Risk review

China’s Belt and Road Initiative had been billed as a big boost to Asian infrastructure financing, but growing resistance to Xi Jinping’s vision has cast doubt over its ability to mobilise additional funds for development.

As world leaders gather on the outskirts of Beijing for the second Belt and Road summit in late April, they could be forgiven for wondering what to make of the flagship initiative a little bit over five years

since it was first unveiled by Chinese President Xi Jinping.

Washington and Brussels have become increasingly sceptical over the geopolitical implications of the Belt and Road initiative, with the US leading resistance to what it sees as debt-trap diplomacy from an emerging economic superpower.

Some of the largest recipients of Belt and Road funding to date, such as Malaysia, have cancelled or have sought to renegotiate projects awarded to Chinese firms because of concerns about unsustainable debt loads, Beijing’s growing political influence and restless local populations.

At the same time, however, more western governments have pledge their support for the scheme in the hope of securing Chinese funding for much-needed infrastructure investment, including most recently – and perhaps most notably – Italy.

Rather than a threat to the initiative, market participants see renewed discussions around debt sustainability and risk pricing as a positive development that could open up more commercial opportunities for non-Chinese firms.

“I think the BRI is currently undergoing a transition,” said Beibei Li, global head of Belt and Road at Citigroup. “During the first phase, the Chinese banks provided the bulk of the lending for the BRI, whether it was corporate loans or project financing, but they are now seeking to cooperate with international banks more because the funding requirements are so huge.”

CHINESE BANKS

Assessing the impact of the Belt and Road initiative is made even more difficult by the fact that the scheme is so vague. One banker remarked that after closing the financing for a power project in South Asia, he was surprised to see an advertisement in the Financial Times from one of the other lenders, trumpeting the deal as evidence of its BRI credentials. “This was the first time anyone had told me I was working on a BRI project,” he said.

Conceived initially as an effort to reinvigorate the ancient Silk Road trading route and develop a maritime equivalent, the scheme has since expanded beyond its geographic core of Eurasia and the Middle East to include Africa, Australasia and Latin America.

Chinese authorities are also increasingly keen to talk up other, less capital-intensive sectors aside from public infrastructure, including technology, real estate, finance, tourism and manufacturing.

Unsurprisingly, data are hard to come by. The government does not publish any official figures and a lot of the funding to date has consisted of bilateral loans involving Chinese policy banks, meaning that estimates for overall investment volumes often vary significantly.

Looking just at loans for infrastructure projects in the 130 countries that are either located along the Belt and Road or have signed cooperation agreements with China, according to the Chinese government’s official Belt and Road website, Chinese banks massively dominate the league tables. Bank of China, Agricultural Bank of China and China Development Bank took three out of the top five positions last year for overall volumes, according to Refinitiv data.

According to research from ICBC Standard Bank and Oxford Economics, Chinese state-owned institutions have accounted for around 80% of the funding for the roughly US$750bn in BRI projects the two organisations track.

Even there, however, there are signs of a slowdown, as China has tightened rules on overseas investments to rein in risks to the financial sector. The struggles of some recipient countries to repay debts on BRI projects have also forced Chinese banks to recalibrate their appetite for risk, opening up opportunities for international banks.

“Looking at the BRI transactions we’ve been working on over the past year, I would say predominantly they’ve still been financed by Chinese lenders, particularly the policy banks,” said David Lam, partner at law firm King & Wood Mallesons.

“But at the same time we’ve seen a shift in preference among some borrowers and lenders towards using English law as the governing law of key loan documentation, which I think is a reflection of the fact that, anecdotally at least, we’ve seen that a lot more Chinese financiers are looking to cooperate with international lenders, which is something I expect we will see more of going forward.”

INTERNATIONAL PARTNERS

Sensing an opportunity to play a bigger role in the initiative, a number of international banks have already signed memorandums of understanding with Chinese lenders to co-finance BRI projects.

Deutsche Bank was the first notable example when it signed a MoU in May 2017 with CDB to work together to finance BRI-related infrastructure projects worth up to US$3bn.

In February last year, Standard Chartered also signed a MoU with CDB under which the state-owned Chinese lender agreed to provide up to Rmb10bn (US$1.49bn) to fund BRI-related projects arranged by the Anglo-Asian bank.

Meanwhile, Citigroup said last year it would partner with BOC and China Merchants Bank on the BRI initiative across a range of areas including capital markets, trade finance, agency and trust services and financial products.

Still, few projects so far have been financed on the back of these agreements. The majority of Belt and Road-related activity involves lending to projects, typically at low margins and in sub-investment-grade countries, while the requirements international banks have around open tendering and environmental and social due diligence have cast further doubt on what role they can play cofinancing projects with Chinese lenders.

Rather, a number of foreign banks are hopeful of winning a lot of the ancillary businesses such as cash management, foreign exchange services and local debt capital markets advisory, where they stand to benefit from both their strong global network and product expertise.

Citigroup’s Li said that revenues from BRI clients grew 30% over the past 12 months as the bank has seen a pick-up in activity in cash management, trade finance and FX-related work. This point is echoed by other bankers.

“The financing itself may not be the playground of international banks as it’s been dominated by Chinese lenders, but given the volumes involved, there will be ancillary commercial banking services requirements,” said Hunter Xiong, head of Deutsche’s BRI office.

“Every project that will be financed requires a lot of trade guarantees and will introduce a lot of foreign exchange and risk management requirements. These are all opportunities for international banks, where we have the knowledge of the local market and a physical presence in the host countries, which mean we stand to benefit.”

MORE BANKABLE PROJECTS

Analysts say the recent backlash in recipient countries might prompt Beijing to take a more collaborative approach.

Malaysia is the most notable example after Prime Minister Mahathir Mohamad cancelled a number of projects that were awarded during the previous administration. The Mahathir government recently agreed to resume construction of the flagship East Coast Rail Line after China agreed to slash the costs of the project by roughly a third to M$44bn (US$10.69bn).

Even in Pakistan, which is one of China’s staunchest allies in the region and is the largest recipient country of BRI funding globally, there has been some pushback with the government rejecting China’s proposal to finance the US$14bn Diamer-Bhasha dam project on concerns about the conditions attached to loans made available for the project.

King & Wood Mallesons’ Lam reckons that this political pushback has prompted China to take a more conciliatory approach.

“In the past when we were working on Belt and Road transactions, the majority of them tended to be very policy-driven and we might not have seen a strong economic case for the underlying projects,” he said.

“But I think that has changed in the past six to 12 months. For the transactions we’ve been working on recently, there has often been a much clearer commercial rationale for the projects, and the terms around things like the granting of construction contracts, importation of labour, etc, have been conducted more on an arm’s length basis.”

“This helps to make projects more bankable.”