Greening the Belt and Road Initiative

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 Expertise of Center www.research.natixis.com

Distribution of this report in the United States. See important disclosures at the end of this report.

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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

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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.

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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.

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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. $3.4tn to $4.4tn today). Middle-income countries, many of which are located along the B&R, are expected to represent around 60% to 70% of those future infrastructure needs. According to the Asian Development Bank (“Meeting Asia’s infrastructure needs”, 2017), Asia will need to invest $26tn from 2016 to 2030, or $1.7tn per year, if the region is to maintain its growth momentum, eradicate poverty and respond to climate change (i.e. including climate change mitigation and adaptation costs).

A point to highlight is that the additional capital cost to be consistent with a 2°C trajectory in the OECD and ADB scenarios is respectively 10% and 13%. Moreover, this affordable cost would be offset by inter alia fuel savings. Arguably, given the long lifespan of infrastructure, failure to invest in the right type of infrastructure in the next 10-15 years would either lock the world into a GHG-intensive development pathway or risk stranding many assets.

2. The B&R is technology-agnostic but strong arguments can be made to prioritise low-carbon and environmental friendly technologies.

China has around one-third of the world’s wind power capacity, a quarter of its solar power, six of the top ten solar panel manufacturers and four of the top-ten wind turbine manufacturers (IEA, WEO 2017). Last year, it sold more EVs than the rest of the world combined, and its expertise in lithium batteries is growing rapidly with champions like BYD and CATL. In January 2017, the NDRC announced a $360bn low-carbon investment by 2020, including solar, wind hydro, nuclear, expected to create 13m jobs.

The B&R has already driven $8bn of solar equipment exports from China, which became the number one exporter of environmental goods and services (IEEFA, 2017). In IEA’s New Policies Scenario, China’s exports of solar PV panels and lithium-ion batteries for EVs alone contribute to global CO2 emissions savings of nearly 1 Gt in 2040, equivalent to around 10% of China’s energy-related CO2 emissions in that year. The IEA concludes “there is a possibility that China could break decisively from the conventional trajectories of energy development followed by advanced industrialised countries, providing a new model for low-carbon urbanisation and economic growth”.

Note that, since 2015, China has been promoting a global network of ultra-high-voltage (UHV) transmission lines that could connect many variable renewable energy bases (e.g. to integrate electricity received from hydro projects in northern Eurasia with wind turbine- generated electricity from the Siberian Arctic). This project is backed by the Global Energy Interconnection Development and Cooperation Organization (GEIDCO), in which China State Grid Corporation plays a prominent role.

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3. Environmental concerns regarding the B&R’s footprint are unquestionably justified.

Despite B&R’s tremendous green potential, the overall picture is mixed. By contrast, China had also been involved in 240 coal-fired power projects in 25 countries along the B&R as of the end of 2016 (notably in India, Indonesia, Mongolia, Vietnam and Turkey), with total installed capacity of 251 GW (GEI, 2017). China’s portfolio of overseas energy finance, mainly from the CDB and Export-Import Bank, the two largest sources of energy finance for governments around the world ($43.2bn energy financing provided in 2016 only), is heavily concentrated in fossil fuel operations, especially in coal. Several B&R projects aim at facilitating the circulation and thus the consumption of fossil fuels, for instance the Yamal LNG and the China-Pakistan Economic Corridor (CPEC), which will halve the length of time it takes to import a barrel of oil from Saudi Arabia (25 days today). The CPEC is the most completed B&R project to date and its energy mix of almost 11 GW is lopsidedly carbonized, split between coal (75%), hydro (15%), solar (8%) and wind (2%).

We conducted a review of M&A transactions by Chinese companies from January 2013 to December 2017, it is a partial but relevant proxy of the B&R footprint because SOEs are indeed the driving forces of the initiative and those who mostly do M&A of foreign companies. Out of around 1,500 transactions for a total of $442bn, approximately 355 were carried in B&R countries for an amount of $90bn, of which solely $2bn went to activities or sectors with clear green benefits (renewable, waste and water treatment), versus $28bn to brown activities or sectors (coal, oil, mining, etc.).

Last January, China’s State Council released its first official Arctic Policy White Paper unveiling a “Polar Silk Road”. It notably promotes technological innovation in Arctic oil and gas drilling and exploitation, and encourages enterprises to build infrastructure and conduct commercial trial voyages. Undoubtedly, heavy maritime traffic and drilling and exploitation could cause irremediable damage should any marine or operational incident occur.

Risks of ghost cities or white elephant infrastructures are considerable. For instance, the Mattala Rajapaska Airport in Sri Lanka faces insufficient demand. To avoid such wasteful projects, thorough analysis of the local needs is needed.

Because of this set of risks, the University of Oxford (Smith School of Enterprise and the Environment) has launched a Green BRI Data and Analysis Platform to document the impacts that current and planned B&R projects will have on the environment and the stranded asset risks they face. Fully available in the first half of 2018, it will cover power generation, cement, iron and steel, automobiles, aviation and shipping and, depending on technical feasibility, it aims at including other sectors including power grids, road, rail, food and beverage manufacturing and processing, paper, refining, mining, upstream oil and gas, pipelines, and LNG.

Chinese decision-makers are aware of the B&R’s sustainability challenges and pitfalls. At the B&R Forum for International Cooperation in May 2017, President Xi declared: “We will set up a big data service platform on ecological and environmental protection”. […] “We propose the establishment of an international coalition for green development on the Belt and Road, and we will provide support to related countries in adapting to climate change”. To date, the platform is only available in Chinese (www.bigdataobor.com). This was coupled with the “Guidance on Promoting Green Belt and Road” jointly issued by the Chinese Ministry of Environmental Protection, Ministry of Foreign Affairs, National Development and Reform Commission and Ministry of Commerce.

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4. An oversight body with clear responsibility is vital to guarantee the consistency of the initiative and preserves its potential greenness and reputation.

The B&R is enshrined into the constitution and is the core concept organizing China’s foreign policy under President Xi era, omnipresent in official rhetoric. However, as the B&R label evades classification, there is neither agreed-upon definition for what qualifies as a related project nor a definitive list of participants. The concept has become inflated and is at risk of dispersion and dilution. To date, several projects associated to a certain extent with B&R have introduced distrust in public opinion. A supervision role must be more played with explicit responsibilities to guarantee the consistency and, we sincerely hope, the green integrity of the initiative. To avoid every project to be labelled a by-product of B&R is crucial in our view.

An office has been established as early as 2015 within the NDRC, China’s top economic planning agency, to coordinate the work related to the initiative with the Ministry of Foreign Affairs (MFA) and the Ministry of Commerce (MOFCOM). Although the three institutions jointly published in March 2015 the “Vision and Actions on Jointly Building Silk Road Economic Belt and 21st-Century Maritime Silk Road”, the document reads more like a broad roadmap than a detailed proposal. If a lax control was once chosen purposefully to not stifle “bottom-up” implementation, it now threatens to backfire.

After multiple self-labelled B&R and Silk Road bonds from Chinese banks and corporate issuers, both offshore and onshore, China’s Securities Regulatory Commission (CSRC) asked the Shanghai Stock Exchange and the Shenzhen Stock Exchange to support orderly the issuing of bonds to fund the initiative. They published B&R guidelines on March 2nd, 2018, but eligible projects are defined broadly as those endorsed by the NDRC at provincial level or above, or those for which issuers have signed agreements with governments or companies along the B&R routes, and have obtained necessary approvals from regulators. Surely, there is a repartition of role to be found between the PBoC, which regulates the interbank market, the NDRC, which is responsible for the enterprise market, and the CSRC and Shanghai and Shenzhen Stock Exchanges that regulate the listed corporate market.

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”.

President Xi assigned to China “a role of torchbearer in the global endeavour for ecological civilization”. Regarding the Paris Agreement, he declared at the World Economic Forum in Davos in 2017 that “all signatories should stick to it instead of walking away from it, as this is a responsibility we must assume for future generations”. To match words with actions, in selected industries such as metallurgy, cement production and chemical plants, SOEs could arguably apply the environmental standards they are subject to domestically in their B&R-related overseas activities. They could encourage the adoption of the best available technologies and promote the de-coupling of economic growth from environmental degradation. Arguably, through the B&R, China can help developing countries to derail the environmental Kuznets Curve hypothesis, which implies that the relationship between growth and the environment is an inverted U-shape, and help those countries to leapfrog the polluting effects of early stages of economic growth. Along B&R countries with poor records of environmental governance or requirements, SOEs could be asked by the Chinese government to use tools to internalize the cost of environmental damage (e.g. pollution taxes, certification schemes) and thus fend-off the critic that it is exporting its more polluting industries. Noticeably, because of the war against pollution, which is coming to fruition, the cement company China Huaxin, which is reliant on coal, has moved to Tajikistan where the production of cement has increased fivefold in less than one decade.

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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.

A significant share of project recipient countries along the B&R lack institutional capacities, are among the riskiest politically and rank poorly in the Corruption Perceptions Index (Transparency International, 2017). In the same vein as the war against pollution, the fight against corruption endorsed by President Xi should apply to Chinese overseas activities along the B&R. Infrastructure programmes are notoriously vulnerable to corruption. It might therefore be relevant to set up controls and to screen the companies that are sub-contracting along with those who own them, to make sure there is no overlapping ownership with government officials.

Importantly, environmental and social safeguard policies should not be considered an overload but rather a risk management tool. Voluntary sustainability recommendations such as the “Guidelines for Sustainable Overseas Forest Resources Management” or “Guidelines for Social Responsibility in Outbound Mining Operations” from the China Chamber of Commerce of Metals Minerals & Chemicals Importers & Exporters (CCCMC) could be further backed by stronger tools for enforcement. One possible solution could involve new liability rules relating to sustainability imposed on China SOE managers.

Lastly, efforts could be made to reinforce compliance with Article 21 of the Green Credit Guidelines that calls on banks to “strengthen the environmental and social risk management for overseas projects to which credit will be granted […] and make sure project sponsors abide by applicable laws and regulations on environmental protection, land, health, safety, etc. of the country or jurisdiction where the project is located”.

7. There is a limit to how much China can finance, so foreign investors are invited to partner up and play a pivotal role.

As early as 2015, the Green Ecological Silk Road Investment Fund ($4.8bn) was launched by several top enterprises in China to back projects on ecological solar panel construction, clean energy and ecological remediation in China and other countries along the B&R. Similar initiatives and scaling up are expected. The slogan of the Asian Infrastructure Investment Bank (AIIB), which is “lean, clean and green, but not mean”, fits in with the B&R. During the Climate Summit in Paris last December, Ma Jun, special adviser to the governor of PBoC, who has been assigned the mission “to make sure Chinese investors are seeking green investments in the Belt and Road region”, declared: “We are now seeking more international support to help this effort”. This call for support is two-fold, it aims at mobilizing international capital market and invites the private sector to share its green expertise. We believe that robust green credentials will boost China’s soft power and appeal foreign investors.

Despite the massive financial firepower set up by China with the Silk Road Fund ($40bn), the establishment under China’s impetus of the AIIB ($100bn) and of the New Development Bank (together with Russia, Brazil, India, and South Africa), the mobilization of China’s five major commercial banks (ICBC, CCB, BOC, ABC, BOCOM) and policy banks (CDB and Exim), all together playing a de-risking role, there is a gap that the private sector is invited to bridge (See Asia Pacific Research’s Report, May 2017, “The Belt and Road: great project as long as one can finance it!). Potential sponsors from Gulf countries and the Islamic Development Bank have been prospected. The Chinese government has expressed interest in the possibility of issuing Islamic bonds (sukuk), which are Shariah compliant, to finance infrastructure projects. Note that in February 2018, Indonesia, has become the first country in the world to sell a sovereign green sukuk bond.

Apart from financing, foreign and industrial companies such as General Electric, ABB, DHL and Caterpillar are reportedly engaged in B&R projects. Many others might follow.

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8. Foreign investors have already more skin in the Chinese game as its financial system is increasingly interconnected with the rest of the world.

Foreign investors would be wise to follow thoroughly B&R unfolding for two core reasons. First, the MSCI’s landmark decision to include Chinese stocks in its global benchmark equity index, indeed, mainland equities (Chinese A-shares) will be included by August this year in MSCI’s emerging markets index. It will introduce domestic Chinese securities into international investors’ portfolios. The size and significance of China’s domestic stock market and economy, meant to be shaped by B&R, will percolate into foreign investors’ portfolio. Second, in September 2016, “Silk Road Bonds” were suggested at a summit co-organized by the International Capital Market Association (ICMA) and the credit agency Dagong. The ICMA warned that traditional funding sources for infrastructure projects, such as government financing, development bank loans and bank project finance, are insufficient to satisfy infrastructure demands. It asserted an international bond market was necessary to help bridge the funding shortfall. Designed to be a new asset class recognized internationally, Silk Road Bonds could emerge as an integral source of financing for the B&R soon. Bank of China, DBS Bank, Goldman Sachs, Standard Chartered Bank have created a joint working group to support the development of a standardized Silk Road bond that could be traded internationally to help B&R countries tap a wider source of funds. If only Silk Road Bonds were adopting ICMA’s Green Bond Principles (GBP), it would be a step in the right direction.

