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Beijing has committed USD136bn in additional funding to

support the Belt and Road Initiative (BRI)

But mobilising more private capital is the key to bridging the

funding gap

Policy coordination and legal transparency are essential for

attracting private investment

Back in 2014, when we first started writing about China’s plan to build a New Silk

Road along the centuries-old trading routes, it was little more than a bold idea. Three

years on, what has generally come to be known as the Belt and Road Initiative (BRI),

is being billed by President Xi Jinping as “the project of the century”, encompassing

about 63% of the world’s population and 29% of global GDP.

Just last month, China announced an additional USD136bn of funding support for BRI-

related infrastructure projects. Aside from signalling Beijing’s commitment to the BRI, it

also reflects a growing need. The Asia Development Bank (ADB) estimates that

emerging Asia will require about USD22.6trn of infrastructure investment between

2016 and 2030, or USD1.5trn a year. No single source of funding can meet the large

demand. Given the vast and growing pool of long-term savings in Asia, money should

not be an issue. The problem is matching these funding resources with investable

projects. In this sixth edition of On the New Silk Road, we look at the options available:

Public and development finance: The New Silk Road Fund, the China Development

Bank, the Export and Import Bank of China, the Asia Infrastructure Investment Bank,

the New Development Bank, and the ADB all focus on providing financing for

investable projects with spin-off effects for economic and social development.

Commercial banks: Through products and services, such as project financing and

transactional banking, banks can help boost investment and trade flows along the

Belt and Road economic corridors.

Capital markets: The challenge is to develop an efficient structure to match projects

with investors who have different requirements in terms of risk appetite and returns.

Whether through debt or equity financing, it’s crucial to make infrastructure-related

financial instruments part of mainstream asset allocation. This would attract a

broader range of private investors, including pension and insurance fund managers.

Greater involvement by the private sector should also help improve the efficiency of

infrastructure investment. As such, better policy coordination among the governments

to provide a transparent regulatory framework for private investment would represent

a crucial step towards reaping the benefits of the BRI.

31 May 2017

Qu Hongbin Co-Head of Asian Economics Research, Chief China Economist

The Hongkong and Shanghai Banking Corporation Limited

hongbinqu@hsbc.com.hk

+852 2822 2025

Ma Xiaoping China Economist

The Hongkong and Shanghai Banking Corporation Limited

xiaopingma@hsbc.com.cn

+86 10 5999 8232

On the New Silk Road VI ECONOMICS ASIA/CHINA

Financing the BRI – where the money is coming from

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ECONOMICS ● ASIA/CHINA

31 May 2017

2

More BRI-related action plans

China’s government held its inaugural Belt and Road Forum (BRF) on 14-15 May 2017. More

than 1,000 delegates from over 30 countries and international organisations attended. President

Xi delivered a keynote speech that outlined action plans to stimulate investment and trade along

the BRI economic corridors. After the meeting, China’s official media outlet (Xinhua) published a

list of 270 initiatives, covering policy coordination, transport connectivity, trade and financial

integration, and cultural exchanges.

More financial support from Beijing

As part of its renewed support for the BRI, China’s government plans to scale up funding by

contributing an additional RMB100bn to the state-owned Silk Road Fund, encouraging overseas

RMB fund business, and setting aside a total of RMB380bn for a special lending scheme for two

key development financial institutions: the China Development Bank (CDB) and the Export and

Import Bank of China (EXIM) (Table 1). In addition, China has called for better financial

integration and enhanced policy cooperation to offer long-term, sustainable financial support to

facilitate BRI projects. The RMB’s internationalisation is expected to benefit from the rising tide

of BRI-related trade and investment flows (see Rise of the Redback VI, April 2017).

Table 1: Beijing’s increased financial support to the BRI announced during the BRF

Action RMBbn USDbn equivalent Timeframe

Silk Road Fund capital 100 14.5 NA Encouraging financial institutions’ overseas fund business in RMB to provide support for the BRI

300 43.5 NA

China-Russia Regional Cooperation Development Investment Fund* 100 14.5 NA China Development Bank (CDB) will set up the B&R Multi-currency Special Lending Scheme for Infrastructure Development

100 14.5 NA

CDB will set up the B&R Multi-currency Special Lending Scheme for Industrial Cooperation

100 14.5 NA

CDB will set up the B&R Multi-currency Special Credit Lines for Overseas Financial Institutions

50 7.3 NA

EXIM will set up the B&R Multi-currency Special Lending Scheme 100 14.5 NA EXIM will set up the B&R Multi-currency Special Lending Scheme for Infrastructure Development

