Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions

by Zongyuan Zoe Liu

The first in-depth account of the sudden growth of China’s sovereign wealth funds and their transformative impact on global markets, domestic and multinational businesses, and international politics.

One of the keys to China’s global rise has been its strategy of deploying sovereign wealth on behalf of state power. Since President Xi Jinping took office in 2013, China has doubled down on financial statecraft, making shrewd investments with the sovereign funds it has built up by leveraging its foreign exchange reserves. Sovereign Funds tells the story of how the Communist Party of China (CPC) became a global financier of surpassing ambition.

Zongyuan Zoe Liu offers a comprehensive and up-to-date analysis of the evolution of China’s sovereign funds, including the China Investment Corporation, the State Administration of Foreign Exchange, and Central Huijin Investment. Liu shows how these institutions have become mechanisms not only for transforming low-reward foreign exchange reserves into investment capital but also for power projection. Sovereign funds are essential drivers of the national interest, shaping global markets, advancing the historic Belt and Road Initiative, and funneling state assets into strategic industries such as semiconductors, fintech, and artificial intelligence. In the era of President Xi, state-owned financial institutions have become gatekeepers of the Chinese economy. Political and personal relationships with prestigious sovereign funds have enabled Blackstone to flourish in China and have fueled the ascendance of private tech giants such as Alibaba, Ant Finance, and Didi.

As Liu makes clear, sovereign funds are not just for oil exporters. The CPC is a leader in both foreign exchange reserves investment and economic statecraft, using state capital to encourage domestic economic activity and create spheres of influence worldwide.

Genres: China, Economics, Politics, Finance, Nonfiction, Asia, History

288 pages, Hardcover

First published June 20, 2023

Reviews

[Liu · Rating 5 out of 5]

This is a fantastic book on how China has channeled its massive foreign exchange reserves into sovereign leveraged funds (SLFs). These SLFs are essentially huge pots of money that the Chinese party-state uses to manage the domestic economy and accomplish geostrategic goals. Instead of regulating markets by imposing external rules onto market actors, China's SLFs let the Chinese state directly intervene in the market as if it were a private investor.

Liu lays out the major SLFs in China today. Central Huijin was the first SLF formed and acts as the "shareholder-in-chief" that manages the domestic economy. It was formed in 2003 to recapitalize the heavily indebted state-owned banks and restructure the banking sector. Central Huijin forced a form of semi-privatization onto the state-banking sector so they would stop issuing so many non-performing loans that had little chance of repayment and propped up inefficient zombie state-owned enterprises. Despite its origins as a bailout fund for the banking sector, Central Huijin has become more of a state-owned private equity firm that uses its influence as a major shareholder to intervene in the market.

After making Central Huijin, the CCP created the China Investment Corporation (CIC) and made Huijin a subsidiary. CIC's creation was the CCP's attempt to reform its foreign exchange management - moving away from US Treasuries and instead making higher-yield investments that could also serve China's developmental and geostrategic needs. While Central Huijin was domestically oriented, CIC has left China's borders to make foreign investments-primarily in the US. For example, in 2007 CIC bought a 10% equity stack in Blackstone. Although it initially lost a lot of money in its investment, it developed important relationships and gave China a backchannel to US policymakers that Blackstone was connected to. In addition, CIC has been a major funder of China's both economically and geopolitically motivated Belt and Road Initiative.

The last SLF Liu references is the State Administration of Foreign Exchange (SAFE). SAFE performs many of the same functions as CIC, but is skewed more towards investments in the UK than the US. SAFE uses its investment to acquire natural resources for China. It also helps fund the Belt and Road and is one of the major shareholders of Chinese banks, many of which are in turn used to fund both domestic and overseas projects.

Although China seems like a centralized party-state from the outside, it is well-established that the Chinese state is extremely fragmented and policy outcomes are often the result of intra-bureaucratic struggle instead of grand strategy. CIC is closely associated with China's Ministry of Finance while SAFE is under the purview of China's central bank, the People's Bank of China. These two administrative bodies are in frequent competition over China's foreign exchange reserves. Both of them are competing for influence in economic policy-making, and more foreign exchange reserves for their respective funds means more influence.

