THE DUBAI CIRQUE DE SOLEIL, MASDAR INVESTS IN CLEAN ENERGY THAKSIN BUYS (AND SELLS) MANCHESTER CITY, and KHAZANAH AND TEMASEK BECOME GLOBAL FORCES:
GLOBAL CAPITAL MARKETS, SOVEREIGN FUNDS AND ECONOMIC REALIGNMENT in 2009

Introduction to Globalization and Capital Markets
Rotman September 9th 2008

Jim de Wilde
www.jimdewilde.net
 

              THE DUBAI CIRQUE DU SOLEIL:   The government of Dubai wants to make Dubai the centre of the world’s entertainment industry.   Cirque due Soleil has gone from being a fusion of Chinese acrobatic dance, street entertainment and Montreal creative cultural fusion to being a multi-billion global product.   The investment of the Dubai government in the Cirque is one of the Canadian business stories of the year and is filled with implications for the way the global economy operates.

THAKSIN ACQUIRES MANCHESTER CITY:  One doesn’t have to be a world football fan to know the commercial value of the positional good called an English Premier Division football team.  Abramovich’s purchase of Chelsea was the arrival of new Russian capital into the major centres of the world.  After Prime Minister  Thaksin Shinawatra left power in Thailand, having failed to manage the mix of globalization and privatization that comes from selling domestic telecommunications capacities to foreign (in this case Singaporean) investors,  he becomes one of the twenty-two owners of this unique positional good, in this case Manchester City.

MASDAR’s CLEAN TECH FUND: In the new planning for a post-oil economy, there is a tremendous advantage if one does not have to meet quarterly expectations.    In this new characteristic of the global economy, the Masdar Clean Tech Fund in Abu Dhabi is well-positioned for long term growth.

KHAZANAH AND TEMASEK BECOME GLOBAL PLAYERS:  The Malaysian and Singapore sovereign wealth funds are examples of new players with increasing global exposure and global interest.   A quick look at the Khazanah and Temasek portfolios shows that they are part of the globalization of investment expertise, and are new partners and players in the global economy.   Khazanah’s investment’s in Chinese waste-to-energy technologies this summer is another template for deal making and a good case study for this discussion. 

             
            There is a great deal of activity and growth in the global economy in the fall of 2008, from these kinds of case studies.    But there is also a real nervousness about how the global economy as we know it comes out of a perfect storm.  Several negative factors have come into play and we seem to lack a political consensus about how to deal with them.   This reflects the confusion in the way they are discussed in the world’s Business Schools.   What is going on and how do we analyze them more successfully?  As public-policy makers, as investment decision-makers, as citizens of the planet.   That is what this course is about.

            Let’s start with the perfect storm:
: 
             (i)  CDOs, the new derivatives and the tyranny of mathematical models:
badly understood financial instruments re-sold without adequate calculation of inherent risks in disguised “new models”,   the derivatives and mathematical model problem one more time but with higher stakes in a more fragile economy with the collateralized debt obligations (CDOs) at the heart of the mortgage and banking crises;           

            (ii)   The power of petro-capital in global capital formation: There is considerable uncertainty over the role of petro-capital in global capital formation.   This overlaps with the new role of sovereign wealth funds,  but speaks also to the insecurities of a world economy that has taken a long time to move from its carbon dependency and to a more financially stable and predictable source of energy.  The political   uncertainty over its role and function of petro-capital in the global economy   is once again with us.  The volatility of oil prices is the only constant as interruptions of supply can come from the Georgian route of the Baku-Tbilisi-Ceyhan pipeline, and even more importantly, the disinvestment from Russian oil and gas resulting from the Russian behaviour over the TNK-BP deal ;              

            (iii)  The rise of sovereign wealth funds has everyone dusting off their economic theory text books:   The rise of new sources of economic power in private equity funds in Europe and sovereign funds in China, the Emirates, Singapore and now possibly Saudi Arabia and the reemergence of new players from India, Brazil and Russia affects the investment market for acquisitions and mergers.  How will their pattern of investment differ, if at all, from that of Goldman Sachs or the Royal Bank of Scotland?   