Note that the ICBC issued a mammoth $2.1bn B&R green bond in 2017 in Luxembourg and further issuances are likely. Apart from offshore fixed-income market, the Shanghai-Hong Kong bond connect program, launched in July 2017, enables a streamlined channel for international investors to access mainland China’s $10tn interbank bond market (which includes a wide range of financial institutions), the world’s third-largest behind the US and Japan. Measures announced by the PBoC in 2016 to open the China Interbank Bond Market (CIBM) to international investors and in 2017 to simplify foreign access via “Bond Connect” make easier foreign investment in Chinese fixed income markets, especially green bond market. In 2017, both the Agricultural Development Bank of China and Export-Import Bank of China launched green bonds through Bond Connect scheme. Foreign investors only hold 1.25% of the total Chinese bond market, there is tremendous potential for increased future involvement. The CSRC said on March 2nd, 2018, that it will allow domestic and overseas companies to issue bonds in the onshore stock exchanges to finance projects related with the B&R.

9. Environmental assessment policies and China’s green finance initiatives are likely to be strengthened and scaled up towards higher standardization and effectiveness.

According to CBI (“China Green Bond Market 2017”), internationally-aligned green bond issuance from China reached $22.9bn in 2017, comprising 15% of global issuance (22% if non-aligned bonds are included). Bold measures have been adopted to help narrow the gap of non-alignment with international green definitions (e.g. differences in green eligibility definitions or lack of disclosure). The Green Finance Committee (GFC) which is part of the China Society for Finance and Banking, and the European Investment Bank (EIB) have published at the end of 2017 a joint document comparing several green bond issuance standards entitled "The need for a common language in Green Finance". It is a first step in a process to harmonise Chinese and European standards. It will serve as a working basis for converging green finance standards and facilitating green capital exchanges between China and the EU. Noticeably, last December the PBoC and China Securities Regulatory Commission (CSRC) jointly released Guidelines for green bond verifiers and verification activities in China (2nd and 3rd party opinion). One further solution could be that SINOSURE, China’s provider of export credit insurance, embeds sustainability criteria in its underwriting requirements.

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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.

10.1 Sector screening. Dual use of infrastructure (military and civilian ports for instance), Arctic related activities (“New Polar Silk Road)” and fossil fuel activities (especially coal mining and power generation, retrofits of fossil fuel power stations) should systemically be disclosed. Any project, especially in the transport and power sectors, should be individually assessed in the light of its alignment with and contribution to the recipient country’s nationally determined contributions (NDC) filed as part of the COP21 (prior to that, on the short term, thresholds of energy efficiency or carbon intensity 20-30% below the average national energy consumption or intensity of an equivalent infrastructure could be set). In addition, biodiversity values and other ecosystem services in corridor countries should be mapped and “no-go” areas must be, if needed, determined. Note that the WWF found that B&R corridors overlap with the ranges of 265 threatened species, including saiga antelopes, tigers and giant pandas, 46 biodiversity hotspots and 200 global ecoregions.

Low-carbon technologies like renewable energy (wind, solar, thermal energy, tidal, waves, hydro <50MW) and associated storage solutions (thermal cycle, power to gas, batteries), alternative materials for steel and cement in the buildings sector, and clean transportation (electric cars and charging infrastructure) should be given priority. Since many of the countries most affected by extreme weather events between 1997 and 2016 are along the B&R (Global Climate Risk Index, German Watch and Munich Re), a special focus on resilient infrastructure seems relevant (transportation, power grids and coastal accommodation resilient to rising sea levels and extreme weather events).

10.2 Responsible lending guidance. Conditions to guarantee the social and commercial viability of projects, and a level playing field, should try to be met by Chinese SOEs and/or required by Chinese financial institutions, requiring for instance:

- A minimal level of debt servicing capacity imposed on project recipients (for instance, compliance with G20 Operational Guidelines for Sustainable Financing, debt limit policies as a shared responsibility for debtors and creditors).

- Exclusion of collateral rules on natural assets (or repayment schemes such as “oil for loans”) and limitation of debt for equity swap deals.

- Local community consultation and involvement in pre-planning and monitoring, and fair compensation for resettled communities.

- A minimal share of local manpower employed in projects.

- Public tenders to ensure fairer access to local and non-Chinese contractors (build-operate- transfer or public-private partnership models).

B&R projects must aim to be more open to local and international participation (89% out of 178 infrastructure projects funded by China between 2006-18, reviewed by the Centre for Strategic and International Studies (CSIS), had Chinese contractors, 7.6% local contractors and 3.4% of foreign contractors, versus 41% of local contractors, 29% Chinese and 30% from third countries for multilateral bank projects).

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10.3 Information disclosure and transparency. Due to the catch-all nature of the B&R, it is hard for investors to clearly grasp the initiative’s perimeter and get a clear understanding of the underlying projects. Monitoring services could help add transparency to the green B&R assets. Besides that, when considering offshore green bonds or loans from Chinese banks or SOEs, it might make sense to provide investors with the following to make them less averse:

- Detailed lists of eligible categories and subcategories (that are not too generic, i.e. clearly defined with hurdle rates or thresholds in eligibility criteria when relevant).

- Detailed lists of eligible projects (location, legal and social context, different sponsors), with ex-ante environmental and social studies. A standalone report assessing the project’s consistency with the fight against climate change and its alignment with or contribution to the recipient country’s NDC would be an outstanding practice.

- The breakdown of forecasts between financing and refinancing and, when relevant, indication regarding the lookback period.

- The proceeds should limitedly be allocated to capital expenditures. With concern to the use of proceeds, a separate account or clear earmarking process would provide greater transparency for investors. Specific policy regarding recycling policy, in cases of project’s early redemption or sale, should be disclosed. Transparent cash management process, if possible cash/pending allocation invested with ESG criteria, would be welcomed.

- Accountability and reporting: regular communication, at least annually, on proceeds disbursement is of interest. Furthermore, project operators and sponsors could commit to engage a third-party opinion, with a comprehensive mandate, to verify ex post the actual allocation of proceeds, actual eligibility of projects financed, as well as impact measurements (robustness and accuracy, tCO2 avoided, MWh produced) at both project level and bond level, allowing investors to calculate their share of financing/impact based on the amount of bonds they hold in their portfolio. Calculation methodologies should be disclosed.

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The Belt & Road Initiative: backdrop and rationales behind the 21st infrastructure project

The genesis of a multibillion-dollar connectivity project endorsed by President Xi

The “Belt and Road” (B&R)1, Yidai yilu in Chinese, is by far the largest overseas investment drive ever launched by a single country. Proposed by President Xi Jinping himself in 2013, it aims to build a trade and infrastructure network connecting Asia with Europe and Africa along and beyond the ancient Silk Road trade routes. It comprises the ‘land belt’ (一带), linking China with Europe through Central Asia and the Middle East, and the ‘maritime road’ (一路), connecting the Middle Kingdom with littoral states in the South China Sea, Indian Ocean and the Mediterranean.

This giant connectivity infrastructure project spans across Eurasia and Africa and the countries it threads through account for around 60% of the world’s total population and one-third of global GDP (16.7% with the absence of China’s contribution).

Chart 1 : Belt & Road Overview

Source: Natixis

1 It is sometimes called the “One Belt One Road Initiative” (OBOR), a name sounding too assertive. In September 2015, the NDRC and the MOFCOM announced that the scheme’s official English name is “The Belt and Road”, or “B&R” 14

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In 2015, China's National Development and Reform Commission (NDRC), Ministry of Foreign Affairs (MFA), and Ministry of Commerce (MOFCOM) published the “Vision and Actions on Jointly Building Silk Road Economic Belt and 21st-Century Maritime Silk Road”, which sets out B&R's five major goals: policy co-ordination; connectivity of facilities; unimpeded trade; financial integration; and people-to-people bonding.

Chart 2 : B&R five official key goals

Sources: Yidaiyilu website, Natixis

Overall, three stages are scheduled: strategic mobilisation (2015-2016), strategic planning (2017-2021) and strategic implementation (2022-2049).

Table 1 : B&R timeline

Source: Natixis

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Noticeably, in October 2017, the B&R was enshrined into the communist party constitution. It was one the main surprise and takeaway of the last CCP’s five-year congress2. As result of that, it guarantees the flagship project a greater political momentum and financial firepower, especially in a context of outbound investments tightening. Consequently, European companies can expect an increasing number of related Chinese investments.

An amorphous initiative hard to navigate for investors

A major challenge is that the B&R label evades classification, there is neither agreed-upon definition for what qualifies as a related project nor a definitive list of participants. It is rather an “umbrella” that encompasses outbound investments and development of infrastructures, such as roads, bridges, pipelines, ports, railways and power plants. Nevertheless, its banner hangs over a wide and ever-expanding list of activities. They are B&R fashion shows, concerts, and art exhibits. By design, it is more a loose brand than a program with strict criteria.

However, we do not consider that B&R is the sole repackaging of past policies or a relabelling of initiatives that China has already attempted. Is it not an empty slogan, now conveniently applied to every contract or agreement that Chinese government agencies or companies had been negotiating for years and would eventually have signed anyway.

The B&R is reportedly “open” to all nations and are not limited by geography. As a proxy to evaluate Belt & Road’s stakeholders and participants, the “Joint Communiqué of the Leaders Roundtable of the Belt and Road Forum for International Cooperation” (May 2017) provides useful information. It has been signed by the following heads of states or governments (table 2). The official platform yidaiyilu also lists countries.

Table 2 : Countries involved in B&R according to official Chinese sources Region Countries (73 countries) Southeast-Asia Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, (11) Timor-Leste, Vietnam South Asia Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka (8) East Asia Mongolia , Republic of Korea (2) Central Asia Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, Uzbekistan (5) West Asia Armenia, Azerbaijan, Bahrain, Georgia, Iran, Iraq, Israel, Jordan, Lebanon, Kuwait, Oman, Qatar, (18) Saudi Arabia, Palestine, Syria, Turkey, United Arab Emirates, Yemen Africa Egypt, Ethiopia, Morocco, South Africa, Madagascar (5) Europe Albania, Bosnia and Herzegovina, Croatia, Belarus, Bulgaria, Cyprus, Czech Republic, Estonia, (22) Greece, Hungary, Latvia, Lithuania, Macedonia, Moldova, Montenegro, Poland, Romania, Russia, Serbia, Slovenia, Slovakia, Ukraine Pacific (1) New Zealand Middle America (1) Panama

Sources: Natixis, Belt and Road Portal (eng.yidaiyilu.gov.cn)

2 Foremost, the 19th National Congress of the Chinese Communist Party (CPC) established “Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era”. 16

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Table 3 : Signatories of the joint Communiqué of the Leaders Roundtable of the Belt and Road Forum for International Cooperation (May 2017) President Xi Jinping of the President Almazbek Prime Minister Hun Sen of the State Counsellor People’s Atambayev of the Kyrgyz Kingdom of Cambodia Aung San Suu Kyi of the Republic of China Republic Republic of the Union of Myanmar President Mauricio President Bounnhang Vorachith Prime Minister Hailemariam Prime Minister Muhammad Macri of the Republic of of the Lao People’s Democratic Desalegn of the Federal Nawaz Sharif of the Islamic Argentina Republic Democratic Republic of Republic of Pakistan Ethiopia President Alexander Lukashenko President Rodrigo Roa Duterte of Prime Minister Josaia Voreqe Prime Minister Beata Szydlo of of the Republic of Belarus the Republic of the Philippines Bainimarama of the Republic of the Fiji Republic of Poland, President Michelle Bachelet President Vladimir Putin of the Prime Minister Alexis Tsipras Prime Minister and President- Jeria of the Republic of Chile Russian Federation of the Hellenic Republic elect Aleksandar Vucic of the Republic of Serbia President Milos Zeman President Doris Leuthard of the Prime Minister Viktor Orban of President of the Government of the Czech Republic Swiss Confederation Hungary Mariano Rajoy Brey of the Kingdom of Spain President Joko President Recep Tayyip Prime Minister Paolo Gentiloni of Prime Minister Ranil Widodo of the Republic of Erdogan of the Republic of the Italian Republic Wickremesinghe of the Indonesia Turkey Democratic Socialist Republic of Sri Lanka President Nursultan Nazarbayev President Shavkat Mirziyoyev of Prime Minister Najib Razak of Secretary General Antonio of the Republic of Kazakhstan the Republic of Uzbekistan Malaysia Guterres of the United Nations

President Jim Yong Kim of the World Bank Group President Uhuru Kenyatta of the President Tran Dai Quang of the Prime Minister Jargaltulgyn Republic of Kenya Socialist Republic of Vietnam Erdenebat of Mongolia Managing Director Christine Lagarde of the International Monetary Fund

Sources: Natixis, Belt and Road Portal (eng.yidaiyilu.gov.cn)

A broad range of projects

The B&R consists mainly in financing, building and operating roads, airports, railways, power plants, bridges, pipelines, LNG terminals, industrial zones and logistics centres.

