IFR Asia Belt & Road Financing Roundtable 2018: Part 1
IFR ASIA: Good morning ladies and gentlemen. The Belt & Road Initiative has been a big talking point for the last five years, but most of the financing so far has come from the Chinese policy banks. Mukhtar, what other financing options are available?
MUKHTAR HUSSAIN, HSBC: The Belt & Road Initiative has been running since 2013, so we’ve seen five years’ worth of implementation, and the data suggests something like US$60bn worth of actual equity investments have been put in place. About US$740bn of trade has taken place along the Belt & Road, and 200,000 jobs have been created. There are many figures around the financing, but it’s a fairly material number, whichever way you cut it.
Looking forward, the scale of financing required to support the Belt & Road is quite substantial. If you just put Belt & Road to one side and look at Asian infrastructure, the ADB estimates we need about US$26trn from 2016 to 2030 to build out Asian infrastructure, that equates to about US$1.7trn every year. Depending on whose numbers you believe, there’s a gap, and that gap simply cannot be met by governments. Even the Chinese government can’t fully fund the Belt & Road. The reality is that we are going to see a migration of funding from the Chinese state-owned institutions, which have been very much to the fore in the first five years, and I think we’ll naturally come to an era where international financial institutions will be more heavily involved. In addition to funding being raised through the international bond markets, we see an opportunity in local currencies as well where capital markets will develop. Asia benefits from having relatively high saving rates. So, the theory is that high savings, against the right projects, against the right structures, could find a home through investing in infrastructure.
Clearly, there are some challenges in all of this. The reality is that many Belt & Road financings thus far can be best described as on-balance sheet lending. They have been done, essentially, by the Chinese state-owned institutions, for policy considerations and not entirely for commercial considerations.
As we move forward I think it will involve a much wider range of players and that allows everybody in the capital markets, hopefully, to play a constructive role.
IFR ASIA: Beibei, you have just taken on this job. The question, I guess, is why now? What opportunities do you see for your global and Chinese clients.
BEIBEI LI, CITI: In my previous role I was covering multinational Chinese companies in North America, so right now it’s about covering Chinese companies that are going to be global BRI agents. There is a clear shift of strategy, I think, from Chinese companies to expand on the BRI map. Undoubtedly, Chinese SOEs would play a vital role in terms of going abroad and finding the right projects, through a joint venture or M&A.
There are a number of roles that Chinese SOEs can play. But we are also seeing the rise of Chinese POEs in the Belt & Road Initiative. For example, in terms of the e-commerce business, Alibaba has been having phenomenal growth in South-East Asia.
If we look across the different industries, I would say there are several waves under the BRI. The first wave we see is infrastructure; it is about energy, construction or logistics. But we will be seeing more waves – for example, the expanded economic cycle in terms of consumption, consumer industries, real estate. There will be new industrial parks in different countries, for example. And then we see a third wave of Belt & Road, which we call the digital Belt & Road.
But it’s really not sequential. The digital part is happening at the same time. As I mentioned, for example, the e-commerce company from China going abroad, or telecommunication companies expanding mobile communications or cell phones to the less-developed markets.
We see a variety of corporate players that can benefit from the Belt & Road Initiative. And that’s just one part of the game. The other piece of the equation is the multinationals from the developed markets. We at Citi have been following the footprint of our Chinese and global clients, and we have heard multinational companies from US and Europe say that they are very keen to play a role in the Belt & Road Initiative as well.
They could be raw material or equipment providers, or they could cooperate with Chinese companies in the EPC sector, because they can provide international expertise. They can provide best practices where Chinese corporate players are lacking at the current stage. And there are good assets in the BRI countries and regions as well, where multinational companies may want to invest. They can partner with Chinese multinationals to seek the best assets.
It is really a whole game that a different variety of players in the market can be a part of.
IFR ASIA: What about the investment side? Ken, what’s the theory behind Belt & Road for you?