            (iv)  Klepto-capital makes rational economic their and the natural efficiency of markets much more theoretical:  The increasingly disruptive effects of klepto-capital,  whether it is drug cartel money in Latin America, Afghanistan or southeast Asia,  the flow of currencies from para-state organizations in Russia and eastern Europe,  or petro-capital transformed into private wealth in, to pick the extreme case,  Equatorial Guinea.

            The convergence of all these phenomena mean that as political economy meets international finance, we are seeing a world which in unrecognizable through the lenses that marked the early days of globalization.

            Optimists, in which camp I count myself, say this is the growing pains of globalization.     Pessimists see some structural flaws in the way international capital is organized.   Until the optimists prevail, there will be continuing uncertainty in the global economy, and difficulty channeling capital to growth opportunities.

            The answers written on the op-ed pages of the world’s newspapers tend to be of three kinds:  (i) from academics who want to defend a particular intellectual perspective on the world (the importance of more tools for analysis of risk is a favorite); (ii) from institutional investors with a position to defend (hedge funds have not destabilized the system); and (iii) from a geopolitics based on nervousness about the rise of new centres of economic power and their accountability.

            In this course, we are closer to the third position, once again seeing a return to Schumpeterian political economy with its emphasis on the preconditions for innovation in rapidly changing markets and the economic psychology of Keynesians who understood that there is an art to consumer confidence.      The intellectual skills requires to navigate twenty first century capital markets are both analytical skills of political economy and a broad understanding of the economic history of innovation in capitalist economies and how that is applicable to the global economy we are currently designing through the day-to-day market decisions and the search for a new global financial architecture.

            Canada has to assess how the new trends:  the rise of sovereign funds and petro-capital,  the competing centres of capital formation with different systems of financial accountability,  the credit crisis caused by the failure of financial markets to measure risk in a manner that captured the fallacious assumptions of “technical”  (i.e. computer-driven) financial instruments.   Like CGI (computer-generated imaging) in films, they should be servants of the plot, not an end in themselves.      All the market-disrupting technological innovations (derivatives in the 1990s,   CDOs in the 2000s) were examples of the technology not serving the goals of value creation.

            The global economy in which we start this term’s analysis is one which is sorting out the misuse of financial instruments, the failure to create a capital market immunized from the impact of petro-capital, and the geopolitics of sovereign funds.     The fluctuation of oil-prices is a constant which will lead to more complex decision-making.  Let’s start with some trends which are going to impact throughout the next few months and then see what strategies are accessible to investors and financial decision-makers operating within the Canadian dollar-zone.    It also is hoped that the implications of this analysis apply elsewhere in B-Schools where the appropriate decision-making models for the 21st Century are being shaped.

            It is impossible to act effectively within the new political economy unless one has some sense of how these changes affect decision-makers.  Arnab Das of Dresdner Kleinwort’s July 2008 Financial Times essay on SWF (sovereign wealth funds) is an excellent starting point for a discussion on the range of future strategies in creating value in the global economy.    The analysis of the strategic decision of sovereign wealth funds creates a need for a different framework of political economy and international finance.  The Monitor Company’s report on the role and strategies of sovereign wealth funds makes an excellent starting point for analysis.    Let us add four case studies:

            (1)  Nakheel buys into the Cirque du Soleil  :  The Cirque has become a major content producer for Los Vegas .   It is a multi-billion dollar Canadian asset, whose expansion capital now comes from sovereign wealth funds based on Gulf Arab oil.

            (2)   Temasek helps Thaksin take control of Shin Corporation, Thailand’s largest mobile telecommunications company:   The economic nationalism engendered from the reaction to Thaksin and the Shin decision resulted in a change in Thailand’s government and an ongoing crisis in terms of economic integration in Southeast Asia.

            (3)   Norway’s sovereign wealth fund owns 1% of Europe’s assets:    The role of Norway’s steady, ethically-driven investment strategy has a profound implication on the development of European business.

