the corresponding real return on a diversified portfolio comprising 60% equities and 40% bonds would have been around 6%. Governments can therefore achieve substantial net gains over the long term by transferring surplus revenues or reserves to a separate sovereign fund.9 Transparency: Transferring assets to SWFs can enhance transparency and political responsibility in the public sector by improving public scrutiny of the use of public money. Depending on a fund’s organisational form and reporting requirements, managing national assets via a separate entity can make the management of sovereign assets more transparent.

As mentioned above, the assets managed by SWFs are currently estimated at around USD 3 trillion, making SWFs the fifth-largest category of investor after pension and investment funds, insurance companies and official central bank reserves. The latter amounted to some USD 6 trillion at the end of 2007, three-quarters of which related to emerging and developing countries. Particularly given a continued rise in commodities prices and increasingly professional management of foreign exchange reserves, the assets managed by SWFs could reach USD 7 trillion by 2012 and USD 10-15 trillion by 2015.10

4.

Is the Swiss banking sector strategically important?

4.1 Importance of the banking sector … With value added of some CHF 40 billion or 8.4% of GDP11 the Swiss banking sector is the largest sector of the Swiss economy. If the banking sector grows in line with the middle rate of the Swiss Financial Sector Masterplan, i.e. by a nominal 8% p.a., its value added will 9

Diversification in equities and bonds can of course entail sizable risk premiums. The relative risks change if a longer investment horizon is accepted, however, meaning that over a ten-year holding period, for example, the likelihood of a negative real return is markedly lower than for a conventional central bank reserve portfolio. 10 Castelli and Deutsche Bank Research 11 According to the methodology applied by the Swiss Federal Statistical Office since September 2007. After adapting the methodology in line with EU standards, the value added generated by the banks was corrected from CHF 51.5 billion to CHF 40.7 billion and the GDP contribution from 10.8% to 8.4%. (Source: internal note from Credit Suisse Economic Research on 18 January 2008)

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double to some CHF 80 billion by 2015. Based on the assumptions in the Masterplan, the GDP contribution will then be 11.8%. At least in numerical terms, therefore, the importance of the banking sector continues to increase. The sector now employs some 100,000 people, who receive above-average remuneration for their work. At CHF 337,000 per employee, productivity in the financial sector is around three times the Swiss average. Banks train 3,600 apprentices, 12% of the total number. Each year Swiss banks place service mandates worth several billion Swiss francs with third parties. They make substantial contributions in the areas of training, foreign trade, sponsorship and foundations. This major economic input is recognised by the Swiss people, with 90% of them believing that the banks make an important contribution to the overall economy. The importance of the banking sector for an economy goes way beyond just the bare numbers, however. A functioning and competitive financial centre is indispensable for any economy. Market-oriented capital allocation for investments, intermediation between savers and investors, and a platform for payment transactions are just a few of the key issues. The financial sector is vital to domestic and foreign trade in the open Swiss economy.12 The importance of the Swiss banking sector is also borne out in an international comparison. According to OECD figures (‘old’, not-yet revised national accounts statistics) the contribution of the Swiss banks to GDP rose between 1996 and 2005. By contrast, the corresponding GDP share of the banking sectors of the peer countries, the UK excepted, stagnated and was (with the exception of Luxembourg) considerably lower than that recorded in Switzerland. Switzerland Germany Italy Luxembourg UK USA Japan

GDP share in % (1996) 9.5 4.9 4.5 23.5 6.4 7.3 6.0

GDP share in % (2005) 11.4 5.0 4.7 24.2 8.3 7.7 6.8

Source: Credit Suisse Economic Research

4.2 … and when is it threatened? The Swiss banking sector is unquestionably of strategic importance for the Swiss economy, and political intervention is therefore required in the event of any internal or external threats. Not least as a result of this fact, over the past year the financial centre, led by the banks, has presented the government and the public with its Masterplan to counter any creeping deterioration in institutional, regulatory or fiscal conditions. However, careful analysis is required to determine when entities such as SWFs represent a genuine threat and justify political intervention, and when the transactions in question are in fact generally desirable investments in Swiss banks and in line with market conditions. Not every holding in or even takeover of a Swiss company or bank by an SWF represents a threat requiring restrictions to be placed on Switzerland’s liberal stance and open approach.

