In a broad sense, the Belt and Road Initiative (“BRI”) can be considered as one large trading corridor that covers almost 63 per cent of world’s population and 29 per cent of world GDP1. The priorities of the BRI are to create the physical sustainable infrastructure, and financial and policy conditions to drive trade and capital flows between the east and west. Whilst the immediate beneficiaries will undoubtedly be those involved with the initial infrastructure build – such as for projects like the Padma bridge2 in Bangladesh, and the high-speed railways planned for South-East Asia3 – it will not just be companies involved with the provision of construction materials, expertise and specialist equipment that will ultimately benefit from the BRI. Companies of all types, both from China and elsewhere will benefit, particularly those in industries such as telecommunications, trade, sustainability, financing and other professional services will all benefit and build on the foundations of the initial physical, then digital infrastructure
Need for Infrastructure, related funding and risk managementThe Asia Development Bank (ADB) estimates that emerging Asia will require about USD22.6 trillion of infrastructure investment between 2016 and 2030, or USD1.5 trillion a year. No single source of funding can meet this large demand and it will require significant investment from the private sector. Vital to the success of the initiative will be the ability to match these funding resources with investable projects. The challenge related to capital markets financing is to develop an efficient structure to match projects with investors who have different requirements in terms of risk appetite and returns. Hence risk identification, quantification and mitigation will be key for successful financing of such projects. Whilst much of this may fall into the “standard practice” category, the specifics of the geographies involved, and business structures often required add additional complexity to the risk management analysis which we explore below.
Opportunities for Chinese and Foreign firms alike
Whilst Chinese companies are inevitably benefiting from the project opportunities arising from the BRI, partly due to their scale and expertise, partly due to “home advantage” benefit, there are still plenty of opportunities for non-Chinese companies to benefit. The sheer scale of some of the projects means that much of the construction work requires the use of sub-contractors, where local companies can have an advantage due to their local expertise, skills and knowledge of the labour market.
In certain countries, where Chinese investment is relatively new, there are opportunities for companies already invested there to form Joint Ventures so that both parties can benefit from existing operating knowledge and the significant capital investment the BRI can bring. Similarly, in areas where specialist expertise is needed such as technology, equipment supply and logistics, and importantly sustainability, which is key to the BRI long term success, specialist JV partners can be brought in to partner with Chinese firms. Looking forward, other, more service orientated skills such as legal, public relations and other consulting roles may be required providing opportunities for outside players either directly or in partnership with Chinese firms.
Stepping outside the comfort zone
For foreign companies looking to benefit from BRI, it is likely to mean stepping outside their comfort zone and home bias. Not just in terms of operating in potentially new countries, many of which are either highly regulated and/or less financially developed, but also in terms of business models and corporate structure, with the use of joint ventures and service provision agreements. Similarly Chinese companies looking to benefit from increased trade with countries along the BRI corridors in the future, will need to understand the complexities of operating in these countries. BRI will inevitably lead to the financial development of these markets as more external investment is attracted and local infrastructure improves, but the immediate risks and complications of operating in these markets must not be underestimated.
Companies investing in BRI projects will need to navigate through the lifecycle of entering into a new market, establishing and hopefully growing the business and finally integrating that new business into their wider regional/global operations.
Increased treasury risk requires enhanced planning
The BRI provides significant opportunities for companies to invest in to new, developing markets and grow their businesses outside of their existing markets.
However, these new opportunities come with their own new and sometimes complex risks, both to understand and manage.
Currency regulations and control are a major consideration in many countries along the BRI. Rigid regulations around conversion of local currency, be it documentary evidence requirements or outright restrictions on buying/selling currency, particularly in relation to hedging products such as forwards and options, can make managing currency risk both onerous and practically difficult. Understanding the potential currency risk faced is important to the assessment of any project, but particularly so when risk mitigation tools may be limited, which may in turn require greater expected profitability margins to justify initial investment.
The availability of local funding and liquidity providers is also vital to understand. Even if existing banking partners operate in local markets, it will be necessary to understand local intricacies in terms of quantum and conditions. This in turn will form an important input into how the local enterprise’s capital structure will be organised – be it via equity injection or shareholder loan, or local funding. Regulations in terms of taxation will be critical to understand as this can have important knock on implications in terms of capital structure, future dividends and ultimately how other market risk such as currency, commodity an interest rate materialise over time an ultimate impact return on investment.
Finally, the implications of the business structure used should not be underplayed. Joint venture partners may not have the same risk appetites, and along with local regulations this could mean certain risks may not be able to be managed as ideally desired. Certain risks may need to be taken on that would normally be hedged and alternative mitigation strategies undertaken, potentially outside of the direct project or entity itself.
All of these risks are inter-connected and in a developing economies will change over time, potentially quickly. It will be necessary to regularly review risk management decisions, and have the flexibility to adjust them to allow for changes, be it in the performance of the underlying business, changes in the market or underlying regulatory regime.
The BRI is a once in a generation project requiring investment, both public and private, on an enormous scale, and along with it opportunity. At the same time the scope of its ambitions in terms of the countries and economies it is looking to bring together in long term trading relationships brings unique and complex risks above and beyond those seen in more traditionally developed markets. A disciplined and methodical approach to identify all potential risk and their implications is more important than ever for any company looking to take advantage of the opportunities BRI presents.
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