Applications for founding membership of the China-initiated Asian Infrastructure Investment Bank (AIIB) closed on 31 March 2015. The fifty-seven prospective founding members notably do not include the United States (U.S.) or Japan, but do include a broad geographical spread of countries from Europe, Africa, the Middle East and South America, as well as U.S. allies such as France, Germany, the United Kingdom and Australia. These prospective founding members now have the opportunity to shape the rules that the AIIB will use to govern itself, as well as those it will employ in its financing of energy and infrastructure projects in Asia.  At this pivotal juncture – prior to finalization of the bank’s Articles of Association, targeted for June this year – it is timely to reflect on the AIIB’s potential governance, approach and standards, as well as the bank’s likely effect on the financing of infrastructure projects in Asia.

Why a new development bank?

Asia is the growth engine of the world economy but suffers from an infrastructure deficit which undermines both the region’s growth potential and human development outcomes for its people. In 2009 the Asian Development Bank (ADB),  a regional development bank based in Manila, estimated that Asia needed to invest approximately $8 trillion over the ten years to 2020 in overall national infrastructure and, in addition, about $290 billion in specific regional infrastructure projects – an average overall infrastructure investment of $750 billion per year.  Existing institutions such as the ADB and the World Bank clearly lack the capacity to meet those needs, given that their combined capital base equals less than $400 billion. The mandate of the ADB and the World Bank extends beyond infrastructure to embrace poverty reduction so these funds are stretched even further. Against this background, employing Asian savings for Asian infrastructure in an effort to help plug the funding gap constitutes a key rationale for the AIIB.

China already participates in financing infrastructure on a massive scale globally. According to Fred Hochberg, chairman of the Export-Import Bank of the United States’, Chinese state-institutions have committed to lend $670 billion in recent years.  China could go it alone in increasing funding for infrastructure projects in Asia but its mixed experience with some of that lending (including arrears and/or economic stress from Ukraine, Venezuela, Ecuador and Argentina) has contributed to a decision by China to multilateralize its infrastructure lending efforts.1 One reason China does not simply channel additional funding for Asian infrastructure through the World Bank or the ADB is because the U.S. Congress has blocked China’s efforts in recent years to acquire voting weight and influence more commensurate with the size of its economy and its contributions to such bodies. As a result China has followed through on its promise to create a new multilateral institution over which it would have the predominant influence, much as the U.S. has over the World Bank or Japan over the ADB.

The initial subscribed capital of AIIB will be $50 billion, with China having put up most of the initial amount.  The initial amount will be increased $100 billion, with rough plans for 75% of funding to come from Asian members going forward.  Beijing will host the headquarters of the new bank which will make its own rules, albeit “built on the lessons of experience of existing [multilateral development banks] and the private sector” according to the AIIB web site.

With the establishment of new rules comes the potential to streamline processing procedures for infrastructure finance. Some advocates of the AIIB claim that the new rules will facilitate an increased flow of funds to infrastructure projects in Asia, which constitutes a further rationale for the establishment of the AIIB. Critics of the ADB and the World Bank maintain that excessively costly project preparation and lengthy reporting obligations inhibit efficient infrastructure funding and development. They maintain that the AIIB offers an opportunity to simplify infrastructure funding by adopting a risk-based approach to lending rather than a legalistic compliance-based approach.

Governance

Officially, a key objection cited by the U.S. for not joining the AIIB is a lack of clarity about AIIB’s governance.  Irrespective of whether one shares those concerns, it is clear that governance standards will underpin the legitimacy of the new institution.  Indeed founding members such as the United Kingdom, France, Germany and Australia have stated that they will use their influence to push for transparency in the AIIB’s governance. The Articles of Association, to be finalized by the prospective founding members by the end of June 2015, will decide several important issues, including the distribution of voting rights between members and the structure of the board of directors.  Asian members will control 75% of the shares and China has signaled that it will not seek a veto right but will likely hold the highest voting percentage (estimated at 25-30%), which will give it the predominant voice in decision-making. China has also said that the new bank will make board and staffing appointments based on merit rather than political considerations.