            (4)   China investment in Blackstone a mixed success story:  This investment was part of a learning curve for Chinese investors, an excellent exit for Blackstone’s highly innovative founders and part of the integration of China into the global economy.

            (5)   How do capital markets create stability for energy pricing and investing?   J.P. Morgan’s President  Jamie Dimon’s proposal at Aspen that governments create a more stable capital market environment by taxing oil and gas to simulate the effects of rising oil prices and facilitate structural adjustment.

            Let us start with three basic observations:

            (1)  We are living in the twilight of the petro-state.  All the world’s economic activities are being targeted towards fossil fuel substitution.   But right now, the capital markets reflect the significant power of oil (Abu Dhabi, Norway and organized sovereign wealth, China, Singapore) are a significant part of capital formation in the world.     The formation of capital from resource wealth will be replaced by other aspects of global capital markets:  the formation of wealth from environmental conservation, from industrial ecology and conversion to agricultural productivity, real estate denominated transactions).    Right now, Abu Dhabi has wealth from oil which it can convert into venture capital that diversifies the UAE portfolio, as in the role of Masdar.
The next generation of capital formation will come from new financial techniques: 

(a)  Real estate value of common lands – e.g. what is the beach property of Namibia worth?  Who owns it?  

(b)  How much is it worth to pay Indonesia, Brazil or Papua and New Guinea not to harvest rain forests:   how much will the Indonesia Rainforest Conservation Sovereign Fund be worth in 2008?   How will it be capitalized?  What new bond and financial instruments will be required? 
(c)   How do we create incentives for the creation of agriculturally productive land from shrub and desert?  What is the ownership structure of the Sahel?  Will we have a Mali High Protein Yield per Acre sovereign fund in the year 2008?  How will it be collateralized?  

(d)  In the two decade long twilight of the petro-state, what will happen to the revenues coming from Sao Tome e Principe’s oil wealth?   How could it be turned into a Gulf of Guinea pension fund?  Who will the depositors be?  What principles of accountability will there be for the actions of the fund or will it be spent the way Saudi and Russian petro euros are currently spent?

            (2)  Cross-border investment instruments will transform many regional economies.  Let us take the example of Ogaden, the probably illegally transferred desert land “given” to the Ethiopians by the British at the end of the Second World War.  Now that it has oil, what are the investment models which could result in mutual benefits from economic development?

            (3)  The power of the capital markets inevitably triggers economic nationalist responses.  The Temasek-Shin case in Thailand is just the canary in the coal mine.   However, most of our economic theories treat economic nationalism as an inherently negative phenomenon, which means that theoretically we should let the Saudis and Chinese purchase anything they want in a highly liquid international marketplace.    Public policies will be designing market-sensitive economic nationalist instruments.  In this sense, the CDP model in Quebec and instruments like Norsk Hydro in Norway become if not prototypes, new templates from which we can design economic strategies in the emerging global economy.

            In a world where Thaksin leaves and buys a good English football team, and then sells it to an Abu Dhabi investment group, and where Dubai uses an innovative entertainment product from Montreal to establish its leadership over Los Vegas as a global entertainment destination, we are dealing with different instruments and means of value creation.   We are in a period of adjustment now to new patterns of growth and the instruments which worked in a different economic period have now proven to be toxic.   Collateralized debt obligations (CDOs), the so-called credit crunch, were clever little instruments for people with access to computerized trading to gain an advantage in a world of expansion.    The winners made 14.9% returns, the losers 14.3% returns.     Now we are in a different world requiring very different business strengths:  one of the fundamental new skills is an understanding of how global political economy and international capital markets combine to create new strategies and new sources of competitive advantage in the emerging really global economy.