The only very minor criticism I have with this book is that it's fairly repetitive, which has the benefit of really drilling in the main points. Also, I'd caution that this book is somewhat specialist and I'd only suggest this to someone with basic familiarity with banking and Chinese politics. But if you're interested in Chinese finance, this is absolutely a must-read.

[Hartley]

"China's SLFs have two primary distinctive features: first, the funds were seeded with capital raised from the Chinese state taking on "leverage" in the form of either explicit or implicit liabilities; second, the funds were generally founded without an explicitly defined geoeconomic mandate but have tended to adopt an underlying geoeconomic agenda as they have expanded in global markets, advancing the strategic interests of the Party-State beyond China's territorial borders."

"Although Central Huijin was initially created as a bailout fund, it ended up behaving like a state-owned private equity fund. It not only recapitalized the Chinese financial institutions on behalf of the state; it also facilitated their restructuring and eventual public listing."

"Although Central Huijin does not directly participate in strategic investments overseas, it nonetheless advances the global ambitions of the Party-State by injecting capital into China's financial system so Chinese financial institutions can continue to expand internationally."

Sovereign Funds is a dry but highly compelling and informative exploration of the methods by which China has succeeded both amassing and deploying its massive foreign reserves. Liu hones in on three institutions, Central Huijin, the China Investment Corporation (CIC) and the State Administration of Foreign Exchange (SAFE), to explore the crisis management, bureaucratic infighting, and savvy financial engineering which have made China's rapid growth possible while placing Western economies at a disadvantage.

Key to their argument is that China does not operate a sovereign wealth fund but a "sovereign leveraged fund" or SLF. While a sovereign wealth fund's capital is primarily drawn from commodity sales (Norway, Kuwait, etc.), an SLF is capitalized through either explicit leverage (sales of bonds or treasuries) or implicit leverage (re-characterization of low-risk assets into high-risk assets). In China's case, implicit leverage has been the main source of fund capitalization, as the People's Bank of China (PBoC) and the Ministry of Finance have each transformed China's foreign exchange reserves, shifting the investment from U.S. treasury bonds (low risk) to both direct and indirect investments within China and abroad.

Liu makes the case that this happened somewhat accidentally and after a long period of disagreement from the fiscally conservative MoF. Key to this transformation is Central Huijin, now a subsidiary of CIC but which actually predates it, having been established in 2003 and overseen by SAFE. Central Huijin was founded to serve as "the most critical part of a state-engineered solution to the urgent problem of China's failing bank sector, burdened by high amounts of non-performing loans, the legacy of decasdes of support for unprofitable SOEs." Rather than intervene directly, the Chinese government created Central Huijin to act as a "quasi-state owned private equity fund," buying up equity and assuming governorship over China's state-owned commercial banks (SOCBs) to aid in their reforms. Adding to the sense of urgency, "as part of China's WTO membership negotiations, the Chinese government agreed that by the end of 2006 it would remove restrictions on the entry of foreign banks and protections for the domestic financial sector." If China's SOCBs were still non-competitive at that point, Western banks would be capable of assuming a dominant market share in China's financial system. Central Huijin's success and current "ubiquity...as a significant shareholder across nearly the entirety of China's financial system" has led to analysts placing it alongside SASAC due to its high levels of control. Central Huijin succeeded in restructuring all of China's "Big Four" banks, bringing numerous institutions to successful IPOs, including ICBC, which in 2006 was the world's largest IPO up to that point. It played a similar role in China's brokerage industry, accruing "dominating stakes in the most prominent Chinese brokerages" as it "exercised enormous influence over the entire industry."

