By Ma Tianjie
In Part 1 of this blog series, we looked at why China’s two major policy banks, China Development Bank and China Exim Bank, whose overseas energy sector lending totaled 251.3 billion between 2000-18, lend only grudgingly to Chinese renewable companies going overseas. The difficulty for Chinese renewable energy projects along the Belt and Road to raise funds is not limited to the arena of policy bank financing, however. A March report from Chinese NGO Greenovation Hub and the Center for Finance and Development at Tsinghua University paints a broader picture of the obstacles to renewable energy financing along the Belt and Road, with key and often poorly understood players including commercial banks, multilateral banks and insurers. The study gives us another perspective on the puzzle of the Belt and Road’s missing renewable energy finance and suggests some financing mechanisms which could break through some of the obstacles.
One of the report’s main conclusions is that there are a number of financial factors that make the overseas expansion of Chinese renewable energy firms less competitive vis a vis their international peers. Factors such as interest rates offered by Chinese banks and higher financial costs become disadvantages for Chinese solar and wind firms when bidding in a cost-sensitive developing country market. It is understandable why some Chinese renewable industry players express grievance over such issues and question the wisdom of host country markets in adopting more competitive price mechanisms.
The main focus of this blog, however, is the financing constraints that disadvantage Chinese renewable projects vis a vis traditional fossil fuel projects, particularly coal power. For the global transition towards a low-carbon energy structure, this second competition is more critical.
Conflicting preferences between project developer and project financier
Based on interviews with a dozen industry insiders, including finance directors from large Chinese energy companies, the report authors came up with the diagram below illustrating the typical financial arrangement for a renewable energy project overseas, financed by a Chinese bank and with Sinosure overseas investment insurance.
A key concept that is embedded in this diagram is that of “neibao waidai” (内保外贷), a practice of using assets inside China as collateral for loans supporting projects overseas. According to the industry insiders interviewed, this is still the most common way for Chinese companies to find financing for renewable energy projects overseas. In other words, even though Chinese companies are developing projects all over the world, from developed markets such as Canada and West Europe to Belt and Road countries such as Indonesia and Ethiopia, they continue to rely on their home market assets and Chinese banks for financing. It is relatively rare for a Chinese developer of renewable energy to tap into the financing pool of host country banks, international banks or multilateral banks, or to go beyond debt financing and make use of capital market, bond market or institutional investors.
The heavy reliance on neibao waidai indicates Chinese companies’ lack of access to alternative funding sources. It is also a sign of risk aversion from Chinese banks. In essence, it’s a form of recourse loan that favors the lender in providing extra assets (other than the project in question) to go after in case the borrower does not fulfil their obligations. For the borrower, the recourse loan will reflect on its corporate balance sheet as potential liability, reducing the amount of assets that it can underwrite other loans.
Naturally, borrowers would want to go for non-recourse loans to keep such liabilities off corporate balance sheets. In the case of overseas energy projects, this means using only project assets, including its future revenues, to secure financing, with the investor’s other assets off-limit. Usually this would mean higher charges as the lender takes on more risks, but Chinese renewable energy developers nonetheless prefer this option. These differing preferences create barriers to finance as risk-averse lenders would prefer to provide asset-backed recourse loans, while developers are keen to secure non-recourse loans.
The ups and downs of China’s domestic renewables policy
Interviews with industry insiders in China also show the overstretched condition of Chinese renewable energy firms that are already “highly leveraged” and can barely allocate more assets to underwrite new loans. One factor that is particularly burdening them is the severely delayed payment of renewable energy subsidies in China, which has proved a huge drag on their cash flow. China set up feed-in tariff for wind and solar in 2011, a favorable policy framework that propelled spectacular growth of renewable energy installation. A renewable energy development fund was set up with money coming from a renewable energy surcharge on industrial and commercial electricity users. The fund is used to pay for the difference between the subsidized solar and wind tariff and the benchmark coal power price.
But with exponential growth of installations aiming to take advantage of the subsidy, the fund’s pool has been unable to keep pace with the number of eligible entities drawing from it. Rationing was installed and payments became slow, leaving many renewables companies surviving on very tight revenue streams.
A large portion of China’s renewable energy sector (solar in particular) is private-owned and does not control large assets compared to their rival state-owned energy companies. This pushes private solar and wind firms to pursue more project financing (non-recourse) that does not eat into their corporate balance sheets.
While “liberating” for some Chinese renewable companies, breaking away from the neibao waidai model is easier said than done. For a financier of renewable energy, to offer project financing requires a confident grasp of local market conditions and risks that many Chinese banks simply do not have. Moreover, Chinese renewable energy projects along the Belt and Road are generally disconnected from multilateral and international banks’ financing, which tend to be more attuned to host country markets.