But operations in other sectors are likely: in agriculture, forestry, animal husbandry, and fisheries, farming, marine-product farming, agricultural machinery manufacturing deep-sea fishing, aquatic product processing, seawater desalination, marine bio-pharmacy, ocean engineering technology, and environmental protection.

From 2013 to June 30, 2016, large SOEs such as China Railway Group Limited and China Communications Construction Company signed construction contracts for 38 large demonstration projects of transport infrastructure, covering 26 countries and focusing on key routes, port cooperation and the improvement of infrastructure in developing countries3. China launched 15 new airport projects and 28 airport expansion projects in provinces along the B&R.

However, the concept has become inflated. Its most existential threat is that of being diluted. Everything is labelled a by-product. For instance, investments from State Grid Corporation in Brazil or the Hinkley Point nuclear project in Britain. The initiative was officially launched in November 2013, but projects started years earlier are often counted, such as the Jakarta- Bandung High Speed Rail has been discussed since at least 2008

3 Renmin University of China (2016), The Belt and Road Progress Report 17

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Table 4 : Landmark projects identified along the B&R Type of Project location infrastructure Railways Mombasa to Nairobi in Kenya Case study: the Chongqing- Djibouti to Addis-Ababa railway Karachi to Peshawar in Pakistan Duisburg railway Hungary-Serbia railway China-Kyrgyzstan-Uzbekistan railway The 11,000-km train line Laos to Vientiane high-speed railway Jakarta-Bandung high-speed railway connecting Chongqing in Moscow-Kazan high speed railway Xinjiang region (an economic Xi’an-Almaty line along the Kazakhstan-Uzbekistan-Kyrgyzstan-Turkmenistan route special area where Foxconn or Yiwu to Tehran via Kazakhstan, Kyrgyzstan, Uzbekistan, and Turkmenistan HP have plants) to Duisburg Ports Gwadar port (Germany) exemplifies Piraeus B&R’s intrinsic logic. It crosses Djibouti Kazakhstan, Russia, Hambantota and Colombo Dry port of Khorgos4 Belorussia and Poland and Logistics Logistics park at TEDA Cooperation Zone in Egypt's Red Sea city of Ain Sokhna, east of the capital Cairo. aims to avoid vulnerable straits such as Malacca, through Power plants Power plant in the Serbian city of Kostolac which 80% of China's oil Lamu coal power plant in Kenya Sasan Ultra Mega Coal Power Project in India imports must transit, and thereby achieve shorter Pipeline 3,666km gas pipeline between Turkmenistan and China delivery times than via sea Oil and gas Yamal project in which China’s Silk Road Fund and China National Petroleum Corp hold a combined stake of 29.9% freight. China railway express Deal to develop Turkmenistan’s Galkynysh natural gas reserves and to acquire an 8.33% stake in Kashagan, Kazakhstan’s largest oil deposit routes are faster than shipping but are still more expensive Telecommunications, Chinese telecommunication service providers such as China Unicom, China Telecom and China Mobile are speeding IoT and e-commerce up cross-border transmission projects in countries along B&R to expand international telecommunication infrastructure (some $8,000-$10,000, twice Internet connectivity over Cameroon, Kenya, Zimbabwe, Togo, and Niger the cost of shipping by sea). JD.com, China’s second-largest e-commerce platform, has already announced a plan to set up more than 20 Beijing wants to upgrade overseas warehouses, many of which will be in B&R countries railways infrastructure, Fiber-optic cables (470 km fiber-optic network in the Baltic Sea acquired by CITIC Telecom International CPC) streamline custom procedures. Utilities A 3.37-km-long water pipeline project, completed by a Chinese company in a Jordanian township, is among the and smooth loading of goods. latest infrastructure projects. A total of 500,000 people living in an area of extreme water shortage now have access to water 24 hours a day, thanks to the project. As of June 30, 2016, 39 freight train lines between China and Source: Natixis Europe were operational, contributing to a transport China pursues its strategy of ports acquisitions under the B&R label to support its merchant infrastructure network linking marine. It has expanding its ports network to secure sea lanes and establish itself as a maritime sub regions in Asia and superpower. Today, five of the top 10 container ports in the world are in mainland China with extending into Asia, Europe another one in Hong Kong. The state-owned China Merchants Group took a stake in the Port of and Africa. Djibouti’s container terminal in 2012 and paved the way for a $9bn investment including the construction of a LNG terminal, a wharf for livestock and a trade logistics park.

The port of Djibouti, modernized by China Merchant Holding (CMHC), is henceforth connected to Addis Ababa by a 466 miles railway line also built by China, allowing to export low-cost production supervised by Chinese companies established in Ethiopia, especially in the special economic zone of Dukem, near Addis Ababa.

4 i.e. terminal without water for handling cargo for trains rather than ships (on the Kazakh-Chinese border is intended to be a hub for goods passing from China into central Asia and Europe). In 2017, Khorgos handled the equivalent of more than 100,000 standard containers full of goods, double what it handled last year. It aims to handle 50,000 containers by 2020, but even that target is only around 1 % of the volume of goods that travel from Asia westward by sea. 18

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Table 5 : China’s investment in ports along proposed maritime route in the past decade Port Investment Antwerp, Belgium Undisclosed Piraeus, Greece $624m Port of Djibouti, Djibouti $184m Lamu Port, Kenya $484m Mombasa Port, Kenya $66.7m Gwadar Port, Pakistan $198m Hambantota Port, Sri Lanka $1.9bn Colombo Port City, Sri Lanka $1.43bn Colombo Port, Sri Lanka $500m

Source: Natixis

As of June 30, 2016, China had launched 52 trade and economic cooperation zones in 18 countries along the “Belt and Road,” with a total investment of $15.6bn.

Table 6: Overseas Trade and Economic Cooperation Zones (As of June 30, 2016) Cooperation zone Chinese company Sihanoukville Special Economic Zone (SSEZ) in Cambodia Jiangsu Taihu Cambodia International Economic Cooperation Investment Co., Ltd. Thai -Chinese Rayong Industrial Zone Holley Industry Group Co., Ltd Longjiang Industrial Park in Vietnam Zhejiang Qianjiang Investment Management Co., Ltd Haier -Ruba Economic Zone in Pakistan Haier Group Zambia -China Economic & Trade Cooperation Zone China Nonferrous Metal Mining Group Special Economic Zones in Egypt TEDA Investment Holding Co., Ltd. Lekki Free Trade Zone in Nigeria (China-Nigeria Economic Zone) China -Africa Lekki Investment Co., Ltd. Sino -Russian Ussuriysk Economic Cooperation Zone Kangji International Investment Co., Ltd The China-Russia Tomsk Timber Industry and Trade Cooperation Zone AVIC Forestry Co., Ltd Oriental Industrial Park in Ethiopia Jiangsu Yongyuan Investment Co., Ltd. Sino -Russia (PrimorskyKrai) Agricultural Cooperation Zone Dongning Huaxin Economic and Trade Co., Ltd. Longyue Forestry Cooperation Zone in Russia Mudanjiang Longyue Economic and Trade Co., Ltd Central European Trade and Logistics Cooperation Zone in Hungry Shandong Dihao International Investment Co., Ltd

Source: Renmin University

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Chinese companies involved in B&R

This “high-speed train and concrete diplomacy” goes hand-in-hand with the consolidation of China’s state-sector segment to better compete for market share. The global expansion of Chinese conglomerates is being driven by mergers and acquisitions.

The Belt and Road Big Data Report 2017 published by the State Information Center lists the top Chinese enterprises taking part in B&R projects, as measured by their scale, input and management. The top 10 enterprises on the list are the State Grid Corporation of China, State Power Investment Corporation, China National Petroleum Corporation, Sinopec Corporation, Alibaba Group, China Railway Construction Corporation Limited, CRRC Corporation Limited, Huawei Technologies Co.,Ltd., Bank of China and China Mobile Communications Corporation.

Table 6 : Sample of Chinese companies involved in B&R Sector Project location and description Shipping & transport and COSCO Shipping (since September 2016, it is the main shareholder in the port of Piraeus in Greece), it is set to logistics become the biggest worldwide container terminal operator by capacity by 2020, challenging rivals such as APM- Maersk or CMA CGM. Yuxinou Logistics China Merchants Group (tanker shipping and logistics business) Railway China Railway Rolling Stock (CRRC), China Railway Construction Corporation Power generation and State Grid Corporation, State Power Investment Corporation, Huaneng, Datang, Huadian, Guodian grid Oil and gas CNPC, Sinopec and CNOOC Mining China Minmetals Corporation Telecommunications China Mobile, China Unicom and China Telecom are planning to pour $180bn into the world’s largest 5G mobile infrastructure over the next 7 years to alleviate data traffic and facilitate productivity gains on a massive scale Huawei has teamed up with the ExIm Bank of China to provide technical knowhow and over $1bn of investments to enhance internet connectivity in Cameroon, Kenya, Zimbabwe, Togo, and Niger. Alibaba Huawei Source: Natixis

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Room for opportunities and collaboration for western companies

According to the Reconnecting Asia Project, run by the Centre for Strategic and International Studies (U.S. think-tank), 86% of B&R projects have Chinese contractors, 27% have local ones and 18% have contractors of foreign origin. Nevertheless, opportunities exist for multinational companies with the experience, skills, technology and connections Chinese firms may lack.

Table 7 : Multinational enterprises involve to some extent or another in B&R projects Company Involvement or positioning General Electric It made sales of $2.3bn in equipment orders in 2016, most under B&R project, up from $400m in 2014. In November 2017, the Silk Road Fund entered into a Cooperation Agreement to set up an energy infrastructure co- investment platform with GE Energy Financial Services, a subsidiary of GE. Caterpillar Group President Bob De Lange recently told China Global Television Network, "Caterpillar is a very strong supporter of the B&R Initiative. I think the key to success is to build partnerships and make sure that we have both a global approach and have been very strong locally." Caterpillar officials said the company uses global resources to focus on solving problems for customers in China and 20 other nations along the new silk road. Honeywell Honeywell employs 13,000 people in China and earned billions of dollars in revenue there in 2016. The company offers a wide range of China-made products that support oil & gas operations, airports, healthcare, and other activities

ABB ABB says it has followed Chinese enterprises’ in the “Go Global” move and participated in their engineering, procurement and construction (EPC) projects in more than 70 countries. It provided more than 400 Chinese enterprises with consultancy, design, engineering and services in 2016 alone. Its cooperation with Chinese enterprises has been widespread in Asia, Europe, Middle East, Africa and Latin America, with the main projects including : - the 275 MW thermal plant in Bangladesh built by Harbin Electric Corporation - the Than Taw Myat Cement Plant in Myanmar contracted by SINOMA - the petroleum polypropylene project of Sinopec in Thailand - the oilfield project of CNPC in Rumaila, Iraq - the Izmir metro line 2 project in Turkey contracted by CRRC Tangshan - the Soyo power plant in Angola built by China Machinery Engineering - the Coca Codo Sinclair Hydropower Plant in Ecuador contracted by POWERCHINA Maersk Group Provides in collaboration with Damco and under the B&R banner, freight service (40 containers) from China to Northern France for Decathlon, a sporting goods retailer.

DHL The German freight forwarder is active in opening or utilizing new intermodal transportation routes which span across Eurasia, including multiple China-Europe rail lines, the new Southern rail corridor which connects China with Turkey, the linking of Japan, Korea, and Taiwan into the Silk Road Economic Belt, as well as an impending new rail terminal on the Poland / Belarus border.

HP As early as 2011, Hewlett-Packard started sending laptops and LCD screens from Chongqing in south-west China to Duisburg in Germany by train rather than boat (it takes 13-16 days, compared with a month or more by sea).

BHP BHP identified 400 B&R core projects that could lead to an additional 15m tonnes per year of steel over 10 years, i.e. an additional 3 to 4% of demand growth on top of the current 1% forecast.

Source: Natixis

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“Tall and firm in the East” – to stay on the side-lines of the B&R is a dead-end “China now stands tall and firm in the East” declared President Xi during the opening remarks of the 19th National Congress. To some extent or another, Western countries, companies and markets will be re-shaped and challenged by the B&R, which draws a “globalization 2.0”. In 2016, the proportion of global gross exports in GDP declined to below 20%. Wang Huiyao, president of the Center for China and Globalization, said with “Globalization 1.0” facing setbacks [Brexit, Trump election], the B&R is providing the world with a new choice for globalization. B&R is expected to serve as a stepping stone towards “the great rejuvenation of the Chinese nation”. The doctrine set-up by Deng Xiaoping, “hide its capacities, bide its time and never take the lead” seems over. Henceforth, China enters a “New Era” and is “moving closer to center stage and making greater contribution to mankind”. Undoubtedly, B&R epitomises China’s new assertiveness. It challenges mainstream economic governance and organizations. But it does not aim to wipe the slate clean and seeks to make room for foreign countries, companies and investors to participate. Beijing has created ad hoc dedicated forums and financial institutions: the Asian Investment Infrastructure Bank (AIIB) and the Silk Road Fund. Created in 2015, the AIIB is currently composed of 61 country members (23 prospective members). They add up to the mighty capacities of the China Development Bank, the Export-Import Bank of China, and the China Investment Corp (CIC) that manages about one-third of China’s $3.1tn in foreign exchange reserves. It has also created a customs clearance and electronic cross-border trade and payments tool, “Silk Road E-Merchants Information Technologies”. Nevertheless, it does not totally side-line existing Washington institutions. Instead it tries to involve them, notably six Multilateral Development Banks. A new modus operandi must be forged because of the weight that President Xi is throwing behind B&R. However, this new backbone of China’s foreign affairs and economic diplomacy shall not be a “take it or leave it”, neither for recipient countries nor for the planet. It is supposedly based on the principles of policy coordination and inclusive cooperation.