Its success, propelled by the use of foreign exchange reserves, prompted the Ministry of Finance to pursue the creation of its own vehicle for pursuing state objectives. This was the CIC, initially approved in 2007 and capitalized through a somewhat complicated scheme by which the MoF was able to "tranfer $200 billion out of the PBoC to CIC" even as the MoF remained the sole shareholder of CIC. Liu writes that "although CIC is nominally independent and enjoys the status of a ministry in China's political institutional hierarchy as a sovereign fund, it is mainly subject to MoF's direct influence" primarily through MoF's organizational dominance of CIC's board. Central Huijin was acquired by CIC in 2007 and remains responsible for domestic investments, while CIC International, established in 2011, handles overseas portfolio investments and CIC Capital, founded in 2015, specializes in overseas direct investments. CIC attempts to stand out from SAFE by nominally adhering to market principles, having signed onto the Santiago Principles in an attempt to preclude fears over Chinese FDI in Western countries being too overtly aligned with government prerogatives. CIC is mainly known for its long partnership with Blackstone and Stephen Schwarzman. Liu writes that "the CIC-Blackstone partnership...advanced China's national interests" as through it "CIC has gained experience and familiarity with global financial markets" and received "direct access to back channels for discussion and dialogue with US policy makers." CIC primarily participates in international markets through foreign private equity funds to "reduce suspicions and protectionism." CIC also invests in natural resources abroad, as well as seeking to support BRI aims. Despite its market orientation, "a close review of CIC's annual reports from 2008-2020 reveals that the fund's global portfolio has been less than satisfactory," a result of CIC's general inexperience and ultimate adherence to Party priorities rather than those of the market.

SAFE has responded to CIC's encroachment on its traditional priorities by also turning to international investment. SAFE, although technically administered by the PBoC, "enjoys a vice-ministry ranking within China's political hierarchy" imbuing it with some independence. In recent years, it allocated a portion of China's foreign reserves to capitalize five investment offices outside of mainland China in Hong Kong, Singapore, London, New York, and Frankfurt. The first four, or the "Four Golden Flowers" are estimated, as of 2015, to collectively manage around $1 trillion in assets. These do not include SAFE-capitalized funds within China, the most of important of which is the Buttonwood Investment Platform, established to help finances the BRI. Through Buttonwood, SAFE contributed $6.5 billion of the Silk Road Fund's initial $10 billion in capital. Buttonwood has also acted on behalf of SAFE to inject capital into Chinese banks participating in the BRI, including the China Development Bank and the Export-Import Bank of China. These institutions have gone on to finance major asset acquisitions by Chinese SOEs.

SAFE Co-Financing also works to aid SOEs in their "going out." Liu writes that "China's policy banks and commercial banks act on behalf of SAFE to provide loans using foreign exchange reserves, most notably for natural resources projects." In this scheme, Chinese banks act as loan agents, with SAFE Co-Financing offering liquidity and credit guarantees. Liu describes this as "almost equal to a government-subsidized foreign currency lending program that allows [Chinese companies] to borrow cheaply from the country's foreign exchange reserves." Where SAFE has appeared to directly intervene, it has sparked blowback, as in the Costa Rica incentive package deal meant to encourage Costa Rica to no longer recognize Taiwan.

Liu concludes the book by offering a generally positive appraisal of China's SLFs, while describing ongoing efforts in the West to heighten scrutiny of Chinese FDI. To mitigate these risks, Liu points to Avoidance and Hedging as potential strategies. Avoidance in this context means collaboration between the US and the EU on heightened and coordinated FDI screening. Hedging means the creation of Western "white knight" SLFs capable of participating in the market to rescue momentarily distressed companies in key sectors from Chinese buy-outs. She closes by saying "sovereign leverage funds may prove to be such a geoeconomic advantage for the Communist Party of China that we may soon see their like appear throughout the West as a response." In my mind, this could mean a broadening of In-Q-Tel's mandate, or a duplication of it for different sectors.

[Sherry · Rating 4 out of 5]

### SLF
This meticulously researched book, based on 105 interviews over four years, offers a fresh perspective on the Chinese Communist Party's (CCP) strategies for economic reform, industrialization, and global expansion over the last three decades. Introducing the concept of a Sovereign Leverage Fund (SLF), the author contrasts it with traditional Sovereign Wealth Funds (SWFs), such as the oil-backed Saudi Public Investment Fund, highlighting the SLF's reliance on debt and unconventional funding sources like foreign exchange reserves. This comparison sets the stage for an in-depth exploration of China's geopolitical maneuvers and domestic economic policies.

