International Review of Law - 2 - Special Issue on Sovereign Wealth Funds, April 2015

Global capital is on the move and sovereign wealth funds, with significant assets, are uniquely positioned to take advantage of the increase in mergers and acquisitions activity, especially in the United States. At the same time, major acquisitions in the US by foreign investors, including sovereign wealth funds, face a key challenge in the Committee on Foreign Investment in the United States (CFIUS or the Committee). CFIUS vets foreign acquisitions of US businesses for national security concerns, and “national security” is a term that is not defined by CFIUS statute or regulation. With increased sovereign wealth fund investments in the US, it is important for policymakers and investors alike to understand the potential roadblock that the Committee presents to foreign investment and for investors and potential US targets to develop an appropriate strategy to approach CFIUS when contemplating an acquisition.

In a recent appellate court decision, Ralls v. Committee on Foreign Investment in the United States, the US Court of Appeals for the District of Columbia Circuit held that the Ralls Corporation (a Chinese-owned and controlled company) had been deprived of its property without due process when the President (at the recommendation of CFIUS) ordered Ralls to divest its interests in certain US wind farm projects on national security grounds. The court held that under the Fifth Amendment Due Process Clause of the US Constitution, Ralls was entitled to receive both the unclassified evidence that was the basis for the government's decision and an opportunity to respond to this evidence. The case is still ongoing at the time of this writing; thus, the full impact of the decision remains to be seen. It is noteworthy, however, as the first legal case ever brought against CFIUS, and because the court's holding is relatively unusual in an area – national security – in which US courts traditionally defer to the executive branch.

Part I of this article provides the history of CFIUS's statutory and regulatory authority; how CFIUS determines jurisdiction over a particular transaction; and the review and investigation process, with special emphasis on the treatment of sovereign wealth fund transactions. Part II examines the recent D.C. Circuit Court decision in Ralls v. Committee on Foreign Investment in the United States and analyzes the decision's implications for foreign investors, including sovereign wealth funds. It concludes by emphasizing that although the Ralls litigation is ongoing at the district court level, the proceedings should, at minimum, result in an opportunity for foreign investors to have increased engagement with CFIUS, which may lead to more informed decision-making by CFIUS. At the same time, as Part III discusses, the decision does not at present change the importance of certain strategies for sovereign wealth funds navigating the CFIUS process to maximize the opportunity for success.

Especially since the start of the second decade of the twenty-first century, once more we have seen more focused interest in the use of SWFs by home states—less as a means of projecting sovereign financial power outwards and more as a means of internal financial management, and development. What makes this interesting from the perspective of SWF development is the role of International Financial Institutions (IFIs) in SWF development. This article takes a first look at the way in which IFIs have also begun to use SWFs in their interactions, with a emphasis on developing states. A review of some recent efforts to establish SWFs with a stabilization or development focus suggests the way in which these funds now may better serve the project of fiscal and governance internationalization, and the development of global policy coherence around the fiscal ideologies of IFIs, rather than as an instrument of national policy. Part II briefly sketches the IFI's interest in and approach to SWFs as a part of their investment, capacity building and rule of law toolkits. Part III then reviews the manifestation of this approach in the development of SWFs in a number of developing states. The article suggests ways in which stabilization and development SWFs may better serve financial globalization than the particular interest of states establishing them precisely by transposing global standards of fiscal and governance behavior into the internal workings of states. In this sense, development and stabilization SWFs serve as an instrument of globalization from the top down (through IFI policy operationalization) perhaps as effectively as SWFs that seek to project national financial power through private market investments abroad. But it also creates the possibility of divergence in SWF character as the consequences of the use of SWFs as governance devices may produce substantial deviation from the traditional organizational parameters of SWFs as instruments of macroeconomic policy.

Sovereign Wealth Funds (SWFs), as they have come to be known, are a hybrid type of foreign investor. They invest beyond their own borders with an aim to maximize returns as a foreign investor is expected to. At the same time, they are closely associated with governments, by ownership, source of funding, and/or investment objectives. Even as within this group, individual SWFs take various forms and may have divergent investment priorities and risk approaches. There is not even a universal definition of SWFs. As a result, they are often not viewed as typical foreign investors. The association of a SWF with a foreign government has raised various issues such as national security, trade protectionism and nationalism in the recipient countries. At the same time, due to the government ownership of some SWFs, they may fall into the group of business entities known as state-owned enterprises (SOEs). Given that SOEs are highly influential in some states, some recipient states have sought to subject SOEs to greater disciplines, such as in ensuring competition law and transparency principles apply to them, in order to level the playing field for other enterprises. Such disciplines have begun to appear in trade and investment treaties, and are coupled with the usual broad definitions of “investor” in such treaties. It is perhaps too early to state that there is a trend of greater legal and cross-border scrutiny over SOEs, and along with them, SWFs, in treaties. The Trans-Pacific Partnership Agreement that is under negotiation is an example of a potentially game-changing treaty which could affect SWFs qua SOEs. The challenge for SWFs is to carve a distinct identity in the twenty-first century, as more treaties that impose binding requirements arise. This article examines some recent developments, how SWFs may need to forge a unique identity and challenges of recipient states in balancing investment openness and the above concerns.