30 4.4 NA

Assistance to developing countries 60 8.7 2017-20 RMB940bn USD136.5bn

*Note: Initial RMB10bn to promote cooperation between China’s Northeast and Russia’s Far East. NA – Not applicable. Source: Belt and Road Portal

Enhanced policy coordination

By linking countries and regions that account for about 63% of the world’s population and 29%

of global GDP, the BRI can provide stronger links with Asia, Europe, and Africa. Unleashing the

growth potential of BRI countries and achieving economic integration and inter-connected

development holds the key to success. So, aside from a series of infrastructure projects, policy

coordination is becoming increasingly important. China signed business and trade cooperation

agreements with over 30 countries during the recent forum. It also signed memoranda of

understanding with 14 international organisations, including the ADB, the AIIB, the NDB and the

World Bank, aiming to better leverage the strength of these multilateral institutions. These

efforts are building blocks that will help create a China-led global development framework.

Infrastructure connectivity the key

Infrastructure connectivity remains the focal point of the BRI. President Xi stressed the promotion

of investment in key passageways, cities and projects, and networks of highways, railways and

sea ports. This will lead to strong demand for cross-border financing services, with financial

integration one of the key components aiding the network. President Xi called for the creation of

new models of investment and financing, encouraging greater cooperation between governments

and private capital in building a diversified financing system and a multi-tiered capital market.

China’s government plans to

scale up funding for the BRI

3

ECONOMICS ● ASIA/CHINA

31 May 2017

Infrastructure demand vs funding gap

According to the ADB, Asia Pacific needs up to USD1.5trn in infrastructure investment per year

through 2030 to sustain its growth trajectory. Total infrastructure investment demand will

amount to USD22.6trn during 2016-30 (Meeting Asia’s infrastructure needs, ADB, 2017). This

estimate covers all 45 ADB member countries in developing Asia, focusing on the region’s

power, transport, telecommunications, water and sanitation infrastructure (Chart 1). Currently,

Asian countries invest USD881bn annually in infrastructure, so the estimated funding gap is

equal to 2.4% of projected GDP for 2016-20.

China, India and Indonesia need the most infrastructure investment (Chart 2), with China

accounting for more than half (58.2%). Other BRI countries also need to bridge the infrastructure

investment gap (Table 2). Similar to China, many BRI countries are on the urbanisation ‘fast track’

(60% of BRI countries’ urbanisation ratios are 30-70%). The average urbanisation ratio of BRI

countries increased by 0.61ppt, higher than the world average of 0.15ppt, in 2015, according to

the World Bank. Simply put, cities generate significant demand for infrastructure.

Chart 1: Asian infrastructure demand by sector

Chart 2: Asian infrastructure demand by country

Source: ADB, HSBC Source: ADB, HSBC

Table 2: Many BRI countries are urbanising rapidly, generating substantial demand for infrastructure

Country GDP per capita (USD) Urbanisation ratio Electricity consumption, 000

kWh/person

Railway density, km/million population

China 8,016 56.1 4.1 88 India 1,688 32.0 0.7 52 Pakistan 1,427 37.9 0.4 63 Bangladesh 1,265 32.8 0.3 15 Indonesia 3,415 53.3 0.7 32 Thailand 5,426 47.9 2.3 60 Vietnam 2,170 32.3 1.2 28 Kazakhstan 11,028 53.0 4.6 810 Uzbekistan 2,129 36.2 1.4 117 Tajikistan 949 35 1.7 80 65 BRI countries (avg) 3,795 47.5 1.5 112

Source: World Bank, CEIC, HSBC

52%

35%

10%3%

Power

Transport

Telecom

Water andSanitation

58%20%

5%2%0%

15%

China

India

Indonesia

Central Asia

The Pacific

Other

ECONOMICS ● ASIA/CHINA

31 May 2017

4

Limited room for scaling up public financing

So far, the public sector has provided the majority of infrastructure investment, particularly in

Asia, where the government contribution is over 90% (Chart 3). This implies that there is limited

room for further scaling up of public investment, so new channels are needed. However,

motivating the private sector to finance infrastructure projects is easier said than done. Yet, the

experience of some developed countries offers some encouragement. For instance, the

Government of the UK has long believed that infrastructure has a critical role to play in

economic development. The UK accounted for 22% of total European infrastructure investment

in 2014 and this is expected to increase in the coming years. The private sector contributed to

more than 60% of the country’s total infrastructure investment before the Global Financial Crisis

(GFC), and still accounts for more than 50%.