Beyond passing the “project bankability” test, Chinese renewable projects on the Belt and Road also need to overcome biases in the system that is built for supporting large fossil fuel projects overseas. A large part of the bias originates from the state financial institution’s perception of risks. For example, the neibao waidai model has a built-in element requiring overseas energy project developers to purchase Sinosure insurance, which provides an extra level of protection for Chinese banks. According to the report authors, this is very much a residual model of overseas fossil fuel financing where large amounts of funding is usually at stake with long project development cycles. Renewable energy projects, in contrast, are nimbler, with much smaller per project investment and shorter development time. Chinese renewable developers cannot, however, be exempted from insurance requirements that invariably increase their development costs. The report authors also highlighted the fact that at Sinosure, there are quotas for mid-long term export credit insurance, a product that is required of developers whose overseas projects involve export buyer’s credit or export seller’s credit. A large portion of that quota is reserved for overseas coal power projects, however. When renewable energy projects do need to tap into that quota, they often find themselves facing the left-over share from coal.
Another bias is that Chinese state financial institutions consider risk at overall country level, rather than sector level or project level. This results in renewable projects in “high risk” countries that are otherwise healthy from a project point of view incapable of securing financing from Chinese banks. In addition, Chinese financial institutions, many of them with fresh memories of cash flow troubles experienced by the domestic renewable energy sector in recent years due to energy curtailment and unpaid subsidies, tend to project these worries onto their assessment of overseas renewable projects, even though market conditions such as pricing and subsidy mechanisms are different from those in China. In short, these biases lead Chinese public banks to take an over-cautious approach to solar and wind projects according to the authors.
Lastly, the report also sheds light on different sets of incentives for Chinese banks when it comes to funding domestic and overseas projects. Inside China, the People’s Bank of China (PBoC, China’s central bank) has included key green financing indicators in its Macro Prudential Assessment (MPA) of commercial banks. First introduced by the PBoC in 2015, after a stock market meltdown almost triggered a financial crisis, the MPA is a powerful rein on Chinese financial institutions. Although a bank’s financial health and risk control are the focus of the assessment (with emphasis on indicators such as capital, leverage and liquidity), green performances were included in the MPA starting from 2018, with quantitative indicators such as the percentage of outstanding green loans in a bank’s overall lending. The domestic renewable energy sector has long been a beneficiary of green finance. Unfortunately, the greenness of a bank’s overseas lending is not part of the MPA, stripping Chinese financing institutions of a key incentive to take Belt and Road renewable energy projects more seriously.
A road through the obstacles – blended financing
In light of these constraints in debt financing from both policy and commercial banks for Chinese renewable energy projects overseas, the report authors advocate for the mobilization of capital markets, institutional investors and utilization of blended financing to overcome the obstacles facing such projects. The report lists two types of arrangements commonly understood as blended financing:
- Blending of development financing and commercial financing
- Blending of corporate financing and project financing at different stages of a project’s life-cycle
Under the first type of blended financing, a development finance institution, usually a multilateral development bank, leads a consortium of commercial lenders to provide what is known as A/B loans to a borrower. The multilateral bank, serving as the Lender of Record for the loan, provides the A portion of the loan while other lenders chip in with the B portion. The blended financing model benefits renewable energy projects for its lower financing costs, as multilateral banks, with their Prefered Creditor Status, are better positioned in risk mitigation. This allows for non-recourse project financing with no sovereign guarantee and a long tenor. Critically, in the case of Chinese borrowers, such arrangements also waive the need to secure Sinosure insurance, further lowering costs. Jinko Solar’s San Juan project in Argentina is one of the few Chinese-invested renewable projects financed through an A/B loan led by the Inter-American Development Bank with participation from Bank of China.
The second type of blended financing takes into account the temporal differences in risks throughout a project’s life cycle and addresses them using different financial arrangements. What is commonly seen in Chinese overseas renewables projects is a combination of short-term corporate financing (raised by the EPC contractor) at the construction phase of a project and project financing after the project goes into operation. This allows projects to speedily go online and reduces the risks in the construction of projects for later financiers who would feel more comfortable taking on project financing of the solar or wind farm.
Authors also pointed to the fact that it is still a relatively recent phenomenon for Chinese companies to take up the role of developer in overseas energy projects. Up to now, they have more commonly been seen under the EPC contractor hat. It takes time for them to develop and cultivate relationships with host country financial institutions and multilateral development banks. Educating domestic market financiers also takes patience.
As Ma Jun, chair of China’s Green Finance Commission and former Chief Economist for the People’s Bank of China, put it at a March 27 webinar, Chinese financial institutions should honor the Party leadership’s Green BRI vision “through their portfolios” by financing less coal projects and more renewable projects.
Understanding the financing challenges of renewable projects along the Belt and Road is the first step towards unlocking and mobilizing the massive financial resources needed to steer the BRI along the green path the Chinese leadership propounds, and to secure a form of development for BRI countries that does not lock them into carbon intensive energy systems. Given the scale of energy sector growth expected in these countries in the medium to long term, many of whom are in stages of rapid development, unlocking renewable energy financing would also significantly help to steer the world away from catastrophic climate change.