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Financial firepower dedicated to the bankrolling of B&R

All things being equal, it is a 21st century Marshall Plan5. In May 2017, President Xi announced a further $124bn for B&R, including $14.5bn for the Silk Road Fund, and special lending schemes for the China Development Bank and the Export-Import Bank of China, worth around $36bn and $19bn, respectively. He also fed on financial bodies to establish a B&R fund worth $43bn.

Overall, it is hard to navigate numbers because different types of financing are mixed, for instance debt rescheduling, export credits, grants, loans.

Hu Huaibang, chairman of China Development Bank said in January 2018 that the bank had extended $110bn in loans to projects along the ancient trade route by the end of 2017.

Chart 3 : Silk road Fund’s shareholder structure (total capital of $40bn)

Source: Silkroadfund.com

According to the MOFCOM6, Chinese enterprises made a non-financial direct investment of $12.37bn in 59 countries along the Belt and Road routes from January to November 2017, going down 7.3% year to year (as result of outbound investment tightening), but taking up 11.5% of the total amount over the same period. The investment mainly flew to Singapore, Malaysia, Laos, Indonesia, Pakistan, Russia and Myanmar.

By contrast with traditional aid agencies, the Silk Road Fund is supposed to be driven by profit. Its chairman, Jin Qi, declared on the sidelines of the 2015 National People’s Congress that: “the fund is not an aid agency. We will seek reasonable mid- and long-term investment returns and protect the rights of the shareholders.”

The portfolio of the NDB and AIIB first batches of lending prioritized clean energy projects. However, the NDB did neither established a solid environmental and social framework for its investments, nor a clear energy strategy. The AIIB avoided highly controversial projects in its first set of loans, but did not exclude financing coal projects. Australia, one of the top ten largest shareholder in the bank, lobbied to include fossil fuels in the bank’s energy strategy.

5 Formally titled the “European Recovery Programme” 6 MOFCOM’s website:(consulted February 21, 2018). 23

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Table 8 : B&R financial firepower landscape COMMERCIAL BANKS CHINESE DEVELOPMENT & EXPORT BANKS MULTILATERAL DEVELOPMENT BANKS

Industrial and Commercial Bank of China (ICBC) Export-Import Bank of China (Exim Bank) Asian Infrastructure Investment Bank (AIIB) The ICBC has 123 branches in 18 countries along the Belt Since 2014, China EximBank has signed over 900 projects China lead the creation of this new-born financial institution and Road regions. It has 208 reserved projects and a total in countries and regions along B&R, with an amount of over that has €100bn of initial capital that is expected to be investment of $220.8bn. It issued on October 2017 a first RMB 600bn. China EximBank issued loans of over RMB spent chiefly in B&R countries. The bank aims to be “lean, B&R related green bonds ($2.1bn) on the Luxembourg 450bn and supported commercial contracts amounting to clean and green, but not mean” according to its President Green Exchange (LGX), certified by CBI. Eligible over $360bn. The projects were distributed in 50 countries Jin Liqun. It has no overarching objective to reduce poverty categories are: renewable energy, clean transportation, and regions along the B&R, especially in infrastructure and considers B&R projects as one of its investment energy efficiency and sustainable water and wastewater connectivity, economic and trade cooperation, industrial priorities. management. The Framework explicitly excludes fossil fuel investment and cooperation in energy resources. As of the It counts 61 members as of February 2018 (23 prospective related assets, nuclear and hydro over 20 MW. Noticeably, end of 2015, the loan balance of the China EximBank in members). Since its opening in early 2016, the AIIB has ICBC will engage an independent third party to provide countries and regions along the Belt and Road had financed more than twenty infrastructure projects, including assurance on its annual Green Bond Report. The second exceeded RMB 520bn. Over 1,000 projects in 49 countries seven clean energy projects that are worth of $1bn in total. opinion provider was Cicero, which acknowledges that and regions along the Belt and Road had a loan balance, China retains 26% of AIIB’s voting power, enough for a ICBC has implemented a Green Credit policy and covering numerous fields including highway, railway, veto on major issues, but to attract broad membership, integrated environmental assessment into the overall credit harbour, electric power and communication. Beijing waived veto authority on policy and lending policy of the bank. It published a study called decisions. In February 2016, the AIIB adopted an “Impact of Environmental Factors on Credit Risks of “Environmental and Social framework” setting up Commercial Banks – Research and application by ICBC guidelines. based on stress test”. China Construction Bank (CCB) The Silk Road Fund New Development Bank (NDB) It has reserved 195 projects related to B&R and credit Established in 2014, its money comes from the PBOC’s In July 2015, the BRICS —China, Russia, Brazil, India demands for $270bn. In November 2015, the first “Maritime reserves, the China Investment Corporation, the Export- and South Africa—initiated and founded the New Silk Road” offshore RMB bond in the world was issued by Import Bank of China and the China Development Bank – Development Bank (NDB). Headquartered in Shanghai, CCB Asia Corporation Limited (CCB Asia) and launched at is used to finance takeovers abroad in sectors deemed NDB is the first international multilateral development the Kuala Lumpur Stock Exchange of Malaysia. This bond strategic for the realisation of the Belt and Road Initiative. bank independently founded and led by emerging market is the first RMB bond in Malaysia. It was the first time that Initial capital of $40bn and started operating in February economies. a Chinese-funded issuer landed in the bond market of 2015. It had spent around $7bn on 17 infrastructure Malaysia. The capital raised from this issuance will be used projects by the end of 2017 and had already announced It has an authorized capital base of $100bn and approved for the financing of B&R projects, and to support the inter alia 3 sets of investment: to inject capital in China its first set of loans of up to $811m for renewable energy Chinese enterprises primarily for the construction of major Three Gorges Corp to develop hydropower plants in projects in April 2016. It also signed an MoU with the projects along the 21st-Century Maritime Silk Road. Pakistan and other South Asian countries; to fund China Construction Bank in June 2016. ChemChina in acquisition of Italian tire maker Pirelli; and to make investments in Russia-based Yamal LNG project. The NDB issued the first green financial bond in Shanghai It had also signed a three-party cooperation framework in July 2016, with a bond size of 3bn RMB and a maturity agreement with Beijing Enterprises Holdings Limited and of 5 years. It was the first time that the NDB was EEW Energy from Waste GmbH, a MoU with the European approved to issue RMB green financial bonds in the Bank for Reconstruction and Development and a MoU with China interbank bond market, and the first operation of Serbia on joint development of renewable energy projects. the NDB in the capital market.

Bank of China (BOC) China Export & Credit Insurance Corporation Sino -Central and Eastern European Countries (CEEC) As of the end of 2015, overseas institutions of the BOC had (SINOSURE) Financial Holding Company covered 18 countries and regions along the B&R. BOC put As of the end of November of 2016, SINOSURE had Financial holding company established in 2016 under the in credits about $28.6bn. It followed around 330 major underwritten an amount up to $383.4bn for countries and cooperative framework of China and 16 countries in projects, with an intended supporting amount of about regions along the B&R. It ensured a series of Central and Eastern Europe. It is engaged in nonbanking $87bn, and issued the first Belt and Road bond in the demonstration projects, including Central Asia natural gas activities to offer customers a wide range of financial international market. pipeline, the transformation of the universal rolling mill in services, including the chances to purchase insurance Chelyabinsk Steel Mill of Russia and QAM chip electrified products and invest in securities. It focuses on projects in railway tunnel of Angren-Pap railway. connectivity and production capacity cooperation that will purchase China-made equipment and products

Agricultural Bank of China (ABC) Green Silk Road Fund The China-EU Co-Investment Fund It has seven institutions in countries and regions along the The first-ever private equity fund aimed at improving the The European Investment Fund (EIF), which is part of the Belt and Road. In Xinjing and Inner Mongolia, ABC has ecological environment of the Silk Road Economic Belt was European Investment Bank (EIB), and the Silk Road Fund established regional cross-border business centres to initiated in March 2015. The Green Ecological Silk Road (SRF) signed a MoU that outlines new strategic explore markets in Mongolia and West Asian countries. Investment Fund will back projects on ecological solar cooperation to support equity investment across Europe. It has realised direct transaction between eight national panel construction, clean energy and ecological Once operational the China-EU Co-Investment Fund is currencies and RMB, with a monetary transaction volume remediation in China and other countries along the Belt. It expected to provide €500m, jointly backed by the EIF and of 30bn RMB. has first round investment of $ 4.8bn and launched by SRF, to support private equity investment and venture several top enterprises in China including Elion Resources, capital funds that support SMEs and mid-caps in Europe China Oceanwide, Chint Group, Huiyuan Juice, Macrolink, and beyond, which have connections with China or are JuneYao, Ping’an Bank and Sino-Singapore Tianjin Eco- likely to develop such connections. The creation of the city. China-EU Co-Investment Fund will develop synergies between the B&R and the Investment Plan for Europe, the so-called "Juncker Plan", the European Union’s strategy to mobilise €315bn of new public and private investment across Europe.

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COMMERCIAL BANKS CHINESE DEVELOPMENT & EXPORT BANKS MULTILATERAL DEVELOPMENT BANKS

Bank of China Development Bank (CDB) Traditional Multilateral Development Banks Communications (BOCOM) As of June 30, 2016, CDB had built a project pool related Six MDBs signed an MoU with the Ministry of Finance of Using instruments such as overseas syndicated loans, to the B&R covering more than 900 projects China at the Belt & Road Summit (May 2017): Asian bilateral loans and financial leasing, BOCOM had provided (transportation, energy, resources) in over 60 countries Development Bank, European Bank for Reconstruction loans worth more than $61bn to 37 projects as of Sept 30, and regions. and Development (EBRD), New Development Bank 2017, to serve the business expansion of its clients in The CDB supported the internationalization of the RMB (former BRIC bank), World Bank, European Investment countries and regions related to the B&R Initiative. and support the strengthening of regional financial Bank cooperation. It had issued RMB 130bn of cross-border loans and issued RMB 28bn of offshore bonds. CDB supported the financial cooperation with the SCO Interbank Consortium and China-ASEAN Interbank Consortium. It also carried out cooperation with international financial institutions like the World Bank and AIIB to build a platform for regional economic cooperation.

Agricultural Development Bank of China (ADBC) It is the second biggest interbank market issuer in China and one of the biggest issuers of domestic green bonds. The bank is responsible for the food security of China and some 50% of its lending goes to the purchase of grains and cereal reserves. The Luxembourg Stock Exchange (LuxSE) signs a MoU with the Agricultural Development Bank of China (ADBC), to set up an access scheme to display ADBC’s green, poverty alleviation and sustainability bonds on the Luxembourg Green Exchange (LGX) platform. Sources: Natixis, CDB internal working paper (2017), from the report “Economic Development along the Belt and Road”

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Decrypting rationales behind B&R from China’s standpoint

The initiative was born from the “Going Abroad Policy” and refers mainly to construction and infrastructure projects. It follows China’s accession to the WTO (2001) and aims to strengthen its economic integration. It is expected to contribute to the “rebalancing” of China’s economy towards a “New Normal” and the country eyes its developing neighbours as the new growth engine. The “New Normal” demonstrates the following characteristics, according to the MOFCOM: “the economy is shifting from high-speed growth to medium- to high-speed growth while maintaining substantial progress in terms of quality; a deeply changed economic structure is still upgrading; and economic growth engines are switched from investment to innovation”.

The share of industry in China’s GDP is projected to fall from 39% today to 32% in 2040 (IEA, World Energy Outlook 2017), conversely, the share of the services sector in China’s GDP increases steadily to 64% in 2040. Its economy is already rebalancing away from reliance on manufacturing and exports, towards a more domestic-and service-oriented economy, with a much less energy-intensive pattern of growth than in the past.

The contribution of consumption to GDP growth has increased from 54.9% in 2012 to 64.6% in 2016; the services industry has replaced manufacturing to become the biggest driving force for growth, with its contribution to GDP growth rising from 44.9% in 2012 to 58.4 % in 20167.