Chart 3: Public sector dominates infrastructure investment in Asia

Chart 4: China – rapid infrastructure ODI expansion in the past few years

Source: ADB, HSBC. Note: UK for 2014, other countries for 2011-14 avg. Source: CEIC, HSBC

…while trillions of dollars are seeking investable projects

The main obstacle to developing infrastructure is not a lack of available financing. The problem

is that global pension funds, insurance companies and other long-term institutional investors,

which have a large pool of capital, have found it difficult to identify investable projects. Only a

very small share of global pension and insurance funds (10-15% in OECD countries) are

invested in infrastructure projects. Long term in nature and capital-intensive, a structured risk-

sharing arrangement is crucial for infrastructure projects to attract private investors.

A properly designed contract can help support efficient project implementation and increase the

security of private sector investments. It’s crucial that contracts are based on incentive-driven

risks and returns. A solid legal framework also helps mitigate political risks, one of the key risks

for infrastructure projects. Only if private investors can trust the legal and political procedures

will they commit large-scale, long-term financing.

A multi-tier system to provide sustainable funding support for the BRI

Given the sheer size of the infrastructure demand, we believe a market-oriented, multi-tier

system of financing is the only feasible way to provide sustainable funding for cross-border

infrastructure projects involved in the BRI. This was also the key message from People’s Bank

of China Governor, Zhou Xiaochuan, at the recent forum. This multi-tier system should include

public funding, development finance, and private financing through both domestic and

international financial markets.

0 2 4 6 8

25 ADB developingcountries

Indonesia

India

China

UK

As % of GDP

Public Private

-40

-20

0

20

40

60

80

100

0

5

10

15

20

25

2011 2012 2013 2014 2015 2016

%yr%

Infra as % of total (LHS) Infra ODI, %yr

5

ECONOMICS ● ASIA/CHINA

31 May 2017

Silk Road Fund and public funding: to provide seed capital and attract private investment

The Silk Road Fund, which has a capital base of USD54.5bn, tends to use a combination of

equity (70%) and debt investments (30%) to provide support in four key areas: infrastructure,

energy, industrial, and financial cooperation. The Silk Road Fund has initiated 15 investment

projects totalling USD6bn as of May 2017. Leveraged total investment now tops USD80bn, Silk

Road Fund Chairwoman, Jin Qi, said in an interview (China Finance中国金融, May 2017). The

Silk Road Fund also set up a China-Kazakhstan Industrial Cooperation Fund of USD2bn in

December 2015 to support production capacity and investment between the two countries.

However, public funding in China could be restrained by mounting debt levels and increasing fiscal

deficits. Developing countries should consider increasing their infrastructure investment as public

funding, when used as seed money, can help reduce project risks and attract private investments.

Development finance: leveraging at a lower cost; “squeeze in” private investment

Development finance aims to meet funding demands that serve long-term strategic objectives.

Such lending, which is market-driven, independent and based on sound credit analysis, does

not rely on subsidies and focuses on long-term investment, capital preservation with a thin

profit, and a sustainable financial model. The CDB and the EXIM are the two key development

institutions in China. Internationally, if we include the newly established AIIB and the New

Development Bank for BRICS, multilateral development banks have provided USD30-50bn

annually in terms of credit support for infrastructure and other developments.

National development banks: China Development Bank, Export and Import Bank of China

Development financial institutions in China have provided crucial funding support for the “going

out” strategy of China’s state-owned enterprises (SOEs) in the past eight years. The launch of the

BRI in late 2013 saw a further strengthening of the investment arm of the China Development

Bank, and the Export and Import Bank of China, the two key institutions in development financing.

Equipped with an increased fund allocation from Beijing, the CDB and the EXIM are expected to

increase investment in BRI-related infrastructure projects. The CDB has a list of more than 500

pipeline projects for BRI countries, with planned investment totalling USD350bn. Outstanding

loans for the BRI totalled USD110bn at the end of 2016 (accumulative lending totalled

USD160bn). EXIM Bank of China’s outstanding loans for the BRI totalled RMB700bn

(USD90bn) at the end of 2016.

China’s national development banks are also setting up special investment funds with foreign

governments or sovereign funds to invest in strategic development projects. In 2015, EXIM Bank

of China and Buttonwood Investments, the State Administration of Foreign Exchange’s (SAFE)

investment affiliate, jointly set up the China-Africa Industrial Cooperation Fund with total capital of

USD10bn. The China-Africa Industrial Cooperation Fund has approved six projects totalling

USD542m of investment as of April 2017. For example, it invested (with Chinese company GCL-

Poly) in an oil and gas project in Ethiopia, which has become a high-profile BRI investment

project, involving a total investment of USD3.68bn.

