Singapore set to inject £2.5 billion into Merrill

Merrill Lynch is poised to become the latest Wall Street bank to seek funds from a foreign government, with Singapore planning to sink $5 billion (£2.5 billion) into the firm for a potential stake of more than 10%.

The bank is desperate to rebuild its balance sheet after $8.4 billion of write-downs on mortgage-related investments and corporate loans. It ousted Stan O'Neal as chief executive in October and replaced him with former New York Stock Exchange chief John Thain. Some analysts believe he will report an additional $8.6 billion writedown for the fourth quarter.

Singapore's state investment fund Temasek is in advanced talks with Merrill about the deal, says the Wall Street Journal, with the Singaporean board having given preliminary approval although pricing, timing and regulatory issues are still being discussed.

Neither Merrill nor Temasek would comment. Any deal will raise new concerns over the flood of foreign government funds into the world's big banks. Those concerns have been highlighted by reports Saudi Arabia is the mystery Middle Eastern investor ploughing Swfr2 billion (£868.6 million) into UBS's recapitalisation.

Temasek's sister fund, Singapore Investment Corp, is putting $8.9 billion into UBS, and the bank was already facing a shareholder revolt over that. News of Saudi involvement is likely to sound new alarm bells. After the deal, 9% of the conservative Swiss bank will have been sold to foreign entities.

Temasek manages more than $100 billion of assets, including controlling stakes in seven of Singapore's 10 biggest companies.

So far, Middle East and Asian government funds have invested about $25 billion in Wall Street firms, taking advantage of the battering they have received during the subprime debacle to pick up bargains.

Citigroup said last month that Abu Dhabi would invest $7.5 billion. It emerged this week that state-controlled China Investment Corp is buying almost 10% of Morgan Stanley after it reported a loss of $9.4 billion from mortgage-related holdings.

Sovereign wealth funds are brimming with cash thanks to China's huge trade surplus and record oil prices that have stuffed coffers in the Middle East. Those of China, Russia, Abu Dhabi, Kuwait, and Norway, and the two Singapore funds, control up to $1.8 trillion in assets. Research by Merrill suggests this could rise to $8 trillion by 2011.

The rapid growth threatens to spark a backlash in the West. The US is pushing for the sovereign funds to declare their investment philosophies as well as be more transparent. There are similar concerns in Europe, but so far Prime Minister Gordon Brown has not made his position clear.

He is thought to be more protectionist that Tony Blair, and is believed to have had reservations about a possible takeover of Centrica by Russia's Gaz-prom last year.

Q&A

What is a sovereign fund?
A pot of money set up by a government, generally to invest in overseas assets. Increasingly their appetite is running high for stakes in giant western companies.

How have these sovereign funds got the money for these investments?
States who have become very wealthy through exports like oil (Middle East), textiles (China) or shipping (Singapore) have accrued huge amounts of foreign reserves. Rather than put them into traditional dollars or gold, they are now looking to invest in big western companies instead. Deals have ranged from successful private equity houses to port operators.

It seems to be that banks are a favourite target. Why?
The collapsing value of subprime mortgages has meant banks, particularly on Wall Street have had to slash the value of their assets by billions of dollars. Those writedowns are taken out of its reserves pot, which the bank needs to carry on doing business. To prop up the reserves, the banks are desperate to find new sources of cash. Merrill Lynch, Morgan Stanley and Bear Stearns have all turned to sovereign funds for the readies. UBS in Switzerland has been bailed out by Singapore. Today it emerged that the Saudis helped bail out UBS.

I'm uneasy about China or the Saudis owning our corporate jewels. They're not especially nice governments, are they?
You're not alone. Many people feel that the likes of Chinese premier Wen Jia Bao may be relatively moderate, but who knows who might be running China in a few decades' time? People fret that foreign governments may in the future use their hold over our industries and economies against us. Hillary Clinton campaigned successfully last year against Dubai taking over ports in the US, including the big New York port in her constituency. She felt it was OK when it was run by Britain's P&O, but did not want such a strategically important asset being owned by Middle Eastern investors, even ones from relatively pro-Western Dubai.

I suppose a bank isn't as important to national security as some other companies?
True enough. Communications networks, infrastructure like road and rail and utilities are far more sensitive assets. The banks attracting the interest of sovereign funds are also giant multinationals, with a large proportion of their operations being abroad. They argue that it is good to strike closer ties with countries whose economies are growing rapidly.