Focus and approach

According to the AIIB’s web site, the Board of the AIIB will  develop, and approve, a business strategy and policies for all AIIB investments. Such investments will focus on the development of infrastructure and other productive sectors in Asia, which may include energy and power, transportation and telecommunication, rural infrastructure, and agriculture development, urban development and logistics, especially those projects that are able to bring benefits to more than one member in the region. The AIIB will direct its investments through loans, equity investments and guarantees and will likely also have capacity to offer technical assistance.

Some proponents of the AIIB claim that it will offer a more streamlined approach than the existing Bretton Woods institutions such as the World Bank, with less reporting and bureaucracy.  However, there are also concerns that China could use its influence over the new institution to advance its own geopolitical strategic interests or commercial interests. Indeed the increased impetus that the bank will give to infrastructure spending in Asia will undoubtedly be viewed as an opportunity by Chinese construction and other firms that are eager to win business abroad. The adoption of rigorous project-screening and approval processes as well as transparent procurement practices will be essential to ensure that the AIIB is not unduly dominated by Chinese interests.

Some have speculated that the AIIB will offer a big boost to the funding of coal-fired power projects and hydropower projects in Asia. Due to concerns over climate change, most multilateral, regional and bilateral development finance institutions and an ever increasing number of commercial lenders no longer lend to, or invest in, coal-fired power and other coal-related infrastructure projects.  However, the AIIB has made no public pronouncements about its stance on coal and could well play a significant role in the plans of India, Indonesia, Vietnam, Japan and South Korea to increase their coal-fired generating capacity.  Less at odds with efforts to combat climate change, is the likely push the AIIB will give hydropower development in Asia. Chinese companies have particular strength in both coal-fired power and hydropower projects and the multilateral nature of the AIIB offers a chance to legitimize the expansion of Chinese interests in those sectors.

HSES – Health, Safety, Environmental and Social

Another key objection cited by the U.S. for not joining the AIIB has been a concern about whether the AIIB will adhere to strict environmental and labour standards in its operations.  President Obama has now stated that the U.S. never opposed the AIIB, and supports it provided that it incorporates strong financial, social and environmental safeguards. Indeed the AIIB itself has stated that it is “committed to the principles of sustainable development in the concept, design, and implementation of its investment activities” and that “building on MDB [multilateral development bank] experience and with the support of international experts”, the AIIB Secretariat has “initiated a process to develop an environmental and social policy framework to assure integration of these concerns in its operations”. The interim head of the new bank, Mr. Jin Liqun, has said that it will ensure that people displaced by new infrastructure projects will be taken care of and that local communities and countries interested in projects financed by the bank will have the opportunity to be involved from the projects’ early stages and have a say through their “full life cycle,” he said.

It remains unclear whether the AIIB will adopt existing HSES standards or establish its own. IFC, other multilateral development banks, such as the ADB, and many commercial banks require their clients to apply its Performance Standards to manage environmental and social risks and impacts so that development opportunities are enhanced. Such standards are incorporated by reference in the Equator Principles, a credit risk management framework used to determine, assess and manage the environmental and social risks associated with certain project based financing.  While some might presume that the AIIB will not apply IFC Performance Standards or the Equator Principles to its investments, it is worth noting that as long ago as 2007 the IFC and China Eximbank entered into a memorandum of understanding to cooperate on supporting environmentally and socially sustainable Chinese investment in emerging markets and that the Chinese bank Industrial Bank of China has signed up to the Equator Principles.