In addition to the China-Africa Industrial Cooperation Fund, China has set up separate funds for

regional investment cooperation, with Eurasia (Central and Eastern European countries and

Asia), Latin American and the Caribbean (LAC), the Middle East, Brazil, Russia and Kazakhstan.

An investment fund with the EU is still under discussion. The total capital of all China-led

international investment funds probably exceeded USD70bn as of May 2017 (Table 3).

The Silk Road Fund has

initiated 15 investment

projects totalling USD6bn

ECONOMICS ● ASIA/CHINA

31 May 2017

6

Table 3: China-led regional development investment funds

Fund name Time Key Chinese stakeholders Capital Investment

China-Eurasia Economic Cooperation Fund Sep-15 EXIM, BOC USD5bn Equity China-LatAm and Caribbean Industrial Cooperation Fund

Sep-15 PBoC, SAFE, CDB USD10bn Debt

China-Africa Industrial Cooperation Fund Dec-15 Buttonwood, EXIM USD10bn Equity & Debt China-Kazakhstan Industrial Capacity Cooperation Fund

Dec-15 Silk Road Fund USD2bn Equity & Debt

China-UAE Joint Investment Fund Dec-15 CBD USD10bn Equity China-ASEAN investment Cooperation Fund Nov-14 NA RMB3bn NA China-Africa Development Fund 2006 CBD USD10bn Equity Brazil-China Cooperation Fund Oct-16* USD 20bn (Brazil

USD15bn, China USD5bn)

Equity

China-Russia Regional Cooperation Development Investment Fund

May-17* RMB100bn Equity

China-EU Joint Investment Fund Ongoing NA

Source: Xinhua News, HSBC. *Signed agreement. NA – Not applicable.

AIIB, New Development Bank (NDB), and other multilateral development banks

In addition to the two newly-established multilateral development banks (MDBs) – the Asian

Infrastructure Investment Bank and the New Development Bank for BRICS – China is also

working with the European Bank for Reconstruction and Development (EBRD). During the BRI

Forum, China signed a series of MOUs with MDBs, which share the same goal of boosting

infrastructure development in emerging markets.

Global MDBs have contributed an average of USD30-50bn to infrastructure in developing

countries in the past decade. They are also trying to increase private sector investment by:

Working together with countries to design programmes and practical tools to help attract

private investors

Providing capital instruments and guarantee products to help crowd-in private finance

Participating in projects to give private finance more confidence in social and governance

issues

Providing financial and pricing commitments to reduce the risk to private investors

Their networks bring together global expertise about infrastructure policy and design, as well as

practitioners engaged in the business of structuring, financing and implementing projects, which

could help make projects more bankable.

Table 4: MDBs infrastructure investment plans

USDbn 2016e 2017e 2018e

African Development Bank* 7.3 9.5 6 Asian Development Bank 70 for 2016-20 Asian Infrastructure Investment Bank 1.2 (1.73 actual) 2.5 3.5 Development Bank of Latin America 4.8 5.0 5.1 European Bank for Reconstruction and Development

5.9 7.1 8.5

European Investment Bank 40-50 40-50 40-50 New Development Bank 15-16 15-16 15-16 World Bank 30-50% of total lending 30-50% of total lending 30-50% of total lending International Finance Corporation 5.8 6.1 6.4

Source: Report to G20 Deputy Finance Ministers and Deputy Central Bank Governors on MDB Internal Incentives for Crowding-in Private Investment in Infrastructure, Global Infrastructure Hub, 1 December 2016. *Note: Including public and private sector investments.

7

ECONOMICS ● ASIA/CHINA

31 May 2017

Asian Infrastructure Investment Bank. The AIIB is now fully operational. In Table 5, we

summarise the projects that have benefited. So far, the AIIB has provided financing support to

nine infrastructure projects in Asia, with the total loan value reaching USD1,730m. In most cases,

the AIIB is working with other leading global financial agencies to make the loans available.

Table 5: Projects financed by the Silk Road Fund and the AIIB

Destination country

Project Investor Sector Investment details

Bangladesh Distribution system, upgrade and expansion

AIIB Power supply AIIB loans: USD165m

Pakistan National Motorway M4 (Shorkot-Khanewal section)

AIIB Transportation AIIB loans: USD100m, co-financed with the Asia Development Bank (ADB) and the UK’s Department for International Development.

