Opinion: Belt and Road Needs Its Own Asset Class

By some estimates, annual infrastructure investment needs across the Belt and Road Initiative participant countries are at least $1.7 trillion until 2030. Naturally, global funding needs for essential infrastructure are much greater and rising and this is before factoring in the expenditure to implement the UN’s sustainability gap in the context of environmental, social and governance (ESG) and green investment.

Some of the countries facing the largest gap are located on the Eurasian plateau and the African regions that the Belt and Road is targeting. With its focus on connecting people and cultures as well as economies, the funding and connectivity scheme of the Belt and Road should have been enthusiastically embraced given also that actual investment and committed funding from Chinese development banks and other Chinese funded institutions is in excess of $250 billion.

Yet the Belt and Road has raised issues for both geopolitical reasons as well as due to earlier structural weaknesses. The latter include placing an emphasis on credit over equity investment, lack of an embedded debt and environmental sustainability framework, and lack of an explicit link to the implementation of the UN Sustainable Development Goals (SDGs).

The Chinese leadership has already taken measures to redress these shortcomings drawing public praise for the revamped Belt and Road, so-called Belt and Road 2 by the head of the IMF Christine Lagarde during her keynote speech to the Belt and Road Forum on April 29 in Beijing. For example, President Xi Jinping said at the second Belt and Road Forum in April that China needs to help participating countries build affordable, durable and high-quality infrastructure projects to promote greater interconnection.

In this spirit, the Export-Import Bank of China Chairwoman Hu Xiaolian has recently stated that the new phase of the Belt and Road should include an “investment, construction and operation” integration model whereby Chinese enterprises can participate in a part of the investment and get involved in the long-term benefits of the project to reduce project owners’ debt pressure.

These are all very welcome developments in the evolution of the Belt and Road’s implementation. However, to secure the successful application of these principles and also close the infrastructure and SDG funding gap China and its Belt and Road partners have to devise credible ways to attract private finance. The sources of such finance may be Western institutional investors but also Asian pension funds and other private investment schemes.

Three critical reforms are essential for private investment to materialise: First, there is a need to refocus the guiding principles on which Belt and Road projects are designed, focusing on a transparent process that follows rigorous sustainability standards should be followed, focusing on the role of the Belt and Road in supporting the SDGs in an environment of debt sustainability. Adopting this procedure is much easier than it sounds given that China has already transposed into binding national law most of the UN environmental standards that are connected with the implementation of the UN SDGs and is committed to achieving the remainder. Moreover, through this process the Chinese funders, the development banks and their partners would move beyond the realm of verbal and written declarations into implementing a rigorous project approval procedure that strongly aligns the Belt and Road to the achievement of the SDGs. The process would also address concerns regarding debt sustainability. As debt sustainability will be hard to achieve for a number of projects that means that Belt and Road project managers will choose only plans that are sustainable. It also means that development banks and other Belt and Road funders will turn into more active equity investors.

The second helpful yet radical step is the creation by the development banks and the Belt and Road partners of special Belt and Road asset classes, which, as they will have passed the sustainability tests set out above, will be eligible to be funded and purchased by institutional and other investors across the world focusing on ESG and green finance, a very significant pool of funds. Offering a direct or indirect stake in Belt and Road projects to private investors will have multiple benefits. First it will raise the levels of transparency and possibly governance of Belt and Road projects. Second, it will go a long way into closing the funding gap through private sector participation.

But for such private sector participation to materialise the third step — marketization of Belt and Road projects — is also essential. Marketization through the creation of liquid public markets for tailor-made Belt and Road assets, mostly in the form of green bonds but also other hybrid or derivative instruments that would enable investors to hedge their risks is an essential prerequisite for attracting private funds for two reasons. First, the transparency public markets create and the diversity of tailor-made, yet green certified, instruments would attract liquidity at the primary market (issuance) stage. Second, it would ensure the existence of a liquid and dynamic secondary market that could secure private investors exit potential from the investment or reinvestment at a stage beyond the initial funding round. While the creation and continuous existence of a seamless spot, stock, and derivatives markets for Belt and Road assets would have sounded utopian a few years ago, luckily today distributed ledger technology, in its current blockchain form and beyond, offers endless possibilities for developing such markets.

It is, therefore, essential that Belt and Road development banks and their partners heed this call and invest urgently in the necessary technical infrastructure required to build and develop a liquid market in Belt and Road assets securing global investor access, taking a broader view of the sorts of infrastructure necessary going forward. Not only the creation of such a market can lead to the development of a separate class for ESG and green Belt and Road assets boosting sustainability and the SDGs while closing the funding gap, it may also be the best answer to the critics of Belt and Road turning its governance into a transparent set of arrangements that connect economies and societies and boost sustainability.

Emilios Avgouleas is a chair in international banking law and finance at Edinburgh University and a distinguished research professor at Hong Kong University. Douglas Arner is the Kerry Holdings professor in law at the University of Hong Kong