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This is the final report to the United States Congress on a study of foreign portfolio investment in the United States that the Department of the Treasury has recently completed. An interim report on the study was submitted to the Congress in October, 1975.
This study was undertaken pursuant to the Foreign Investment Study Act of 1974 (Public Law 93-479), which authorized and directed the Secretaries of the Treasury and Commerce "to conduct a comprehensive, overall study of foreign direct and portfolio investments in the United States.” In dividing this responsibility, the Act directed the Secretary of the Treasury to undertake that part relating to foreign portfolio investment while the Secretary of Commerce was to cover foreign direct investment.
The term “foreign portfolio investment" generally refers to foreign investments in U.S. securities that do not involve any significant influence on the management of the enterprise. The definition used for the purpose of this study covers investments in the United States in voting stocks involving less than 10 percent ownership by the foreign investor, in non-voting stocks, and in debt instruments with maturities of more than one year by persons residing in foreign countries (other than non-voting stock and debt owned by a "direct investor").
It should also be noted that the term “foreign” includes U.S. nationals residing abroad and excludes foreign nationals residing in the United States.
The idea for this study originated in 1973, at a time of increasing public concern over the possible effects on the economy of a rise during that year in investments here by European and Japanese interests. It received a further impetus the following year as the focus of this concern shifted to the oil-producing countries, who had begun to accumulate substantial amounts of investable surplus funds as a result of the increase in oil prices.
During the earlier phase of this concern, the Executive Branch undertook an overall review of U.S. policy toward foreign investment here. The conclusion of that review was that we should maintain our traditional "open door” approach to such investments, under which we (1) offer no special incentives to foreigners to invest in this country and, with a few exceptions, no special barriers, and (2) treat them equally with domestic investors once they are established here. It was also concluded, however, that more information on foreign investment in this country was needed.
Thus, the Executive Branch welcomed the bill which authorized this study of foreign investment in the United States when it was introduced in the Congress in December 1973. Officials of the Executive Branch testified in
favor of the bill in both houses of Congress and their staffs worked closely with Congressional staff members to refine it during the following months. In the fall, both the House and the Senate passed the bill by substantial majorities and on October 26, 1974, the President signed it into law.
Well before the Act was passed, the Treasury staff had already completed a substantial amount of groundwork for the study—the first of this type to be done since 1941. A major part of the study was a statistical survey to collect data on foreign portfolio investment in this country. In this effort, first priority was given to determining exactly what data were needed and then designing forms and elaborating regulations that would facilitate their collection. Consultations were held with representatives of potential reporters to ensure that they could produce the required data at a reasonable cost to reporters and within the time frame set by the Act.
The final reporting forms and regulations were mailed to potential reporters in January 1975 with a deadline of March 1 for their completion and return. In total, some 10,000 forms were completed and returned to the Treasury.
For some of the non-quantitative parts of the studyrelating mainly to the institutional and legal aspects of foreign portfolio investment in the United States-the Treasury contracted for the services of a private consulting firm. In accordance with established legal procedures, the Treasury released a "request for proposals, soliciting bids from qualified firms. A number of firms responded to the request, and the contract was finally awarded to the firm of R. Shriver Associates.
The contractor's work plan involved two major tasks in regard to the institutional aspects of the subject:
A survey of the reasons for foreign portfolio investment activities in the United States. Identification of the processes and mechanisms through which foreign portfolio investment is made in the United States, the financing methods used, and the effects of foreign portfolio
investment on American financial markets. The bulk of the contractor's effort consisted of interviews with more than 100 individuals in prominent financial institutions, both here and abroad, that are active in foreign portfolio investment in the United States. The institutions covered included investment banks, broker/dealers, stock exchanges, industry associations, bank trust departments, investment advisors, U.S. subsidiaries of foreign financial institutions, and insurance companies. The foreign countries in which interviews were conducted were: Canada, France, Hong Kong, Japan, the Netherlands, Switzerland, the United Kingdom, and West Germany.
The contractor's legal work was directed toward an analysis of the purpose and effects of U.S. and foreign laws and regulations that relate to foreign portfolio investment here. Information was obtained through study of the laws themselves and their legislative histories, discussions with officials of Federal and state government agencies, and interviews with representatives of the financial communities in the United States and selected foreign countries.
The findings of the study are presented in seven chapters, which represent groupings of specific tasks imposed by Section 6 of the Act. Chapter 1 contains a summary of the major findings and a brief discussion of the implications for future patterns of foreign portfolio investment in the United States.
Chapter 2, which should be read in conjunction with the data presented in the tables in Appendix A, defines the scope of the statistical study (set forth in more detail, with a full explanation of the methodology, in Appendix B) and describes the nature of private foreign portfolio investment in the United States. The principal topics considered in this chapter are: the major characteristics of the holdings (stocks, bonds, other debt); the distribution by industry of the U.S. issuer or debtor; the geographic location and type of foreign investor; the relationships between foreign holdings and total securities outstanding by principal industry groups; and a brief historical survey of foreign portfolio investment in the United States.
