Shandong Energy Efficiency and Emission Reduction Project (RRP PRC 40524)

FINANCIAL MANAGEMENT ASSESSMENT OF CHINA EVERBRIGHT CO. LTD.

Background: The (CEB) is a national commercial bank established in 1992 by the China Everbright Group, Ltd., a state-owned investment conglomerate of the People's Republic of China (PRC). It has its headquarters in Beijing and has 38 provincial level branches and 483 subbranches distributed in major cities of 23 provinces, municipalities and autonomous regions. It also has a representative office in Hongkong and maintains correspondent relationships with many overseas worldwide. CEB provides financial services to all its retail and corporate clients covering areas of corporate and , treasury services wealth and asset management, mortgage, credit card, and fund custodianship, among others.

In 1998, CEB acquired the China Investment Bank (CIB), which was established in 1981, as a sole state-owned policy bank. The acquisition resulted in the immediate doubling of CEB’s operational capabilities and CEB benefited from an increase in its domestic market share through synergy and access to CIB’s large customer deposit base. However, the acquisition caused financial problems as well since CEB assumed the bulk of the liabilities and nonperforming assets of CIB. CEB launched a series of financial restructuring in 2007 and received a capital injection of CNY20 billion from the State through China Central Huijin Investment Ltd. (China SAFE Investment Ltd.), a wholly state-owned investment company. The financial restructuring has substantially enhanced CEB’s overall capital strength. By the end of 2009, CEB's total assets reached CNY1,198 billion, with total loans of CNY632 billion. Its operating income is CNY24.3 billion while its net income is CNY7.6 billion. In 2009, CEB was on the list of best 16 Banks of Asia, and is also one of the Top 10 Banks of PRC. CEB plays an important role in the PRC's financial market and a major player in the asset management business. The CEB Jinan branch in Shandong is a major onlending bank of loans from foreign governments and international financial institutions in Shandong Province, and is familiar with the policies and procedures of Shandong Provincial Finance Department.

Shareholder At end of 2009, CEB has a registered capital of CNY33.43 billion, with a Structure: shareholders’ equity of CNY48.12 billion. The majority shareholder is China Central Huijin Investment Ltd. (China SAFE Investment Ltd.) with 49.61% stake. The next two largest shareholders, are the China Everbright Group Limited with 5.31%, and with 4.45% stake. The top 10 shareholders own 74.07% of CEB.

Top 10 Shareholders of Everbright Bank (As of 17 August 2010) Proportion of Shareholding Name (%) Central Huijin Investment Ltd. 49.61 China Everbright Group Limited 5.31 China Everbright Limited 4.45 2

China Reinsurance (Group) 3.72 Corporation China Power Finance Co., Ltd 2.03 Shenergy (Group) Co., Ltd 1.98 National Council for Social 1.41 Security Fund Hongta Tobacco (Group) Co., Ltd. 1.39 Aerospace Science and 1.39 Technology Finance Co., Ltd. China Aerospace Science and 1.39 Technology Corporation Baosteel Group Corporation 1.39 Source: Shanghai Stock Exchange.

Operations: The bank’s primary governing body is the general meeting of shareholders, which conducts management and supervision through the board of directors and the board of supervisors. The president is appointed and authorized by the board of directors to take full responsibility for the bank’s routine management and operation. The bank employs a single legal person system, in which all branches (subbranches) are nonindependent accounting units, and they conduct business under the authorization of the head office and report to the head office. The bank has independent and complete business lines and independent business operation competence, and its board of directors, board of supervisors and senior management operate independently.

The roles and responsibilities of shareholders, board of directors, board of supervisors, and management are clearly defined to ensure independence and effective checks and balances. Mechanisms to separate duties and internal controls are in place. The organizational setup and operating procedures are reported to China Banking Regulatory Commission (CBRC), which has the right to examine the company at any time. CEB constantly reviews its operations for potential risks so that mitigating measures may be taken in a timely manner. It has clear procedures for the internal audit mechanism including one internal audit department and two audit committees, which operates independently from other departments and reports directly to the president, the board of directors and the board of supervisors.

CEB's scope of business, as approved by CBRC are: taking deposits from the public; making short-term, medium-term and long-term loans; effecting domestic and overseas payment settlements; accepting and discounting instruments; issuing bonds; acting as agents to issue, underwrite government bonds; trading government bonds and financial institution bonds; engaging in interbank lending; engaging in foreign exchange trading as principal or as agent; engaging in bank card business; providing letters of credit and guarantee services; collecting and making payment as agents and acting as insurance agents; providing safe deposit box services; and other businesses approved by the CBRC. 3

Current market conditions are favorable for the growth of CEB, including (i) continued rapid economic development and income growth requiring diversified financial services; (ii) stronger competitive on asset custody business, including entrusted loan; (iii) the successful initial public offering in August 2010, and (iv) good reputation of CEB among its clients. The challenges that CEB faces include the management of the rapid business growth and increased competition in Chinese banking sector.

