LegiStorm

Summary:

China established its major sovereign wealth fund, the China Investment Corporation (CIC) on September 29, 2007—six months after it first announced its intention to create such a fund. Financed with $200 billion in initial capital, the CIC is one of the largest sovereign wealth funds (SWFs) in the world. The creation of CIC was somewhat controversial in China. Both the People's Bank of China (PBOC) and the Ministry of Finance (MOF) reportedly wanted the CIC under their authority. In the end, the CIC reports directly to China's ruling State Council. However, as part of the interagency struggle, it was decided that the CIC would have to make significant purchases in several state-owned banks, as well as purchase the Central Huijin Investment Corporation (CHIC) from the PBOC. Although some of the CIC's initial investments were apparently political in nature, the CIC's top management have repeatedly asserted that future investments will be commercially based. The CIC and its subsidiaries have made several investments, including the purchase of 9.9% of the U.S. financial firm, Morgan Stanley, on December 19, 2007. Meanwhile other government-owned entities in China—including the State Administration of Foreign Exchange (SAFE)—have started to act like sovereign wealth funds and have been making sizable overseas investments. According to top Chinese officials, the CIC was created to improve the rate of return on China's foreign exchange reserves and to prevent the nation's excess financial liquidity from contributing to domestic inflation. Depending on its performance, the CIC may be allocated more of China's growing stock of foreign exchange reserves in the future. However, its first-year results have raised questions about its investment strategy and calls for administrative reforms for CIC. A number of experts in international finance have expressed some concern about the recent growth in SWFs and China's creation of the CIC. Analysts have cautioned that major shifts in SWF investments could potentially disrupt global financial markets and harm the U.S. economy. Other experts are less concerned about SWFs and the CIC, and welcome their participation in international investment markets. China has responded by maintaining that the CIC will prove to be a source of market stability. China has also stated that it has no intention of using its SWF to disrupt the U.S. economy or global financial markets. There have been calls for greater oversight and regulation of the activities of SWFs. The International Monetary Fund (IMF), in consultation with many of the leading SWFs, has developed a set of voluntary "Generally Accepted Principles and Practices" (GAPP) for the operation of SWFs. The Organization of Economic Cooperation and Development (OECD) has drafted policy guidelines for countries that are recipients of SWF investments. Some international financial experts have suggested elements to be included in such guidelines, including standards for transparency, governance, and reciprocity. Other experts have suggested that the United States should review its current laws and regulations governing foreign investments in the United States, and possibly implement special procedures or restrictions on proposed investments by SWFs. These include financial reporting requirements, limits on SWF ownership of U.S. companies, restrictions on the types of equity investments SWFs can make in U.S. companies, and special tax provisions for SWFs. This report will be updated as circumstances warrant.