### Background
The book begins by observing that GFC and COVID-19 have exposed the vulnerabilities of capitalism 1) The crisis pushed western governments to operate outside the markets to bail out large financial institutions and systematically important companies, against their spirit of "invisible hands" . 2) SWFs from Asian and oil-rich Arabian Gulf poured state capital, disguised as "free capital flow", to Western financial institution to take advantage of their distressed condition. Western government started to recognize the impact of the state-backed money on national interest, which in turn force themselves to re-examine financial capitalism(a system that the FIRE sectors dominated policy making and extract profits through RENT instead of industrial expansion), not least the state-market relation.

### Literature Review
The broad geoeconomic background is followed by a whole section of literature review, which could have scared a whole bunch of readers away. But it served a grand purpose - to point out the limits of traditional framework in understanding China's economic development and the different stakeholders' roles in it. It established a "coordinate system", laying out where the existing literature (state capitalism, development state , economic statecraft) are in explaining how China has been able to "industrialize and grow richer by participating in global markets without fully assimilating the prevailing liberal norms at home. " And with the limits of the existing theory in mind, she went on applying her SLF framework to examine the nature of the State-market relation and its role in China's economic expansion.

### FX
The accumulation of foreign exchange ("FX") reserve is a sufficient but not necessary condition to the experiment of SLF. Zoe expanded on the evolving foreign exchange landscape in China starting from the late 1990s. China's FX has 3 high-growth period:
- 1997 -2001, there is a 52% increase in FX following the lesson from the Asian Financial Crisis. This is accompanied with financial repression - a system characterized by policies that keep interest rates artificially low, compulsory saving rates, and capital controls. These policies were used to mobilize domestic resources initially for financial stability and later for investment in industrial development and infrastructure.
- 2001- 2005, an Accelerated period, with a 382% increase unleashed through the "going-out" strategy adopted after joining WTO. However, there is a huge gap between the reported large trade surplus and significantly lower FX increase. Studies show over 80% of the change in FX reserve for the period of 2003-2005 is associated with hot money flows with only 20% directly from current account surplus and acceleration of inward FDI. This can be explained by the re-categorization of the FX into riskier asset on PBoC's balance sheets or funneled into SLFs through financial engineering.
- Post 2008 GFC, there had been increasing concern over the opportunity cost associated with passive investment in US treasury, amid the low-interest environment.

### Structure and Evidence
#### Structure
In introducing the 3 main Chinese SLF complex in Chapter 2-4 , Zoe adopted an empirical analysis methodology, focusing on 1)Background - the economic and political landscape 2) Funding - capital source, process and people/institution -in-control 3) Evolution - its leadership rotation and shifting in mandates and strategies 4) Inter/Intro Relationships - its subsidiary and interplay among the SLFs or other state apparatus 5) Milestones - projects and investments through which the Party-State exerted their will.
#### Evidence
The use of flow charts, graphs, stories and mini-case in these three chapters are engaging and support her arguments well. But there were multiple times when the flow of information were interrupted by her "dry" summary, the key conclusions of the book that she keeps on coming back to. It makes sense to me at the beginning, but this pattern has repeated itself, and she is basically paraphrasing her own statements.

People love stories, I really do, especially those that are not dramatized with conspiracy theory. Zoe's field study and interviews brought in first-hand information such as behind-the-scene milestone projects, internal political struggle and key-person dynamics. I got lost in those stories, familiar but mystical names, such as Jiang Zhicheng (Former President Jiang's grandson), popped up and I clicked on links after links to devour stories of the financial transactions and investment. The interplay among the various bureaus can be a little overwhelming at first, but once I got familiar with these financial institution and quasi-government entities, I started to draw a mind map of how each of them were inter-related, and what the different roles they assumed, who their supervisory ministry and what are the key person, enabling me to grasp a broad understanding of the policy and strategic investment landscape of China in the past few decades. While I might be nitpicking, it would be beneficial to have a more comprehensive exploration of the transactions, particularly providing insights into the full spectrum of those landmark initiatives, spanning from their commencement through to their implementation and current outcomes. This undoubtedly demands augmented research diligence, but would substantially enhance the robustness of the supporting evidence.

