March 8, 2018 Environment The Next Big Challenge: Greening the Belt and Road Initiative ◼ The Belt and Road (B&R) is China’s multi-billion- dollar connectivity initiative across Eurasia and Africa. It spans nearly 70 countries, accounting for a third of global GDP, and will be the backbone of Beijing’s foreign policy and SOE agendas until 2049. ◼ To date, the B&R evades classification and does not elicit unanimity. Carbon lock-in and white elephant infrastructures are as plausible as renewable revolution or climate change adaptation and resilience projects. Meanwhile, President Xi Jinping has both tied his name to the B&R and assigned to China a “role of torch-bearer in the global endeavour for ecological civilization”. ◼ In our view, to match words with action, and to make Sustainable Hub Hub Sustainable B&R projects palatable for foreign investors and enterprises, they must deliver a “triple win” result for Chinese firms, host countries and the planet. Navigating B&R complexity with a sustainable finance compass –and bridging the infrastructure gap in a 2°C consistent way– is an enthralling Green& challenge. The B&R strategic planning stage ends in - 2021, it is still a blank page with no definitive framework or scope of activities… let’s green it! ………………………………………………………….….…… Cedric Merle +33 1 58 55 30 55 [email protected] With the participation of: Jianwei Xu (Greater China Economist) +852 3900 8034 [email protected] Sustainable Hub Hub Sustainable Center of Expertise www.research.natixis.com Distribution of this report in the United States. See important disclosures at the end of this report. C1 - Public Natixis Center of Expertise - Green & Sustainable Hub Contents Introduction 3 Key findings 6 The Belt & Road Initiative: backdrop and rationales behind the 21st infrastructure project 14 The genesis of a multibillion-dollar connectivity project endorsed by President Xi 14 An amorphous initiative hard to navigate for investors 16 Financial firepower dedicated to the bankrolling of B&R 23 Decrypting rationales behind B&R from China’s standpoint 26 What a low-carbon and sustainable Belt and Road could look like 29 The B&R is a golden opportunity to bridge the infrastructure gap and achieve the goals set out in the Paris Agreement and the 2030 Agenda for Sustainable Development. 29 To match words with action, carbon lock-in projects financing, especially coal, should be phased out 37 Biodiversity along B&R corridors must be considered and preserved 39 Striving for a “triple-win” Belt and Road thanks to sustainable finance 42 Chinese leaders’ call for sustainability support and partnership 42 Towards a green finance laboratory 44 Ways to overcome the “wait-and-see” attitude among foreign investors and companies to jump on the bandwagon46 Abbreviations 49 2 C1 - Public Natixis Center of Expertise - Green & Sustainable Hub Introduction The Belt and Road (B&R) is the multi-billion-dollar flagship infrastructure initiative across Eurasia and Africa initiated by China in 2013, endorsed by President Xi and henceforth enshrined in the constitution of the Communist Party of China (CPC). It will undoubtedly be the backbone of Beijing’s foreign policy and SOE agendas for decades. Noticeably, the 3rd stage, “strategic implementation”, spans from 2022 to the 100th anniversary of the People's Republic in 2049. A major challenge is that the B&R label evades classification. There is neither an agreed-upon definition for what qualifies as a related project, nor an official list of participants or projects. Overall, it embraces nearly 70 countries, accounting for a third of global GDP. Emblematic connectivity projects often referred to include the Piraeus, Gwadar and Djibouti ports, the China Pakistan Economic Corridor, the dry port of Khorgos in Kazakhstan, or the freight train lines from Chongqing to Duisburg or Rotterdam, or from Yiwu to London. The scope of the B&R is deliberately kept vague, without detailing its territorial or industrial boundaries. It is rather an “umbrella” that encompasses outbound investments and the development of green field infrastructures such as roads, bridges, pipelines, ports, railways and power plants. It takes various forms like M&A, project finance, debt rescheduling, export credits, grants and loans. It often ties financing from the China Development Bank or the Exim Bank to the involvement of Chinese firms like COSCO Shipping or China Railway Construction, either as suppliers of machinery and materials, or as construction and operating partners. This report addresses the B&R’s sustainability challenges and pitfalls but aims at a larger audience than the ESG community. To date, it does not elicit unanimity given inter alia the limited competitive tenders, low-debt servicing capacity of recipient countries or harsh collateral rules. It is fraught with risks of carbon lock-in and ghost or white elephant infrastructures unaligned with the Paris Agreement goals. Linear infrastructure –highways, power transmission lines, pipelines– can have major negative impacts