Tajikistan Dushanbe-Uzbekistan border road improvement project

AIIB Transportation AIIB loans: USD27.5m, co-financed with the European Bank for Reconstruction and Development

Indonesia National slum upgrading project AIIB Social services, transportation and solid waste management

AIIB loans: USD216.5m, co-financed with the World Bank

Pakistan Tarbela 5 hydropower extension project

AIIB Hydropower, energy AIIB loans: USD300m, co-financed with the World Bank and the Government of Pakistan

Oman Railway system preparation project AIIB Transportation AIIB Loans: USD36m, Omen Global Logistics Group (OGLG) USD24m

Oman Duqm Port Commercial Terminal and Operational Zone Development Project

AIIB Transportation AIIB Loans: USD265m, Special Economic Zone Authority of Duqm (SEZAD) USD88.33m

Azerbaijan Trans-Anatolian Natural Gas Pipeline Project

AIIB Energy AIIB Loans: USD600m, World Bank USD800m, Other IFIs (EBRD and EIB) USD2,100m

Myanmar Myingyan 225MW combined cycle gas turbine power plant

AIIB Energy AIIB loans: USD20m, co-financed with the International Finance Corporation (IFC), the ADB and certain commercial lenders

Source: AIIB. Note: All approved and perspective projects information are available on AIIB’s website.

Commercial banks – loans and debt instrument for bankable infrastructure projects

Commercial banks are encouraged to get more involved amid rising trade and investment flows

along the BRI. A wide variety of banking products/services are needed, including

correspondence banking, syndicated financing, capital market financing, cash management and

cross-border settlement, project financing, account management and risk management.

Commercial banks to expand overseas service networks. Given most enterprises, central

SOEs and private companies alike are existing customers of domestic commercial banks,

facilitating their cross-border business is a natural extension of their existing business relationship.

The only constraint could be the banks’ limited international reach (Table 6). This is particularly

relevant in countries along the Belt and Road route. BRI countries tend to be less developed and

have low international credit ratings, suggesting higher risks. This explains why commercial banks

often find BRI projects financially unviable. Financial innovation is needed to deal with the mismatch

between the substantial investment demand and the lack of private investment/financing.

According to the State-owned Assets Supervision and Administration Commission (SASAC), 47

out of 102 central SOEs are engaged in more than 1,670 projects in BRI countries, mainly as

engineering contractors, equipment producers, and construction companies. Industrial and

Commercial Bank of China (ICBC) and Bank of China (BOC) are the leading state banks in BRI

expansion. ICBC’s BRI-related projects in the pipeline total USD337.2bn and it has accumulatively

provided USD67.4bn for 212 investment projects. BOC has so far provided credit lines of

USD68bn to 460 BRI projects.

ECONOMICS ● ASIA/CHINA

31 May 2017

8

China Construction Bank (CCB) has provided financing to 46 BRI projects (total funding of

USD6bn). It also has a total of 268 infrastructure projects, such as power, construction, mining,

transport, oil & gas and telecom related to the BRI, located in 50 countries and involving

investment of USD466bn. CCB aims to expand its international business-related bank assets to

8-10% by 2020, still a relatively low level due to the bank’s traditional lack of overseas business

advantages (ICBC 8.8% and BOC 27%, both for 2016).

Table 6: State banks: increasing international exposure

______ Global _______ _________________________________ BRI _________________________________

Country

coverage Branches Country coverage Branches Projects/Financing Perspective projects

/investments

ICBC 42 412 18 127 212/USD67.4bn 412/USD337.2bn BOC 51 578 20 21 460/USD68bn 420/USD100bn of credit lines CCB 29 251 6 >10 46/USD6bn 268/USD466bn ABC* NA 13 NA NA NA NA BOCOM* 16 20 NA NA NA NA

Source: Hexun, Bank websites. Data as of end-2016. *ABC – Agricultural Bank of China, BOCOM – Bank of Communications. NA – Not applicable.

For the past three years, state-owned banks have focused on trade finance, cross-border M&A,

project finance, bond, syndicated loans and financial leasing. Bank syndicated loans for

infrastructure projects are usually secured by collateral, so have the lowest level of risk and can

be securitised and sold to institutional investors.

Beijing to work with regulators in BRI countries to reduce market access barriers and

promote an open and fair regulatory environment for financial institutions’ international

expansion. For example, the Silk Road International Bank, initiated by three Chinese companies

including Izptec, a big data company, and Djibouti’s Ministry of Finance, was set up in January

2017 to promote financial support for investment in Africa (China Daily, 19 January 2017). There

could be more new financial institutions as the BRI market opens further.

