If gv put the oil & gas windfall to work

It is said that opportunity comes but once. Suffice it to say that the recent run up in oil and natural gas prices demonstrates beyond a reasonable doubt that opportunity to create long term wealth has emerged once more for Nigeria. Today, and conceivably for the next 3-5 years, Nigeria’s political leaders have a rare opportunity once more to make some transformational economic and institutional choices for Nigeria.

What would be the different choice Nigeria can make? President Obasanjo can demonstrate far sighted leadership by creating an independent asset management corporation – Nigerian Government Investment Corporation – owned by the Central Bank of Nigeria (and possibly the Ministry of Finance), to manage Nigeria’s external reserves and “excess crude and gas earnings.”

The question of what to do with Nigeria’s foreign reserves and excess crude oil earnings has being a perennial one which has never being satisfactorily answered. As a result, billions of dollars have being wasted on value destroying projects. With respect to “excess earnings,” or more accurately, temporary windfall earnings, a proposal to use a stabilization fund a la Chile has emerged from both the World Bank and Nigerian commentators on multiple occasions since 1991. The challenge with such a fund is that it does not represent a hard constraint against expenditure ambitions in that a percentage if not all of the funds are available for use should oil prices fall below budget estimates.

Watching the astronomical rise in oil and natural gas prices over the last 12-24 months, a number of commentators and political officials have called for the “sharing” of the assets. Others, who are more institutionally minded, including the Central Bank, have suggested husbanding the assets with the reformed commercial banks. However, the purpose of such a decision remains unclear.

Recruiting Nigerian universal banks to manage Nigeria’s foreign reserves may not the optimal solution. If the intent is to secure asset management services, then logically it would make sense to hire experienced asset managers. Few Nigerian banks have strong asset management capabilities, though some are in the process of building it. If the intent is to transfer liquidity to the banking sector and create a quasi-artificial demand for Naira denominated assets, it is not clear given the track record of the banking sector that they ought to be given such a responsibility either.

Furthermore, spreading the assets thinly across 10-12 banks may while supportive of the concepts behind the sector’s forced consolidation, be imprudent in that it represents a continued “cuddling” of the sector. Just as the banks should have taken the steps to drive mergers and acquisition activity, it is important that another round of asset dependence not be created by predicating a bank’s success on its ability to attract Nigeria’s reserves, just as in the pre-July 2004 universe, success was predicated on the ability to attract and arbitrage public sector funds.



Suggested Solution

A more efficient institutional solution would be to create a government owned but independently staffed and managed asset management company. The suggested name is Nigerian Government Investment Corporation (NGIC). The company would be given a significant percentage of current and future foreign reserves as well as excess crude oil revenues to invest in a range of asset classes within and outside Nigeria.

The intent is to ensure that the assets do not just earn the overnight lending rate, but actually participate in creating long term value. In return, the assets should earn at a minimum, the indexed return in the asset class in question. Sample asset classes include equities, bonds, currencies, private equity, hedge funds, real estate, venture capital etc. It is expected that depending on the asset class, NGIC should generate dollar denominated returns between 3%-30% over a multi-year investment period.

The goal of such a company would be to manage Nigeria’s assets to the risk adjusted parameters established in concert with the Central Bank (and possibly Ministry of Finance). Once created, the company will report to the CBN and the Presidency via quarterly and annual reports, but on a daily basis would be to free to hire and fire its own staff, train them (e.g. fund Chartered Financial Analyst designations), and nurture them as it chooses.

The company would over time fund the cost of its own operations from the asset management fees it charges its investors a la the Securities & Exchange Commission. The company should also be able to solicit or accept management mandates from other levels of the Nigerian government as well as African governments. In effect, the intent would be to build a world class asset management company that offers conditions of service comparable to any available in New York, London, Bahrain or Hong Kong.

Such a solution would not be unique. Two forward looking governments – Abu Dhabi and Singapore – are among the developing countries that faced with similar circumstances (growing oil wealth and high savings respectively) decided to create a mechanism for putting such assets to work.

