Understanding China’s Sovereign Funds with Dr. Zoe Liu

Zongyuan Zoe Liu is Maurice R. Greenberg Fellow for China Studies at the Council on Foreign Relations. She researches issues in the areas of international political economy, global financial markets, and energy security in East Asia and the Middle East. Dr. Liu is the author of Can BRICS De-dollarize the Global Financial System? (Cambridge University Press, 2022) and Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions (Harvard University Press, 2023). She is also a columnist at Foreign Policy. Dr. Liu received her PhD in international relations from Johns Hopkins University and she is also a Chartered Financial Analyst (CFA) charterholder.
Enya Kamadolli '26 interviewed Dr. Zongyuan Zoe Liu on February 28, 2024.
Photograph and biography courtesy of Dr. Zongyuan Zoe Liu.

How has China leveraged its sovereign wealth funds as a tool of power projection? Would you characterize these funds as primarily a geopolitical tool or an economic stability instrument?

They started as a risk mitigation tool, and over time have evolved. The very first time that China leveraged its foreign exchange reserves to establish a sovereign fund was to address the non-performing loan problem in Chinese state-owned banks. In the late 1990s and early 2000s, China's domestic state-owned banks accumulated a lot of non-performing loans. By international standards, the Chinese banks at that time could be characterized as insolvent. To address Chinese banks’ non-performing loan problem the Central Bank used foreign exchange reserves to capitalize a special policy vehicle and inject capital into those banks that were crippled by non-performing loans. In 2007, China leveraged foreign exchange reserves once again to create another sovereign fund called China Investment Corporation (CIC). The CIC was created with Ministry of Finance issued special purpose bonds, and then they used the bond proceeds to purchase foreign exchange reserves from the People's Bank of China and capitalized the CIC. On one hand, the goal was to diversify China's foreign exchange reserves. And on the other hand, the goal was also to invest in strategic assets in global markets, such as natural resources and foreign companies, as well as China's own indigenous tech companies.  As time went on, the CIC, in response to global changes and the changing economic landscape, partnered with host countries’ influential financial institutions. The purpose was to gain market access and to mitigate growing resistance to strategically motivated Chinese investment. In summary, it started as a risk mitigation tool to address a domestic crisis but later has evolved to take on new missions.

Do you think China’s sovereign wealth fund’s investment approach has been successful in decreasing aversion to Chinese investment broadly, such as BRI initiatives?  

The majority of China’s BRI money has been in the form of loans. China's sovereign funds support the financial institutions that directly participate in the BRI, including China's state-owned banks like ICBC, the ICBC, China Construction Bank, China Development Bank, Import-Export Bank, etc. Collectively, given all these Chinese financial institutions, China is now the largest creditor to developing countries. Although China's sovereign funds very rarely directly give out loans, they make equity investments into financial institutions that directly participate in BRI. Central Huijin is the major shareholder of all these financial institutions.

The approach of partnering with local funds and institutional investors offers a way to mitigate growing pushback against Chinese state-led strategically motivated investment. CIC and the Silk Road Fund have both pursued such an approach. Such partnership or joint venture has achieved some moderate success. In the US, it matters from a regulatory perspective that these joint ventures are viewed as domestic entities rather than foreign aliens. One successful example is China Investment Corporation’s partnership with Goldman Sachs, which was created during Trump’s visit to Beijing. For the US, 2017 and 2018 were watershed moments in US-China relations. In 2017, Trump basically cut off the high-level, bilateral dialogue: The Strategic and Economic Dialogue. But even during the intense deterioration of the US-China relationship, the joint venture between CIC and Goldman was able to materialize and make investment. 

In what ways are China’s sovereign wealth funds unique? And in what ways are they like that of other countries?

China's sovereign funds are different from traditional commodity-based sovereign wealth funds both in terms of where the money comes from, and how they are used and managed. First, traditional sovereign wealth funds – such as Abu Dhabi Investment Authority or Kuwait Investment Authority – are commodity-based, they invest natural resource wealth in the global financial market to better diversify. Those Gulf funds are also commonly managed by professional fund managers. In contrast, the source of China's foreign exchange reserves is not natural resources, but rather the export of manufactured goods. In other words, the ultimate source of money is the hard work of Chinese people. China’s process of creating sovereign funds entails the government taking on either explicit debt, like the issuance of special purpose bonds, or implicit leverage by basically re-characterizing the risk profile of foreign exchange reserves. Moreover, the way that Chinese funds invest is also very closely related to the government (i.e., the party's) agenda. Since President Xi came to power, especially since his launch of the BRI, Chinese sovereign funds have made investments that indirectly or directly support BRI projects. The one case that very concretely supported the BRI was the creation of the Silk Road Fund, which was specifically created to fund BRI projects and the source of money for the SRF was foreign exchange reserves. Although initially the funds were not a tool for geopolitical power projection, as these funds go global, so does China’s influence.  

Do you think channeling foreign reserves towards projects that serve the Communist Party's agenda in a political capacity is at odds with producing the greatest returns? Is this phenomenon what has been causing some of the major losses that in these sovereign wealth funds?