Capital market financing

From a project finance perspective, the structure of infrastructure financing depends on

mitigating risks related to projects and enhancing returns related to different financing

instruments and funding channels. The risks include political, regulatory, macroeconomic,

business operational, and technical issues.

The capital market can be an efficient way to develop risk-sharing structures. Whether through

debt or equity finance, it’s crucial to make infrastructure instruments part of mainstream asset

allocation for a broader spectrum of private investors, including pension funds, insurance funds

and asset managers all over the world.

Debt finance (excluding loans). Given the long-term, low return and capital-intensive nature of

infrastructure investment, debt financing products – i.e. government bonds, municipal revenue

bonds, corporate bonds and project bond issues – can finance infrastructure projects at a

relatively lower cost, compared with syndicated loans or project loans. All these bonds, from

private sector or public sector institutions, are market-based instruments to finance

infrastructure projects and are sold to fixed-income investors.

Government bonds and sub-sovereign bonds are key components of investment grade bond

portfolios for most institutional and retail investors. Long maturity and high credit ratings make

them core instruments for mutual funds and ETFs. They have long been a traditional source of

funding for infrastructure and will remain a key funding source. The performance of the bonds is

linked to the fiscal capacity of the government or sovereign institutions, rather than the

infrastructure asset. It’s worth noting that corporate bonds issued by a sub-sovereign entities

are also included in this category. In Europe, a large proportion (50% for Europe and 20% for

the UK) of infrastructure corporate bond issuance is through sub-sovereign entities, and the

bonds trade with yields close to the sovereign. However, for BRI emerging countries, which

have a relatively low credit ratings, this may not be a preferred funding channel.

The structure of

infrastructure financing

depends on mitigating risks

9

ECONOMICS ● ASIA/CHINA

31 May 2017

Corporate bonds are standardised securities allowing infrastructure companies to lock in long-

term financing and tap the deep and liquid capital market. This is a relatively reliable source of

funding for those corporations that are able to access that market. Compared with project bonds,

corporate bonds bear the risk of the issuers’ asset portfolio, instead of the risk of an individual

project, so are less risky. Most large infrastructure projects are funded at least partly through the

corporate bond market. This requires an efficient corporate bond market, and, with better

financial integration, BRI countries could benefit from China’s large and increasingly open bond

market, which already accounts for 8.7% of the global bond market in terms of bonds

outstanding. For example, Panda bond issuance (RMB-denominated bonds from a non-Chinese

issuer) is expected to exceed USD50bn by 2020, up from RMB148bn, or USD22bn, as of end-

2016. In Asia, bond financing has outpaced syndicated loans in the past five years and provided

more support to infrastructure investment, with corporate bonds in China playing a leading role.

Project bonds are standardised securities issued by a project company special purpose vehicle

(SPV) financing a specific infrastructure project. This is a growing area of project finance and

provides a potential solution for financing brownfield infrastructure projects with long-term debt.

A large total, exceeding USD100m, and long duration (50 years or longer), could make a project

bond more viable. The bond’s creditworthiness depends on the cash flow performance of the

SPV, or by a credit-enhancement mechanism. Project bonds, like corporate bonds, have a

higher level of transparency, greater liquidity and pricing, compared with bank loans. A deep

and liquid capital market is a pre-condition. However, investors usually find it difficult to assess

the risk of a complex infrastructure project and rely on ratings issued by external rating agencies.

So ratings are a pre-requisite to reach a broader base of bond investors. And the rating has to

be investment grade or above so that more institutions can invest. For BRI projects, it is worth

keeping in mind that it’s possible to obtain a credit rating for a project higher than that assigned

to the country in which the project is located.

Green bonds are corporate bonds, project bonds and sub-sovereign bonds that finance green

infrastructure investment, such as clean energy. The bonds can be issued by development

banks, governments, corporations, banks or by SPVs as project finance and asset-backed

securities. Green bonds are no different from other project bonds or debt instruments and

issuance has been growing rapidly in the past few years, reflecting a rising global appetite to

combat climate change. The launching of green bond indices has also helped raise the profile of

green bonds and provide a benchmark for investors.

The New Development Bank (NDB) sold RMB3bn (USD440m) of RMB-denominated green bonds

in China’s interbank market on 18 July 2016. This is the first five-year tenor green bond by a MDB

in China. BOC was the lead underwriter and book runner for the issuance, with joint underwriters,

including ICBC, CCB, and Standard Chartered. China’s green bond issuance exceeded

RMB200bn in 2016, making it the world’s largest green bond market thanks to the policy support

from the PBoC and the National Development and Reform Commission (NDRC).

