Sustainable Risk Management for Belt and Road Initiative
The plenary session on Finance at the Sustainable Silk Roads Conference in Edinburgh.
China’s Belt and Road Initiative (BRI) has gained greater attention in the United Kingdom. The arrival of the first freight train from Yiwu (Zhejiang) into London earlier this year indicates that BRI has physically reached the UK. In Scotland, Sustainable Silk Roads Conference was held last week at the University of Edinburgh, which aimed to make BRI known in this part of the world. The conference, the first of its kind on that scale, featured opening keynotes from the UK former Prime Minister, Rt Hon Gordon Brown.
This is the first major conference in Scotland that provides exposure to the world’s largest economic development initiative and assess what impact the BRI will have in business, in academia, in policy making, and on the world. It seeks to understand how BRI can be implemented in a sustainable fashion.
Speaking at the conference’s plenary session on Finance, Dr Marizah Minhat, Director of Ethical Finance and Investment Research Foundation, raised a concern about the risks associated with BRI-linked projects.
Dr Minhat said: “Deviation across countries in terms of legal infrastructures, transparency and governance systems is a source of risk in itself. I suppose lenders or investors should be worried not only about financial risk such as credit risk and forex risk, but also political risk that would create greater uncertainties of the future cash flows to be derived from any infrastructure, energy or green projects that we may have in mind and talked about.”
It is widely understood in finance literature that a riskier project attracts higher cost of borrowing. It is reported by various sources that huge amount of loans have been committed to finance BRI-linked projects across different countries. However, accessing reliable information on cost of borrowing can be useful to reflect on the financing and risk aspects of BRI.
Dr Minhat added: “Using conventional debt to finance BRI is feared to contribute further to unsustainable debt burden. While one may argue, $900b total investment required for BRI may not be material enough to shake the financial world, I fear that amount could be well underestimated.”
It has been fully acknowledged that BRI provides tremendous investment opportunities, but a critical question is how to manage such risky investment projects.
While a common source of funding for BRI-linked projects at this stage seems to be borrowing (debt), it may be worthwhile to explore other sources of funding and the prospect of profit/loss sharing such as Islamic financing to contribute to this world-changing Silk Roads project. Speaking on behalf of her research team, Dr Minhat suggested, “We view profit/loss sharing as a sustainable financing strategy because it does not impose fixed (payment) obligation that can cause bankruptcy if a project underperforms that may well trigger liquidity crisis.”
She also raised a concern on the risk shifting activities that might take place to transfer the credit risk associated with loans to finance BRI-linked projects. Perhaps it is still early to establish evidence on this, but it is not uncommon for lenders or financial institutions to transfer credit risk by buying credit derivatives such as credit default swaps. Previous experience has shown that, in a systemic credit event, the sellers of credit default swaps (e.g., specialty monoline insurance companies and AIG), did not have the ability to fulfil their obligations to provide compensation against default risk, hence some of the hedging benefit of credit default swaps turned out to be illusory. Whether this sort of unsustainable risk management is to be replicated in BRI context remains to be seen.
(Notes: This article is based on the Plenary Session on Finance of the “Sustainable Silk Roads Conference” jointly organised by the Confucius Institute for Scotland on 5 October 2017. Details of the event can be found here http://www.confuciusinstitute.ac.uk/ssr/programme/)