As noted in by Deborah Brautigam in her book “The Dragon’s Gift – The Real Story of China in Africa”, one of the most enduring criticisms of Chinese engagement in Africa concerns exploitative labor practices.  The World Bank, ADB and many other lenders insist on compliance with IFC Performance Standard 2 on “Labor and Working Conditions”.  Performance Standard 2 recognizes that the pursuit of economic growth through employment creation and income generation should be accompanied by protection of the fundamental rights of workers. The requirements set out in this Performance Standard have been in part guided by a number of international conventions and instruments, including those of the International Labor Organization (ILO) and the United Nations (UN). It remains to be seen whether the AIIB will adopt equivalent labor standards.  China’s record of bringing in its own labor for large infrastructure projects, as well as its ignorance and/or non-observation of local labor laws, can lead to conflicts with local communities and workers. This means that labor standards on AIIB-funded projects will undoubtedly attract close scrutiny.

Bribery and corruption

Mr. Jin, the interim leader of the AIIB, has said that the AIIB will have “zero-tolerance” of graft. However, China continues to suffer from perceptions of corruption with its performance in Transparency International’s Corruption Perceptions Index recently slipping from 80th among 175 countries in 2013 to 100th in 2014. China’s broadening of the AIIB’s membership will see the institution come under pressure to uphold international rules and norms relating to bribery and corruption, such as the OECD Anti-Bribery Convention (1997) – based on the U.S. Foreign Corrupt Practices Act of 1977 – and the IFC Anti-Corruption Guidelines.

Currency

The AIIB will contribute to the further internationalization of China’s currency – renminbi (RMB), a key aim for China in the run-up to this year’s special drawing right (SDR) basket review by the IMF. Singapore and London will strengthen their market positions as centers for RMB-denominated offshore transactions by virtue of the membership of Singapore and the United Kingdom in the AIIB. Indeed, it has been suggested that this constituted Prime Minister Cameron’s key motivation for the United Kingdom joining the AIIB; London’s aim to be the first RMB clearing house outside Asia can only be helped by such joining.

Working with other institutions

While some see the AIIB as a threat to the ADB in particular, economist Joseph Stiglitz has pointed out that the ADB has previously “defended the virtues of competitive pluralism”. Indeed ADB President Takehiko Nakao has said that he does not see the AIIB as a threat to the ADB, that the ADB will cooperate with the AIIB, and that the ADB could co-lend to projects with the AIIB and assist the AIIB with environmental standards. However, the ADB has also warned that it will find it difficult to cooperate with the AIIB if it fails to adopt high-quality standards. The World Bank President Jim Yong Kim has stated through a spokesman that his staff are in “deep discussions” with the AIIB “on how we can closely work together”.  Even the U.S. has struck a new cautiously cooperative tone with Treasury Secretary Jack Lew stating at the recent annual meeting of the World Bank in Washington D.C.: “We are ready to welcome new additions to the international development architecture, including the Asian Infrastructure Investment Bank, provided that these institutions complement existing international financial institutions, including by adopting their high quality standards. Having the AIIB co-finance projects with existing institutions will help demonstrate a commitment to these high standards.” In addition, IMF president Christine Lagarde has also said that she expects that the IMF will cooperate with the AIIB.

The Asian Infrastructure Development Bank follows the establishment of two other China-led institutions over the past year: the Shanghai-based New Development Bank (NDB) that brings together the five BRICS countries of Brazil, Russia, India, China, and South Africa and the Silk Road Fund (SRF).  Some commentators see this trio of new institutions as ushering in a new world economic order.

More projects, better quality projects

The AIIB’s new funding for roads, railways, airports and other infrastructure projects in Asia will likely lead to more of such projects being constructed. However, whether the efforts of China and the prospective founding members to establish a new institution lead to an increase in the quality of such projects, and the probity of funding to projects, remains to be seen. The AIIB could drive standards up by competing with the World Bank and the ADB and fulfilling its promise to be “lean, green and mean”. However, the AIIB could also drive standards down. Which direction the AIIB takes, and its influence on infrastructure projects in Asia, will largely depend on the behavior of the AIIB’s membership in establishing and administering the new institution.