Chart 4 : Changing structure of the economy in China

Source: IEA, World Energy Outlook 2017

In the space of ten years, China has built over 80,000 km of highways and 20,000 km of high- speed train lines, but its domestic market is somehow saturated. As a result of the central government’s stimulus measures in 2008, infrastructure investment, especially in urban areas, increased sharply in 2009. More than 60,300 km of expressways were built in 2008 alone, as compared to 8,600 km in 2007.

Furthermore, the significant stimulus package over $580bn unleashed in the wave of the global financial crisis of 2008-9 led to unviable assets and unsustainable pressure on the environment, counteracting the war against pollution.

7 MOFCOM’s figures 26

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Table 9 : Multifaceted initiative and intertwined objectives Objectives Sub-objectives Context and description

To facilitate the To launch a stimulus package abroad to China eyes its developing neighbours as the new growth engine. B&R supports Chinese companies through an transition to a ease the economic domestic rebalancing overseas “Keynesian stimulus program” by rechannelling excess industrial capacity (e.g. steel, cement). “New Normal” Relocating the no longer desirable facilities outside of China, together with their outdated production processes, To handle the “reform tightrope” and clean pollution, environmental externalities, and excessive labour force. away structural imbalances In the face of China’s economic slowdown and war against pollution due to heavy industries, the government To ascend the value-added chain and announced a cut of 1.8M jobs at SOEs in February 2016—1.3 M in coal and 500,000 in steel out of a total support “China manufacturing 2025” workforce of 12M in both industries—but the priority given to sustaining growth and maintaining employment supersedes the need to implement structural reforms. SOE bail-outs and large-scale layoffs are risky in terms of social stability. To diversify, To reduce tariff trade barriers and sign tax To make customs-clearance times quicker and simpler thanks to bilateral agreements. shorten and treaties secure trade To set up free trade zones and cross-border economic cooperation zones. routes To expand the scope of local currency According to Tim Smith, chairman and chief representative of Maersk Line in North Asia, a 10% improvement in settlement & currency exchange in trade connectivity between countries along the B&R would deliver a 3% decrease in Chinese trade costs, boosting and investment China’s imports and exports by around 6% and 9% respectively.

To reduce non-tariff trade barriers Last January, the State Council released its first official Arctic Policy White Paper, saying it would encourage enterprises to build infrastructure and conduct commercial trial voyages, paving the way for Arctic shipping routes To avoid straits and chokepoints that would form a "Polar Silk Road". The Northern Sea Passage is believed to take 20 days off the 48 days it takes to ship to Rotterdam via the Suez Canal. To support the To support the “going abroad policy” S everal firms operating in sectors key to the realization of B&R have been merged. The State-Owned Assets internationalization Supervision and Administration Commission reiterated in March 2016 the objective of reforming the state sector and consolidation To consolidate state-sector conglomerates by making companies “bigger and better” through mergers and acquisitions. It was the case of the container of SOEs to avoid efforts duplication and better shipping operator China COSCO Shipping Corporation (formerly China Ocean Shipping Group Company and compete for market share against their China Shipping Group), the tanker shipping and logistics business China Merchants Group (which purchased foreign challengers. Sinotrans and CSC Holdings Co.), the mining giant China Minmetals Corporation (which incorporated the China Metallurgical Group), and the power company China State Power Investment Corporation (formerly China Power To shape international standards Investment Corporation and State Nuclear Power Technology Corporation). The merger of China South Railway and China North Railway into China Railway Rolling Stock Corporation was announced in 2015 as China’s international “high-speed railway diplomacy” and B&R were both gathering momentum.

Guidelines for "developing procedures and mechanisms for mutual certification of standards adopted in countries" along B&R (adoption of Chinese technical standards in the iron and steel, nonferrous metals, railways, highways, water projects, oil & gas fields, and overseas engineering services sector) T o open To address regional inequality and spur Coastal or Maritime China are rich as compared to hinterland and inner regions. Annual per capita income by landlocked regions growth in “Continental China” province varies greatly in China. Xinjiang, Qinghai, Tibet, Inner Mongolia, Gansu provinces are well below the median income in the rest of China. It is necessary to narrow this gap preserve social stability, especially in the western province of Xinjiang. To alleviate the threat from terrorism, separatism and extremism by infrastructure connectivity and economic development To secure access To halve the length of time to import oil I n 2015, extractable oil and natural gas reserves in countries and regions along the B&R made up 58% and 78.9% to energy from Saudi Arabia (CPEC) – where 16% of of total reserves of the world. resources China’s oil imports originate Arctic Circle holds an estimated 13% (90bn barrels) of the world’s undiscovered conventional oil resources, and To bypass geopolitical deadlocks and the 30% of the world’s undiscovered conventional natural gas resources (US Geological Survey, 2012). so-called Malacca dilemma Mongolia has rich coal, copper, iron, and phosphorus resources but poor transportation and communication infrastructure. To strengthen To fill the vacuum left by Donald Trump’s To counter the USA’s presence in Asia (i.e. the pivot strategy engaged by Barack Obama) regional influence abandon of Trans-Pacific Partnership (TPP)

To help with the Through the further issuance of renminbi- The IMF added the renminbi to its “special drawing rights” basket in October 2016, describing this step as a internationalisation denominated loans “milestone in the integration of the Chinese economy into the global financial system.” of renminbi Establishment of cross-border RMB Despite the initiatives to develop the RMB at an international level, China remains a very dollarised market. As of payment, clearing and settlement, and June 2017, 98% of the payments between the United States and China are performed in US Dollars, and the RMB integrated electronic infrastructure is used for more than 2% of payments to China in most markets, Taiwan being the only notable exception.

The Silk Road E-Merchants Information Technologies is a foreign-trade service company that designs digital platforms for customs clearance and electronic cross-border trade and payments.

To secure a stable To facilitate People’s Liberation Army China dual-uses ports as strategic trading bases and platforms to deploy military vessels (e.g. the Djibouti and peripheral (PLA) projection of power abroad for Gwadar ports, embodying what is called the “String of Pearls” strategy). environment and defensive purpose advance military bases Transcontinental infrastructures to hedge against disruptions to maritime supply in the event of conflict

Source: Natixis

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The B&R does not elicit unanimity

The Initiative is still being given only a tepid welcome by some governments, mainly from the Western European Union (EU). The “16+1” initiative between 16 Eastern European countries and China deepens the EU’s divides. Meanwhile, Russia cannot keep pace with China’s finance firepower and is ambivalent vis-à-vis the Belt and Road which somehow challenges its Eurasian Economic Union.

India is firmly opposed to the B&R because notably of a territorial dispute about Kashmir. The India’s Ministry of External Affairs stated in May 13rd, 2017, on the side-line of the B&R International Cooperation Forum: " We are of firm belief that connectivity initiatives must be based on universally recognized international norms, good governance, rule of law, openness, transparency and equality. Connectivity initiatives must follow principles of financial responsibility to avoid projects that would create unsustainable debt burden for communities; balanced ecological and environmental protection and preservation standards; transparent assessment of project costs; and skill and technology transfer to help long term running and maintenance of the assets created by local communities. Connectivity projects must be pursued in a manner that respects sovereignty and territorial integrity.”

Table 10 : main critics arising from the B&R Grievance Description A smokescreen for B&R is squarely dismissed by a few of China’s neighbours. India and Japan launched in May 2017, few days strategic control or after the B&R first international summit, the Asia Africa Growth Corridor (AAGC), also called Freedom Corridor. hegemonic domination The AAGC will give priority to development projects in health and pharmaceuticals, agriculture and agro-processing, disaster management and skill enhancement.

Fears about ports’ use as military base have been expressed. A debt trap linked to harsh R ecipient countries have little debt-servicing capacity and, unlike China, they cannot rely on huge foreign collateral rules exchange reserves to support a hefty debt load. Contrary to International Monetary Fund and World Bank lending, Chinese loans are collateralised by strategically important natural assets with high long-term value (even if they lack short-term commercial viability, or for instance “oil for loans” repayment scheme).

The size of the sums involved is raising concerns, including from the IMF. Countries such as Sri Lanka are in debt trap, unable to pay back China for the port of Hambantota or airport built and had to renegotiate under unbalanced terms. Detractors affirm China is using sovereign debt to bend other states to its will. As Sri Lanka's handover of the strategic Hambantota port demonstrates, states caught in debt bondage risk losing both natural assets and their sovereignty. Trapped in a debt crisis, Djibouti had no choice but to lease land to China for $20m per year.

Nepal and Pakistan have either repudiated or moved to renegotiate B&R dam projects (Budhi Gandaki and Diamer-Bhasha) due to the lack of tenders or unbalanced terms forcing borrowers to swap debt for equity.

A disguised and distorted “Chinese -style free-trade” is denounced. The CDB and Ex-Im Bank usually specify that the projects they finance way to trade must be executed by Chinese contractors, meaning that competitive tenders are rare. The European Commission, which has launched an investigation into compliance with EU laws on public tenders along the rail between Belgrade and Budapest.

A carbon lock-in stock of As infrastructures are by nature long-lived, investment decisions being made today can lock in development infrastructures patterns (“green” or “brown”) for decades to come.

White elephant Risks of ghost cities, which are not former boom towns but cities that have yet to come to life. “Dynamic where infrastructures or ghost Chinese interest in cultivating demand for large infrastructure projects may not necessarily align with the local cities realities of the actual kinds of infrastructure needed by host countries “(Friends of the Earth US). Low commercial viability According to Fitch Ratings, “there is a risk that [B&R] projects might not be aimed at addressing the most pressing and politicized investments infrastructure needs and could fail to deliver expected return” (distorted and politicized investments, implied (credit rating below backing of projects by authorities could add to complacency, in the end, low level of commercial viability). investment grade)

Sources: Friends of the Earth US, Fitch Rating, Indian government, European Commission

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What a low-carbon and sustainable Belt and Road could look like

The successful implementation of the Paris Agreement and the Sustainable Development Goals will be impossible if the amount of capital invested under the B&R is inconsistent with climate change and sustainable development. Greening B&R is thereby a priority of global significance.

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.

B&R 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. $3.4tn to $4.4tn today). Middle-income countries, many of which are located along the B&R, are expected to represent around 60% to 70% of those future infrastructure needs.

Chart 5 : Annual infrastructure investment needs and fuel savings in a low-carbon future Global estimates (annual average for 2016-30, USD 2015 trillion)

Sources: OECD (2017), Investing in Climate, Investing in Growth, OECD Publishing, Paris.

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According to the Asian Development Bank (“Meeting Asia’s infrastructure needs”, 2017), Asia will need to invest $26tn from 2016 to 2030, or $1.7tn per year, if the region is to maintain its growth momentum, eradicate poverty and respond to climate change (i.e. including climate change mitigation and adaptation costs).

Interestingly, the additional capital cost to be consistent with a 2°C trajectory in the OECD and ADB scenarios is respectively 10% and 13%. Moreover, this affordable cost would be offset by inter alia fuel savings. Arguably, given the long lifespan of infrastructure, failure to invest in the right type of infrastructure in the next 10-15 years would either lock the world into a GHG- intensive development pathway or risk stranding many assets.

Table 11 : Estimated Infrastructure Investment Needs by Region, 45 developing member countries, 2016–2030 ($ billion in 2015 prices)

Source: Asian Development Bank (ADB), 2017, “Meeting Asia’s infrastructure needs”

Note that B&R could be a key part of the effort in the post-war reconstruction of Syria, which the United Nations says could cost $250bn.

China could capitalize on its unrivalled renewable expertise

China has around one-third of the world’s wind power capacity, a quarter of its solar power, six of the top ten solar panel manufacturers and four of the top-ten wind turbine manufacturers (IEA, WEO 2017). Last year, it sold more EVs than the rest of the world combined, and its expertise in lithium batteries is growing rapidly with champions like BYD and CATL.

“China is the undisputed renewable growth leader” (IEA, 2017). Renewable energy installed capacity there increased from 148.44 GW in 2007 to 570 GW in 2016 (versus 2,134 GW worldwide, including 244 GW in US, 105 GW in Germany, 46,3 GW in France).

China accounted for 40% of the global growth in renewables in 2016 (+175 GW coming online). It had just 100 MW of installed solar PV capacity in 2007. By the end of 2016, that figure had increased almost 800 times to reach 77 gigawatts.

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Chart 6 : Renewable capacity additions in 2015 and 2016 by country/region and technology

Source: International Energy Agency (IEA)

Between 2017 and 2022, global renewable electricity capacity to expand by 922 GW, including 660 GW of solar, an increase of 43%, China alone accounting for 40% of this growth (i.e. 363 GW). Renewable energy capacity in China will reach 933 GW in 2022 (1,034 GW in IEA’s accelerated case, up from 570 GW in 2017). Solar PV in China could reach a total of 320 GW by 2022 (up from 77 GW in 2017).

