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Monday, February 4, 2008

GIC takes long-term, responsible approach

Jan 28, 2008
GIC takes long-term, responsible approach

GIC's deputy chairman, Dr Tony Tan, spoke with ST Deputy Editor Warren Fernandez and correspondent Bhagyashree Garekar about the key themes at this year's World Economic Forum meeting in Davos, which wrapped up yesterday. Here are excerpts from the hour-long interview:

THE whole issue of sovereign wealth funds (SWFs) is a matter of great concern at this year's Davos forum. Our view from Singapore is that these concerns over SWFs are valid and have to be addressed.
In the past, when there were only a few SWFs - Kuwait, Abu Dhabi, Singapore - there really wasn't very great discussion about them. Because obviously, Abu Dhabi, Kuwait, Singapore are too small to have any impact on economies or politics of the United States and Europe.

But now new funds are being set up - China, Russia, possibly more of the Middle Eastern countries. So it's understandable that there should be some worries about what the SWFs will do.

Do they have a political agenda, are they investing for other than commercial and financial reasons?

Our view is we understand these concerns, we believe the situation concerning SWFs has changed fundamentally, and that it's best to bring it out into the open.

Last October, at the IMF- World Bank meeting in Washington, the US Treasury Secretary convened a dinner at which several SWF countries were present, including Singapore as well as, I believe, the OECD countries and representatives from the IMF and World Bank.

Mr (Hank) Paulson suggested that the IMF and WB be tasked to work out some codes or best practices for SWF and their investments.

In general, Singapore supports this initiative. We believe it's a good starting point. Whatever code will arise remains to be seen, but our view is that it should not be too prescriptive.

The code should be general, it should be flexible. To an extent, it should be voluntary because SWFs are not the same, countries are not the same. Even the definition of SWFs hasn't been agreed.

GIC, I suppose, is a classic example of an SWF. We are a fund management company. We manage the foreign reserves of the Singapore Government. But the other entities, such as holding companies, state pension funds, are sometimes classified as SWFs, sometimes not. It's still a very vague area. But we believe further discussion is helpful, not only with regard to the SWFs, but also with regard to the recipient countries.

The big danger is that if we do nothing, then these worries build up, and may lead to some form of financial protectionism where barriers may be erected to hinder the flow of capital. I think this would be detrimental to world trade and to the world economy.

Different countries have expressed different views of SWFs. In Europe, Germany and France seem to have some reservations. Britain seems to be very relaxed about it. The Prime Minister of Britain, Mr Gordon Brown, has just been to China and has suggested that Chinese Investment Corporation set up an office in London and that Britain welcomes investment from China.

In the US, various congressmen have made some comments and, of course, it's an election year so the candidates who are vying for the Democratic and Republican nominations have also made some comments, basically to catch the headlines. So everything is in a state of flux.

That's why we think discussions should go on to clarify a lot of confusion regarding this area. What is important is that whatever code of practice is set up, it should not disadvantage the SWFs.

There has been a suggestion that copying the model in Norway, which is transparent for their own needs, the SWFs should be required to publish all of their shareholdings. I think that will not be fair.

It will not provide a level playing ground if other funds, hedge funds, private equity, hedge fund managers by Wellington, Capital group do not have to do so. And they will put the SWFs at a competitive disadvantage. So we don't think that it is necessary.

But even with a code of practice, it'll still be a code, what is more important is how each of the SWFs conducts itself.

In the case of GIC, because of the way it has conducted its operations over the last 27 years, it is generally well regarded as a professional investor. GIC is not a trader like a hedge fund.

Neither are we a strategic investor which takes stakes in companies for strategic or political reasons. We are a long- term financially-oriented investor. And the companies which we have invested in have generally welcomed GIC as a responsible, supportive investor.

GIC's general preferred mode of operations is to take a very low key, take stakes on a relatively small scale. Less than half per cent in a large number of companies.

We made two investments in December and January, in UBS and Citigroup, which is a bit unusual. This is a departure from our norm brought by an unusual set of circumstances. But it does not change the way in which GIC intends to conduct its investment operations.

New environment

THE environment in which GIC was able to operate in the 1980s for example, where we kept very much below the radar and actually there was very little notice taken of GIC, is the way we would like to conduct our business.

But we also know that with all these worries now, we cannot. We have to change some modes of our operation. The Ministry of Finance (MoF) has agreed that in the coming months, GIC will disclose more. We'll be more transparent in some of our operations. We have already put up a lot of information on our website but we'll probably do more.

For example, with regard to our rate of returns. The last time we announced our rate of returns was in 2006, when GIC chairman Minister Mentor Lee Kuan Yew, at our 25th anniversary dinner, announced that on average, GIC had made a return of 9.5 per cent in US dollar terms each year for the last 25 years; 5.3 per cent on real return rate, accounting for inflation.

It's impossible to do it only once in 25 years, we'll do it at regular intervals. But we've not yet settled on how often we should do it, probably won't be every year.

Because GIC is a long-term investor, it doesn't make sense to report year-to-year figures which may vary widely. So we'll probably do it in some form of average 10-year return. But we still have to settle this, discuss it with MoF.

New code

IT'S STILL at the very early stages. First of all, we don't think the one-size-fits-all code of practice is going to work. Countries are too different, the SWFs are too different. So we would suggest that we should start in a very general way with a code of practice which is flexible and to some extent voluntary.

We have also stated our view that what is important is to clarify the purpose of the investment made by each SWF. What is the reason, what is the motivation? Is it for commercial gain, financial reasons or is there any other agenda? We think that is fundamental.

The second area in which we think there should be more disclosure is governance. How is an SWF governed? To whom is it responsible? In the case of Singapore, of course, GIC is responsible to MoF which provides the funds. We manage and pay GIC a fee for managing the funds.