Chapter 3 discusses the reasons why foreigners invest in U.S. securities and the processes and mechanisms used for this investment. The material was derived principally from the work performed under contract by R. Shriver Associates, whose full report is reproduced in Appendix F.
The effects of foreign portfolio investment on the U.S. balance of payments, international investment position, and financial markets are discussed in Chapter 4.
Chapter 5 deals with the legal framework confronting foreign portfolio investors in the United States, and compares U.S. legislation with that in several foreign countries that are major recipients of foreign portfolio investments. This material is based primarily on the report done by R. Shriver Associates which is reproduced in full in Appendix G.
In Chapter 6, U.S. portfolio investment abroad is compared to foreign portfolio investment in the United States.
Finally, in Chapter 7, the implications of the study for past and future collection of data on foreign portfolio investment are considered. The adequacy of the information obtained from Treasury Foreign Exchange Forms S-1, B-3 and C-1/2 is evaluated, and conclusions are presented on the steps needed for improvements in data collection activities.
The Appendixes also include a copy of P.L. 93-479 and copies of the reporting forms and regulations used for the benchmark survey.
Foreign portfolio investment in the United States at the end of 1974, including both private and official holdings, amounted to $67 billion, according to the results of the Treasury Department survey. Some $25 billion of this total consisted of stocks of U.S. corporations (at their market value on the last business day of 1974), and $42 billion of debt of U.S. businesses and governmental entities. Of the latter amount about $8 billion comprised corporate bonds.
Based on balance of payments estimates and changes in security prices, it is estimated that foreign portfolio investment rose by $28 billion in 1975 and the first quarter of 1976 to reach a total of $95 billion as of March 31, 1976. Of this increase, about one half was due to net foreign purchases of U.S. securities and one half to the increase in market values.
Of total portfolio investment at the end of 1974, over $27 billion represented the holdings of foreign official institutions, mainly central banks, monetary authorities, and international lending agencies. Of this amount, nearly $25 billion consisted of U.S. Government debt (including U.S. agencies). Most of these official holdings, together with about $56 billion of short-term claims, represented the international reserves of the countries concerned, placed in the United States because of the peculiar position of this country as the world's chief reserve center. The volume of such holdings (“portfolio" and short-term combined) is determined mainly by balance of payments factors, independently of the ability of U.S. financial markets to attract foreign capital through the operation of normal market forces. Only to a small extent do the official funds, particularly the investments of official foreign pension funds and some of the more recent investments of the Middle East oil exporting countries, move primarily in response to market criteria. For this reason most of the discussion which follows in the absence of a clear indication to the contrary-refers only to private foreign portfolio investment.
About 60 percent of total private portfolio investment consisted of stocks of U.S. corporations, with a total value of $23.7 billion. Total foreign holdings, including $1 billion of official holdings, amounted to less than 4 percent of the value of the voting stock outstanding of all companies with reportable foreign holdings.
The distribution of foreign holdings of U.S. stocks by industry does not seem to differ much from that of American investors; one evidence of this is that the proportion of foreign ownership is broadly similar among major industry groups. However, among individual issues there was a wide variation, with aggregate foreign holdings of a few issues running upwards of 20 percent.
Foreign private portfolio holdings of bonds and other forms of U.S. debt amounted to $16 billion, about twothirds the value of stock holdings, and of much less relative importance in U.S. credit markets taken as a whole. Debt owed to foreigners, marketable and non-marketable combined, excluding U.S. Government debt and bank deposits, was less than 2 percent of all outstanding debt of non-bank business firms in the United States. However, the heterogeneous nature of debt instruments owned by foreigners makes overall comparisons misleading; and many forms of debt of U.S. entities (e.g. consumer debt, housing mortgages) are, for institutional reasons, not readily available for foreign ownership.
Foreign holdings of marketable bonds of private United States corporations, including about $5.6 billion of so-called Euro-issues, were only 2.7 percent of all corporate bonds outstanding (also including Euro-issues). Excluding the Euro-issues, which were placed abroad under very unique circumstances, the ratio falls to less than 1 percent. Private foreign holdings of U.S. Government long-term debt, about $1 billion, accounted for less than 1 percent of total marketable long-term Government debt in the hands of the public, although, as already indicated, official holdings of U.S. Government debt are relatively important.
Foreign private holdings of both equity and debt issues are heavily concentrated by country. About 57 per cent of the combined total-$22.8 billion out of $39.7 billion-was held in three countries, Canada, the United Kingdom and Switzerland. However, the beneficial holders are not necessarily residents of the same countries as the holders of record. This is particularly true with respect to Switzerland. Three other countries, France, Germany and the Netherlands, with more than $2 billion each, accounted for another 20 per cent of the total.