Silk Road Bonds are intended to become an internationally recognised asset class, capable of

being scaled to provide the necessary funding requirements for BRI infrastructure. In June 2015,

BOC issued the first Silk Road Bond, totalling USD3.55bn, in four currencies: USD, EUR, SGD

and CNY. The deal attracted orders of around USD12bn (Reuters, 25 June 2015). In April 2017,

BOC issued the second Silk Road Bond, totalling USD3bn, in USD, EUR, AUD and CNY; issuing

entities included BOC branches in Macau, Dubai, Johannesburg, Sydney and Luxembourg.

Silk Road Bonds have gained support from government authorities in both China and BRI

countries, regulatory bodies, MDBs and industrial experts. The International Capital Market

Association (ICMA) and Dagong have set up a Silk Road Bond Working Group in Hong Kong to

help drive the development of Silk Road Bonds.

Most large infrastructure

projects are funded at least

partly through the corporate

bond market

Green bonds finance green

infrastructure investment,

such as clean energy

ECONOMICS ● ASIA/CHINA

31 May 2017

10

For pension funds and insurance funds, which have ‘deep pockets’ and seek long-term stable

income, bond products could be tailor-made to meet their specific demands and preferences.

Bonds sold to institutional investors have broader access to global fixed-income markets.

Traditionally, bond financing accounts for a large chunk of infrastructure investment.

Equity finance is critical for initiating an infrastructure project or refinancing. As risk capital,

equity finance is provided in return for ownership. Financial providers usually are interested in a

higher return and an exit strategy is also an important component. They can sell the stake in a

secondary market or in other ways.

Listed infrastructure companies raise capital by selling shares to investors through stock

exchanges. In the past decade, major index providers have started offering infrastructure

indices that track the performance of listed companies. Investment products that are

benchmarked against these indices allow investors to make targeted allocations to

infrastructure. Listed infrastructure companies included in established stock market indices can

help provide attractive investment opportunities for retail and institutional investors.

Listed infrastructure funds raise capital through public equity markets by issuing stocks or

attracting capital from investors. Retail investors buy into these funds to gain exposure to

infrastructure assets. Funds can invest in listed or unlisted project companies. Although a listed

infrastructure fund can offer quick access to infrastructure investment, it also has the

disadvantage of being exposed to the volatility and risks associated with the equity market.

Unlisted direct equity investment platforms are for sophisticated investors, such as pension

funds and insurance companies that can undertake due diligence on infrastructure assets and

acquiring equity stakes in the business entity. Co-investment platforms are created to bypass

the large fees associated with investing through unlisted equity funds. Large pension funds and

sovereign wealth funds are able to pool their financial and internal resources to invest jointly in

infrastructure projects. Compared with investment funds, which usually have a shorter lifespan

than the infrastructure assets, direct and co-direct investors can commit capital and

management of assets over a longer time period. On average, 10-15% of OECD countries’

pension and insurance investment are invested in infrastructure.

Unlisted infrastructure equity funds offer ways for institutional investors to directly invest in

infrastructure assets. Investors can participate in the fund as limited partners (LP), while the

fund is managed by a general partner (GP), often an investment bank or investment

management firm. There could be conflict of interests between short-term capital gain-driven

fund managers (2-5 years) and long-term institutional investors (>10 years), making the

determination of a fee structure difficult. Long-term funds that better match long-term investment

objectives, with a structure suitable for a wider range of investors, are available.

A supportive project finance environment and deep, liquid debt markets are essential to attract

investment funds to infrastructure projects, particularly private equity investors. Private equity

currently accounts for 10-30% of global infrastructure investment. Some of the investment funds

are invested in PPP/PFI assets.

There are also hybrid instruments that act as a bridge between debt and equity financing

instruments. For example, MDBs can issue subordinate or hybrid debt, providing credit support

for infrastructure projects.

Greater involvement by the private sector will not only provide more financing but also help

improve the efficiency of infrastructure investment. As such, better policy coordination among

the governments involved to provide a transparent regulatory framework for private investment

would represent a crucial step towards reaping the benefits of the BRI.

Bonds sold to institutional

investors have broader

access to global fixed-

income markets

Retail investors buy into

these funds to gain exposure

to infrastructure assets

11

ECONOMICS ● ASIA/CHINA

31 May 2017

Chart 5: Debt financing instruments have historically comprised 60-80% of global infrastructure capital

Source: OECD. Note: Debt instruments include bank loans.