12

Swiss Banking – Roadmap 2015 (September 2007)

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On the contrary, a hasty or unjustified political response would threaten capital inflows into Switzerland and raise the prospect of retaliatory action by foreign governments, for instance against Swiss investment in their countries. Neither development would serve the interests of Swiss companies and banks and would damage the economy. The growing importance of SWFs raises specific questions for Swiss banks and the Swiss parliament that set out the issues in clear terms. 1. Does a potential investment by a foreign SWF in a major Swiss bank represent a threat that necessitates political intervention? From the SBA’s point of the view the answer is no, as the competition situation means that individual financial institutions are not strategically important. Even in the event of a – hypothetical – complete takeover of a major bank and a subsequent – even more hypothetical – decision by the new owners to withdraw completely from Switzerland, banking services would continue to be available in Switzerland. 2. Would this assessment change were SWFs to invest in several of the country’s larger banks? Answer: No, provided that the functionality of key financial sector infrastructures is assured. This refers in particular to supplying the public with cash, payment transactions, and securities trading and processing. Cash supply is assured given the large number of competitors and the high density of branches. Payment transactions and securities infrastructures are the responsibility of the banks’ joint organisations, which enjoy de facto protection against foreign takeovers due to their ownership structure and a shareholder agreement designed to ensure their long-term stability. The infrastructures would continue to function even if SWFs were to gain a major indirect influence over SIC and Swiss Financial Market Services13 via holdings in several major banks. 3. Could investments by foreign, ‘politically motivated’ SWFs in Swiss banks a) create serious political or reputational risks for the financial centre? Examples might be systematic abuses of bank-client confidentiality, undermining the fight against money laundering, terrorist financing or other types of serious fraud. b) constitute a systemic risk for the financial centre, for example if a bank were to become insolvent because it was intentionally or unintentionally run down? Answer to 3a and 3b: The existing range of SFBC powers, which extend as far as closing down banks that undertake illegal activities of this nature, should in principle be sufficient (see section 5.3). It also seems a plausible argument that “if political aims are to be achieved with economic pressure,…the power [lies] not with the creditor countries but with the debtor countries, not with the countries of the owners, but with those of the ‘items deposited’, and not with the home countries of … the shareholders, but with the countries in which the physical assets, human capital and know-how of the companies are actually located. ... In short, in the event of

13

“Swiss Financial Market Services is jointly owned by around 160 domestic and foreign shareholders, who are also users of the infrastructure. Such a broad-based ownership structure, whose long-term stability is secured by a shareholder agreement, underpins the company's commitment to its clients and the members of the Swiss financial centre.” (SFMS website)

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political conflict, only claims based on genuine control are actually worth anything. Purely legal claims – including co-determination rights under company law arising from strategic holdings – are extremely vulnerable.”14

5.

Does Switzerland need a set of defensive powers?

A growing number of industrialised countries seem to fear that state investments by thirdparty countries could have an impact on national security, particularly with regard to controls and know-how in respect of the arms industry, public and private infrastructure, high technology and financial markets, but also with regard to access to natural resources around the world. These fears are in principle legitimate. Although no such cases have been reported to date, it is not inconceivable that a country could use its SWF to acquire targeted holdings in strategically important companies and hence put itself in a position from which it can influence corporate strategy and transactions or control these companies’ assets and knowhow. Since this can impact on the national interests, and in particular the national security, of the target country, it is understandable that politicians in many countries are paying closer attention to the activities of SWFs. It is also possible that a takeover of a domestic company by a politically motivated SWF could have a negative influence on competition in a given sector, resulting in a loss of prosperity in the recipient country. The costs of an excessive defensive response are probably even higher, however, as the advantages of a liberal economic environment and free market access are enormous. Most developed economies already have effective rules in place to encourage efficient markets and competition. Transactions involving foreign capital and foreign entities are generally subject to the applicable national provisions on cartels, reporting and company management. Foreign companies are also subject to the full range of statutory provisions applicable to all firms operating in the legal area concerned, allowing governments to ensure that foreign companies and investors are in line with their national economic and competition policy targets. Recent experience has shown that the activities of foreign SWFs and the associated reservations in recipient countries are used to fuel protectionist fears that go beyond legitimate national security requirements. Protectionism is counter-productive, however. The movement of capital across national borders should only be restricted if it represents a danger to vital national or security interests. For each foreign holding, the decision as to whether or not this is the case should be taken on the basis of defined principles and an indepth analysis by the authorities as part of a structured, quantifiable assessment process that takes into account the usual timeframes for major capital market transactions. In particular, governments should be required to take their decisions within a reasonable period of time. Sovereign wealth funds themselves can do a lot to build trust in the countries and sectors in which they are keen to invest. The Norwegian SWF, for example, has been able to dispel any potential concerns about state investments by limiting itself to small minority holdings in individual companies and spreading its portfolio across a wide spectrum of financial institutions (said to be almost 4,000 different investments worldwide with a maximum