As the influence of Sovereign Wealth Funds (SWFs) is increasing in the world economy, the legal problems between the possessing States and recipient States become very important. The famous Santiago Principles are self-pledges of the governance and activities of SWFs by the possessing States and do not regulate the legal problems between the possessing States and the recipient States. This article considers the following relevant problems from the point of international law: (A) restrictions on foreign investment, (B) sovereign immunity, (C) taxation and (D) responsible investment.

As to (A), although restrictions on foreign investment for national security reasons is generally permitted under international law, they should be guided by the principles of non-discrimination, transparency of policies and predictability of outcomes, proportionality of measures and accountability of implementing authorities.

As to (B), when SWFs are involved in a civil action concerning holding shares in a company, they cannot enjoy jurisdictional immunity. This is because holding shares come under participation on companies in the United Nations Convention on Jurisdictional Immunities of States and Their Property.

As to (C), there is no established rule of customary international law whether SWFs are granted exemption from taxation in recipient States. State practice is mixed. Some States including Japan do not categorically grant exemption from taxation to SWFs, but grant it to specific SWFs based on bilateral tax treaties.

As to (D), Norway's Government Pension Fund Global and New Zealand Superannuation Fund are faithful to the method of responsible investment. The heart of its responsible investment lies in the disinvetement and negative screening in particular. The disinvestment does not constitute unlawful intervention under international law.

Finally, the balance of interests between the possessing States and the recipient States has to be kept in order to attain an equitable result. The concept of equity, although somewhat ambiguous, can play an important role in this field.

Sovereign Wealth Funds (SWFs) lie at the cutting edge of a tectonic transformation in global business and international law embodying the sweeping changes in the global order. Illustrating the new financial and legal paradigm, SWFs demonstrate the blurring of lines between public actor states and private market actors. Ostensibly entrusted with the advancement of the public good of their respective citizenry, SWFs traditionally invested their vast pools of capital in apolitical, non-controversial, conservative government debt. Starting around 2006–2007, SWFs initiated an aggressive campaign of diversification and commenced allocating their immense investment capital into equity markets, real estate, energy projects, farming and private equity. This significant change led to SWF investment becoming inextricably linked to strategic industries in recipient nations. Simultaneously, apprehension developed in capital recipient nations with respect to potential non-financial motivation of SWF investment and the interrelated national security implications. In response, SWFs emphasized that they were not interested in exercising control over companies or countries, voluntarily limited their stakes, and expressed intent to embrace a passive shareholder approach. Since plowing into various investment markets, SWFs have generally acted cautiously and refrained from activist conduct which substantially obviated concerns over undue foreign control in host states. However, SWFs have recently undertaken a more activist investment approach comparable to other large investors. While the SWF activism is profits-centric, the behavioral shift reintroduces anxieties with respect to foreign government influence over political decision-making in host nations as well as undue dominance over strategic industry and infrastructure. Moreover, given their titanic financial strength, even profits based investment raises concerns over SWF dominance and influence over financial markets, portfolio companies and economic sectors.

In the United States, securities laws mandate disclosure and regulatory approval for certain transactions. Such laws afford regulators an opportunity to review investment activity and provide an alert to ascertain whether the investor is in compliance with rules and regulations. In light of the budding activism, it is timely to examine whether securities laws need to be updated. What are the ramifications of SWFs working with other SWFs with respect to acting in concert and group action? Are SWF investors sufficiently different as to justify heightened regulation? This article will examine current US regulatory policy, identify potential shortcomings in light of the developing investment climate, and concludes with suggested reforms.

The variety of investments made by powerful Sovereign Wealth Funds (SWFs) is often directed to the globally booming service sector which is regulated by the General Agreement on Trade in Services (GATS). This paper analyses the scope, substance and procedural rights which may benefit SWFs. The basic principles of World Trade Organization (WTO) law provide a legal framework for regulating SWF investment while the members' specific commitments may provide significant liberalization. These positive elements for SWFs are tempered by the existence of exceptions and the relative shortcomings of state-to-state dispute settlement in the WTO and the lack of retroactive remedy. However, the paper shows that far from being perfect and complete, the GATS provides an international basis for SWFs to devise their investment strategies and an ideal forum in which to obtain further liberalization in current negotiations.