Chart 7 : Net additions to renewable power capacity by selected countries and regions

Source: International Energy Agency (2017)

The B&R has already driven $8bn of solar equipment exports from China, which became the number one exporter of environmental goods and services (IEEFA, 2017). In January 2017, the National Development and Reform Commission (NDRC) announced a $360bn low-carbon investment by 2020 (solar, wind hydro, nuclear), expected to create 13m jobs. Investments in low-carbon technologies in China are significant and could have a large spill over effect towards B&R countries. In sub-Saharan Africa, Chinese companies operating as the main contractor for power generation projects were responsible for 30% of new capacity additions in 2010-15. State Grid Corporation of China (SGCC), the world’s biggest utility company, has become the largest power generation and distribution company in Brazil.

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Table 12 : Investments in low-carbon technologies in China in the New Policies Scenario, 2017-2040 (billion $2016)

Source: International Energy Agency (2017)

China accounts for a disproportionately high share of global investment in a range of technologies, including electric vehicles, CCS, wind power, solar PV and nuclear power.

Chart 8 : China’s share of cumulative global investment in selected fuels and technologies in the New Policies Scenario, 2017-2040

Source: International Energy Agency (2017)

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In IEA’s New Policies Scenario, China’s exports of solar PV panels and lithium-ion batteries for EVs alone contribute to global CO2 emissions savings of nearly 1 Gt in 2040, equivalent to around 10% of China’s energy-related CO2 emissions in that year.

Chart 9 : Global CO2 emissions savings from China’s export of solar PV panels and batteries for electric cars by scenario

Sources: Natixis, CEIC

The IEA concludes “there is a possibility that China could break decisively from the conventional trajectories of energy development followed by advanced industrialised countries, providing a new model for low-carbon urbanisation and economic growth”. Arguably, through the B&R, China can help developing countries to derail the environmental Kuznets Curve hypothesis, which implies that the relationship between growth and the environment is an inverted U-shape, and help those countries to leapfrog the polluting effects of early stages of economic growth. Note that, since 2015, China has been promoting a global network of ultra-high-voltage (UHV) transmission lines that could connect a large number of variable renewable energy bases (e.g. to integrate electricity received from hydro projects in northern Eurasia with wind turbine- generated electricity from the Siberian Arctic). This project is backed by the Global Energy Interconnection Development and Cooperation Organization (GEIDCO), in which China State Grid Corporation plays a prominent role.

China holds 3.5M of the 8.1M renewable energy jobs globally. B&R face perhaps the greatest short-term job creation challenge in world history because their working population is growing at an alarming rate.

Chart 10 : Employment in renewable sector worldwide (2015)

Source: Frankfurt School – UNEP Collaborating Centre for Climate & Sustainability Energy Finance

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In 2016, the Silk Road Fund, China Gezhouba Group (CGGC) and China Environmental Energy Holdings, signed a MoU with the government of the Republic of Serbia On Joint Investment and Development of Serbian Renewable Energy Projects in Belgrade.

Also, the Chinese company Goldwin will supply Serbia with wind turbines, while China Machinery Engineering Company signed a memorandum of understanding which provides financing and construction of a power plant that will generate electricity from waste.

Table 13 : Examples of infrastructure and technologies needed for a low-emission reducing the impact of carbon intensive sectors or industry

Source: OECD (Investing in Climate, Investing in Growth, 2017)

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The bulk of Chinese M&A transactions targeted brown sectors

We conducted a review of M&A transactions by Chinese companies from January 2013 to December 2017, using a database from Merger Market. We used it to assess the greenness of M&A transactions.

Out of around 1,500 M&A transactions for a total of $442bn, approximately 355 were carried in B&R countries for an amount of $90bn, of which solely $2bn went to activities or sectors with clear green benefits (renewable energy, energy efficiency and sustainable water and waste water management), versus $28bn to brown activities or sectors (coal, oil, mining, etc.).

In sum, M&A transactions in B&R countries account for around 23% of worldwide M&A transactions by Chinese companies. Sectors and industries with clear green benefits represent around 2% of M&A transactions in B&R countries, versus around 30% for brown activities. We counted more than 22 operations in the oil sector in B&R countries for a total of around $17bn and 20 operations in the mining sector for a total of $7bn.

Noticeably, M&A transaction is not necessarily the best proxy to assess the B&R footprint but it nevertheless provides information about the sectors and industries targeted by SOEs. Those are indeed at the forefront of B&R unfolding.

Chart 11 : Greenness of Chinese M&A transactions in B&R countries ($m) – 2013-2017

900 800 Brown sectors or activies (coal, oil, gas, mining, airlines) 700 600 500 Neutral or unproven green benefits 400 (i.e. dependent on the specificis of the project, e.g. services, leisure, 300 etc.) 200 Green sector or activities (e.g. 100 renewable energy, waste 0 management, sewage ) Non B&R countries (e.g. Germany, B&R countries Canada, UK, France)

Sources: Merger Market, Natixis

Note that 74% of Chinese investments in the Middle East are in the form of project finance (the rest being FDI). See Asia Pacific Research’s report “How is the belt and road impacting the Middle-East” (September 2017).

Overseas investment approval procedure Based on the size of the investment, investors must register and/or receive approval from the National Development and Reform Commission (NDRC), Ministry of Commerce (MOFCOM), and the State Administration of Foreign Exchange (SAFE). For state-owned enterprises (SOEs) or publicly listed companies, approval must also be given by the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) and the China Securities Regulatory Commission (CSRC). Large investments over $2bn must be approved by the State Council.

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Chart 12 : Companies with the highest M&A total transactions in B&R countries (2013-2017, $m)

Temasek Holdings Pte Ltd; Canada Pension Plan… China National Petroleum Corporation China General Nuclear Power Corporation Giant Network Group Co., Ltd. Sinopec International Petroleum Exploration and… Bohai Capital Holding Co., Ltd. China Molybdenum Co., Ltd. Silk Road Fund Co., Ltd. China Construction Bank Corporation; Banco BTG… Chengdong Investment Corporation Bright Food (Group) Co Ltd Consortium for Stats ChipPac Ltd Microsoft Corporation; eBay Inc.; Tencent Holdings Ltd. China National Chemical Corporation China Petrochemical Corporation YTL Power International Berhad; Guangdong… Bohai Industrial Investment Fund Management Co Ltd SoftBank Group Corp.; Tencent Holdings Ltd. Beijing Gas Group Co., Ltd. An investor group led by Alibaba Group Holding Ltd China Petroleum & Chemical Corporation Anbang Insurance Group Co., Ltd. Alibaba Group Holding Ltd 0 1 000 2 000 3 000 4 000 5 000 6 000 7 000

Source: Natixis

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To match words with action, carbon lock-in projects financing, especially coal, should be phased out

Since 2013, most of capacity additions to China’s power system have come from wind, solar PV, hydropower and nuclear.

Chart 13 : Annual power generation capacity additions by type in China

Source: International Energy Agency (WEO, 2017)

However, by the end of 2016, China had been involved in 240 coal-fired power projects in 25 of the 65 countries along the Belt and Road (notably India, Indonesia, Mongolia, Vietnam and Turkey), with a total installed capacity of 251 GW (Source: Global Environmental Institute). Currently, 52 of these projects are in the pipeline (planned or signed projects), with a total installed capacity of 72,116 MW, accounting for 12.66% of coal-red power projects in the pipeline worldwide; 54 projects are under construction, with a combined installed capacity of 48,005 MW, accounting for 17.59% of coal-red power plants under construction globally; 114 projects are in operation, with a combined installed capacity of 88,018 MW, accounting for 4.48% of the coal-red plants in operation globally.

Chart 14 : Belt and Road Coal-Fired Power Projects with Chinese Involvement, by Number and Installed Capacity

Source: Global Environmental Institute

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China has been one of the world’s biggest backers of coal-fired power stations, lending $40.4bn to such projects between 2000 and 2016, according to a database from the Boston University’s Global Economic Governance initiative. The biggest recipients of Chinese loans for such coal power plants are India, Indonesia, Vietnam, Ukraine and Pakistan. In 2016, the China Development Bank and the Export- Import Bank of China provided over of $43.2bn in energy financing—close to triple the average annual energy lending of the World Bank and all the Western-backed multi-lateral development banks combined. Because of the war against pollution, the cement company China Huaxin, which is reliant on coal, has moved to Tajikistan where the production of cement has increased fivefold in less than one decade. Therefore, in the medium term, to avoid carbon leakages from the recently introduced Chinese carbon trading scheme (which currently applies only to the power sector), linkages with B&R projects could be examined (for instance, SOE emissions consolidated at international level).

Several B&R projects aim at facilitating the circulation and thus the consumption of fossil fuels, e.g. the Yamal LNG and the China-Pakistan Economic Corridor (CPEC), which will halve the length of time it takes to import a barrel of oil from Saudi Arabia (25 days today). The CPEC is the most completed B&R project so far and its energy mix of almost 11 GW is lopsidedly carbonized, split between coal (75%), hydro (15%), solar (8%) and wind (2%). In Pakistan, China helps to build the world’s largest solar farm: a 100MW project under the CPEC. But it has also approved a $1.2bn investment for coal mining in the Thar Desert and the construction of 660MW coal-fired power generators. The CPEC will materialize a couple of hundred infrastructure projects, including the construction of highways, railways, oil and natural gas pipelines, power plants, a China-Pakistan cross-border fiber-optic network, and the development of Pakistan’s Gwadar port.

Chart 15 : Energy mix of projects in China-Pakistan Economic Corridor

Source: IRIN

China is the largest customer of commodities worldwide (Iron Ore, Copper, Coal Nickel) and is driving demand and pricing, thereupon, BHP identified 400 B&R core projects that could lead to an additional 15m tons per year of steel over 10 years, i.e. an additional 3 to 4% of demand growth on top of the current 1% forecast.

China’s NDC China’s nationally determined contribution (NDC) to the United Nations Framework Convention on Climate Change (UNFCCC) includes the following objectives: - To achieve peak CO₂ emissions around 2030 and make best efforts to peak earlier. - To lower CO₂ emissions per unit of GDP by 60-65% by 2030, against a baseline of 2005 (vs. 40-45% announced in 2009 for 2020, vs.-33.5% between 2005 and 2014 already). - To increase the share of non-fossil fuels in primary energy consumption to around 20% by 2030. B&R is a catchall initiative whose “stamp” is likely to be used inappropriately, financing carbon bomb projects. Meanwhile, President Xi Jinping declared in his inaugural speech at the last Congress Party in October 2017 that is China “Taking the driver’s seat in international cooperation to respond to climate change, China has become an important participant, contributor, and torchbearer in the global endeavour for ecological civilization”. Continue to finance coal projects under B&R label will erode China’s growing soft power on climate change, deter foreign investors to participate in the initiative, and wreak havoc the acceptance of the initiative.

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Biodiversity along B&R corridors must be considered and preserved

At the B&R Forum last May (“Work Together to Build the Silk Road Economic Belt and The 21st Century Maritime Silk Road”, May 17th, 2017), President Xi referred to “a big data service platform on ecological and environmental protection” and “interconnection and green and low-carbon development”. The joint communique of the leader’s roundtable of Belt and Road Forum lists “cooperation objectives” including one related to environment, biodiversity and natural resources protection.8

The WWF found (“WWF recommendations and spatial analysis”) that B&R corridors overlap with the range of 265 threatened species including saiga antelopes, tigers and giant pandas; also, BRI corridors overlap with 1,739 Important Bird Areas or Key Biodiversity Areas and 46 biodiversity hotspots or Global 200 ecoregions.

Chart 16 : Spatial Analysis of B&R overall potential impact

Source: WWF Belt and Road Initiative - Recommendations and spatial analysis

Chart 17 : Ecosystem Services (Water Linked)

Source: WWF Belt and Road Initiative - Recommendations and spatial analysis

8 “Enhancing cooperation in ensuring the protection of the environment, of bio-diversity and of natural resources, in addressing the adverse impacts of climate change, in promoting resilience and disaster-risk reduction and management, and in advancing renewable energy and energy efficiency. “ 39

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The Polar Silk Road

China’s State Council published on January 26th, 2018, a white paper to create a “Polar Silk Road” through the Arctic, by expanding new seaways opened up because of global warming. Last August, a Russian tanker travelled from Norway to South Korea without an icebreaker escort for the first time. The concept was first put forward in July last year, when President Xi met with Russian Prime Minister Medvedev in Moscow. This awaited report fleshes out China’s polar strategy, notably “to guide relevant Chinese government departments and institutions in Arctic-related activities and cooperation, to encourage relevant parties to get better involved in Arctic governance”.

The white paper states that “China enjoys the freedom of rights of scientific research, navigation, overflight, fishing, laying of submarine cables and pipelines, and resource exploration and exploitation in the high seas”. It says it “promotes technology innovation in Arctic oil and gas drilling and exploitation”. As a reminder, the Arctic Circle holds an estimated 13% (90bn barrels) of the world’s undiscovered conventional oil resources, and 30% of the world’s undiscovered conventional natural gas resources (US Geological Survey, 2012).

Chart 18 : Arctic routes

NB : Purple areas represent U.S. Geological Survey oil and gas reserve estimates;Arctic Council member states are highlighted in green, and observer states are highlighted in blue.