14

Jörg Baumberger, “Macht und Ohnmacht von Staatsfonds” [Power and powerlessness of SWFs], NZZ, 26 February 2008, p. 27

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holding of 5% of equity capital). Similarly, limiting its involvement in the target company’s management decisions to strategic issues – as part of the long-term goal of maximising the return on the investment – can be an important signal that a fund does not have any political ambitions. Should Switzerland establish its own sovereign wealth funds? The short answer is no. None of the reasons set out in section 3, which could under certain circumstances suggest that an SWF should be created (intertemporal stabilisation, diversification, return optimisation, transparency), apply to Switzerland. In a sense, Switzerland already has a private-sector equivalent to safeguard future generations in the form of the well-established system of 2nd pillar pension funds. These funds have been successfully managing globally diversified assets on a private-sector basis for decades. The AHV compensation fund also enjoys solid political support and is universally accepted. Switzerland is in the middle of the OECD index of restrictions on foreign direct investment15, but it is above-average in terms of the openness of its banking sector. Based on this international comparison, there is no need for Switzerland to implement measures against SWFs.

China India Russia Brazil Non-OECD Switzerland OECD Norway USA Japan France Italy UK Germany

National average (0=open, 1=closed) 0.405 0.401 0.318 0.195 0.189 0.174 0.148 0.144 0.119 0.101 0.094 0.073 0.065 0.063

With regard to FDI in the banking sector 0.550 0.350 0.550 0.400 0.211 0.110 0.157 0.105 0.275 0.075 0.094 0.144 0.067 0.072

The question of reciprocity of investment is likely to become increasingly relevant. With regard to Russia and China especially, such concerns are entirely understandable. The SWF issue has so far barely registered on the WTO radar, with very little attention paid to reciprocity. There are signs, however (the increasingly frequent appearances by EU trade commissioner Peter Mandelson in place of Charlie McCreevy, for example), that this subject will feature more prominently on the agenda going forward. The opening up of the emerging markets for foreign investment is one key aim of a raft of multilateral political initiatives, including talks relating to the WTO, the Doha round, the G8 summit, the OECD and a large number of bilateral negotiations. 15

OECD FDI Regulatory Restrictiveness Index, OECD WORKING PAPERS ON INTERNATIONAL INVESTMENT, Number 2006/4 (December 2006)

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To ensure comparable competitive conditions and prevent inefficient capital movements between countries, efforts at the political level should focus on creating free and open markets for foreign direct investment. Both investors and target companies can only benefit from the unhindered movement of capital across national borders, and symmetrical, open market access can play a key role in achieving this objective.

5.1

Legal provisions to prevent undesirable holdings and takeovers in the banking sector

Art. 3 of the Banking Act – duty to disclose qualified holdings Anyone wishing to acquire a holding of more than 10% in a bank is required to notify the SFBC in advance, as set out in Art. 3 of the Banking Act: “2 The licence shall be granted if: [...] cbis the natural persons and legal entities who directly or indirectly hold at least 10% of the bank’s capital or votes or can significantly influence its business activities in any other way (qualified holding) provide assurances that their influence shall have no detrimental impact on prudent and solid business activity […]. 5 Every natural person or legal entity must notify the Banking Commission before directly or indirectly acquiring or disposing of a qualified holding as defined in para. 2 cbis 16 in a bank that is subject to Swiss law. This duty to disclose also applies if a qualified holding is increased or reduced such that the holding reaches or goes above/below the thresholds of 20%, 33% or 50% of the capital or votes. 6 The bank shall disclose the persons and entities that meet the requirements under para. 5 as soon as it becomes aware of them, but at least once per year.” This ensures that the SFBC receives advance notification of a qualified holding for foreign investors and can enforce the requirement for a supplementary licence pursuant to Art. 3ter of the Banking Act (see below). Art. 3ter of the Banking Act – duty to obtain a licence in the case of foreign control A supplementary licence must also be obtained if at any time a foreign investor acquires a controlling interest in a Swiss bank17: “1 Banks which come under foreign control after being established require a supplementary licence pursuant to Art. 3bis. 2 A new supplementary licence is required for a foreign-controlled bank if the foreign investors with qualified holdings change. 3 The members of the bank’s board of directors and management must notify the Banking Commission of any facts that point to the bank being foreign-controlled or to a change in the foreign investors with qualified holdings.” bis