The BRI as a driver of the RMB’s internationalisation

The RMB’s internationalisation is expected to benefit from this rising tide of BRI-related finance

and business flows, as well as enhanced policy cooperation (The Rise of Redback VI: Making

the right connections).

Strengthening the connectivity of financial infrastructure among BRI countries is part of this

process, and China is ready to share its experience in cross-border payment networks, rural

banking, and payment by mobile phones. For example, Ant Financial, Alibaba’s finance affiliate

and China’s largest provider of internet financial services, has expanded its mobile-payment

business to India, Thailand, Korea and France in the past two years (Bloomberg, 18 May 2017).

At the country level, expanding the role of local currencies in the BRI will better utilise domestic

savings and reduce currency exchange costs. From a project finance perspective, debt issuance for

infrastructure projects is usually in local currency to minimise currency risks (currency mismatch in

project revenue and financing flows). Hard currency or multiple-currency issuance is also possible.

China’s efforts to sign local currency swap agreements with other countries, promote the direct

exchange of RMB with various currencies, appoint RMB clearing banks offshore and set up the

cross-border payment settlement (CIPS) system give it the experience needed to help BRI

countries expand the use of local currencies. This renewed effort to push forward policy

cooperation is expected to boost trade and investment connections in BRI countries in the next

few years. In addition to using the RMB in trade settlement and direct investment, the BRI is

helping to build a framework based on investment, financing and a credit information.

Hong Kong and London: international financial centres have an edge in the BRI

As the BRI involves more than 60 countries, increasing trade and economic connections implies

a greater demand for complex financial services, such as cash flow management, foreign

exchange, cross-border payments, and risk and liability management. International financial

centres can provide professional project finance and risk management services for BRI projects

and enhance operational efficiency and reduce currency risk. Hong Kong and London have an

advantage in this area thanks to their well-developed financial infrastructure and deep and liquid

FX markets and concentration of the world’s leading financial institutions.

Debt

Hybrid

EquityDebt:60-80%

Hybrid:0-20%

Equity:10-30%

Bonds ( government and sub-sovereign bonds, corporate bonds, project bonds, Greenbonds); loans (syndicated loans, securitized loans, CLOs)

Equities ( listed infrastructurefunds, trusts, ETFs ; unlisted infrastructure funds)

Decreasing cost

Increasingrisk

China is ready to share its

experience in cross-border

payment networks

ECONOMICS ● ASIA/CHINA

31 May 2017

12

Infrastructure network: Action plan for mutual efforts

It is well known that infrastructure is the key physical component of the Belt and Road Initiative,

in addition to trade, investment connections. Financial integration with better policy coordination

within BRI countries is needed to bridge the investment gap. While China has invested heavily

in infrastructure in the past few years, with support from major development financial institutions,

the commercial banks need to grab a larger slice of the action as Chinese enterprises expand

overseas. We believe that better policy coordination between BRI countries and financial innovation

can help them achieve that goal.

In addition to infrastructure investment, China’s rising overseas investment in manufacturing,

especially equipment manufacturing, is another area to watch. This reflects Beijing’s efforts to

promote international cooperation with regards to industrial production and equipment

manufacturing. The idea is to upgrade the domestic manufacturing industry by internationalising it.

We see many positive developments supporting future ODI flows in the BRI region. There are a

substantial number of new projects being negotiated or about to be announced, which will

translate into a stable flow of future outward investment.

In conclusion, now that the global economy is showing signs of recovery, more projects are

reaching the implementation stage, cross-border trade connections are becoming more

sophisticated, and financing support is gradually strengthening. We expect RMB trade

settlement and investment to continue to strengthen in parallel with the expansion in China’s

trade and investment in the BRI region in the next couple of years.

China’s rising overseas

investment in manufacturing

is another area to watch

13

ECONOMICS ● ASIA/CHINA

31 May 2017

Disclosure appendix

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personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific

recommendation(s) or views contained in this research report: Qu Hongbin and Ma Xiaoping

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31 May 2017

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[697163]

Global

Global Chief Economist Janet Henry +44 20 7991 6711 janet.henry@hsbcib.com

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Europe

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France

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North America

US

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Ryan Wang +1 212 525 3181 ryan.wang@us.hsbc.com

Canada

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Asia Pacific

Managing Director, Co-head Asian Economics Research and Chief Economist Greater China Qu Hongbin +852 2822 2025 hongbinqu@hsbc.com.hk

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Global Economics Research Team