### Capital Mobilization
The book revolves around Capital Mobilization, the Party-State's mechanisms to attract, generate, and allocate capital efficiently across its vast economy, which is 1) to attract capital with its commitment to the Open-Up policy, 2) to generate capital through its growing export and trade Surplus, and 3) to allocate with its SLFs under the help its "National Team". The team can be categorized based on where the money is going:
• Team1, led by CHJ, Buttonwood(SAFE onshore subsidiary), CDB, and CSF. They focus on stabilizing financial stability or financing urban development, infrastructure and other national priority projects.
Since last September (2023), there have been a few rounds of "national team" campaign to save the $9.5 trillion Shanghai Stock Exchange. The on-shore team, consisting of CHJ and China Securities Finance Corp ("CSFC") and off-shore team, have poured more than $57 billion into onshore shares in Jan and Feb (see Bloomberg charts below).
• Team 2 led by CIC, Export-Import Bank of China and SAFE affiliated offshore investment arms. They are tasked with foreign investment, especially in resources, advanced technology and key financial institutions, and provide capital for SOES in their strategic acquisition abroad.

### Reflection and Further Exploration
One aspect of the book I appreciated is its impartial portrayal of the massive state apparatus. Rather than depicting it as a monolithic bureaucracy, the author presents it as a complex, evolving collection of entities and individuals (including elites - the Princelings, technocrats and interest groups). It avoids characterizing the state as a beleaguered defender, wrestling with the legacy of the "Century of Humiliation", and instead offers a nuanced view free from emotion bias. This practical lenses allow me to interpret the events and decisions with a framework where policy, instrument, agency and people are separable but correlated functions of the giant machine.

I find the "Capital Mobilization" concept to be intriguing. It has been a cornerstone of China's economic development reflecting a multifaceted approach to harnessing financial resources for growth, industrialization, and modernization. It involves a blend of domestic savings, foreign investment, capital market development and strategic state-led investment. There are 2 books that are great resources to further explore this topic
1) "Capitalism with Chinese Characteristics: Entrepreneurship and the State" by Yasheng Huang: This book provides a historical perspective on China's economic reforms and the evolution of its model of state capitalism, focusing on capital mobilization among other topics.
2) "Chinese Economic Statecraft" by William Norris: The book introduces an innovative theory that pinpoints how states employ economic tools of national power to pursue their strategic objectives.

[Zach · Rating 4 out of 5]

Far more insightful and well researched book than the clickbait tagline would suggest.

[Jedd · Rating 5 out of 5]

random thoughts first. more review later ~

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fine book on the global geopolitical impact of sovereign wealth funds and central bank leverage/accounting methods. well-researched, tightly argued, and written in an easy to understand manner for those not necessarily involved in the day-to-day inner-workings of corporate finance (as long as one has the patience and some background knowledge!).

not sure though how much of my review bias is clouded by the fact that i may not necessarily be this book's original intended audience — feels very Brookings-y and meant more as defense research/reading for US and Western mainstream policy makers.

however inadvertently, Ms. Liu shines a light on something very critical for many of us in the "rest of the world" ought to remember — that when matters of domestic and national sovereignty are at stake: playing by the rules doesn't have to mean playing the same game as your peers and/or adversaries.

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to be re-reviewed later with a focus and emphasis on highlighting more the mechanisms and specific details that i find really valuable such as the seconding of monetary interests to national security interests (good! banks should be tools and not ends lest we end up back in 2008), and the value in exchanging money reserves for hard energy industrial reserves (good but a lot more complex to execute in practice), plus the idea of state-controlled "special purpose vehicles" that serve effectively as "central banks in the market" (good but very "who watches the watchmen" — requires a Very Disciplined, Willful State to work successfully).

was good companion reading to David Graeber's "Debt: The First 5,000 years"

also — "global ambitions" might be a bit of a stretch — "global defense" i think works better as a general title/re-framing of the book's content. it's not just China after all that trades heavily with China on account of its relatively cheap cost of labor in factories and such...

