IFR Asia Belt & Road Financing Roundtable 2018: Part 2
IFR ASIA: Abdul Qadir, you said earlier that China is one of the only sources of capital for some of these projects. How do you come to that conclusion? Does Pakistan try to find private sector financing first?
ABDUL QADIR MEMON, PAKISTAN: First of all, let me make an observation regarding competition. We are reading that the United States has come forward with a plan to compete with China in the Belt & Road. As a recipient country, we think that investment in infrastructure is essential, but we also believe that investment alone is not sufficient. We also need to look at the regulatory environment, the ease of doing business, the environment. We also need a trade facilitation environment. Instead of the United States competing with China, or Japan, or the UK, we want them not to compete, but to complement each other. If China is investing in infrastructure – road, bridges, ports and so on – the United States, UK and the other development partners can help developing countries like Pakistan in improving governance structures, in improving the ease of doing business. For example, if China built a port in a developing country and the capacity of the public services means it takes 30 days for the customs to clear goods from that port, I think that the objective of that investment would have failed.
To your question regarding investment in Pakistan, of course, we have been partners with the United States in the war on terror. Afghanistan is our nextdoor neighbour, and the situation there is still quite uncertain, unfortunately. Situations like this create risk for investors, and we have seen this increasing trend that appetite for such risks is not there. For example, we know that there is around US$100trn of pension funds in the West – in the EU, United States and other countries. We don’t see those pension funds investing in infrastructure in developing countries. They’re more interested in the equity markets and other less risky areas. And our experience has been recently that there has been more talk, more rhetoric than actual resources from that side. On the other hand, China has been quite forthcoming. They have been able to address our concerns.
There is a big misconception around the Belt & Road that China has this list of ready-made projects being offered to developing countries. From Pakistan’s point of view, it doesn’t work like that. We have approached the government of the People’s Republic of China with our own projects. If we take 10 projects to People’s Republic of China, we might be successful in getting funding for two.
Another important aspect around dealing with the People’s Republic of China has been that they have been very accommodative on Belt & Road projects. We have seen examples of this in Malaysia, where they have accommodated projects, which were politically important for the previous government. Of course, then, there was a change of government and then there was a lot of political noise. But I don’t blame People’s Republic of China for being accommodating: if there is no political ownership or desire, those projects are not needed. China has been able to accommodate those governments, and this has at times backfired. But I don’t see there’s any other option to move forward on it.
For us, when we take these projects to other investors, we don’t get a good response. We get a lot of talk. We get a lot of rhetoric. We get a lot of advice. But we don’t see any money.
IFR ASIA: David, have you seen examples of how you can mitigate some of these risks – political and otherwise?
DAVID LAM, KWM: From our perspective, we have seen that there are all sorts of risk in the Belt & Road contracts and there’s no legal means of eradicating the risks. The right thing to do is to allocate the right risk to the right parties. If it goes to the wrong parties, it just doesn’t work.
We understand that in the contracts we have to think about the different parties. For example, if we are talking about political risks or natural disasters, we’ve got lots of insurance experts here who play a very important role in covering those sorts of risks. In terms of legal risks, we know that a lot of developing countries may not have a very sound legal system. We’ve seen that in some of our recent transactions, and we suggested that one way of doing it is to use international law in the main documentation, to the extent possible.
So, for example, the facility agreement, could be governed by English law, Hong Kong law, instead of the local law of the host country. While the local system might also be sound, foreign parties may not be that familiar with dealing with local issues.
In some contracts or for some types of assets you might have to use local laws. Land and mortgages are usually very jurisdiction-specific. Then, you have to think of mitigating measures. For example, other than creating local security, can you do an English law security in parallel? Or can you take an English law share charge over the holding company, the intermediate holding company for the SPVs owning the chain of assets.
We’ve got ways to mitigate those risks and actually to make the transaction bankable. Otherwise, if the risk can’t be assessed, it can’t be allocated, and it can’t be mitigated. In that case, then I don’t think we can move a Belt & Road transaction from a Chinese policy-driven format to a more international standard, with more commercially driven terms and the involvement of more international players.
IFR ASIA: What’s the role for Hong Kong here? Where does Hong Kong sit on the Belt & Road?
