The Regulation of Sovereign Wealth Funds: The Virtues of Going Slow

Any symposium on private-equity firms and the going private phenomenon would be incomplete without discussion of Sovereign Wealth Funds (SWFs). These governmentowned investment vehicles have and will continue to play an important role in the going private phenomenon. SWFs have not only helped fuel that phenomenon through their participation as limited partners in private-equity funds and hedge funds, but their massive capital infusions into ailing financial institutions and private-equity firms in the wake of the subprime mortgage crisis may, in a very real sense, save it. It is not hyperbolic to suggest that the future of private equity—including the going private phenomenon—and the future of SWFs are inescapably intertwined. Misguided regulation of the latter will, quite foreseeably, operate to the detriment of the former. And the scope of potential mischief is broad.

SWFs have existed for decades, but today they face heightened scrutiny due to their recent rapid growth and a concomitant shift in their investment strategy from primarily conservative debt instruments to higher risk/reward equity investments. This shift in strategy has stoked fears in the United States and Europe that these funds—which find home primarily in the Middle East and Asia—will use their economic clout to pursue political goals. This type of rhetoric has led some to call for increased regulation of SWFs.

In this Article we argue against imposing any additional burdens on investments by SWFs in the United States, at least at present. In our view, at this point a policy of watchful waiting is preferable to any immediate effort to impose special restrictions on SWFs. On the one hand, the nightmare scenarios painted by SWF critics often involve activities that would be caught by existing laws, either as they relate to national security or to various forms of business regulation under the securities and antitrust laws. On the other hand, we do not possess perfect foresight and cannot say that every possible permutation of SWF investment should escape a regulatory response in the future. What we do know, however, says that the burden of proof lies on those who think that further prophylactic regulation is in order at this juncture. To date, SWFs have acted as model investors, and the risk that they may act strategically in the future is significantly mitigated by existing safeguards. A far greater danger to America’s economy and security inheres in taking unnecessary action that would encourage SWFs to redirect their investments elsewhere, or to harbor resentment toward the United States that could express itself in a wide range of hostile actions.