[Scott · Rating 4 out of 5]

A short but important book about how China has shifted about $2 trillion from its foreign exchange reserves into geostrategic investments. While $2 trillion may seem small compared to the GDPs of large economies like the US, EU or China, comparable firm level coordinated leveraged investment by other governments is no more than a twentieth this size. $2 trillion goes a long way when you can buy a quarter of Germany's leading robotics firm, Kuka, for $4.6 billion. Or, give all Chinese multinationals a critical financing edge in the acquisition battle with lower than market rate loans. The book documents a large number but not a large percentage of investments flowing from the quarter trillion under the control of the Ministry of Finance controlled CIC. It documents many fewer of the interventions sponsored by the secretive SAFE agency of the People's Bank of China. But, the cases that could be documented are sufficient to show the danger of coordinated state directed investment by China. The solution is improved and coordinated foreign investment screening by the US and the EU coupled with getting serious about creating our own "white knight" defensive Sovereign Leveraged Funds (SLF).

[Iris · Rating 4 out of 5]

informative outside-in look into china's sovereign leverage funds (to be distinguished from sovereign wealth funds, which uses money earned from natural resources).

SLFs drive CPC's agenda in three ways:
1. Recapitalize failing Chinese banks through Central Huijin
2. Secure access to natural resources
3. Support expansion of Chinese corporations (e.g. through financing the Belt and Road Initiative)

Two institutions, with a big of rivalry, but nonetheless loyal to the CCP:
1. CIC (explicit leverage) - presents itself as a traditional institutional investor (e.g., joined the Santiago Principles)
2. SAFE (implicit leverage) - very opaque institution

These institutions finance CPC's global ambitions through:
1. Converting China's foreign exchange reserves into strategic overseas assets + portfolio companies
2. Intermediaries between Party-State and global markets (e.g., recapitalizing other state-owned banks, support Chinese enterprises)
3. Partnerships with other sovereign investors and private investment institutions to establish cooperation funds (helps alleviate national security concerns but also advances Party's foreign policy goals)

[Apoorv · Rating 5 out of 5]

Sovereign (government owned and controlled) funds are almost anachronistic in the modern capitalist economy, yet they are possibly the most influential class of investors globally. Zongyuan Zoe Liu narrates crisply and compellingly, the story of China's SWFs, which are unique in how they are capitalized (the author refers to them as "sovereign leveraged funds"). The book offers precious insights into the past, present, and future of these state-owned financial behemoths.

[Carlisle · Rating 4 out of 5]

Very thorough and dense, impacting the readability a bit. Otherwise, interesting examination of a topical and recent phenomenon. While most times I’m inclined to say it’s too soon, in this case it’s a great primer so one can watch the rapid emergence of SFs in real time.

[Farishad Latjuba · Rating 5 out of 5]

Starting from the opportunity cost of holding the foreign reserves (mostly US dollar denominated) thus the creation of China’s sovereign wealth fund. But, since China uses their foreign reserves as a leverage to fund their enterprises it is called sovereign leveraged fund. Well, it has drawbacks & risks but surely it has entrenched the main government initiative to create their modern Silk Road as powerhouse economy power of the current time & future.

[Noah Falkovich · Rating 5 out of 5]

Fantastic, rigorous examination of how the CCP has restructured its financial system to generate strategic influence at the level of the international firm, expanding state power and capacity abroad while circumventing the burdens of global financial governance.

[Alley Mcintosh · Rating 5 out of 5]

Great expiation of the topics. The writing could be slightly more engaging but given the topic I think it works! Highly recommend

[Lindsay · Rating 4 out of 5]

Very informative about the depths of how China uses its vast reserves around the world. Gets a little repetitive towards the end, but a good read overall.

[Emma · Rating 3 out of 5]

3.5 Stars

[Quinn Anh Pham · Rating 5 out of 5]

Shed some light on the history of Chinese sovereign funds: how it grew from a clumsy starting point, to learning from the best and exerting its influence on the global financial market

[Ji Cheng · Rating 4 out of 5]

The book covered how Sovereign funds formed in China, and two different rivalries - PBoC and MoF.

[Reader · Rating 5 out of 5]

Last book with wrong method of taking notes.