News analysis: The (Chinese-owned) road to riches
China is targeting European 'recovery' infrastructure assets - but not as you might expect.
China Investment Corporation (CIC) chairman Lou Jiwei announced in the past few weeks that the $410bn (€309bn) sovereign wealth fund planned to ignore European leaders urging it to buy debt and focus instead on infrastructure.
There are a couple of good reasons for it to do so. If reports of Lou's speech to the Chinese Economists 50 Forum are correct, the leader of the fifth-largest sovereign wealth fund believes infrastructure will benefit from the "recovery" - or, with respect to price and terms, from economic instability.
Thus far, CIC has focused, like most sovereign wealth funds, on 'traditional' infrastructure assets. It started relatively early with a 2009 investment in a Kazakh gas firm and followed it up with equity investments in Canadian energy via Penn West and GDF Suez, which gave it exposure to gas, water and power in Asia. Last month, it acquired a stake of just under 9% in Thames Water.
Yet even traditional infrastructure assets are hardly a risk-free investment. Energy, utilities and other infrastructure assets accounted for $20bn of sovereign wealth in 2011, including some of the largest transactions. But First State in a recent report pointed out that the most sought-after assets - utilities - come with potentially significant regulatory risk. Pricing for assets including ports and airports is likewise vulnerable to macroeconomic uncertainty.
Keith Pickard, portfolio director at InfraRed Capital Partners, which manages listed infrastructure firm HICL's portfolio, rejects investment in pure infrastructure in favour of social infrastructure. "Public sector infrastructure has a low credit risk, and it doesn't matter whether the building is occupied, as long as the lights are on."
CIC has already explored the potential of alternative energy sources with a 20% shareholding in solar firm GCL-Poly Energy. Yet many investors are sceptical about the immediate potential for the renewables market, even aside from the regulatory risk in evidenced in the past few years in the Spanish market.
How CIC invests is also undergoing modification. Up to now, the fund has focused its infrastructure investment on small equity holdings acquired from existing investors, often via subsidiaries, in economy-critical energy companies. Now, it is looking to build new assets. In November, Lou announced that CIC was looking for fund manager or public-private partnership projects in UK infrastructure, including a potential commitment to the UK's £30bn (€36.1bn) National Infrastructure Plan launched last autumn and going nowhere slowly.
Significantly, Lou is still focusing on the UK as the most mature and least protectionist of European infrastructure markets. "If, [as in the UK], you're looking to attract outside investors, it mitigates the risk somewhat," Pickard said. "If you're looking for new money, it makes you far less likely to want to change the rules." Likewise, Marko Maslakovic, economic research senior manager at TheCityUK, sees no reason why the UK's largely open invitation to overseas capital would change.
Yet although Lou has indicated that he believes European protectionism is a thing of the past, Chinese premier Wen Jiabao believed it was enough of an issue to reassure European leaders, after his meeting with German chancellor Angela Merkel, that China would not "buy" Europe. Earlier this month, China's acquisition of a 25% stake in the privatised Portuguese electricity grid led to accusations in parliament that the government was handing over not only the grid but also Portugal's honour.
There are risks for the investees, too. CIC is a commercial, rather than a political, investor, with additional injections of capital predicated on performance. Yet the People's Bank of China recently acquired a stake in CIC in return for injecting $50bn into the fund. It is yet unclear what - and whose - influence comes with the stake.
The sovereign wealth fund itself is undergoing change. Its real estate division is haemorrhaging personnel, including its head, Patrick Wu, just a few months after his appointment. Lou himself has been tipped as a future finance minister - a role that, were he to covet it, would give him a significant motivation to keep China's political masters on-side.
CIC distinguishes between strategic and tactical investments. While China has a significant interest in not seeing its major export market collapse, buying influence and driving a wedge between US and European interests are undoubtedly also motivations, not least because of the US policy of containment over Taiwan and what the Chinese government perceives as political interference in domestic matters. (For the eight years to 2011, the US was the destination of the largest volume of sovereign wealth.)
Even aside from the economic arguments for infrastructure assets, they could at the very least give China more political leverage than being a major creditor. Creditors as often as not get the sharp end. "But if you own the rubbish collectors, you can make governments smell pretty bad," said one former central bank economist. "Control over employment and investment provide leverage bondholders might lack."