KEN HU, INVESCO: If we look at the big picture, I would say that China has been changing its business model, and that will affect our fixed-income investments. If we look at the old days, say 10 or 20 years ago, China’s business model was to import a lot of raw materials, like iron ore, and then make use of those raw materials to produce the basic materials that the country needs, like steel. That model worked very well in the last 20 years or so, but some years ago this model started to give China several major problems. One is the shipping costs. If the country continues to ship most of its raw materials from Latin America or Australia, it faces high shipping costs. Another problem to China is pollution as quite some factories in the country are substandard. Over-production is also a problem to China. As China over-produced some basic materials, like steel, it exports them to other countries, the US in particular, leading to current trade tensions with the US. To address pollution and over-capacity issues, the Chinese authorities have been shutting down those sub-scale polluting factories.
Under the banner of “Belt and Road”, we see that China is moving a new business model. Meanwhile, China is diversifying its FX reserves from US Treasuries. We forecast that China will set aside US$100bn to US$200bn to invest in infrastructure, commodities and manufacturing sectors of selective countries in Asia, Africa and Europe, the so-called Belt and Road Region. In addition to capital commitments, with a growing pool of well-educated talent, China has been sending engineers to those countries to support construction projects. The local factories and infrastructure projects could make use of local natural resources. With improving infrastructure, some of manufactured goods and newly explored natural resources could be exported to China and the rest of the world.
Under the old business model of China, investors might focus on the countries which could export more to China. Under the new “Belt and Road” business model of China, we focus on the countries which would receive more direct investments and capital from China and are able turn that capital into productive uses. We expect those selective countries to out-perform in terms of sovereign credit rating upgrades and productivity growth.
In the last two or three months, amid the EM corrections, we saw that the currencies and sovereign credit spreads of those countries which receive more capital from China and are able turn that capital into productive uses were more robust.
China’s Belt & Road Initiative means a new investment framework – we should focus on countries which will receive more capital from China and will be able to turn that capital into productive uses.
IFR ASIA: Lots of talking points to come back to there. Abdul Qadir, I want to ask you if Pakistan’s experience as a recipient country has been positive. And how does that differ from, perhaps, some of the public perceptions?
ABDUL QADIR MEMON, PAKISTAN: Well, from a recipient country’s point of view, we think that there is no master document or masterplan for the Belt & Road. There’s no blueprint. It is more like a brand. Another important aspect is to distinguish what are Belt & Road projects. Sometimes, every project where we see Chinese involvement is tagged as a Belt & Road project. It may be, or it may not be. There are also projects that commenced before 2013, and they are also being seen as Belt & Road projects. For us, Belt & Road is more of a brand.
So far, the Belt & Road commitments that we have received from the People’s Republic of China are about US$62bn. The break-up of that money is important. It’s not 100% debt: 20% of that US$62bn is actually grants. Pakistan will not be returning that money. The rest is divided into two segments. One is the loans from the Government of China to the Government of Pakistan for those infrastructure projects. And the other aspect is private equity. We have seen substantial private equity in Belt & Road projects in Pakistan, especially in power generation projects.
What we have been told, as to why China is investing in so much infrastructure, of course we know that China is dependent on its energy needs through the South China Sea. Today, around 80% of China’s energy needs and about 70% of its global trade passes through a very narrow piece of water, the Malacca Strait. If something happens in the South China Sea, China may face consequences. We think that China is diversifying its risk and investing in the Belt & Road.
The China-Pakistan Economic Corridor is going to connect the Western region of China with the deep-sea port in Gwadar in the South of Pakistan. The same consignment that passes through the South China Sea takes 45 days to reach the ports in Beijing, and if they transit through the territory of Pakistan it is going to take 10 days. There is a substantial time saving, and that will enhance China’s global competitiveness. So, Pakistan has agreed, in principle, to provide the right of transit for People’s Republic of China through its territory. In return, China has committed to build the infrastructure. And the grant component is going to those projects where China is going to benefit directly by using those facilities for transit. The other important aspect about Belt & Road is that China is also interested in developing its Western region, which is one of the most underdeveloped in the country.