It should be quite clear what the role of the board of directors is, what is the role of management, and that we'll provide more information.

We're in the process of starting to draft some form of document which will provide more information in these areas. We still have to agree on the areas with MoF, but we would expect, hopefully, to make available more information on GIC's process, governance purposes of investment by possibly in the second quarter of this year.

GIC's recent investments

GIC has always had a very conservative approach to its investments. Today we conduct our investments under the risk parameters which have been specified by MoF. We adhere rigorously to these risk parameters. We don't breach them at all.

When we consider an investment, we always look at the risk first, whether it comes within our risk management framework, whether it is not excessive. Having decided that the risk is acceptable, then we look at the return. Our philosophy is if you look after the downside, the upside will look after itself.

In the case of two large investments in UBS and Citigroup, we have structured our investment in the form of convertible notes which pay GIC a rate of return over the next few years before we convert the notes into shares in UBS or Citigroup.

So this gives us a downside protection which we think is necessary in these turbulent circumstances. It doesn't mean we have taken no risk at all, we can't. If we take no risk at all, we would do nothing at all.

Our job is try to minimise risk as much as possible and we've done so in the case of UBS and Citigroup. But then the risk is if something terrible happens to Citicorp or UBS, and they go bankrupt, then we would have lost the investment.

But if we try to eliminate all risks, you will do nothing at all and keep all your money in cash, which is just as risky because then, if inflation is high, oil price is US$100 (S$144), then you'll face steady erosion of the purchasing power of your reserves.

SWFs not saviours for troubled banks

I SHOULD make it clear that when GIC invested in Citigroup and in UBS, we did so because we thought this was a good opportunity which only comes maybe once in two or three decades.

GIC did not do these investments to bail out the banks or to help stabilise the US financial system. With our investments, with a stronger capital base, we expect the prospects of UBS and Citicorp being able to overcome their problems, return to normal levels of profitability, will become more possible. It's good for all shareholders, including GIC. But I don't see SWFs riding to the rescue of the financial system in the US or in Europe.

For us in Singapore, GIC has a responsibility to the Government and the people of Singapore to make sure the funds which are entrusted to us are managed for the good of Singaporeans. It's not our job to try to be a white knight, to save the world's economic systems. That's the job of the IMF.

Why major banks turned to SWFs

WHEN a bank raises capital, it's different from a company raising capital. The bank has to do it quickly and the bank must succeed because banks run on confidence.

I'm sure that when the management and boards of directors of UBS, Citigroup, Merrill Lynch, Morgan Stanley decided to raise capital to rebuild their capital base after their writedowns over their mortgage-backed securities, they must have thought first - can we do it from our shareholders through a rights issue? That's the obvious thing to do. But a rights issue is uncertain and takes a long time.

Under the circumstances, the management decided this was not possible, and they decided to approach SWFs to see if they can inject the funds at very short notice. The fact that this has been done has helped the banks.

GIC's US$16b cash for investment

WE HAVE been very worried about the financial markets for many months. We thought the level of leverage in the US market was excessive, risk was not being priced correctly, asset prices were going up at a rate which was not sustainable. These worries have been growing over the years.

In the second quarter of last year, looking at all of these developments, we took a fundamental review of the GIC portfolio. Up till then, GIC had been fully invested in the markets. They had served us very well, giving us very good returns.

But under these circumstances, we felt we should move towards a more conservative portfolio and convert part of our equity holdings into cash, which is something we have not done for many years. We did that in the third quarter of 2007, in order to raise cash - because we were very worried about the outlook for the economies and the financial markets.

Even as late as the third quarter, the markets were still doing well - there had been modest falls, but they were still strong. Then in the last quarter, everything fell apart. By that time, we had raised a considerable amount of liquid resources. So when the invitation from UBS and Citigroup came to invest in their equity, we had the resources.

In retrospect, GIC was right in determining the direction in which the market would go. What surprised us was the fact that when the markets actually turned, they did so at such a speed and the contagion effect was so broad that they affected even the best-known and well-regarded banks such as UBS, Citigroup and Morgan Stanley.

There are worries about what happens in the first six months of this year, and we are right to be concerned.

But my real worry is the second six months...that's the real test. If it goes down in the first six months and it recovers, then I think we're all right, it's a downturn, but I think we can manage that. If it continues in the next six months, then we're in new territory. We don't know what will happen.'

GIC's decision not to sit on UBS board

WHEN we agreed to the investment of 11 billion Swiss francs (S$14.2 billion) in December, a seat on the board was not a condition of the investment. Subsequent to the investment, UBS chairman (Marcel) Ospel wrote to me to invite GIC to nominate a representative to be elected to the UBS board of directors. This was in December.

Over the last few weeks we have considered the invitation seriously. And our view is that as a financial investor, investing not only in UBS but also in other banks, and in the light of our intention to clearly not seek any control of UBS, or to have a say in the direction and management of UBS, we've decided that we will not be taking up a seat on the board.

I saw Mr Ospel on Thursday, thanking him of course for the invitation, but informed him that GIC will not be taking up his invitation. He said he understood the reasons and he agreed that under these circumstances, it's best for GIC not to accept.

We feel we have adequate access to the UBS board and management as a shareholder. As a shareholder, we've a right to express our views. We already have a small investment in UBS, in less than half a per cent of their equity, even before this large investment. We give our views. But we have also been making it very clear to them that these are views as a shareholder.

It is up to the management and the board of directors to make the decisions. They are the ones who are running the bank, we are not running the bank. And we want to make that clear. By not having a seat on the UBS board, I think this clarifies the situation.

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