Branches: CEB has its headquarters in Beijing and has 38 provincial level branches and 483 subbranches distributed in major cities of 23 provinces, municipalities and autonomous regions. It also has a representative office in Hongkong and maintains correspondent relationships with many overseas banks worldwide.

Corporate The organization structure of the CEB is shown in Appendix 1. It Governance: includes a board of directors with 15 members, and a board of supervisors reporting to the shareholders with 11 members. The board of directors has five independent directors. The board of supervisors has an oversight role, and can be divided into two committees: the nomination committee and the audit committee. Five committees report to the board of directors: nomination and remuneration committee, audit committee, risk management committee, related party transaction control committee, and strategy committee. CEB operations are managed by a president with the assistance of eight vice presidents, and conducted by 25 functional departments and 15 functional committees.

Management The senior management consists of the president, chairman, secretary and Employees: of disciplinary committee, five executive vice presidents, one assistant president and one corporate secretary. It has more than 19,000 employees of which 70.8% of them have obtained diplomas at above college level.

Anti-Money In PRC, anti-money laundering legislation applicable to all financial Laundering: institutions was enacted in 2003. The legislation addresses drug trafficking, organized crimes, and smuggling as money laundering crimes. In 2006, the definition of money laundering was expanded to include corruption, bribery, financial regulations violations and financial fraud.

In accordance with relevant anti-money laundering requirements of the authorities, CEB optimized internal processes and further improved the anti-money laundering reporting system in order to increase the quality and effect of bank-wide anti-money laundering. The bank reported, and provided assistance to the investigation of bank-wide large sum transactions and data on doubtful transactions and related business cases in accordance with requirements. To deepen the implementation of anti-money laundering, the bank urged all branches to reinforce their anti-money laundering organizational structure and internal control systems and to enhance the identification of customers and client risk 4

classification as to anti-money laundering.

In accordance with relevant requirements of the People’s Bank of China, CEB cooperated with the government in deploying anti-terrorism measures and rolled out the Convoy 2009 anti-terrorism financing activity.

Capital It has consistently maintained a cushion above the regulatory capital Adequacy: adequacy ratio requirement. In 2009, the core capital adequacy ratio and the capital adequacy ratio (capital to risk weighted assets ratio) of CEB is 6.84% and 10.39% compared to the 4% and 8% minimum required by the CBRC. The asset liquidity ratio (liquidity asset to liquidity liability) is 35.15%; higher than the regulatory minimum of 25%.

Asset Quality: 69.6% of its loan portfolio in 2009 is backed by guarantee or secured by either monetary or tangible assets other than monetary assets.

Both the balance and ratio of nonperformance loans declined, reaching CNY8,123 million and 1.25%, respectively. Loan structure was continuously optimized, and the proportion of performing loans in total loans increased by 3.72 percentage points. Credit provision coverage ratio increased by 43.97 percentage points to 194.08%.

Manufacturing, water and public utility, property development, transportation and storage, lease and business services, and wholesale and retail trade account for almost 60% of the total commercial loan portfolio in 2009. The portfolio appears well diversified with no sector accounting for greater than 15% of the portfolio. CEB balance sheet is provided in Appendix 2.

Profitability: At the end of 2009, CEB generated an operating income of CNY24.26 billion, with a net profit of CNY7.64 billion, an increase of 34.8% after excluding the tax preference factor of the year before last year. Return on equity was 19.43% in 2009. The income structure was further optimized. Fee-based business developed rapidly, contributing to 13% of the bank’s total income, up by 4.2 percentage points compared to 2008.

Asset-Liability The assets and liability management committee oversees the bank’s Management: overall liquidity risk and is responsible for managing bank-wide liquidity according to regulatory requirements and the principle of prudence. The planning and finance department of the head office monitors middle-term and long-term liquidity and formulates liquidity management strategy, while the treasury department monitors day-to-day cash flow and maintains an appropriate level of high liquidity assets in line with the liquidity management strategy.

CEB’s liquidity has been strong and stands at 35.15%, which is well above PRC regulatory requirement of 25%.

In terms of its liabilities, CEB has maintained a stable deposit base as a steady source of funding. As of 2009, deposits-to-assets was 86.1%, up 5

from 85.33% in 2008.