MUKHTAR HUSSAIN, HSBC: Well, Hong Kong is simply pivotal to the execution of Belt & Road. Hong Kong will be and is, indeed, a hub for expertise. David raised a lot of the issues around legal mitigation of risk, and we’ve got a world-class financial centre here that has a lot of risk management expertise. You’ve got a critical mass of people who have been very successfully involved in the execution of a wide range of infrastructure transactions. You’ve got one of the best listing destinations. You’ve got a very deep bond market. You’ve got a very mature investor base.
In many ways, Hong Kong has all the ingredients, the expertise and the track record, to play a major role. And, indeed, in fairness to the Hong Kong government they’ve been very forthright in investing and making that capability more widely known.
As we go forward, and as we see the transition into more finance from the private sector, not just from state-owned institutions in China, there’s a very natural role for Hong Kong to play in the promotion of those standards. We see Hong Kong continuing to be central to the Belt & Road roll out.
Audience: A quick question about potential problems. China has got a very well-developed arbitration regime, as does Hong Kong. What about the countries on the Belt & Road that don’t have that kind of legal structure? How do you deal with that?
DAVID LAM, KWM: We understand there are two major ways of resolving disputes. Either you go through courts or you through arbitration. And we understand that if you’re choosing courts, it’s usually pretty difficult to enforce a foreign court judgement in another country, like if you want to enforce a Cambodian judgement in China, that’s probably not possible. In the Belt & Road transactions I’ve seen, there’s a trend towards arbitration.
We usually can say that arbitration awards are relatively easier to enforce, because most of the countries are party to the New York Convention on the recognition and enforcement of arbitral awards. So if we have agreed an arbitration forum in a New York Convention country and then you want to enforce the arbitral award in another country, which is also a party to the New York Convention, then it would be much more facilitating.
In reality, we know that there will be obstacles. But it’s important to make these choices on day one, at the time when people are still friendly, not when the dispute occurs. You have to decide on the mechanics of dispute resolutions on day one in the contract.
One perception is that many people may not want to do dispute resolutions in Hong Kong because it’s part of China. But, actually, I think this is misguided, because Hong Kong is a separate jurisdiction. And Hong Kong has a bilateral arrangement with mainland China to reciprocate enforcement of both court judgements and arbitral awards. This is maybe a less well-known fact globally. Agreeing to a dispute resolution in Hong Kong, either through courts or arbitration, actually gives a foreign party a much better chance of enforcing that award or court judgement in mainland China, because of the bilateral arrangements between mainland China and Hong Kong, compared to, say, Singapore.
ABDUL QADIR MEMON, PAKISTAN: For Belt & Road projects, which are basically funded by the Government of People’s Republic of China and executed by Chinese state-owned enterprises, from Pakistan’s point of view, we haven’t witnessed a desire by the Chinese state-owned enterprises to use arbitration in any dispute.
We have observed that the People’s Republic of China wants to resolve those issues bilaterally, through government to government talks. There were some issues in Pakistan, which were amicably resolved at the G to G level. If they had opted for arbitration or other judicial means, they would have to exercise other options. It would have been very, very expensive for the investors as well as the government.
Audience: What kind of incremental projects has the Belt & Road made possible, and which ones would run anyway? For Pakistan, you say you found investment for two of 10 projects. It would be a very positive effect if the other eight would also materialise.
ABDUL QADIR MEMON, PAKISTAN: Yes. For example, if we are building a port in a city, we would also like China to come forward and build an export processing facility. We would like a water desalination plant, if that area has a water shortage. We would also like a power generation plant. So, for example, China may agree to build the port, power generation plant and desalination plant, but they would not build the export processing zone. This is in our master plan, so if any investor is interested he is welcome.
It’s just an example. Of course, when we are building new airports through funding from People’s Republic of China, we would also like to build hotel accommodation near the airport, and we would request funding for a hotel and shopping mall or something like that. China may agree to fund the building of the airport, but they may not agree to fund the other commercial ventures that support the airport. There are many examples. From the projects presented to the People’s Republic of China by the Government of Pakistan, the acceptance rate is around 20% to 25%. Those opportunities still exist, if any investors have the appetite and are able to take the risk.
BEIBEI LI, CITI: I just would like to add that I think the Belt & Road initiative is a multi-decade effort and we are at the very beginning stage. I think we will see that build-up of the whole ecosystem around the Belt & Road. At the beginning, as I mentioned earlier, it is more about large infrastructure projects, followed by the industrial build-out. But we will be able to see more benefits for individual consumers after the road is built, for example. We will be able to see the booming of the economy, and there will be logistics needs in those regions. E-commerce is also growing, and we will be seeing that more very soon in different parts of Belt & Road countries.