Because we do not have counterfactuals, it is very hard to measure any loss by the sovereign funds’ investments due to non-market motivations or purely strategic goals. The way that I think about fund management is that if you are a pure market-based actor, you cannot always underperform. But if you look at CIC’s performance, it often underperforms, and this is not unique among sovereign funds. This is partially because these funds are established with a broader mandate. This is not just true of Chinese funds. For example, some sovereign wealth funds have chosen to not invest in the so-called sin industries (such as tobacco) at all, despite the potential for higher returns. They want to invest in things that are good, that are sustainable, even though there may be better performing investments elsewhere such as hydrocarbons, especially since the war in Ukraine began. This is a major reason why sovereign funds may not outperform passive index funds. In the case of China, the Party’s agenda may include seeking to expand access to advanced technology in global markets, or securing access to strategic resources and commodities. In short, for all these sovereign investors, financial returns are not always their only concern.

Could you elaborate on some of the specific factors and goals that China considers when making investments using their sovereign funds?

When you ask the fund managers, they say “we are just another market participant.” CIC specifically reiterates that it is a voluntary signatory of the Santiago Principles, which is a set of rules established amid the global financial crisis when several sovereign funds came to rescue American banks. Essentially, by signing you agree that you only invest for economic reasons; you don't invest with strategic goals in mind. China does not always abide by this. After all, they set up the BRI and established the Silk Road Fund. However, I wouldn't narrowly characterize BRI as just a strategic tool in China’s foreign policy arsenal, because BRI itself started as a mechanism to address China's domestic industrial overcapacity problem. Later it evolved to serve other purposes, like strengthening bilateral relationships.  There is only one case in my study in which I discovered China explicitly using the sovereign funds to buy recognition or by love from a foreign government. This was the case of Costa Rica in 2008. At the time, Costa Rica had a diplomatic relationship with Taiwan instead of Beijing. The deal was that China would agree to buy Costa Rican government bonds in exchange for Taiwan cutting off its relationship with Taiwan. That triggered a lot of international backlash. Since then, I haven't uncovered such an explicit use of sovereign wealth to forward geopolitical goals. There is an implicit policy agenda, however, of ensuring access to raw materials, natural resources, and food security. Additionally, China also deeply cares about investing in foreign technology, which is related to strengthening China's economic and financial security while diversifying China's foreign exchange reserves.

In what ways do Western scholars and leaders misunderstand China's sovereign wealth funds and their goals? Often the West's conceptions of China can be characterized are “fear mongering.” Do we see that manifested in perceptions of China's sovereign wealth funds?

Fear mongering is prevalent. There is a lack of distinction between what is a private entity and what is not private in China. This lack of transparency is one source of this fear in the West. I wouldn't say that this fear is totally ungrounded, not only because of the lack of transparency, but also because many of these entities do have mixed ownership. Thus, it's hard to figure out which ones are and are not Party vehicles.  Certainly, measures that seek to stop Chinese investment into the United States or Europe and vice versa result in not only missed opportunities for investors, but also accelerate the trends of decoupling that are already taking place. Having an investment screening procedure to defend against undesired foreign investors was a watershed moment, and it constituted the recognition of the risk of Chinese strategically motivated investment. In Europe, this trend began after a Chinese appliance company called Media invested in one of the crown jewels of a German robotics industry called Kuka. It triggered a tremendous amount of criticism, which is why Germany played a very important role in drafting the initial investment screening.

Do you think the increased decoupling of the West and China will severely impact the performance and ability of Chinese sovereign funds to continue expanding their global reach? Do you predict a pivot to Southeast Asia, Central Asia, Latin America, or Africa?

China will still want to have access to Western markets, especially American tech companies. For a long period of time, China's rise depended on having relatively easy access to advanced technology provided by the West., However, those in Washington who prioritize national security over economic benefits are afraid of how Chinese influence might undermine US national security. Thus, China continues to seek out partnerships with American influential institutional investors, not only because the investments made by joint ventures are considered domestic transactions, but also because US democracy is shaped by lobbying. China is also working to partner with countries in Europe, Korea, and Japan that have advanced technology but less sophisticated review processes. The major downside of all this investment screening is the rise of industrial espionage. If you cannot have access to it and you're very interested in it --especially when the Chinese economy is slowing down-- industrial espionage may increase. There is a real risk and capacity for it in the status quo.

In general, are we seeing China’s sovereign wealth funds pivot towards mostly focusing on these direct joint ventures, like the one with Goldman Sachs?

Yes. Since Xi came to power, China's CIC has set up so many different joint -venture investment funds, not just with Russia, France, and Italy, but also the US and Latin American countries. In the context of BRI, China has set up joint venture investment funds like Industrial Corporation founded with countries in Latin America, as well as in Southeast Asia. There has been a rise, but to what extent can this trend continue given the current decoupling?

Lastly, what drove your initial interest in Chinese sovereign wealth funds?

When I went into my doctoral program, I wanted to study cross border pipelines. Eventually, however, I pivoted to study sovereign wealth funds since I was curious how these commodity-based economies manage their wealth. Then I found out that China --the world's leading commodity importing economy—also has established sovereign wealth funds. Where is the source of their money? My book takes the approach of “follow the money”. My research also focused on why China used foreign exchange reserves to create all these funds while Japan specifically said no to creating SWFs. The lesson for students is that going out of your research comfort zone is not a bad idea. You might stumble upon something new to you, and perhaps you can make your unique contribution to the world.

Enya Kamadolli '26Student Journalist

Andrey Filippov 安德烈 from Moscow, Russia, CC BY 2.0 <https://creativecommons.org/licenses/by/2.0>, via Wikimedia Commons


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