The total holdings (including official holdings) of Middle East oil exporting countries in United States noted that the overall average yield for outstanding U.S. corporate bonds as calculated by Moody's Investors Service was 9.56 per cent in December 1974.
Economic and Institutional Factors
stocks and private corporate bonds were still relatively small ($1.3 billion) at the end of 1974, although, as noted below, they increased substantially after 1974.
Over half of the foreign private holdings of U.S. stocks were reported in the names of "banks, brokers and nominees,” who presumably were, in the vast majority of cases, acting for clients. Moreover, as already stated, $5.6 billion of the holdings of marketable bonds, out of a total of $7.4 billion, consisted of estimated holdings of off-shore (Euro) issues; for the most part no direct information on foreign ownership of such issues (which are, in the main, bearer bonds) was actually secured in the survey. It was assumed that all of the outstanding amounts of such issues as of December 31, 1974, remained in foreign hands, and the holdings were assigned to foreign countries and types of owners on the basis of only very general information available from the underwriters regarding the distribution at the time of the original sale.
The lack of information on the beneficial owners of U.S. securities makes it impossible to be precise about the economic character of the owners. Of the $10.6 billion of U.S. equities held directly by types of private holders who probably can be presumed to have been the beneficial owners (that is, all private holdings except those of "banks, brokers, and nominees"), some $2.2 billion was held by U.S. nationals residing in foreign countries, $2.2 billion by other individuals residing abroad, and about $6.1 billion by various other private institutions; foreign official holdings at the end of 1974 amounted to a little less than $1 billion.
There were 327 companies in which the total private portfolio ownership exceeded 10 per cent of the stock outstanding; foreign portfolio investment in these companies amounted to $6.6 billion, representing mainly holdings in large well-known firms whose stock is apparently very popular with foreign investors. An additional 535 companies fell in the five to ten percent range of foreign ownership, also accounting for $6.6 billion of portfolio investment in the U.S. stocks; the remaining $10.7 billion was invested in 4,424 companies where the ownership was less than 5 per cent.
The total income-interest and dividends—that would have been payable during 1974 on the foreign portfolio as it stood at the end of the year is estimated at $4.2 billion, consisting of $1.2 billion of dividends and $3.0 billion of interest. Since there were net foreign acquisitions during the year, average holdings were less than year-end holdings; therefore, the amounts actually paid would have been slightly less than the amounts just mentioned. Some $1.8 billion of this income was received by foreign official accounts. These data indicate that the average yield on foreign portfolio investment in U.S. stocks in 1974 as a percentage of the market value at the end of the year was 4.7 percent. This was virtually the same as that calculated by Moody's Investors Service for all dividends, but less than the 5.5 percent on the 500 common stocks in Standard and Poor's index.
The yield on private holdings of U.S. debt securities was 8.3 per cent. This figure is not readily comparable with any particular domestic series, although it may be
Basically foreigners invest money in the United States in order to maximize the return on their investment, either in terms of income or capital growth, while at the same time reducing risk by portfolio diversification. The possibilities for long-term capital growth, the avoidance of economic and political risk in other countries, the size and liquidity of U.S. capital markets, the protection of investors under the regulations of the Securities and Exchange Commission and U.S. law in general, ample diversity of investment choices by industry, and sales efforts of American broker/dealers are among the major factors stimulating foreign investment in the United States.
The actual volume of investment during any particular time period is, of course, affected by relative economic conditions in the United States and abroad, current and prospective developments with regard to exchange rates, the relative level of interest rates in major world capital markets, the effects of foreign exchange controls on the outward movement of capital, and other transitory factors. There is considerable evidence that net foreign purchases of U.S. stocks tend to increase at times when stock prices are rising in the United States and to decline, although in recent years never to become absolutely negative, at times when stock prices are declining.
Foreign investors in U.S. securities use essentially the same channels as U.S. investors and the bulk of their holdings of U.S. stocks are listed on the New York and American stock exchanges. Also, many of the larger U.S. companies are listed on foreign exchanges, which tends to make these issues more visible to residents of those countries. Foreign institutional investors apparently rely on U.S. brokers for investment advice more than their U.S. counterparts, although the former have access to a large body of printed information from other sources.
There appears to be virtually no connection between foreign portfolio investment and foreign direct investment in the United States; foreign portfolio managers interviewed uniformly disclaimed any intent to convert portfolio investments into direct investments. Very little foreign portfolio investment is financed from U.S. sources; credit from U.S. lenders is subject to the same Federal margin requirements as U.S. investments.
Effects on U.S. Economy Balance of Payments Effects
Under the new exchange system in which rates are reasonably free to fluctuate, foreign net purchases of U.S. securities in general have a tendency to strengthen the value of the United States dollar on the foreign exchange markets, thus improving the terms of trade, and in effect making it possible to pay for imports with funds "borrowed" from abroad instead of with exports. Over