I think the build-out of that ecosystem will be seen, perhaps, in the next five years. In 10 years’ time we will be discussing a very different set of topics and challenges.
AUDIENCE: For Abdul, given the Chinese economy is slowing down, it is perceivable that China’s foreign exchange reserves will be decreasing. How would your country react if one day China says it will only lend to you in Chinese currency?
ABDUL QADIR MEMON, PAKISTAN: Of course, the ongoing trade war between China and United States is a cause of concern for all of us, because it is not only going to affect mainland China or United States. It’s going to affect every country in the world.
China is a very important trading partner for Pakistan, and so is the United States. Instead of taking unilateral tit-for-tat measures, we would like to see both countries approach the World Trade Organisation, which is the right place for such disputes. It’s very normal for countries to have trade disputes.
Right now, what we see in Pakistan on the Belt & Road is that most of the Chinese government-funded projects, which are loans to the Government of Pakistan, have an RMB component. The private equity commitments, especially in the power sector, are based on US dollars. Pakistan has a currency swap agreement with the People’s Republic of China. Every project document that is signed also has the modalities of how we will pay back the debt component. If the agreement says we will pay back in RMB, we pay back that debt in RMB. Of course, the agreement can be renegotiated on the consensus of both sides, but we hope that situation does not arise.
Audience: There’s a lot of talk about bringing the projects to international standards. I take that means that there will be a syndication involving both Chinese banks and international banks, such as Citi and HSBC. How would you be able to team up with Chinese banks, given that your risk profile is so different?
MUKHTAR HUSSAIN, HSBC: Perhaps, the way that we would look at it, is that your selection of transactions, your selection of counterparties, is all part of your risk framework in terms of how are you proposing to transact business. We have robust frameworks that we apply to risk mitigation and analysis. Transactions absolutely have to make sense for us in their own right. Lending against security is a poor practice: if your sole basis for lending into a transaction is because it has a guarantee from an export credit agency, that’s probably not a good starting point.
What you want to see is projects that are well structured, where the risks are well mitigated and the parties are all motivated to perform correctly. And then you avoid that situation of having to call on the security. Security certainly helps in terms of pricing, it helps in distribution and it helps to get more people involved. I think the international banks have a role to play in providing funding to support transactions where it’s commercially sensible to do so.
BEIBEI LI, CITI: I agree the risk assessment is the number one priority in terms of assessing a project. But I don’t think we should only look at the Chinese banks or the international banks’ loan books here. We are here to, actually, develop deeper capital market access for the Belt & Road projects. For example, when we are partnering with the Chinese banks, we can provide funding to them by issuing bonds for them under the Belt & Road initiative. Instead of co-lending, we can find a vehicle to get them access to the capital market by giving them bonds from the capital market, so that they can further lend.
But, of course, risk assessment is always the first criteria. In addition to loans, we can always look at other players in the capital markets. There will be investors focussed on project bonds, and there are private equity providers who could be more risk-takers. If we can build that overall system then we’re not only relying on the bank loans or using Sinosure as the main risk mitigant.
Audience: To follow on from that question, to Ms Li and Mr Hussain, what keeps you awake at night as financiers for the Belt & Road Initiative?
MUKHTAR HUSSAIN, HSBC: That’s a very good question to which there are many unknown answers. The reality of Belt & Road is that we can assess what we know, and what is in front of us in terms of the transactions, the territories, the parties. What’s very difficult to know is whether those circumstances will change during the process, if there’s a political transition that takes place, or there’s a viewpoint change around the viability of a particular transaction. It’s managing the unknown risks, because a lot of our models and a lot of our risk frameworks and assessment procedures rely on known variables.
For some of the Belt & Road projects, those variables are much more easy to discern, because there’s data available, and there are precedents. In some of the more frontier markets, that’s more challenging, because that data isn’t there. In some cases, you might be breaking new ground in new jurisdictions, and that requires some very considerable assessment. I think, what keeps us awake at night will be things that we don’t understand in markets where we’re not familiar.
BEIBEI LI, CITI: I think, for me, I will be watching very closely what our clients need. We follow the needs of our clients as they look at a new geography, or a new development. I have always been a client-facing person, so that’s what would be keeping me excited in this field.
Audience: This is a question to the bankers, as well as to you, Steve, at Thomson Reuters. How do you define which projects are part of the Belt & Road brand?
IFR ASIA: I’m going to pass that along to the panel, I think!
