Sanctions: California's Attorney General says pension funds should dump Iran-related shares

Sacramento—Attorney General Edmund G. Brown Jr. today called on the nation’s two largest public pension funds—the California Public Employees’ Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS)—to “honour the state law” that requires them to divest from companies doing business in Iran.

Brown's comments come at a time when Iran is saying, openly, that it intends to work on uranium enrichment to bring the product up to the 20% level that makes it viable for commercial use - but also close to weapons grade. Iran said last night that it intends to start the work today, having had little or no positive response to its offer last week to send uranium overseas for processing.

Iran's president Ahmadinejad said last week that he was happy to enter into such an arrangement: he said that he had no doubt that the uranium would be processed as agreed and returned - adding that if it was not, then it would demonstrate bad faith on the part of the UN and its members. In the absence of any signs of positive moves, he ordered that Iran's Atomic Energy Organisation would inform the International Atomic Agency yesterday of its plans and that work would start today.

But there have been some positive steps: the UN has structured a deal to allow Iran to send low-grade uranium out of Iran in return for special fuel assemblies. These would be tailored to fuel a medical research reactor that Tehran is building but could not be converted to make bombs.

That led to calls for yet more sanctions despite a widespread feeling that the sanctions so far imposed have achieved little or nothing. Robert M Gates, the US Defence Secretary, implied as much when he spoke in Rome following Ahmadinejad's announcement. Gates said "there is still time for sanctions and pressure to work."

Brown immediately called for action from the world's biggest state pension fund, CalPERS and its near relative CalSTRS.

“CalPERS and CalSTRS need to honour the state law requiring them to divest from companies doing business in Iran,” Brown said. “It’s time for our public pension funds to show some leadership and stop supporting companies that do business with a tyrannical regime.”

CalPers is the California pension scheme for public sector workers and has a huge investment budget, so huge that it has been known to move markets simply by an announcement that it is considering buying stocks in companies listed there: for example, about three years ago, the Kuala Lumpur Stock Exchange (KLSE, now known as Bursa Malaysia) was boosted by a CalPERS announcement that it was considering returning to the market which it had left several years earlier.

How huge is its fund? As of the end of last year, it stood at USD195,500 million of which more than half is invested in global equities.

CalPERS may take Brown's comments to heart in relation to those global equities. The current rate of 53% exceeds the target of 49% which has been reduced from a previous level of 56%. The lower target is due to be met by June this year.The mix is approximately 2/3 passive investment as against 1/3 active investment.

For CalPERS, the challenge is to be certain as to each transaction that a company in which it has shares performs. The due diligence required is extraordinarily onerous but it is a challenge that CalPERS has risen to in the past.

However, this time may be different for transactions involving Iran are often passed through third parties with whom CalPERS has no direct contact or influence.

That, potentially, has a simple solution - but it's a solution that may be catastrophic for some companies. CalPERS could simply pull out of entire markets where there is knowledge or suspicion that companies in those markets trade with Iran, classing - as they see it - the good with the bad.

With markets already spooked by a range of factors that indicate a risk of significant falls, such an action would be potentially devastating to markets and other investors in them.

Many of the markets that would be most severely hit by such a strategy are in developing countries, an area that CalPERS has focussed on in order to provide both excellent returns for its funds and to deliver, through its corporate governance programme, improved management techniques and therefore corporate strength and success.

A pull out from those markets would create increased instability.

Brown may think he's helping the Federal Government with its sanctions strategy but he may well be undermining one of the USA's most successful, and politically neutral, outreach programmes.