Source: Center for Strategic and International Studies / Energy and National Security Program (January 2018)

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Note that the State Council states: "Sustainability" is the fundamental goal of China's participation in Arctic affairs”. In order “to effectively protect the marine environment of the Arctic” it is said “China works with other States to enhance control of the sources of marine pollution such as ship discharge, offshore dumping, and air pollution”. Scientific evaluation of the impact on the Arctic ecological system caused by climate change carried by China will supposedly encompass: “protection of migratory birds and their habitats, migration patterns of Arctic migratory birds, adaptability and resilience of the Arctic ecological system, international cooperation in the protection of Arctic species of fauna and flora”.

The item “utilizing Artic Resources in a Lawful and Rational Manner”, based on the statement that “the Arctic has abundant resources, but a fragile ecosystem”, let us sceptical. China says “It encourages its enterprises to participate in the infrastructure construction for these routes [ Northeast Passage, Northwest Passage, and the Central Passage] and conduct commercial trial voyages in accordance with the law to pave the way for their commercial and regularized operation. It is also quoted: “As fish stocks have shown a tendency to move northwards due to climate change and other factors, the Arctic has the potential to become a new fishing ground in the future”, again referring to “rational use”; a formula which does not ease our concerns.

Beyond natural resources, China strives to cut the logistic cost when trading with European countries, and avoid vulnerable straits, such as Malacca, through which 80% of its oil imports must transit. The Northern Sea Passage is believed to take 20 days off the 48 days it currently takes to ship to Rotterdam from China via the Suez Canal.

Worries are expressed about Arctic life protection and indigenous peoples. Apart from the damages heavy maritime traffic and the extraction of Article Circle fossil fuel resources could inflict on the ecosystem (risks of oil spill), it would lead to GHG emissions increase derailing Paris Agreement achievement (and accelerating loss of polar sea ice). We believe it conflicts with China’s positioning (at least in words) for leadership on the topic.

China’s presence and ambitions in the Arctic Circle

In December 2017, the Yamal liquefied natural gas (LNG) project in Russia reached initial operational capacity. China’s Silk Road Fund ($40bn, created in 2014) and China National Petroleum Corp (CNPC) hold a combined stake of 29.9% in the project. That same month, a joint-venture of China LNG Shipping and Teekay LNG Partners signed a $1.6bn loan to finance six LNG carriers to operate in the region. Iceland has granted China National Offshore Oil Company permission to explore in Iceland's waters and is cooperating on an observatory to study the magnetic phenomena known as the Northern Lights. In December 2016, the PBoC extended a currency swap deal with the central bank of Iceland. The deal is worth $507m and will last for three years, aiming at “facilitating bilateral trade and investment and helping regional financial stability”. China operates a research station in Norway and is an observer member of the Arctic Council since 2013, among 13 countries. Last year, China’s research vessel Snow Dragon made its debut sailing around the Arctic rim.

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Striving for a “triple-win” Belt and Road thanks to sustainable finance

In our view, to match climate ambition words with action, and to make B&R projects palatable for foreign investors and enterprises, they must deliver a “triple win” result for Chinese firms, host countries and the planet.

Chinese leaders’ call for sustainability support and partnership

Chinese authorities are aware of environmental risks and potential controversies surrounding the initiative. They frankly requested foreign support to achieve a green and sustainable B&R while promising bold commitment from China. At the “Belt and Road Forum for International Cooperation” in May 2017, President Xi declared: “We will set up a big data service platform on ecological and environmental protection”. […] “We propose the establishment of an international coalition for green development on the Belt and Road, and we will provide support to related countries in adapting to climate change”. He added: "We should pursue a new vision of green development and a way of life and work that is green, low-carbon, circular and sustainable". The slogan of the Asian Infrastructure Investment Bank (AIIB), which aims to be “lean, clean and green, but not mean” fit in with the B&R.

Chinese Ministry of Environmental Protection, Ministry of Foreign Affairs, National Development and Reform Commission and Ministry of Commerce jointly issued the Guidance on Promoting Green Belt and Road to further boost green development.

During the Planet Summit in Paris last December, Ma Jun who has been assigned by the mission “to make sure Chinese investors are seeking green investments in the belt and road region”, declared: “We are now seeking more international support to help this effort”. He declared about the countries covered by the B&R that “If nothing is done… their emissions could be three times China’s emissions”.

During his visit in China, France’s President Emmanuel Macron declared that the two countries “are going to strengthen [their] dialogue in anticipation of the COP 24 in 2018 and the United Nation's Convention on Biological Diversity, which China will host in 2020”. He proposed “to work on the Global Pact for the Environment, which France has brought to the United Nations to bring international law in line with the challenges of our time”.

Table 14 : Overview of some of China’ Green finance initiative and efforts Initiative Description Guidance on Green Bond standards The National Development & Reform Commission (NDRC) and China Securities Regulatory Commission (CSRC) released guidance on green bond standards. This spurred further regulatory advancements like the launch of benchmark indices tracking the performance of Chinese green bonds.

Guidelines for Establishing the Green Released On 31 August 2016 by seven ministerial agencies including the People’s Bank of China Financial System (PBoC) and the Ministry of Finance, setting out, for the first time, the official definition of green finance, incentives, disclosure requirements, development plan for green financial products, as well as risk mitigation

Green Credit Guidelines (GCG) The China Banking Regulatory Commission (CBRC) promulgated policies to align the activities of the financial sector with the country’s domestic environmental objectives few years ago. In 2012, it scaled up these efforts by upgrading, expanding, and internationalizing one of its most advanced sustainable finance policies, the Green Credit Guidelines (GCG). It calls on banks to “strengthen the environmental and social risk management for overseas projects to which credit will be granted [,] and make sure project sponsors abide by applicable laws and regulations”. In particular, its article 21 states: ‘Banking institutions shall strengthen the environmental and social risk management for overseas projects to which credit will be granted and make sure project sponsors abide by applicable laws and regulations on environmental protection, land, health, safety, etc. of the country or jurisdiction where the project is located. The banking institutions shall make promise in public that appropriate international practices or international norms will be followed as far as such overseas projects are concerned, so as to ensure alignment with good international practices.’

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Initiative Description Greening the belt and road “Greening the belt and road” Partnership was launched at Bonn during the COP23 (with City of partnership London Corporation, Renmin University)

CBI and CECEP Hundred partnership Recent agreement to provide green finance advice to China’s Belt and Road development campaign between CBI and China’s state-owned clean-energy company CECEP Hundred9.

Brookings -Tsinghua Center for Public Brookings -Tsinghua Center for Public Policy, Stockholm Environment Institute (SEI), and the Policy & Stockholm Environment Embassy of Sweden in China are organizing a dialogue to promote innovation in green finance and Institute (SEI) partnership sustainable infrastructure in the B&R. B&R Economic Indices ICBC Standard Bank, in partnership with Oxford Economics, has recently launched a set of Belt and Road Economic indices to offer investors a standardised framework to compare the investment climates and economic and political risks of individual countries across the ‘Belt and Road’ region.

Source: Natixis

Policymakers in China have been introducing various incentives to stimulate development of the market. Unlike the international market, where the definition and eligibility criteria are defined by issuers and voluntary standards, the scope of the green bond market in China is currently defined by the guidelines published by the PBOC and the NDRC. The two regulatory bodies, alongside stock exchanges, are essentially playing the role of certification bodies of issuance documents submitted by issuers in accordance with the guidelines for approval. The PBOC regulates the interbank market, while the NDRC is responsible for the enterprise market. Shanghai and Shenzhen Stock Exchanges regulate the listed corporate market

In December 2015, the Green Finance Committee created by the PBoC (2/3rd of assets under management in China, regulators and biggest commercial banks and development banks as well as the Climate Bonds Initiative and the International Capital Markets Association represented) released its Onshore Chinese Green Bond Guidelines (CNY). It applies to all the interbank bond issuances from financial institutions (93% of the outstanding Chinese bond market, including Panda Bonds.

In January 2016, the NDRC published its guidelines to promote the use of green bonds to finance projects in 12 specified industries. In May 2017, the CSRC published its guidelines, the rules applied are the same as the ones of PBoC with the inclusion of a selection criteria based on the ESG score of the issuer: Issuers conflicting with the national industrial policy are not eligible.

The harmonization of green bond eligibility standards between China and the EU

The Green Finance Committee (GFC), which is part of the China Society for Finance and Banking, and the European Investment Bank (EIB), have published a joint document comparing several green bond issuance standards entitled "The need for a common language in Green Finance". This report is the first step in a process to harmonise Chinese and European standards initiated by both agencies a few months ago. The document will serve as a working basis for converging green finance standards and facilitating green capital exchanges between China and the EU.

It compares the green bond issuance standards applied by China on its internal market, and those used by the EIB and other development banks (FMO, NIB, etc., hereafter referred to as the “MDB-IDFC standard”). Several differences exist, primarily because China’s definition of “green” assets is much broader, including categories such as “clean coal” and the eligibility of technologies that are considered controversial (coal-to-gas for instance) as long as they are efficient in relation to the local reference situation (though less so in other regions). The document highlights a glaring lack of harmonised classification and standards that would largely facilitate communication between issuers and investors and could prevent the market becoming increasingly complex due to a high number of local criteria.

9 The Memorandum of Understanding (MoU) is centered on the promotion of green finance in the Belt and Road countries. Both parties will contribute their expertise in the green industry and green finance to provide a full range of green advisory services to boost the greening process of the Belt and Road. 43

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It sets out four key conclusions, which are likely to be addressed over the coming months by the relevant GFC & EIB teams: -Each framework looked at uses a different classification system for underlying assets. The Chinese classification includes assets related to “environmental protection” (adaptation) while the other standards relate to assets involved in combating climate change (mitigation). -The “mitigation” project categories under each standard differ, mainly the Chinese definitions and the EIB and MDB-IDFC standards. -Where there are categories that are eligible for each of the three standards, they still show differences in terms of sub-categories; e.g. nuclear energy is admissible for the EIB in the context of renewable energies but is not admissible under Chinese and MDB-IDFC standards. -The MDB-IDFC standard includes several specific categories that are not mentioned in the EIB standard (energy efficiency at coal plants), and this is also the case for the Chinese standards which do not include, among other things, CCS, the modernisation of renewable energy farms, and energy audits. The report’s final recommendation is the development of a larger working group to harmonise standards and establish common categories conducive to the issuance of Chinese bonds internationally and the entry of international issuers on China's local market.

Towards a green finance laboratory

The B&R could serve as hothouse to bankroll climate change adaptation and environmental friendly projects in countries that have the greatest needs and the most exposure to extreme climate-change related events.

After pledged $3.1bn to South-South Cooperation Fund on Climate Change, China said it would serve as a third party facilitating developing countries to adapt climate change. Note that the AIIB and the World Bank financed Manila Flood Control Project (Phase I) through communication between the Philippine government and the Asian Infrastructure Investment Bank (AIIB). The total cost of the project is $500m. The ADB and the World Bank will provide $207m and the Philippine government will bear the remaining $86m. It will rebuild 36 pumping stations in Metro Manila, with more than 200 pumping stations in Manila, Pasig, Mandaluyong, Quezon and other cities to build 20 new pumping stations.

Transportation represent the bulk of climate proofing investments— estimated at $37bn annually in Asia by the ADB. Countries should ensure their infrastructure is resilient to the expected impacts of climate change, as phenomena such as sea level rise and intensified extreme weather will damage infrastructure, and impair its longevity and performance. It could be achieved by measures such as elevating road embankments, relocating upstream water intake and treatment works, and enhancing design and maintenance standards. It consists also in pursuing a different approach to provide the same service, for example expanding green spaces to absorb rainfall in urban areas, instead of investing in larger drainage pipes. Climate adaptation demands shifts in portfolio and large investments in sectors such as irrigation and food security, disaster risk management (flood control especially), and coastal protection to maintain and build climate change resilience.

As resilience features are intrinsically linked with the way in which extreme weather event insurance policies are designed and with the possibility of bringing their premiums down, B&R could become a climate-change insurance hothouse. It is also an opportunity to make Chinese offshore green bonds more stringent and palatable to foreign investors. Conversely, western corporates looking to invest in China through “panda bonds” might need green B&R mentoring.

In September 2016, “Silk Road Bonds” were suggested at a summit co-organized by the International Capital Market Association (ICMA) and the credit Agency Dagong.

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The ICMA warned that traditional funding sources for infrastructure projects, such as government financing, development bank loans and bank project finance, are insufficient to satisfy infrastructure demands. They asserted an international bond market was necessary to help bridge the funding shortfall. Designed to be a new asset class recognized internationally, Silk Road Bonds could emerge as an integral source of financing for the B&R soon. If only Silk Road Bonds take the track-record of ICMA on green bond, namely the Green Bond Principles (GBP), it would be a step in the right direction. Note that the ICBC issued a mammoth $2.1bn B&R green bond in 2017 in Luxembourg and further issuances are likely.