Art. 3 of the Banking Act – additional requirements in such cases Pursuant to Art. 3bis para. 1 of the Banking Act, the need for a supplementary licence in the event of foreign control is dependent on

16

Qualified holding: natural persons and legal entities who directly or indirectly hold at least 10% of the bank’s capital or votes or can significantly influence its business activities in any other way (Art. 3 para. 2 cbis of the Banking Act. 17 Controlling foreign interest: “if foreign entities with qualified holdings directly or indirectly acquire more than bis half of the votes or exercise a controlling interest in any other way” (Art. 3 para. 3 of the Banking Act).

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“a. reciprocity being guaranteed by the countries in which the foreigners with qualified holdings are domiciled or headquartered, provided there are no international obligations to the contrary; b. the company’s name not indicating or giving reasons to believe that it is of Swiss origin.” However, the reciprocity requirement only still applies to countries who are not entitled to GATS/WTO most favoured nation treatment. Intervention options available to the SFBC Provided that the licence requirements under national (and international) law are met, the SFBC must grant the licence; there is no scope for rejecting it on political or economic grounds. However, the SFBC can take the opportunity to review the general requirements in respect of the guarantee of irreproachable business conduct and if necessary conclude that they are no longer met. Pursuant to Art. 3 para. 2 cbis of the Banking Act this would be the case if “the natural persons and legal entities who directly or indirectly hold at least 10% of the bank’s capital or votes or can significantly influence its business activities in any other way (qualified holding)” can no longer “provide assurances that their influence shall have no detrimental impact on prudent and solid business activity”. The consequence of this would be revocation of the licence, but this would be limited to breaches of the guarantee of irreproachable business conduct and hence exceptional cases. The SFBC is therefore likely to maintain its open and liberal stance. Applicability of the same principles to securities dealers Art. 37 of the Stock Exchange Act states (subject of course to the provisions of the GATS) that: “A foreign or foreign-controlled stock exchange may be refused a licence if the countries in which the foreign stock exchange is headquartered or in which the controlling persons are domiciled do not grant the Swiss stock exchanges access to their markets and do not offer the same competition opportunities available to domestic stock exchanges. The same rules apply to the granting of licences to securities dealers.” Art. 56 of the Stock Exchange Ordinance also states that: “1 Stock exchanges and securities dealers that are subject to Swiss law are deemed to be foreign-controlled if foreign persons with significant holdings directly or indirectly hold more than half of the votes or exercise a controlling interest in any other way. 2 Foreign persons are: a. natural persons who are neither Swiss citizens nor have a Swiss residence permit; b. legal entities and partnerships that have their headquarters abroad or, if their headquarters are in Switzerland, are controlled by persons who meet the description set out under a. 3 Stock exchanges and securities dealers that come under foreign control at a later date must obtain the approval of the Banking Commission. The same applies in the event of any change in the foreign persons with significant holdings in foreign-controlled stock exchanges or securities dealers. 4 The members of the stock exchange’s or securities dealer’s board of directors and management must notify the Banking Commission of any facts that point to the stock exchange or securities dealer being foreign-controlled or to a change in the foreign persons with significant holdings. 5 Foreign-controlled banks are governed exclusively by the provisions of the Banking Act of 8 November 1934.”

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Conclusion There is in theory a way under supervisory law in which the SFBC can intervene to prevent a foreign investor acquiring a holding of 10% or more of the capital or votes. However, the SFBC would have to prove that the foreign investor represents a threat to the guarantee of irreproachable business conduct. It is likely to be extremely unwilling to do this, not least because as the authority responsible for supervising the economy it has no desire to shape economic policy and certainly does not want to be protectionist. Company law: Art. 692 para. 2 sec. 2 of the Swiss Code of Obligations – statutory restriction on shareholders’ voting rights Pursuant to Art. 692 para. 2 sec. 2 of the Swiss Code of Obligations, a company’s articles of association can “restrict the number of votes available to holders of large blocks of shares.” Peter Böckli (Schweizer Aktienrecht [Swiss Company Law], 3rd ed., 468) suggests the following possible clause in the articles of association: “A shareholder may cast the votes of at most 5% of all shares for their own shares and those they represent combined.” UBS’s articles of association, to give one example, do not contain a clause of this kind – it would be at odds with the principle of “One share, one vote” and perhaps also with the global aspirations of a multinational company. Conclusion A firm could in theory impose a voting rights restriction and ‘seal itself off’ to some extent from any undesirable investors (not just foreign ones) in the future. In reality, however, this option ceases to be viable as soon as the firm becomes dependent on the capital of these investors. History has shown that voting shares in particular do not offer any lasting protection against undesirable share acquisition.