Singapore: In 1981, The Government of Singapore created the Government of Singapore Investment Corporation (GIC) with the explicit mandate of reinvesting Singapore’s reserves. At inception, the company had just a few billion dollars under management. At present, GIC, with over US$100 billion under management, maintains offices in Singapore, Tokyo, New York, London, Beijing, and San Francisco and a staff cohort in the 100s. The company is divided into three separate companies reflecting their different risk profiles and investment mandates: Government of Singapore Investment Corporation, GIC Real Estate and GIC Special Investment. Sample cross-company holdings include Shell Refining Company (Federation of Malaysia), AT&T Corporate Center in Chicago, the Shiodome City Center in Tokyo, the Seoul Finance Center, South Korea, and as principal investor in the over $3 billion AIG Asian Infrastructure Funds.

Abu Dhabi Investment Authority (United Arab Emirates): The Investment Authority manages approximately $250-$400 billion for the Emirate. Some estimates have placed the funds under management as high as $600 billion. The funds represent initial and continued contributions from oil earnings as well as capital gains from investments the Authority has since exited. The funds are invested in both domestic and international assets. Sample holdings include stakes of 2%-3% in a number of Fortune 1000 Companies, and stakes in Walden International (a global private equity investment partnership), Worms & Cie, and Abu Dhabi Commercial Bank.

Today, these government investment companies are combining a mix of assets and strategic choices to grow wealth within their home countries, as well as participate in wealth creation opportunities in fast moving regions such as Brazil, India and China, as well as stable markets such as Japan, Europe and United States. For example, the Abu Dhabi Investment Authority has leveraged its asset base to push for assets which it acquires to relocate elements of their production or operations to the United Arab Emirates. In some respects, these institutions have become mechanisms for technology and process know-how transfers. For Nigeria, such a capacity is important; while it may not be immediately possible to engage in such knowledge transfer transactions, over time, as the funds under management grow, the NGIC’s influence will also expand.

The ability to concentrate assets and reputation under one brand name with global reach is an awesome power which Nigeria will not have access to should foreign reserve management responsibility be scattered among 10-12 banks, or the funds merely sit with JP Morgan Chase Bank in New York. In investing, track records are important, and the ability to participate in certain transactions depends on the relationship between the investor and potential opportunity. It is likely that with a track record, NGIC will have better results than 10-12 banks trying to achieve the exact same thing.

That said, in the interest of competition, the Presidency should offer the banking sector the opportunity to form consortia and capitalize 2 or 3 asset management firms which would compete against the NGIC for the reserves and excess funds management mandate. It is possible, subject to the pension legislation that the new pension fund managers should also qualify to manage foreign reserves. In such a scenario, individual banks would be shareholders in one of the asset management consortia, with bids for new mandates up for renewal every 3-5 years. Taking such a step would help to sterilize any idea that NGIC would become another government monopoly. The downside to the alternate pathway is the dilution of the leverage one blockbuster institution will have as the size of funds under management as well as investment track record after the fact are key calling cards of the asset management business.



Advantages of an NGIC

Stream of Income: The NGIC will in addition to investing in select domestic and global assets (subject to investment mandates), pay dividends and/or capital gains to its principal shareholder, the CBN/FGN a la NLNG. That stream of dividend income whether utilized as part of the Federal Government’s recurrent expenditures or reinvested represents a net gain that would not have being created where the assets earning an overnight rate at JP Morgan Chase Bank for example.

Institutionalizing Prudence and Managing Windfall Risk: Nigeria has never actively managed her foreign reserves to the nth degree possible. It is important that Nigeria recognize that having a reserve pool of almost $10 billion and an indeterminate “excess” crude oil and gas earnings pool grants her the wherewithal to become an institutional investor. As an institutional investor, such funds can be used to create wealth. Creating the NGIC will allow Nigeria to also support her capital market development efforts in that the NGIC will also hold Nigerian (and African) equity and bond securities. Holding these securities confer on the institution the ability to shape directional change in the market’s traditions and processes.

In the long term, creating the NGIC sets up a wealth creation mechanism that is government owned but independently managed to manage the periodic windfalls that emerge in natural resource markets. The failure to effectively utilize such windfalls have helped distort public sector behavior in the past and will quite probably do it again as demonstrated by the recent streams of pronouncements around how to “share” the excess crude revenue. By “sweeping” the bulk if not all of the windfall into a wealth creation mechanism whose track record over 2-5 years justifies the trust placed in it, perhaps this solution will start to shift the mindset of both public and private actors in Nigeria about value creation.