Loans and CEB does not carry significant net exposure to other banks. As of end- advances to the 2009, CNY111 billion or 9.2% of total asset is placed with other banks Bank: and financial institutions, while it borrows CNY254 billion from other commercial banks.

Loans and Advances to Loans advanced, by industry 2009 2008 Customers: Manufacturing 13.54 14.85 Water, environment and public utility management 11.48 11.79 Property development 9.84 6.83 Transportation, storage and postal services 9.61 10.89 Lease and business services 8.12 6.25 Wholesale and retail trade 6.93 4.94 Production and supply of electric power, gas and water 4.09 7.92 Mining 2.15 3.25 Others 5.46 6.68 Subtotal of corporate loans 71.22 73.40

Personal loans 21.73 19.49 Discounted bills 7.05 7.11 Gross loans and advances to customers 100.00 100.00

Largest Loans: There is no significant concentration risk. The top 10 largest loans account for only 5.26 % of total loans in 2009.

Loans to All transactions conducted by the company with related parties are Related Parties: granted and approved by relevant authority, and conducted in the normal course of business at normal commercial terms.

Non-performing CEB's nonperformance loans ratio fell to 1.25% and 2%, respectively, at Loans: end-2009 and end-2008, which are lower than the 5% required by the CBRC. Meanwhile, loan loss reserve coverage rose to 194% and 150%, respectively.

Risk The board of directors establishes CEB’s risk management strategy and Governance: the acceptable overall risk limits. The committee also monitors CEB’s risk management environment and regularly assesses CEB’s risk position and risk management strategies and gives advice on the internal controls related to risk management. CEB’s major functional departments which are involved in risk management are the risk management department, credit approval department, special assets resolution department and legal and compliance department. The risk management department is responsible for implementing CEB’s overall risk management system. Besides risk monitoring and control, the risk 6

management department is also responsible for formulating the risk management policies. The credit approval department is responsible for organizing credit ratings and approval activities of corporate and institutional business. Besides risk monitoring and control, the retail risk officer and credit card risk officer are responsible for retail credit approval and credit card approval, respectively. The legal and compliance department is responsible for CEB’s overall legal and compliance risk management. The front end departments such as the corporate banking department and retail banking department carry out the credit businesses according to CEB’s risk management policies and procedures.

CEB initiated the construction of the third phase of the risk management project, a compliance system for the new BASEL Capital Agreement, a personal loan risk analysis system, a market risk model verification system, and an information technology risk management system. CEB continued to improve the vertical risk management organization framework, dispatching credit risk officers to review every business lines. CEB restructured the loan follow-up management functions for corporate banking, and further improved the post-lending management system to be standardized, professional and thorough.

In response to the volatile economic situations, CEB optimized industrial management system, and preliminarily established an early warning system for different industry sectors composed of key risk indicators, expected default frequency and rating. With reference to the practices of international leading banks, CEB has preliminarily established an operational risk identification and evaluation system that consists of operational risk control self-assessment, operational risk events reporting and internal audit and compliance evaluation. It is introducing key risk indicators system for operational risk. CEB has established operational risk reporting system, requiring each business line and branch office to report on operational risk events according to the specified reporting scope, route, style and limit, on weekly and monthly basis. As the regulation of CBRC, the number of staff in internal audit department must take the minimum of 1% of total staffs of a commercial bank.

In CEB and CEB Jinan branch, the internal control responsibility is shared by internal audit department with two staff and legal compliance department with 11 staff. CEB’s internal audit departments and legal and compliance departments cooperate with each other and conduct independent inspection and evaluation of the compliance and risks of all business operations. For the investment program, CEB will undertake the financial due diligence of the subproject applicants, identify risks, and take necessary mitigation measures to control these risks. The internal control system of CEB and CEB Jinan branch will be applied to the subborrowers of the investment program.

Both CEB and CEB Jinan branch are using computerized accounting system with software provided by SAP, a German company and the 7

world's leading provider of business software especially in enterprise resource planning sector, and approved by CBRC. The accounting items are standardized according to “The accounting System for Business Enterprises” approved by Ministry of Finance, 2006. The computer system helps the risk management work more instantly and easily.

Accounting firms conduct annual audits of CEB and historical audited financial statements are available for public disclosure. For the last 3 years, the auditing firm has been KPMG, which had provided the standard opinion letter on the financial statements. Subbranch offices are randomly selected for individual audits and KPMG audited the CEB Jinan branch as part of the annual bank-wide audit in 2007, but it does not report separate financial statements. Furthermore, CEB is also subject to annual audit by the CBRC and People’s Bank of China.

Interest Rate Determination CEB will determine the interest rate of each loan according to the market Mechanism: interest rate and its risk adjusted pricing policy.