Bond Connect

Bond Connect is a new mutual market access scheme that allows investors from Mainland China and overseas to trade in each other's bond markets through connection between the related Mainland and Hong Kong financial infrastructure institutions. Launched in July 2017, it enables a streamlined channel for international investors to access mainland China’s $10tn interbank bond market (which includes a wide range of financial institutions), the world’s third- largest behind the US and Japan. Measures announced by the PBOC in 2016 to open the China Interbank Bond Market (CIBM) to international investors and in 2017 to simplify foreign access via “Bond Connect” make easier foreign investment in Chinese fixed income markets, in particular green bond market. Note that in 2017, both the Agricultural Development Bank of China and Export-Import Bank of China launched green bonds through Bond Connect scheme

Companies allowed to issue B&R bonds by the CSRC

The China Securities Regulatory Commission (CSRC), announced on March 2nd, 2018, that it will authorize domestic and overseas companies to issue bonds in the onshore stock exchanges to finance projects related with the B&R. The Shanghai and Shenzhen stock exchanges will carry out the pilot B&R bond program. According to the CSRC, government- backed institutions in economies participating in the B&R initiative can also sell bonds in China. Seven domestic and overseas companies have gained the regulatory approval to issue B&R bonds worth a total of CNY50bn ($7.9bn) and four of them have already raised CNY3.5bn through their bond issuances.

The Shanghai Stock Exchange and the Shenzhen Stock Exchange published B&R guidelines on March 2nd, 2018. However, they define B&R bonds broadly as either those issued by onshore and offshore companies to fund projects associated with the B&R initiative, or those issued by foreign governmental, corporate and financial institutions in countries along the new overland and maritime trade routes. Up to 30% of the proceeds of bonds issued specifically to fund B&R projects can be used to repay bank loans and replenish capital. B&R projects eligible under the new bond category are either those endorsed by the NDRC at provincial level or above, or those for which issuers have signed agreements with governments or companies along the B&R routes and have obtained necessary approvals from regulators. If the use of proceeds involves cross-border capital flows, the bond prospectus should document details such as the remittance of proceeds, plans for onshore use and purchase of foreign currencies. Different bond formats, including Green bonds and perpetuals, are eligible under the new category. Invesco, an international asset manager, has launched a Belt and Road bond fund on March 2018. It is the first such fund approved by the Securities and Futures Commission for retail.

In March 2017, Russian aluminium producer UC Rusal issued renminbi-denominated bonds worth CNY1bn at the Shanghai Stock Exchange, becoming the first company from an economy involved in the B&R initiative to sell bonds in China. In January, Chinese cement producer Hongshi Group raised CNY300m through its bond offering at the Shanghai Stock Exchange to fund its projects in Laos. The group was the first Chinese company to issue B&R bonds at the stock exchange, according to the CSRC.

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China’s financial integration to the rest of the world

The People’s Bank of China is strengthening currency cooperation with central banks of other countries. The RMB inclusion in the IMF's Special Drawing Rights basket in October 2016 was a landmark.

MSCI’s decision to include Chinese stock in its global benchmark equity index for the first time (mainland equities, Chinese A-shares, will be included by August this year in MSCI’s emerging markets index). We are heading towards a deeper introduction of domestic Chinese securities into international investors’ portfolios, reflecting the size and significance of China’s domestic stock market and economy.

Offshore RMB markets are multiplying. Besides China’s Hong Kong, Taiwan and Singapore as the major offshore RMB deposit and loan markets, the accelerated development of offshore RMB markets in Britain, Germany and some other key countries of Europe – which is expected to be the most important offshore RMB market outside Asia – are to be witnessed.

China signed bilateral currency settlement on general trade with central banks of countries such as Russia and Belarus, and signed bilateral currency settlement on border trade with central banks of countries such as Kyrgyzstan and Kazakhstan

Ways to overcome the “wait-and-see” attitude among foreign investors and companies to jump on the bandwagon

To alleviate foreign investors’ reluctance to participate in the B&R initiative, especially SRI investors, brown sectors could be totally or partially excluded, while favorizing sectors with net green benefits. In addition, financing terms should be aligned with best disclosure and transparency standards.

Sector screening

Dual use of infrastructure (military and civilian ports for instance), Arctic related activities (“New Polar Silk Road)” and fossil fuel activities (especially coal mining and power generation, retrofits of fossil fuel power stations) should be disclosed. Any project, especially in the transport and power sectors, should be individually assessed in the light of its alignment with and contribution to the recipient country’s nationally determined contributions (NDC) filed as part of the COP21.

Otherwise, biodiversity values and other ecosystem services in corridor countries should be mapped and “no-go” areas must be, if needed, determined. Note that the WWF found that B&R corridors overlap with the ranges of 265 threatened species, including saiga antelopes, tigers and giant pandas, 46 biodiversity hotspots and 200 global ecoregions.

Low-carbon technologies like renewable energy (wind, solar, thermal energy, tidal, waves, hydro <50MW) and associated storage solutions (thermal cycle, power to gas, batteries), alternative materials for steel and cement in the buildings sector, and clean transportation (electric cars and charging infrastructure) should be given priority. Furthermore, since many of the countries most affected by extreme weather events between 1997 and 2016 are along the B&R (Global Climate Risk Index, German Watch and Munich Re), a special focus on resilient infrastructure seems relevant (transportation, power grids and coastal accommodation resilient to rising sea levels and extreme weather events).

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Responsible lending guidance

Conditions to guarantee the social and commercial viability of projects and a level playing field should try to be met by Chinese SOEs and/or required by financial institutions, requiring for instance:

- A minimal level of debt servicing capacity imposed on project recipients (for instance, compliance with G20 Operational Guidelines for Sustainable Financing, debt limit policies as a shared responsibility for debtors and creditors).

- Exclusion of collateral rules on natural assets (or repayment schemes such as “oil for loans”) and limitation of debt for equity swap deals.

- Local community consultation and involvement in pre-planning and monitoring, and fair compensation for resettled communities.

- A minimal share of local manpower employed in projects.

- Public tenders to ensure fairer access to local and non-Chinese contractors (build-operate- transfer or public-private partnership models). B&R projects must aim to be more open to local and international participation (89% out of 178 infrastructure projects funded by China between 2006-18, reviewed by the Centre for Strategic and International Studies (CSIS), had Chinese contractors, 7.6% local contractors and 3.4% of foreign contractors, versus 41% of local contractors, 29% Chinese and 30% from third countries for multilateral bank projects).

Information disclosure and transparency

Due to the catch-all nature of the B&R, it is hard for investors to clearly grasp the initiative’s perimeter and get a clear understanding of the underlying projects. A monitoring entity could help add transparency to the green B&R assets. Besides that, when considering offshore green bonds or loans from Chinese banks or SOEs, it might make sense to provide foreign investors with the following to make them less averse:

- Detailed lists of eligible categories and subcategories (that are not too generic, i.e. clearly defined with hurdle rates or thresholds in eligibility criteria when relevant).

- Detailed lists of eligible projects (location, legal and social context, different sponsors), with ex ante environmental and social studies. A standalone report assessing the project’s consistency with the fight against climate change and its alignment with or contribution to the recipient country’s NDC would be an outstanding practice.

- The breakdown of forecasts between financing and refinancing and, when relevant, indication regarding the lookback period.

- The proceeds should limitedly be allocated to capital expenditures. With concern to the use of proceeds, a separate account or clear earmarking process would provide greater transparency for investors. Specific policy regarding recycling policy, in cases of project’s early redemption or sale, should be disclosed. Transparent cash management process, if possible cash/pending allocation invested with ESG criteria, would be welcomed.

- Accountability and reporting: regular communication, at least annually, on proceeds disbursement is of interest. Furthermore, the issuer could commit to engage a third-party opinion, with a comprehensive mandate, to verify ex post the actual allocation of proceeds, actual eligibility of projects financed, as well as impact measurements (robustness and accuracy, tCO2 avoided, MWh produced) at both project level and bond level, allowing investors to calculate their share of financing/impact based on the amount of bonds they hold in their portfolio. Calculation methodologies should be disclosed.

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Table 15 : Possible sustainability / ESG guidelines for Belt & Road projects Objective Solution / ways To prevent B&R inflation and To establish stringent eligibility criteria or even exclusion list: fossil fuel energies (at least coal), dual-use of dilution by narrowing its scope infrastructure (i.e. civilian and military, for instance ports), forbiddance of loans collateralised by strategically to projects with clear important natural assets, restriction on Arctic related projects (“Polar Silk Road” expansion). environmental and social benefits Resources intensive industries such as mining, coal-fired power plants could be excluded. Infrastructure, steel, cement, building materials, chemicals, and textile and dyeing should be submitted to “best-sectors and best available technologies available” screening (breakthrough technology).

Biodiversity values and other ecosystem services in “corridor countries” could be mapped with “no-go areas”

To set-up robust and transparent process for project evaluation and selection, including detailed eligibility criteria: - alignment with SDGs/2°C policy and greenness demonstration; - assess projects in the light of recipient countries’ nationally determined contributions (NDC) filed as part of the COP21; - minimum eligibility thresholds (share of local manpower used in projects, debt servicing capacity of project recipients); - evaluation of ESG risk mitigation at project level (local population consultation or involvement in decision- making); - dedicated governance process and externality management process To guarantee investors high To define clear earmarking and management of proceeds (specific project categories or projects identified as transparency and proceeds eligible (location, features, etc.) and recycling policy. tracking Strong proceeds tracking with specific account/sub-account/audit trail identifying proceeds throughout their lifespan; specific policy regarding recycling policy (in cases of early redemption or sale); transparent cash management process (cash invested with ESG criteria pending allocation).

To prevent bribery To develop strong and independent oversight to prevent corruption: infrastructure programmes are notoriously vulnerable to corruption. It could be relevant to set up controls, to screen on the companies that are sub- contracting, who owns them, making sure there is no overlapping ownership with government officials To require Sino-sure to embed The state-backed insurance firm is designed to support and encourage Chinese enterprise and financial into its overseas investment organisations to make investments overseas. It obligates the insurer to underwrite an investor’s economic insurance program E&S losses in overseas investments caused by political risk in the host country, especially in developing countries. criteria Sinosure could require comprehensive contractual arrangements that factor in E&S criteria and support from the host countries and local communities as key conditions To set-up new liability rules Voluntary CSR recommendations such as the “Guidelines for Sustainable Overseas Forest Resources related to sustainability for Management” or “Guidelines for Social Responsibility in Outbound Mining Operations” from the CCCMC could China SOEs managers be further backed by stronger tools for enforcement. One possible solution could involve new liability rules relating to sustainability imposed on China SOE managers. Efforts could be made to reinforce compliance with Article 21 of the Green Credit Guidelines that calls on banks to “strengthen the environmental and social risk management for overseas projects to which credit will be granted […] and make sure project sponsors abide by applicable laws and regulations on environmental protection, land, health, safety, etc. of the country or jurisdiction where the project is located”. To develop new approach to Credit officers must consider a range of financial strategies to cope with more variable cashflows from infrastructure credit risks infrastructure projects arising from climate and weather risks. They can impact revenues, expenditures, assets, capital and financing. Impact assessment of climate change related events on several types of infrastructures should be made compulsory prior to launch any B&R project. Those could be: airports, sea ports, gas and oil transport and storage, power transmission and distribution, wind farms, data centres; telecommunications; commercial real estate; healthcare; and sports and entertainment facilities.

Source: Natixis

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Abbreviations

ADB: Asian Development Bank

B&R: Belt and Road

CDB: China Development Bank

CBRC: China Banking Regulatory Commission

CIBM: China Interbank Bond Market

CPEC: China Pakistan Economic Corridor

CSRC: China Securities Regulatory Commission

EBRD: European Bank for Reconstruction and Development

EIB: European Investment Bank

EPC: engineering, procurement, and construction

EXIM: China Export-Import Bank

GCG: Green Credit Guidelines

GFC: Green Finance Committee of China Society for Finance and Banking

ICMA: International Capital Market Association

MDB: multilateral development bank

MFA: Ministry of Foreign Affairs

MOFCOM: Ministry of Commerce of the Government of China

PBoC: People’s Bank of China

NDRC: National Development and Reform Commission

SAFE: State Administration of Foreign Exchange

SOEs: state-owned enterprises

SASAC: State-owned Assets Supervision and Administration Commission of the State Council

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Research Team

Green & Sustainable Hub

Orith Azoulay Global Head of Green & Sustainable Finance +33 1 58 55 52 05 [email protected]

Green & Sustainable Center of Expertise Cédric Merle Ivan Pavlovic Expert, Green & Expert, Green & Sustainable Center of Sustainable Center of Expertise Expertise +33 1 58 55 52 05 +33 1 58 55 82 86 [email protected] [email protected]

Asia Pacific Research Chief Economist, Asia Pacific Emerging Asia Greater China

Economist Economist Alicia Garcia Herrero Trinh Nguyen Jianwei Xu +852 3900 8680 +852 3900 8726 +852 3900 8034 [email protected] [email protected] [email protected]

Japan, Pacific Sectoral Research Asia Economist Economist Kohei Iwahara Gary Ng +813 4519 2144 +852 3915 1242 [email protected] [email protected]

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