Sovereign wealth alarm: will the big sovereign wealth fund surge lead to European protectionism?

• Author: Schonberg, Stefan

After hedge funds and private equity firms, European policymakers have been eyeing lately another source of foreign capital deemed dangerous for the well-being of their economies: sovereign wealth funds, a loose term to describe state-owned investment pools playing an increasingly significant--and controversial--role in cross-border investment. While assets held by governments in another country's currency are nothing new under the sun, the size of sovereign funds fed by "excess" foreign exchange reserves, accumulated by emerging market economies but not needed for short-term currency stabilization and liquidity management, has increased dramatically over recent years.

The International Monetary Fund estimates that presently such funds have $2-$3 trillion under management, and that their total size could reach some $10 trillion by 2012.

Sovereign wealth funds are a symptom of two phenomena: high oil and other commodity prices, and global macroeconomic imbalances. Both are set to stay for some time. While countries such as Russia and Saudi Arabia, significant exporters of oil and gas, will continue to profit from the rise in commodity prices, non-commodity exporting developing countries running big current account surpluses, like China, are accumulating vast amounts of foreign exchange reserves looking for longer-term investment.

What is giving headaches to European policy-makers is not only that a major proportion of the assets administered by sovereign wealth funds is concentrated in the hands of a small number of countries, mainly China, Russia, Norway, Singapore, and the major oil-exporting countries in the Middle East. There are, above all, misgivings about the ultimate intentions of foreign governments running such funds. Concerns are growing in Europe (and elsewhere among industrial countries) that the purpose of the investments might be to secure control of strategically important industries for political rather than financial gain. Also, the risk of an unwelcome transfer of sensitive technology has been cited if "key industries" in EU countries are being targeted by sovereign wealth funds.

In line with such concerns, European policymakers have demanded legal protection for sensitive industries against takeovers by foreign state-run investment funds. German Chancellor Angela Merkel, for instance, called such funds, worth double- or even triple-digit billions, a "new element" on international capital markets to which appropriate responses were needed. Also other European governments, the European Commission, and the European Central Bank have raised concerns, often diffuse, over the influence of sovereign funds.

However, what may appear a reasonable reaction to the European public, already worried by globalization and alerted by policymakers about the supposed risks involved in the activities of foreign hedge funds ("locusts") and private equity companies ("raiders"), poses in fact a threat of...