Monitoring and CEB adopts a loan risk classification approach to manage the loan Collections portfolio risk. Loans are generally classified as normal, special mention, Procedures: substandard, doubtful and loss according to their levels of risk. Substandard, doubtful and loss loans are considered to be impaired loans and advances when one or more events demonstrate there is objective evidence of impairment and possible losses. The allowance for impairment loss on impaired loans and advances is collectively or individually assessed as appropriate.

Conclusion: Due diligence assessment of CEB indicates that they are financially sound, have adequate risk and management policies, acceptable corporate and financial management practices, and complies with regulatory requirements. Additionally, CEB satisfies the requirements under OM D6 and a portion of the PPTA part B will be directed to CEB to enhance its capacity to underwrite energy efficiency loans. 8 Appendix 1

ORGANIZATION CHART OF CHINA EVERBRIGHT BANK LTD.

Source: China Everbright bank.

Appendix 2 9

BALANCE SHEET OF CHINA EVERBRIGHT BANK LTD. China Everbright Bank Balance Sheet (Expressed in thousands of RMB, unless otherwise stated 2009 2008 2007 Assets Cash and deposits with central banks 137,366,556 100,284,457 120,638,581 Deposits with banks and other financial institutions 110,545,669 59,404,985 15,376,392 Placements with banks and other financial institutions 9,061,314 19,552,478 12,646,578 Financial assets held for trading 10,401,474 12,668,171 7,508,610 Derivative financial assets 2,584,579 3,758,834 1,619,248 Financial assets held under resale agreements 121,295,098 49,582,387 52,654,969 Interest receivable 3,341,261 3,403,420 2,691,453 Loans and advances to customers 632,115,334 450,520,669 395,103,848 Available -for-sale financial assets 54,617,799 57,661,616 44,923,226 Held-to-maturity investments 73,530,023 61,187,131 69,544,092 Long-term equity investments 134,125 97,904 121,694 Fixed assets 8,825,898 8,022,069 3,748,303 Intangible assets 1,651,671 1,608,240 1,566,140 Deferred tax assets 575,784 736,336 2,240,947 Others assets 41,601,930 23,349,443 8,802,375 Total assets 1,197,648,515 851,838,140 739,186,456

Liability and equity Liability Deposits from banks and other financial institutions 231,260,084 121,694,434 89,721,634 Taking from banks and other financial institutions 23,090,506 3,099,376 326,344 Financial liability held for trading 8,059,225 20,682,456 20,041,458 Derivative financial liability 2,235,746 3,871,257 1,082,743 Financial assets sold under repurchase agreements 14,641,527 6,956,782 38,786,637 Deposits from customers 799,611,303 605,170,169 540,661,242 Employee benefits payable 3,420,302 2,909,617 1,641,675 Taxes payable 752,547 847,726 3,669,612 Interest payable 6,283,742 6,599,083 4,025,974 Provisions 60,424 60,998 197,443 Subordinated debts issued 21,550,000 18,550,000 5,550,000 Other liabilities 38,575,872 28,164,158 8,792,601 Total liabilities 1,149,541,278 818,606,056 714,497,363

Equity Share capital 33,434,790 28,216,890 28,216,890 Capital reserve 6,433,681 1,084,388 -142,303 Surplus reserve 1,157,482 393,081 0 General reserve 5,485,180 1,375,782 0 Retained earnings 1,596,104 2,161,943 （3,385,494) Total equity 48,107,237 33,232,084 24,689,093 Total liabilities and equity 1,197,648,515 851,838,140 739,186,456

Profit and Loss Statement Operating income 24,258,202 24,700,998 20,044,365 Operating expenses -13,734,755 -16,571,576 -11,579,252 Operating profit 10,523,447 8,129,422 8,465,113 Add: non-operating income 52,087 79,125 60,405 Less: non-operating expenses -82,081 -284,506 -136,179 Profit before tax 10,493,453 7,924,041 8,389,339 Less: Income tax -2,849,436 -607,741 -3,350,187 Net Profit 7,644,017 7,136,300 5,039,152

Statement of Cash Flows Net cash flows from operating activities 24,512,177 26,050,521 12,059,870 Net cash flows from investing activities -12,269,372 -12,530,400 -101,435 Net cash flows from financing activities 11,356,986 12,648,159 19,661,729 Effect of foreign exchange rate changes on cash -18,773 -1,091,745 -549,276 and cash equivalents Cash increase/(decrease) for year 23,581,018 25,076,535 31,070,888 Cash and cash equivalents at the end of year 115,848,609 92,267,591 67,191,056 Data source: the annual report 2009/2008/2007 of China Everbright Bank ‘