We have no objection. If China connects Western region through Pakistan and develops its Western region, we understand that. And as a recipient country, we have seen that the appetite for risk from other investors is not there. Chinese capital is the only available option for us, where investors are willing to take the risk.
Out of the US$62bn around US$20bn has been spent so far. It’s too early to see its impact, but our economy has been doing well since the initiation of Belt & Road projects. Last year, we had 5.5% GDP growth. This year, we expect 6%, which would make Pakistan the fifth fastest-growing economy in the world. BRI has contributed around 1.5% to 2% annual growth in our GDP.
As far as public perception is concerned, a survey by Pew Research, a US-based think tank, last year found that 84% of the people of Pakistan viewed China favourably. That was China’s highest positive rating in any country. In fact it was the highest rating for any country in any other country. Pew Research also mentioned that wherever China is investing in BRI projects, the public perception of China has improved.
This is a positive aspect and I think this sits with China’s policy objectives, because they don’t want to be seen as an imperial power or a hegemonic power. They would like to be seen as a development partner for the Belt & Road countries.
For the Government of Pakistan, it’s an opportunity for us to improve our infrastructure, to improve livelihoods and opportunities, and we hope that this would help Pakistan to realise its policy objectives.
IFR ASIA: David, can you explain to some of us who aren’t so familiar with the legal concepts, what kind of protections have you seen in Belt & Road contracts?
DAVID LAM, KWM: Well I’m a lawyer, and as lawyers we like to help our clients to transact transactions. We like closing deals. And we also like to help our clients prepare for any bad luck.
I would just like to share some of the experience that we’ve had in Belt & Road countries. Initially, in some of these Belt & Road transactions, I echo what Mukhtar mentioned earlier, there is a lot of policy-driven financing. We’ve seen a lot of those transactions driven by the Chinese government and Chinese financiers. They would, probably, prefer to use PRC law, Chinese documentation and they might prefer standard forms, which can be just a few pages long. So, in those initial phases of the transactions we did not really see external lawyers involved.
But as these Belt & Road initiatives evolve, China has also seen the need to bring those transactions to a more international standard, because some of the upcoming transactions might be more market-driven. We have witnessed a transition from more Chinese-law contracts into more international-law contracts. I would say English law has been quite prevalent, especially in Asian transactions. We’ve seen Chinese policy banks willing to enter into English law financing contracts in the Belt & Road countries. This would actually be a very good move for China to raise the standard, and it would give a pretty good foundation for international market players, like the banks and investors, to come into these transactions.
Hong Kong law has also been quite popular recently. Chinese institutions may take some comfort in using Hong Kong law instead of English law, given that London is so far away. Hong Kong, in the same time zone, would make it easier to attend to any dispute resolutions. And from a foreign perspective, Hong Kong is still a common law system, with a lot of resemblance to English law, so that also gives foreign players some comfort. From a contracts perspective, we’ve seen this uplift from a local Chinese standard to a more international standard.
We’ve also seen these policy transactions becoming more market-driven. I echo Beibei’s comment that more multinationals are getting involved. We’ve recently worked on a club deal, a financing, which involves policy banks as well as the Chinese commercial banks. It’s still all Chinese capital, but we’ve seen a move away from solely policy banks. The commercial banks are Chinese, yes, but they are market-driven. They still need to report to their shareholders. They need to make profit. That’s actually great to see.
IFR ASIA: The theme we want to focus on today is the shift to a more commercial framework, and the opportunities for private sector finance. Mukhtar, are we going to be seeing structured project financings with a Belt & Road angle? Is that where we’re going?
MUKHTAR HUSSAIN, HSBC: I think, Steve, that’s the direction of travel that we should move in, because, so far the bulk of the financings have been done through policy institutions. It’s largely been state-led. There have been very few market structures as it were.
But as we look forward, and if China is going to benefit from the provision of external capital, then you need market-driven structures to attract that capital. Those structures provide a level of transparency, a level of inclusivity that actually gives more capital owners a rationale to invest.
