Gov's can find management tips for their new stakes in financial firms in unlikely places

By Max von Bismarck and Ben Hoffman (chinadaily.com.cn)
Updated: 2009-09-16 10:33

They are not very fashionable, and not very sought after when it comes to advising Western governments in an economic crisis. Yet investment firms – criticized amid the financial turmoil - and the many governments not fully committed to Western capitalist models could just hold the answer to one of the most pressing issues faced by Western governments today: how to manage their newly held interests in financial services companies.

By engaging in dialogue with investment firms - such as private equity, sovereign wealth, pension and hedge funds - governments can benefit from decades of experience in taking stakes in private firms, influencing management, and exiting when the time is right. Similarly, much of the East has seen this story before – nationalizing banks to avert crisis and then reprivatizing them, or dealing with a partially private banking sector saddled with an unsustainable level of toxic assets.

Western governments lack experience in managing large and complex institutions. Moreover, academic literature suggests that government ownership in most cases depresses performance. With the stakes so high - $1 trillion of direct public investment in financial institutions and five to ten times that in asset purchases, guarantees and subsidized loans - governments should seek out expertise wherever it lies.

Partial nationalization was the norm in Southeast Asia during the crisis in the late 1990s. South Korea privatized its banking system and has been exiting partial government ownership stakes since the early 1980s. China has a wealth of experience shepherding the financial system for long-term growth and pursuit of social goals through an array of financial institutions with different levels of state ownership. In many ways, since the launch of banking modernization efforts 10 years ago, the Chinese financial system has been operating in the grey zone between private and public: managing a partially nationalized banking sector saddled with an unsustainable level of non-performing assets.

Now, much of the West is in a similar position and could benefit from global historical experience. Instead of retrenching behind our differences - rehashing the debate between free markets and state control - perhaps now is the time to focus on our shared problems and aspirations to find a more efficient way through the crisis.

There is also much to learn from the private sector. For decades, institutional and private investors such as pension, sovereign wealth, private equity and hedge funds have made significant investments in private institutions - from large minority stakes to outright purchases. While many of these investment funds have struggled through the crisis, they nonetheless have a time-tested playbook for making sizable investments in private firms, exerting some degree of managerial control, and walking away when the time is right. One question with which governments are now confronted is whether and how to influence management of institutions in which they have invested. UKFI (the agency tasked with managing HM Treasury's investments in RBS, Lloyds, Northern Rock and Bradford & Bingley) has adopted principles very much aligned with those of many institutional investors. In its July 2009 annual report, UKFI stated:"We believe that value will be re-established in the banks themselves, under the leadership of their own management and boards […] Our role as shareholder is nevertheless to ensure that the banks have sound long-term strategies, and that they are effectively managed and properly governed."

The real challenge is in converting principle to practice. Will government agencies tasked with ownership be sufficiently insulated from political pressures to focus on investment management instead of day-to-day management of the business? Do boards need to be reconstituted? How should governmental shareholders interact with boards? Institutional and private investors have walked this line for decades - at times more successfully than others. As with China, wholesale endorsement of the practices of all institutional investors is not necessary in order to engage them in dialogue for the benefit of all.

With trillions of dollars of government investment and the global financial architecture foundation needing repair, the risks and potential rewards could not be higher. It is imperative that all stakeholders in the current crisis advance the dialogue around the role of government both in the short and long term. Leaders of financial institutions, elected officials, taxpayers and all members of the global community who rely on the financial system - both directly for basic financial needs and indirectly as an engine of global economic growth - have a vested interest in the performance of governments with their new task. Let’s help them get it right.

Max von Bismarck, Director and Head of Investors, World Economic Forum

Ben Hoffman, Project Manager, Financial Institutions, World Economic Forum