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SOVEREIGN FUNDS, NEW PATTERNS OF GLOBAL ECONOMIC GROWTH AND HARMONIZATION OF RULES IN INTERNATIONAL POLITICS

Opening class Rotman course on Globalization, Capital Market Innovations and Sustainable Prosperity

Jim de Wilde

September 2007

www.jimdewilde.net

                        There are some new patterns of activity in the global economy.  The first is that there are new categories of growth activity, from motorcycle companies in India to design studios in Shanghai.   From investment behaviour, restructuring of petrochemical companies in Thailand and commercialization of resource production in Kazakhstan create new opportunities for investors.      A slowing of growth in the North American economy can be compensated by enhanced activities in new markets.     The competition for new investors can create an auction for assets.   This is what is called the management of global capital markets.

                        With this comes new challenges:  the globalization of labour gives a competitive advantage to those whose manufacturing facilities lack both unions and safety regulations,   the free movement of capital means that state-controlled capital from Dubai or China can behave the same way as savings-formed capital among institutional investors in Switzerland, Japan or Canada or personal investing from Canadians, Americans or Germans investing through public exchanges,  the concentration of expertise in the hands of private equity players and hedge funds creates new issues of accountability.

                        Let us start the course with some case studies that illustrate these changes in global capital markets, political economy and economic security.  From these we can start to discern future patterns of global economic activity, wealth-creation and financial risk:

(i)  Sovereign wealth funds and global investment hollowing out and reciprocity:  the role of sovereign funds has transformed the logic of trade and investment liberalization, but also assumptions about capital market activities and behaviour.     If we start by looking at the investment strategies of   Singapore and Dubai, Dubai’s oversees investment strategy, China and Qatar’s as case studies; we start to see the shape of new economic activity.

(ii)  Dubai attempts to buy the Auckland airport as a gateway for Pacific travel.  The bid is withdrawn, allowing a possible Canadian investment from Canada Pension Fund Investment Board. 

(iii)  China and Blackstone.   The Chinese government investment activities involve the substantial investment of Blackstone

(iv)  Qatar shops for Sainsbury.  The interest of Gulf capital in restructuring the European retain sector makes the Sainsbury case particularly interesting and relevant.

Sectoral restructuring:

(v)   Russian builder of nuclear plants. Atomstroyexport has developed a strategy for exporting nuclear reactors and in the process is reshaping the global nuclear energy industry.  The competitive structure of the market between Areva, Siemens, GE and Atomstroyexport are revealing of new patterns of global competition with implications for geostrategic debates about nuclear power.

(vi)  Thai petrochemicals.  Thailand’s plans to become a world leader in petrochemicals are another example of national strategies potentially restructuring global capacities in a key sector.

New capital market centres:

(vii)  FT on which Asian centre rivals NY and London .  The spikes in the global economy are creating substantially different roles for Asian markets.  Mumbai, Dubai, Singapore, Hong Kong, Shanghai are all developing new roles in the global economy.  The Dubai Investment bid for the OSX Scandinavian exchange reveals a similar set of strategic issues and challenges about the way the new global capital markets are organized.  

(viii)  FT hedge funds and private equity a line to Berlin.  The German government’s reaction to hedge funds and private equity investment has changed substantially since the Merkel government’s election and an election campaign which raised the question of the role of hedge funds and private equity in the most focused manner since the Malaysian government’s reaction to the role of hedge funds in the 1997 Asian financial crisis.

Political trends that affect global capital market strategies and regulation:

(ix) Estonia and cyber-sabotage .

(x) China and India compete for PetroKazakhstan.

(xi) China as a model for Iran .

            When one examines these eleven case studies, rather like a geological relief-map, one can see the way the world economy is being reshaped.

            (Case 1) The pattern of cross-border investments and M&A is changing with thee emergence of sovereign actors.   These will not behave in the same way as private equity funds or traditional M&A operations.   The importance of government continues to grow, and the difficulty of providing reciprocity (same standards in both jurisdictions) changes the way in which international capital markets behave.   The government of Kazakhstan can but through sovereign equity a real estate project in Canada. 