on soil, hydrology and water ecosystems. The “Polar Silk Road” to develop shipping lanes and promote oil and gas exploitation across the Arctic could cause irremediable damage should any marine or operational incident occur. However, President Xi tied his name to the B&R and simultaneously assigned to China a “role of torch-bearer in the global endeavour for ecological civilization”. Tainting the programme’s overall reputation with environmental scandals would backfire on the perpetrators. Furthermore, China’s foreign reserve limits and the non-performing loans on the balance sheets of its commercial banks require the intermediation of overseas financial resources. Indeed, despite having established massive financial firepower (e.g. the AIIB and the Silk Road Fund) to support its grand vision, China welcomes foreign investors to fill the gap. The ICMA warned that traditional funding for infrastructure projects, such as government financing, development bank loans and bank project finance, are insufficient and is suggesting “Silk Road Bonds”. Outstandingly, a $2.1bn B&R related green bond was issued last October by the Industrial and Commercial Bank of China. Similar issuances will inevitably follow but to blossom on international capital markets, Chinese protagonists must foremost close the gap between two views regarding what is green. The Green Finance Committee of China Society for Finance and Banking and the EIB try to bridge it by collaborating on a common green taxonomy. It is crucial to explore what a sustainable and 2°C compatible B&R could look like. The initiative’s success will crucially depend on strong ESG credentials. Embedded at the core of strategic risk management, they could safeguard local projects against political turmoil and alternating leadership in the host countries, and make Chinese fixed-income products attractive, especially that it is now possible to tap into China Interbank Bond Market. We believe the B&R could serve as a green finance laboratory with unprecedented opportunities to bankroll climate change adaptation at last. If China exports its unrivalled expertise and track- record on renewables, it could unleash a low-carbon energy access revolution for over 60% of the world’s population. 3 C1 - Public Natixis C1 - Public Natixis C1 - Public Natixis Center of Expertise - Green & Sustainable Hub Key findings 1. The Belt and Road (B&R) is a golden opportunity to bridge the infrastructure gap and achieve the goals set out in the Paris Agreement and the 2030 Agenda for Sustainable Development. 2. The B&R is technology-agnostic but strong arguments can be made to prioritise low-carbon and environmental friendly technologies. 3. Environmental concerns regarding the B&R’s footprint are unquestionably justified. 4. An oversight body with clear responsibility is vital to guarantee the consistency of the initiative and preserves its potential greenness and reputation. 5. To really take “the driver’s seat in international cooperation to respond to climate change”, China should not displace excess capacity abroad but export its “war against pollution”. 6. Robust environmental, social and anti-bribery due diligence will be decisive in increasing the acceptance of B&R projects among local populations and in managing political risks. 7. There is a limit to how much China can finance, so foreign investors are invited to partner up and play a pivotal role. 8. Foreign investors have already more skin in the Chinese game as its financial system is increasingly interconnected with the rest of the world. 9. Environmental assessment policies and China’s green finance initiatives are likely to be strengthened and scaled up towards higher standardization and effectiveness. 10. To overcome the wait-and-see attitude among foreign investors towards jumping on the B&R bandwagon, sectors prioritization and best transparency standards are key. 6 C1 - Public Natixis Center of Expertise - Green & Sustainable Hub 1.The Belt and Road (B&R) is a golden opportunity to bridge the infrastructure gap and achieve the goals set out in the Paris Agreement and the 2030 Agenda for Sustainable Development. The B&R is backed by the promise of significant financial resources, some of which will be offered by new financial institutions created through Beijing’s initiative on the assumption that existing organizations cannot fill massive infrastructure financing gap. B&R is not an aid program but it could bridge the investment infrastructure gap in impoverished or landlocked countries. Its projects can contribute significantly to the 2030 Agenda, besides inter alia poverty and hunger eradication, they have a direct impact on SDG n°9 (building disaster-resilient infrastructure) and n°11 (making urban and human habitat sustainable). The OECD (“Investing in Climate, Investing in Growth”, 2017) estimates that around $6.9tn per year will be needed worldwide between 2016 and 2030 in energy, transport, water and telecommunications infrastructure to sustain economic growth in a 2°C consistent scenario (vs.