In September 2013 Chinese President Xi Jinping unveiled a grand vision to reawaken and extend the old Silk Road in the name of enhanced international trade, development and cooperation. This instalment discusses China’s Belt and Road Initiative (BRI) and the role sustainable finance can play to facilitate this initiative.
Belt and road initiative
The scope of the BRI is gargantuan, set to account for 30 percent of global GDP and require up to US$6 trillion of investment by 2030. Funds will be strategically invested in transport links, energy and infrastructure projects along several economic corridors from China into Central Asia, the Middle East, Europe, South-East Asia and Africa. Trade along many of these corridors is underdeveloped and could offer China new outlets for the goods it manufactures, and the opportunity to increase its geopolitical influence. Though Chinese public funds are being used as an initial stimulus, much of the subsequent investment is envisaged to come in partnership with private capital. Investment on this scale cannot be driven by Chinese public funds alone.
Green belt and road
It is estimated that from 2015 to 2030, global demand for climate resilient infrastructure could surpass US$90 trillion. It is now similarly acknowledged that there is an enormous need for green infrastructure, transport links, renewable power and water services along the designated trade routes. Sustainable design is key because new structures will be used for decades to come and the level of sustainability will be, to an extent, "locked in" for the lifespan of the structure. One of the biggest constraints on the expansion of the green finance market has been the lack of viable investment opportunities on the scale sought by institutional investors.
The BRI dovetails perfectly with the drive for increasing Chinese sustainable finance activity. The scale of the BRI and the range of targeted projects and investments mean that this figure is expected to continue to escalate. The BRI is a perfect supply conduit for sustainable technology and investment opportunities as many of the projects born out of the BRI will be energy and infrastructure-based and will require both private and public funding. Many of the projects within this vast initiative can be made more sustainable by incorporating low-carbon technology, which will promote these projects as viable investment opportunities to investors who are clamouring for green investments. Partnering green and BRI projects presents synergies in both practical and economic terms1. Greening the BRI2 has been described as crucial to the initiative’s success, and four Chinese ministries have jointly published a highly ambitious action plan on promoting the Green BRI , reaffirming China’s national commitment to making this a reality.
Chinese sustainable commitments
China is taking up the mantle in leading global efforts to combat climate change. In December the UN signed an agreement with China to promote the sustainable development of the BRI, and by 2020 China plans to spend more than US$360 billion developing renewable energy and decommissioning coal-fired power stations. These commitments are already backed up by results: China’s solar energy capacity increased by 82 percent in 2016, contributing to China now having the biggest renewable energy industry in the world.
China is also implementing a carbon emissions trading scheme, capping the amount of greenhouse gas companies can emit. The fact that it immediately included power generation into the scheme is a significant policy shift towards a low carbon economy given China’s historic reliance on coal. Related to this, China has begun shutting down coal power stations and increasing renewable capacity.
China’s green promises are supported by its “zero to hero”3 entry to the green bond market in 2016 following the launch of its domestic green bond frameworks as well as the introduction of policy incentives offered by the government. Despite being somewhat late to the party, China’s debut year in the green bond market in 2016 saw it issuing US$36.2 billion – almost 40 percent of global green issuances in that year. China’s experience of beginning the transition from a fossil fuel-based economy to something more sustainable will be key when initiating projects in the BRI.
Financing BRI projects
Finance for the BRI will come in a variety of forms and from many different market players, from the initiative-dedicated Silk Road Fund to state-owned banks and the US$100 billion Asian Infrastructure Investment Bank.
The variance in project type, geography and scale will mean that a toolbox of financial instruments will be necessary. Some of the key options available are set out below.
Bank finance will be an invaluable instrument to getting many sustainable projects off the ground in the pre-construction stages of development. Local banks are best equipped to assess risk, and most initial infrastructure financing is provided by banks4 . Having released the Green Credit Guidelines in 2012, Chinese fiscal policy has since strongly promoted green lending by banks. As of 2014, the equivalent of US$920 billion of green credit was outstanding in the biggest 21 Chinese banks. Numerous proposals are being floated by the PBoC to further encourage green lending, including government-subsidised interest rates for green loans5 , and requiring each financial institution’s green credit rating to be included in their macroprudential assessment6.
Green bonds are useful as a method of refinancing a project initiated by a bank loan owing to the lower cost of capital they represent. A leading Chinese bank recently issued the inaugural BRI green bond raising US$2.15 billion, setting the bar high for others to follow. The use of proceeds will be dedicated to eligible green assets in renewable energy, low carbon transportation, energy efficiency and sustainable water resource management across the BRI.
Islamic finance is an invaluable tool to unlock investor capital along the BRI. There are natural synergies between Islamic and green finance principles. sukuk may prove to be instrumental in broadening the global green investor base and tapping private (and public) capital in regions with strong Islamic finance markets. Green energy and infrastructure projects are well suited to Islamic finance owing to their asset-based nature. Unsurprisingly, there has been significant interest in developing infrastructure sukuk as a financial instrument, Shari’a-compliant products could finance the construction of public investment works7.
Green ABS and CLOs
Green ABS and CLOs are key tools to scale up green finance to make it more commercially viable, given that most individual green projects are not of a sufficient financial magnitude to warrant a bond issuance without aggregation. Banks can use the freed up capital to originate new facilities. This technique could be utilised by Chinese banks to alleviate the significant volumes of green loans on their books.