Risks faced by institutional investors
"Global investment rules are typically bilateral and fragmented. There is no universal system of investment rules, and bilateral investment treaties are blatantly on the wane."
Tu Guangshao, former vice chairman and president of China Investment Corporation (CIC) and member of the board of IFSWF, talks about the major risks sovereign wealth and government funds are facing today.
"As an old Chinese saying goes, better take away the firewood from under the caldron than try to stop water from boiling by skimming it off and pouring it back." Tu Guangshao commented that a comprehensive risk management system can to some extent ease the negative impact of risks on institutional investors.
He added that solidarity and common efforts among institutional investors to build an open, fair, stable, transparent and friendly investment environment are very important:
"This could change danger into safety, risks into opportunities."
It has been over 10 years since the China Investment Corporation (CIC) was established in 2007. How has CIC’s approach to risk management changed over this time? What factors have driven those changes? Are there any new risks now than they weren’t sizeable when CIC was established?
Since its inception, CIC has weathered major risks including the global financial crisis, the European debt crisis, and the end to the commodities supercycle. But its investments overseas have withstood the challenges. This is attributable to the risk management system that was put in place in the very early stage of CIC’s development. It also helps that CIC has constantly refined and improved the system in the spirit of craftsmanship, forming a comprehensive risk management system featuring sound mechanisms, clear processes, solid defence, early warning and refined management. Independently, CIC also developed its comprehensive investment management system – the Risk and Performance Analysis System (“Fengye System”). This enables CIC to carry out pre-investment risk identification and assessment, as well as and post-investment risk monitoring and warning. CIC also put in place a risk factor system, improved various risk management instruments, and constantly improved risk management capabilities from the total portfolio perspective. As risks are becoming more complicated, we are also striving to add technologies like big data analysis, cloud computing, cloud storage to our toolbox for risk management.
Can you tell us a bit more about CIC’s risk management philosophy?
As an old Chinese saying goes, better take away the firewood from under the caldron than try to stop water from boiling by skimming it off and pouring it back. A comprehensive risk management system can to some extent ease the negative impact of risks on institutional investors, but it requires solidarity and common efforts from institutional investors to build an open, fair, stable, transparent and friendly investment environment to deal with the root cause. This could change danger into safety, risks into opportunities.
Do you think that political risk in developed markets is increasing? If so, how do you think this situation is currently affecting investment decisions by long-term investors like SWFs?
Trade and investment, economic interconnection and supply chains have all benefited from globalisation. But this process has also caused development imbalances among nations and regions, and among citizens for some countries. Left unresolved, these problems have given rise to protectionism and unilateralism. Some countries are alarmed by globalisation, and there are even examples of besmirching and blocking, causing shocks to the global supply chains. In addition, the effects of recurrent geopolitical events are sprawling into the global economic system, and institutional investors face greater legal, compliance and security risks, and their confidence in investment is shattered.
Do you think that transaction costs are likely to rise and investment opportunities diminish as some countries contemplate imposing tariffs and limits on international trade and greater regulatory burdens on foreign investment?
There are generally high uncertainties in the regulatory environment for foreign investment in major investment recipient countries. Global investment rules are typically bilateral and fragmented. There is no universal system of investment rules, and bilateral investment treaties are blatantly on the wane. In the meantime, international investment disputes are frequent and often. The odds of the court ruling in favour of institutional investors in investment dispute cases are relatively low. Some countries implement more stringent regulation and review rules against sovereign wealth funds’ cross-border investments and even expand the scope of review through reform and legislation in a bid to impose limitations on foreign investments in key technologies and infrastructures. They have thus set man made barrier for the free flow of capital around the globe.
Some sovereign wealth funds believe that cybersecurity is now a key risk for them to address and factor into their investment strategies. Do you agree, or do you think is it simply an operational risk?
The technological revolution is leading the adjustment of global economic structure. It is not only changing our lives but also profoundly shaping the development path of human beings. Traditional and emerging industries, century-old enterprises and unicorns, and people’s lives and industrial structures are all subject to the effects of profound and fundamental changes brought by artificial intelligence and big data among other new technologies. Along with the era of data, ransomware like Petya and Wannacry, and cyber-attacks are evolving at an unexpected pace and are hurting the financial markets and can be more harmful to the whole system in the future.
Do you think sovereign wealth funds are more exposed now that we are “late in the economic cycle” to market risks?
Since the 2008 crisis, central banks have resorted to quantitative easing on a large scale. This, while providing a stimulus for the economy, has resulted in excessive liquidity. Now that the global economy has embarked on the path of recovery, central banks have begun to shrink their balance sheets, which is expected to prop up long-term interest rates, increasing corporate financing costs, tightening liquidity, and causing spillover effects on financial markets. Recently, there have been major episodes of heightened volatility in the economy and financial markets, and significant ups and downs in main stock indices. Concurrently, after a 10-year upturn, global asset valuations are high and prices face more downward pressure. Also adding to the picture is the increasingly fierce competition among sovereign wealth funds for alternative investment. Therefore, the expected return targets of sovereign wealth funds are generally lower. At the current stage of globalisation, any risk element will have spillover effects and ripple effects. We expect the aforementioned risks to linger, overlap and interact, hurting the global economy.
How can international organisations such as the International Forum of Sovereign Wealth Funds (IFSWF) play a role in reducing risks long-term investors are facing today?
Members of the IFSWF are mostly beneficiaries of globalisation. It is the common mission of guarding against protectionism that brings us together to formulate and unswervingly promote the Santiago Principles. Today, faced with more severe challenges, we call for advancing the new globalisation by inclusiveness, innovation, cooperation and mutual benefits. In the meantime, as long-term institutional investors, we should beware that challenges and opportunities coexist in long-term investments, uphold our solemn commitments to the Santiago Principles, tap into our advantages of having a long-term investment horizon, low demand for liquidity, and a high risk tolerance to ease short-term swings in the financial markets, and play the role of a stabiliser of the international financial market. Above all, we should take advantage of the IFSWF as a key platform for multilateral cooperation, strengthen peer cooperation, optimise investment philosophies, and make common efforts to improve institutional investment capabilities by sharing research finds on hotspot issues of investment such as technological innovation, addressing climate change, demographic changes, and geopolitical issues.