5.2

Subsequent objections to a foreign holding that was originally approved?

The requirement for a guarantee of irreproachable business conduct in respect of controlling shareholders must – like any other licence requirement – be met not just at the time the licence is granted but on an ongoing basis. In the event of any subsequent breach of the guarantee, the licence must be reviewed. Art. 3 para. 2 cbis of the Banking Act contains an ongoing requirement that the influence of controlling shareholders “shall have no detrimental impact on prudent and solid business activity”. The SFBC can and must intervene if this requirement is no longer met. Even in this case, however, the requirement relates to economic supervision rather than economic policy. The controlling shareholder simply becoming ‘political’ is not grounds for the SFBC to intervene; the shareholder must actually destabilise the bank’s governance or finances.

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5.3

Do sovereign wealth funds threaten financial market stability?18

One aspect of SWFs that is increasingly coming under discussion is their potential impact on financial market stability. The SWF industry is more than twice the size of the hedge fund sector. In view of its size, and looking at the various players as a single, homogenous investor group, despite major differences in their market conduct, the SWF sector represents a systemically relevant portion of the global financial system. Given the size of certain funds and of certain holdings in these funds, this can even be said to apply to individual funds within the sector. The possibility cannot be ruled out that a single transaction by an SWF could trigger the ‘herd instinct’ among other market participants – thereby causing excessive capital movements and price fluctuations for the security concerned and, in the event of contagion effects, for correlated investments as well. In extreme cases such herd behaviour could lead to destabilisation of the financial markets at a regional, sectoral or even global level. Clearly, herd behaviour and contagion risks are not phenomena specific to SWFs and can equally be caused by other market participants. SWFs are less transparent than other institutions, however, and this increases the likelihood of the market overreacting – all the more so in periods of high volatility. State-owned institutions have in the past had a less than exemplary record with regard to transparency. One example of this is the secrecy of central banks in respect of the way they manage their reserves. Unlike central banks, however, SWFs invest in a much broader range of less liquid securities. Furthermore, central banks assume direct or indirect responsibility for financial market stability, which is a major incentive for prudent market conduct. By contrast, the stated aim of SWFs is to maximise the value of their portfolios over the long term, making them more similar to regulated and monitored institutional investors in this regard. But even compared with hedge funds – which as offshore companies are not subject to financial supervision or comparable reporting obligations and as a result have attracted criticism from various parties in the past due to a lack of transparency – information on the SWF sector as a whole and on individual funds is extremely scarce. As directly or indirectly controlled state-owned institutions, SWFs are generally not subject to the statutory and regulatory provisions that similar institutions, particularly investment and pension funds, are required to adhere to. This general lack of transparency is compounded by the fact that SWFs are increasingly investing in private equity, enabling them to circumvent even more supervisory restrictions. As a result, their reporting is usually inadequate and not systematic. Even informal market information on the strategies and day-to-day activities of SWFs is only available on a piecemeal basis. This is true in particular of fund allocation, intended transactions and the use of derivatives and leverage. All these aspects combine to make SWFs relatively opaque market participants that can trigger uncertainty on the financial markets. It is for this reason that political decision-makers and market participants are becoming increasingly concerned about the possible destabilising effects of the activities of major SWFs on the global financial markets. From a market perspective the most efficient solution to this problem is to increase the transparency of state-owned investment vehicles. In the case of SWFs this transparency is difficult to implement at international level, as it is driven by independent states, some of which are unlikely to be prepared to provide more detailed information on their investment activities. 18

Based on Deutsche Bank Research, op.cit.

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5.4

Restraint in international coordination

There is a consensus among institutions such as the International Monetary Fund (IMF) and the OECD that the IMF will focus on the transparency and governance of SWFs (drawing up a voluntary code of conduct), while the OECD is concentrating its efforts on preventing unnecessarily restrictive limitations on market access in the target countries (recommendations). However, the countries with SWFs have shown little support for a code of conduct. At international level, too, the watchword for Switzerland is restraint. Unilateral protectionist moves by individual countries must be avoided.

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Swiss Bankers Association Aeschenplatz 7 PO Box 4182 4002 Basel Switzerland T +41 61 295 93 93 F +41 61 272 53 82 [email protected] www.swissbanking.org