Exposure to Global Asset Classes: With a mandate to invest in currency, private equity, hedge funds, government securities, equity and corporate bonds, as well as real estate, the NGIC would be positioned to participate in every key investment trend globally. For example, exposure to the stock of shipping companies such as Teekay and Frontline would create an income stream associated with the rise in crude oil demand in China, India and Brazil, while ownership of bonds issued by Freddie Mac or Toll Brothers would bring access to the US housing market’s boom which is expected to continue driven by net immigration trends, and to a lesser extent by low interest rates. Ownership of Samsung shares in turn will provide exposure to South Korea and the growing global demand for electronics such as flat screens, iPods and next generation mobile phones.

Brand and Virtuous Cycles: Looking 10-20 years ahead, an NGIC brand associated with smart, strategic and careful investing means more opportunities that may normally be closed off will be accessible. Equally important is the information telegraphed to the world; for the world to be aware that a single institution is in charge of investing $50 billion in Nigerian funds sends a distinct message about importance and role, which in turn creates a virtuous cycle of access, importance and role for NGIC. The concentration of such assets under management invariably means such an institution cannot be ignored by the global investment banks conducting road shows, corporations offering high quality bonds, or world class private equity partnerships seeking new limited partnerships for example. In such a world, NGIC may become an information and relationship broker between foreign investors/know-how and opportunities in Nigeria.



InstitutionalCapacityBuilding: Both the CBN and Finance Ministry have complained about the inadequate supply of high quality financial analysts and economists in their respective institutions. The NGIC could help solve part of their problem, just as the world’s leading investment banks and consulting firms act as a the training ground for legions of private equity and venture capital investors. The NGIC could become one of many “training institutions” for sourcing future senior Ministry of Finance and Central Bank of Nigeria officials, and vice-versa. The requirements to be a successful asset manager – knowledge of financial markets, macroeconomics, understanding enterprise strategy, analyzing financial statements, assessing investment risk – are consistent with the skill set and experience base necessary to run world class public sector institutions such as the CBN and MoF. It would be in Nigeria’s best interest to take the steps over a 3-5 year horizon to build up such capabilities.



Requirements for Success

Independence: The NGIC must be free to act on its own with respect to management of the assets, timing of investments and exits, equity and bond investments to hold etc. Equally, and perhaps more important, the firm must be free to hire talent from across the globe as necessary as well as determine their compensation in line with global asset management practices.

Effective Board of Directors: The CBN (and MoF, with input from the Presidency) should select a skilled and effective Board of Directors that would provide both governance support, as well as technical “wisdom.” To that effect, at least a majority of the membership of the Board should be individuals with a keen understanding of global economic trends, asset classes, risk management, leadership, and value creation. Ideally, these individuals should be balanced with other members with the insight to navigate the political terrain of Nigerian governance, as well as reassure international markets that Nigeria is a worthwhile investment partner.

Establish Clear Performance Metrics: It is important to establish clear performance metrics for the NGIC. For example, such a metric (and associated mandate) would be to deliver a performance that is at least 400 basis points above the performance of the S&P 500 Index or a similar comparable index (Russell 2000). Such performance mandates can be established for every asset class e.g. CSFB Tremont for Hedge Fund investments, MSCI for international equities, Nigeria’s All Share Index etc.



Conclusion

The NGIC’s organizational design should be a reflection of the rollout and growth strategy envisioned by its founders. An aggressive rollout would require that the essential capabilities required to be successful 5-10 years ahead of the curve be put in place right away, while a more leisurely growth path would call for sequenced introduction of capabilities. Is creating an NGIC risky? Yes such a step is risky. The principal risk of utilizing such a structure is the potential to lose the principal invested, as well as asset class specific risks. Such risks can be managed by specifying risk parameters and adhering to these, as well as using the Board of Directors to diligently support NGIC’s operations. In the long term, however, the greatest risk is not acting to place the reserves and “excess crude and gas earnings” out of harm’s way. Nigeria’s painful history around windfall earnings dictates that we act wisely to immunize our children’s future from ourselves.



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