Testimony of Roger W. Robinson Jr.
Before the California State Joint Legislative Audit Committee
January 5, 2000
Since the 1980’s, emerging market economies, like those of China and Russia, have become increasingly sophisticated in the way they finance their respective governments and affiliated companies — transitioning from reliance on syndicated commercial bank loans and Western government funding vehicles to the private capital markets (i.e. the issuance of stocks and bonds). Through these new venues, large sums of money can be attracted at relatively inexpensive rates with often minimum disclosure regarding where the money is going or how it will be used. As of December 17, 1999, CalPERS held in portfolio some 70 Chinese companies – all but one listed on Hong Kong Stock Exchange — with an estimated market value of over $750 million.
The pace of emerging market companies and sovereign entities tapping our capital markets was slowed temporarily by the financial crisis which afflicted these markets in 1997-1998, but is expected to surge again this year, at least with respect to China. To underscore this point, China has already issued over $14 billion in dollar-denominated bonds (the bulk of which are held by US investors) and will be seeking to come to market with well over $10 billion in dollar-denominated equity offerings in 2000 alone, the probable majority of this sum on the New York Stock Exchange.
Regrettably, not all of the emerging market players seeking to enter our capital markets are benign, commercial operations. Some have ties to potentially hostile national militaries and intelligence services or have links to proliferation activities, money laundering, organized crime, technology theft, arms smuggling, state sponsors of terrorism and other global bad actors. This fact was confirmed last year by the bipartisan Select Committee on U.S. National Security and Military/Commercial Concerns with the People’s Republic of China, chaired by Representative Christopher Cox. Among the troubling implications of this statement is that Californians — through CalPERS or other publicly-managed state funds — may be holding the equity or debt of Chinese government-affiliated entities engaged in military modernization efforts, espionage, technology theft, human rights abuses or other activities inconsistent with American interests and values.
This burgeoning concern is by no means confined to China or Russia. Indeed, even Iran has announced its intention to return to the global financial markets for the first time in some 20 years with a $300 million sovereign Eurobond offering. A second bipartisan commission convened to assess the organization of the federal government to combat the proliferation of weapons of mass destruction, chaired by President Clinton’s former CIA Director John Deutch, concluded in its report last summer that, "The Commission is concerned that known proliferators may be raising funds in U.S. capital markets…Because there is currently no national security-based review of entities seeking to gain access to our capital markets, investors are unlikely to know that they may be assisting in the proliferation of weapons of mass destruction by providing funds to known proliferators. Aside from the moral implications, there are potential financial consequences of proliferation activity — such as the possible imposition of trade and financial sanctions — which could negatively impact investors."
Advocates of human rights and religious freedoms are also alert to this new financial challenge. The bipartisan U.S. Commission on International Religious Freedom, in a 20 December 1999 press release, announced the establishment of a Capital Markets Task Force, in large part out of concern that certain international oil companies, such as Talisman Energy Inc. of Canada, may use funds attracted in the U.S. markets to help finance their corporate activities in terrorist- and slavery-sponsoring Sudan. It should be noted that our preliminary survey of the CalPERS portfolio indicated that as of 17 December 1999 the fund held some 203,000 shares of Talisman, valued at approximately $5.4 million. Similarly, Colorado’s State Treasurer has recently called for the creation of such a task force to assess the extent of this potential problem with respect to Colorado’s public pension systems and what steps, if any, should be taken.
Representatives Spencer Bachus (R-AL) and Dennis Kucinich (D-OH) have introduced legislation (HR 2204) entitled the "US Market Security Act of 1999" which would merely require that the names of foreign government-affiliated companies be provided quarterly to relevant Congressional committees. These members also sent letters and pertinent attachments to every state treasurer and attorney general in the country in August and again in November of last year urging a security-minded review of state equity and debt portfolios.
It is interesting to note that on 14 June 1998 the South China Morning Post published the result of its investigation of Hong Kong companies with direct or indirect ties to the Chinese People’s Liberation Army (PLA) and broader military establishment. It reported, "Nearly 200 Hong Kong companies have been identified as being linked to PLA or Chinese defense industries. And experts predict a rise in the number of mainland groups with military or aerospace connections — as well as in supporting industries — opening ‘window’ companies in the SAR [Special Administrative Region]. The links of PLA Inc. and defense and aerospace conglomerates run deep into corporate Hong Kong, giving them access to international markets and technology."
It is clear that shrill charges of "modern-day ‘McCarthyism’ at its worst" — of the type leveled at Investors Business Daily by Mr. Valdes [CalPERS Chairman] — will not solve these growing security and human rights challenges. Arguably, the least disruptive approach — which would not impede the free flow of capital into and out of the United States and minimize the need for government intervention — would be the voluntary adoption of new security- and human rights-minded "due diligence" by U.S. investment banks and fund managers, including those in California.
In the case of California, an audit of international equity and debt holdings of CalPERS and other publically-managed funds would be prudent to determine if a significant problem exists and, if so, its dimensions. It might also be useful to establish legislatively a "Capital Markets Working Group" or similar such consultative body, comprised of relevant legislators, public pension and other portfolio managers, and the Office of the State Treasurer. Such a working group could convene as needed to review past or prospective purchasing decisions should credible security and human rights concerns be in evidence. Promoting greater communication among the interested parties is, in any event, a valuable undertaking.
It is inevitable, particularly in the Internet age, that the employees and residents of California — as well as those of other states — will increasingly want to understand better to whom their money is going and its end-use. This is especially the case with respect to state holdings in foreign companies and government-affiliated entities. Although the federal government has been delinquent in assuming its responsibilities in this area and needs to do more, public portfolio managers and legislators at the state level cannot simply walk away from these growing challenges.
The largest pension fund in the United States, TIAA-CREF, and the Texas Retirement System recently discovered this reality the hard way — notwithstanding stated policies of not responding to such "external, non-financial pressures" — when they reportedly could not sustain their holdings of Talisman Energy because of the company’s relationship with the odious Sudanese regime. Although there are no claims contained herein that a fool-proof system of vetting questionable emerging market entities can be configured at the state, or even federal, levels, a good-faith effort to strengthen transparency and dialogue in this area could avoid some of the most troubling abuses of the US capital markets as well as help safeguard the public portfolios of California and other states.
Roger W. Robinson Jr. is the President and CEO of RWR Inc., and former Senior Director of International Economic Affairs at the National Security Council.