MUKHTAR HUSSAIN, HSBC: I think we need to be clear that when the Belt & Road Initiative was set up it wasn’t done with clear parameters saying it’s these transactions in these countries, in these sectors that are eligible.
The Consul General is very clear on this. This is a brand that has developed through discussions between counterparties, in many cases government to government.
You might argue that those transactions would have existed in any event as part of national development plans. What the Belt & Road initiative has done is act as a catalyst to allow those projects to find a form of funding or a realisation that might not have occurred otherwise.
BEIBEI LI, CITI: The Belt & Road Initiative, as Abdul Qadir said, can be a brand. There is so far no defined list of projects, or even of countries. The list from the Chinese government, actually, keeps getting longer. It’s a strategy for China. For example Latin America is now involved. Brazil is the top country for us in Latin America, and we would map that into the Belt & Road Initiative.
The Belt & Road Initiative is also evolving. Currently, we are at the very early stages of including the international capital markets, but globally, BRI can also be an enabler for local capital markets. For example, in Malaysia or in Indonesia, we would be able to see capital markets developing to support a BRI project itself. These stages will unfold gradually, and that’s why BRI is very exciting.
IFR ASIA: In 2016, the official BRI country list included 64 countries. According to Xinhua News, by the end of 2017 China had signed agreements with 86 countries and international organisations.
Ken, you mentioned at the beginning that you’ve got Belt & Road strategies in place, so how do you define what goes into those funds?
KEN HU, INVESCO: We invest in bonds issued by issuers from Africa, Europe, the Middle East and Asia, which directly or indirectly benefit from the Belt and Road Initiative. The issuers may be governments or non-government entities.
We have identified five themes.
One is improving funding costs. For sovereign or corporate issuers in emerging markets, if they could put the capital from China in productive uses and benefit from increasing connectivity with China and the rest of the world as well as increasing trades, their credit profiles will tend to strengthen. This will improve their funding costs and hence credit spreads.
Another theme is infrastructure. We expect more companies in the Belt and Road region to increase their export revenues with improving infrastructure. Commodities, energy and raw materials would be the third theme. The fourth one is consumption. We’ve been seeing, for example, that real estate prices in Vietnam have been rising because of improving job market. So, we may invest in bonds issued by real estate companies in Vietnam. And the fifth one is economic corridors that connect border areas of China to its neighbour countries. We see that the Belt & Road would also benefit some companies in the Western part of China. For example, Xinjiang province could become a railway transportation hub and an energy hub for China, benefiting some local Chinese companies.
The agriculture sector in the Belt and Road Region may also benefit from the US-China trade war. China may need to diversify its soya bean imports from the US. We expect that Chinese companies may increase its direct investments in farming, irrigation systems and fertiliser sectors in the Belt and Road Region. Going forward we may expect China to increasingly import soya beans through railway from some countries in the Belt and Road Region.
Audience: From the banks’ perspective, in your Belt & Road lending or investments, how do you work together with CDB? Do they give you some kind of amount of cheap money and then you lend down to some Belt & Road projects?
BEIBEI LI, CITI: China Development Bank is a very important partner for us in terms of providing support to BRI. We, actually, can collaborate in a number of areas. As an example, we can refer projects to each other. CDB may have their preference on certain regions or certain projects, but they’re not necessarily so familiar with the market outside of China. Citi has a footprint in 60 out of the 70 Belt & Road countries. Collaboration around identifying project opportunities, that’s number one. And number two, we can always be partners in co-lending. We would be able to help CDB going into the international loan markets because we are one of the leading syndicated loan arrangers, and we are familiar with the investor base. As I mentioned before, we may help go deeper into the loan markets through securitisation and further distributing the risk to new investors. There are many innovative ways we cooperate with CDB or other policy banks.
MUKHTAR HUSSAIN, HSBC: I entirely agree. Collaboration amongst financial institutions is already becoming fairly industry wide. Clearly, it’s important that CDB as an institution reaches out to a whole host of institutions – including the Citigroups and the HSBCs and others – as it seeks to extend its capabilities.
Sometimes, it’s as simple as giving people exposure to either markets or industries which will help them develop their sector capabilities or their market assessment or risk capabilities.
The intention, really, is to cooperate meaningfully with each other, so that when activities take
place – co-lending or capital markets issuance, for instance – you’ve got counterparties. This is an industry where you need two hands to clap.
IFR ASIA: Thank you all very much for your time.