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06.19.2014 18:44

Closer Look: Audit of CIC Shows Its Corporate Governance Must Be Enhanced

While it's true the sovereign wealth fund should enjoy longer assessment cycles, the problems uncovered show a need for a more professional approach
By staff reporter Li Qing
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(Beijing) – China Investment Corp. (CIC), the country's US$ 575 billion sovereign wealth fund, has been blamed by the state auditor for flaws in its management of both domestic and overseas investment projects, leading to losses.

On June 18, the National Audit Office issued a report on CIC's operations in 2012. It criticized CIC for a series of irregularities in investment assessments, subsidiary operations, and personnel and financial management.

Internal and external supervision are crucial for a sovereign wealth fund like CIC. The auditor's report rings the alarm and should prompt the sovereign wealth fund to reexamine itself.

However, assessing the investment performance of a sovereign wealth fund is not straightforward.

The auditor says that inadequate due diligence studies and management were found in 12 of CIC's overseas investment projects from 2008 to last year. Six of the projects reported losses, and four had unrealized losses. The other two faced potential losses. The auditor also warned of insufficient management in CIC's other overseas deals.

Because the information provided by the auditor is brief, the details of the deals are unclear. The auditor should consider market rules when assessing overseas investment. Not every market-oriented investment can turn a profit, and this is especially so over a short period.

The mission of the CIC is to seek diverse investments and returns for China's huge foreign exchange reserves. To control risks, the CIC has emphasized its market-oriented approach and role as an investor in overseas deals. Thus, its supervision and incentive mechanisms should also follow market rules. Take Norway's sovereign wealth fund as an example. Its assessment is based on a comparison with market indexes for each sector, instead of an absolute return rate.

Assessments of most country's sovereign wealth funds are on long-term performance because frequent short-term assessments may cause problems with decision-making. In 2011, the State Council, China's cabinet, decided to extend the assessment circle from five years to a decade, and mainly base them on accumulated return rates. These changes fit the CIC's approach as a long-term, strategic investor.

Unlike its counterparts abroad, the CIC's position regarding investment scale, incentives and assessment mechanisms has never been clearly defined. Therefore, its operations and investment decisions easily become a target of intervention and questioning.

The auditor said in the report that by the end of 2012, US$ 10 million worth of the CIC's private equity investment returns stood off-book. The company was also found violating necessary financial procedures for payment of US$ 8.8 million in commission fees. Without detailed information, it is difficult to judge these issues. However, it is true that there has long been a gap between international standards and domestic rules that create flexibility for the CIC's operations.

The audit report offers a reminder that supervision at the CIC is inadequate, but it does not provide a fundamental solution.

A speech by the CIC's general manager, Li Keping, at a recent conference gets at the root of the problem. Li said that in order for institutions like the CIC to be professional investors, they need to be independent and responsible for their investment decisions. The CIC should also set up a professional investment and management team and decision-making mechanism. Furthermore, he said, it should stick to market-oriented operations, be free of intervention and have enhanced corporate governance.

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