Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Libya assets freeze: will other sovereigns start hiding assets?

I have been thinking about whether the moves by many countries to freeze Libyan assets could cause many sovereigns to start hiding their foreign assets (including assets held by foreign exchange reserves as well as sovereign wealth funds). First of all the asset freezes:

  1. The action began in Switzerland on Thursday (February 24). The text of the ordinance is in German, but the media release says:

    In order to avoid any misuse of state monies, the Federal Council decided today to block with immediate effect all assets in Switzerland of Moammar Gaddafi and those associated with him. The sale and any disposal of goods – in particular real estate – belonging to these persons are also prohibited with immediate effect. The Federal Council thus intends to take all the necessary steps to avoid any embezzlement of Libyan state assets that may still be in Switzerland. The corresponding ordinance will take effect today and will remain valid for three years.

    Apparently, most Libyan government assets were pulled out of Switzerland a couple of years ago because of a dispute between the two countries. So the impact of this freeze is minimal but it is of huge symbolic significance.

  2. The next day (Friday), the US followed up with a freeze very similar to the order used against Iran in 1979. The US order covers deposits with US banks outside the US, but in the case of similar sanctions back in 1986 (coincidentally against Libya itself) a UK court ordered the London branch of a US bank to release the assets and the US accepted this verdict.

    Some reports have suggested that the US was waiting to close down its embassy in Libya and bring most of its citizens back before doing the asset freeze on Friday. Similarly, it has been suggested that the UK had delayed action on a similar freeze while it tried to get its citizens back. This is important because the majority of Libyan foreign assets are probably in the UK.

  3. On Saturday, the UN Security Council passed Resolution 1970 requiring all UN member countries to freeze Libyan assets:

    [The UN Security Council] Decides that all Member States shall freeze without delay all funds, other financial assets and economic resources which are on their territories, which are owned or controlled, directly or indirectly, by the individuals or entities listed in Annex II …, and decides further that all Member States shall ensure that any funds, financial assets or economic resources are prevented from being made available by their nationals or by any individuals or entities within their territories, to or for the benefit of the individuals or entities listed in Annex II …

I recall that the 1979 US asset freeze against Iran had a dramatic and lasting impact on the investment of sovereign assets in the Arab world. Most Arab dollar deposits are today placed in non US banks in London or elsewhere out of reach of a US asset freeze. This is true though many of these nations are on friendly terms with the US and have no love lost for Iran. A significant part of Chinese holdings of US Treasury is also routed via London for possibly similar reasons.

The Libyan asset freeze poses far more serious challenges for sovereign asset managers, and could I think lead to even more dramatic changes. Most importantly, since countries other than the US (and in particular, Switzerland) are acting on this, it is hard to see where to park the money safely.

China did vote for the UN resolution: “Taking into account the special circumstances in Libya, the Chinese delegation had voted in favour of the resolution.” Yet it is arguable that in a post “Resolution 1970” world, Tiananmen Square might have led to much stronger action by many other countries. Surely, China has a veto in the UN Security Council, but I must point out that the Security Council records “Resolution 1970” as being welcomed by Libya:

IBRAHIM DABBASHI ( Libya) expressed his condolences to the martyrs who had fallen under the repression of the Libyan regime, and thanked Council Members for their unanimous action, which represented moral support for his people, who were resisting the attacks. The resolution would be a signal that an end must be put to the fascist regime in Tripoli.

Under this precedent, the veto is potentially useless during a period of intense internal turmoil when the country’s representative in the UN might have defected to the rebel regime.

Many countries other than China must also be wondering whether their assets are safe. Even India would remember the international sanctions that came after Pokhran II. Can India be absolutely confident that its assets outside India would be safe under all conditions?

It appears to me that the Westphalian sovereignty of the nation state is really dead. All sovereigns will have to start acting on this assumption, and trying to safeguard their foreign assets as best as they can. I suspect that this means that at least some part of sovereign wealth will have to be invested in assets whose ownership is opaque if not untraceable.

What might these assets be?

  • First is of course currency notes. All governments do have the facilities to store large amounts of their own currency, and storing billions of dollars or euros would not pose a serious logistical problem even if it is thought safer not to use the notorious 500 euro note. Over a period of time, it should be easy to accumulate large quantities of used notes whose ownership would be impossible to trace. It should even be possible to accumulate notes of nonconvertible emerging market currencies like the real, rupee and yuan. I believe that it would be another couple of decades before currency notes become obsolete as they are progressively replaced by electronic money.
  • Next would be gold and other precious metals. Though gold bars do have serial numbers, I do not believe that it is practical to trace their ownership and in any case, it is trivial to melt the bar.
  • Other commodities like base metals, crude oil and agriculturals would also have merit not only as a store of value but also as a safeguard against temporary trade sanctions.
  • Bearer shares certificates and bearer bonds are rapidly becoming extinct and it is increasingly common to require some form of identification at the time of encashing. The only exception might be the eurobonds that are issued in bearer form.
  • It might not be difficult to hide the ownership of a diversified portfolio of corporate securities behind a chain of multiple shell companies and trusts whose ownership is extremely opaque. Similar structures applied to government bonds are perhaps more likely to be uncovered.

In short, sovereign fund managers who have been putting all their money in safe government bonds might have been focusing on the wrong risk. Assets with greater market risk and credit risk might have lower political risk particularly tail risk.

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