We see that trend beginning to develop in some markets. I can give one specific example, where we were advising Indonesian public utility company PLN, which was looking to install some additional power generation capacity in Java. The advice that HSBC provided was really on how to structure the tender process and how to get the largest number of bidders at the most attractive terms.
Essentially the approach that was taken was adopting market discipline, in terms of understanding the structural transparency that the market will look for. What are normally the challenging factors in execution – issues like land rights, environmental consents, community approvals – many of these issues were thought through in advance. And we were able to structure a tender process which got a very large number of bids. It led to a bidder being found at the lowest possible terms within 14 months. In that case, a Chinese entity won the transparent bidding process, but this wasn’t restricted to China.
We had seven bidders from the US, from Japan, from Europe. And that led to a competitive process, which led to the right outcome for the client. I think that began to demonstrate that if you bring in private sector disciplines, around transparency, risk mitigation, feasibility studies, environmental consents, you can bring in all the best bidders from around the world.
That particular example is probably just emblematic of what can be done if that approach is more widely adopted. I think there is scope for private capital to drive these structures from being predominantly corporate-based as they are today to being more broad-based and therefore more attractive to external capital sources, which are much more commercially driven in terms of their outlook.
IFR ASIA: Let’s look at some of those commercial investments, then. Ken, when you look at long-term instruments, does a Belt & Road angle or a Chinese sponsor help?
KEN HU, INVESCO: International geopolitics has just started heating up direct investment competition among China, the US, the UK and Japan, that would benefit long-term investors.
In the US, the White House has launched its Indo-Pacific strategy, and has indicated US$113m of capital and sharing some of the US technology research with selective countries. The US government is trying to strengthen diplomatic relationships with countries like India and Mongolia. The US also plans to turn some federal government agencies into overseas investment vehicles to support American corporations to invest in foreign countries, indicating a capital commitment of US$60bn. In August 2018, United Kingdom’s Prime Minister, Theresa May, made her first official trip to Africa, visiting South Africa, Kenya, and Nigeria. She mentioned that she wants Britain to be the biggest investor in Africa among the G7 nations. Japan is increasing its direct investments in ASEAN countries, competing with China on infrastructure projects.
We see this kind of competition is good for those recipient countries, as it would not only improve economic terms but also transparency of infrastructure projects.
Invesco has put a lot of resources into studying environment, social and governance factors at both the country level and the level of individual bond issuers. My research team focuses on countries which have received capital from China and are able to turn the capital in productive use in a sustainable basis. We pay close attention to governance, environment and social issues.
IFR ASIA: Beibei, how do you think we can get some of these projects up to a standard where you can attract more private sector financing?
BEIBEI LI, CITI: Sure. I would start by saying that a key word for BRI is connectivity. It’s about connectivity among regions and countries, and in the finance world it’s also about connectivity between different partners, who can play complementary roles, as well as connectivity in the capital markets. How to connect origination to distribution means how we can translate risks that cannot be easily understood by investors into something that is more obvious.
I can give two examples. On the connectivity between financial institutions, Citi in April signed an MOU with two of the largest banks in China: Bank of China and China Merchants Bank. The purpose of that is we don’t want to be a competitor, but we want to work hand-in-hand with the Chinese financial institutions to provide insights and best practices in a region where they, perhaps, don’t have a presence. They are very good at long-term lending, but they, perhaps, lack expertise in terms of market solutions or distributing risk. We are still developing the details of the cooperation. But I see those strategic alignments between financial players as key to bringing down the risks to a level that the market can understand.
The second example relates to how to translate or transfer the risk to investors that have appetite for different asset classes or different geographies. Citi has recently helped a government-affiliated single purpose entity on a CLO transaction, which is to securitise all the collateralised loans for infrastructure projects, many of which are along BRI. We have a good range of investors with appetite for different asset classes, and we can properly structure these loans through the right channel for them. It’s a matter of how to make it more transparent and how to utilise our investor connections to best support the financing needs of the Belt & Road Initiative.