            Major changes in the financing of infrastructure are made by (case 2) players with large supplies of capital.   Auckland Airport, Dubai Ports activities in its acquisition of P&O leaving it with an ownership position in American ports are prototypical case studies of this new global economy.     

            The Chinese attempt to invest more in the profitable activities of private equity players like Blackstone ( Case 3) show that for China, Dubai, Kazakhstan, the Emirates are engaging in strategic investment activities.   The diversification process of the Emirates from oil and gas leads them into specific new markets like U.K. retail.      Other previous examples of this diversification come from quasi-state players like Kingdom Holding of Prince Al-Waleed    , through which his portfolio of publicly traded companies like Citigroup and Apple is held.   Kingdom is not yet listed on the Riyadh stock exchange.

            Similarly, the Qatar government’s acquisition of U.K. retailer Sainsbury (case 4) represents a substantial change in investment strategy for Gulf capital markets with implications for the valuations of European retail industry in particular.

            The restructuring of global industries, like nuclear energy (case 5) and petrochemicals (case 6) involve substantial numbers of new players emerging from areas where they were not previously market-forming actors.

            Investment banking and portfolio activities are also transforming where there are key areas of activity in the global economy, from the potential rivalries of Seoul, Mumbai, Singapore, Shenzhen, Tokyo, Hong Kong, Shanghai to the New York and London financial markets (case 7).  

            The changing attitudes towards longterm private equity players like Blackstone in Germany from “locusts” like hedge funds to the agents of creative destruction and regeneration of the German Economy (case 8) show how transformative the emergence of these new players has been.

            This all is taking place against a new backdrop of global politics, where non-state actors or actors with the passive backing of states can have severe economic impact.   The example (case 9) of the sabotage of the Estonian economy as the world’s first act of cyber sabotage makes a good starting point for this analysis. 

            The battle between China and India for ownership of the Canadian-formed Kazakh oil company Petro Kazakhstan (case 10) shows the new patterns of competition in the global economy.  

            The emerging China-Iran relationship as great empires attempting to modernize (case 11) also show some new patterns in the way that  the world political economy is evolving.

            The skills required to be successful in global finance in the future will require the understanding of the new trends of wealth creation and investment banking in the global economy.  These cases will focus on questions that are beyond this course or any business degree to resolve in their entirety:   (i)  how does the development of microgeographies, the development of remittances , and the globalization of labour markets affect currency flow and the conventional assumptions about capital formation in emerging markets; (ii)  how does the current credit-crunch in U.S. capital markets affect the relative power of hedge funds, sovereign equity funds and private equity in the operation of the international economy, on issues like privatization, cross-border mergers and acquisitions and sectoral consolidation?   (iii)  how does one achieve  a non-corrupt and predictable global capital market where innovation can be rewarded , entrepreneurs backed and large amounts of capital are not wasted through the kind of “oil curse” process of revenue transfers that have characterized other economic patterns?   (iv) What happens to the quantitative modeling on which much wealth management has been based when Chinese, Singaporean and Gulf capital market strategies operate according to criteria different from those which programmed the assumptions of the modelers.

            My view is that there are two new trends which are going to shape the global capital markets in the next decade:  the first is that the capacity to back entrepreneurs through global investment structures will change dramatically, leading to global venture capital models and strategic alliances between wealth-creating investors.   If this trend is encouraged by the expansion of microcredits and entrepreneurial philanthropy, we will see thousands of new wealth-created companies from Senegal to Surinam with capital structures very different from those we have imagined in the commercialization of technologies like Intel or Bausch in previous business-cycles.     For this to happen, the global capital markets have to have the information required to predict future sources of value and discover new entrepreneurs, but also the discipline and the non-corruption necessary for these companies to grow.      This may lead to entrepreneurial “spikes” in the global economy, where certain regions of the world become collaborative entrepreneurial science centres in the way Silicon Valley did in the past.   The Red Herring Asia list shows many of these new companies and a scale of potential wealth creation with obvious ramifications for the global economy.   The history of economic geography teaches us that even with web communication; geographical regions become hosts to entrepreneurial activities.  People like to socialize, exchange ideas informally,  live in a secure area, feel that they are functioning in a transparent and aggressively ethical legal culture and so zones will become magnets for activities:  Helsinki-Tallinn is one example, perhaps the development of a venture capital friendly zone in  Tianjin  is another,  the Dubai Internet City remains another, and the attempt to build Singapore-Malaysia-Indonesia economic development zones in the Riau islands may be another.  . 

            These may or may not succeed depending on the relationship they have with B-Schools, which remain the driver of so much commercialization of knowledge and the extent to which they develop a legal culture that makes possible economic growth.    But this first trend is exciting.    If Riau and Dubai were really competing to be the new Switzerland of wealth-protection and discipline capital formation, then there would be collateral benefits from all of us from this competition.

            The second trend is more complicated.  In investment banking, the ability to manage the borderlines between economic and politics are precisely what determines successful from unsuccessful activities.    Advocates of free trade have historically been naive about the ways in which domestic economies favour local actors:  the “non –political court systems of the United States”, the capacity to disguise subsidies in defense expenditures in many countries, including the United States and France,   a blame-outsiders mentality which kicks in when there is a crisis .     Consolidation of an international economy requires multilateral processes (perhaps institutions, but certainly processes) which ensure that there are transparent global rules.   This requires a new economic thinking.    Is a   billion-dollar investment from Lukoil the same as a billion-dollar investment from CNOOC or a billion dollar investment from Goldman Sachs or a billion dollar investment from a hedge fund in Connecticut?    One can talk about these questions as much as one likes,  but the reality is two of the past five Secretaries of the Treasury in the United States ran Goldman Sachs, and a third head of Goldman Sachs became a powerful Senator from New Jersey (and is now Governor of that state).   The Minister of Finance in France, Christine Lagarde, ran the Chicago activities of the international law firm Baker McKenzie. 

            This is all to say that the challenge is economics is the same as the challenge in international war crimes trials:  to establish an international rule of law which does not look like an imposition of rules designed by former colonial powers and the United States on other countries in the world.   On the other hand, weak international frameworks which take the lowest common denominator from the legal systems of Denmark, Australia and Equatorial Guinea make no sense in moral or economic terms.    This challenge lies at the heart of many of our concerns about the stability of the international financial system.  Some of us remain enormously concerned about the economic empowerment of regimes like that of Equatorial Guinea, which has the competitive advantage of geographical geology.   The Iraq war and the incompetence of the Bush Administration have served to obscure many of the key trends which need management if the global economy is to achieve stability.     Europe shows the potential in harmonizing the economic systems of Slovenia, Bulgaria and Finland, but also shows the tremendous challenges in doing this without ending up with lowest common denominator decision-making disguised as good-faith multilateral bargaining.

            The framework within which decisions are taking place makes the issues of this course even more urgent: for financial decision-makers, we are constantly assessing risks in various trends and how to position ourselves (in portfolio management, in assessing acquisition targets) in this topography of risk.    The political redesign of the global capital markets will be led by those countries with a stake in transparency because they are knowledge-rich, export-oriented democracies.   A Prague-Helsinki-Ottawa-New Delhi-Singapore collaboration could move beyond a council of democracies to be a steering committee for global financial market regulation.    If we fail to do this, the current trends will lead to a protectionist backlash as suspicion of CNOOC,  Temasek,  Dubai investment activities and the  export of Russian capital leads to , at  minimum, the establishment of different classes of capital in economic activity, and at a maximum, the restriction of foreign investment in generic terms, simply because that seems to be the easiest and superficially most popular policy initiative. 

            A global capital market where Dubai, Singapore, China played by the same kinds of rules as Swiss and Dutch banks in the earlier 20^th Century is potentially an exciting prospect, possibly ushering in a long cycle or economic growth and the chance to ameliorate global conditions by creating the preconditions for economic growth in corners of the planet.  Once again, a new generation of decision-makers has to learn that there can be no economic growth without efficient and disciplined global capital markets.