Infrastructure Strategy, Risk & Value Advisors
Infrastructure finance in China
George C Currie, Principal
T raditional project finance has been
moribund in China for the past decade
– the Chinese municipalities simply found it
too complex, too transparent, and not what
really wanted from private sector
involvement. Add to that domestic banks
increasingly having the capacity to provide
the money without insisting on intrusive
checks and there was no longer any
demand for it.
So how have the “project finance”
guidelines issued by the Chinese banking
regulator last year changed the position on
the role to be played by project finance and
international investors in meeting China‟s
ever-growing infrastructure needs?
New Lending Guidelines
The “Guidelines for the Project Financing
Business” and the “Tentative Measures for
the Administration of Loans for Fixed
Assets” (both issued in July 2009) contain
some desirable requirements: for example
demanding that Chinese banks conduct
basic due diligence, make better use of
security, reserve accounts and/or
performance bonds, and conduct post-
lending monitoring are all good ideas.
These requirements are not all new
however, they simply haven‟t been
enforced in the past. Probably the key
question is, “will Chinese banks behave
differently now?”
There are reasons to believe that this time
they might. The new guidelines are a lot
more about bank control by the government
than they are about project finance, and
need to be seen in context of the Chinese
stimulus package in response to the global
economic crisis. The first six months after
the announcement of the stimulus saw a
very large volume of short term loans
extended, and the reaction of the Banking
Regulatory Commission through these
guidelines is mostly concerned about
channelling this bank credit to the right sort
of projects, to ensure that the investment
goes into fixed assets (of which
infrastructure forms a part).
According to analysts, since July 2009 new
long and medium-term lending has continued
apace while new short-term lending to non-
financial corporate entities has all but ground
to a halt. It appears then that the government
may have been successful in its aim to stamp
out the use of bank loans for short-term
speculative uses, while continuing to force
the economy to invest in the development of
its long term assets.
“It’s Project Finance Jim, but not as we
know it”
Despite the new guidelines on due diligence
and scrutiny for project finance deals, in most
recent “project finance” loans it appears that
Chinese banks have continued to look more
to the connections of the sponsors rather
than necessarily at the quality of the project
itself. Likewise the „project finance‟ that
Chinese banks do outside of China is
generally, on closer examination, more like
export finance in support of (well-connected)
Chinese contractors and manufacturers.
For the past 10 years or so, the Chinese
model of private sector involvement in
infrastructure projects has typically:
Seen the project undertaken by a JV
between a private sector developer
and the local government, in which
the local government unit contributes
land and existing hard assets as all
or part of its (majority) stake and the
private partner leases a minority
share of the JV for 25 years.
Seen these JVs being largely (100%
in most cases) equity financed, since
with little or no concept of the cost of
capital, municipal JV partners often
dislike the idea of „debt‟ and officials
often tend to see debt interest
payment as an unnecessary cost
that can be avoided.
Rarely featured fixed price, turnkey
contracts for the construction, but
rather an array of individual
agreements with a number of
suppliers and contractors.
Seen frequent renegotiation of the
contract, according to shifts in the
political climate as well as the
commercial performance of the JV.

The first green shoots of improvement may
recently have been spotted though. With
some Chinese banks now building
relationships with, or even taking equity
positions in, experienced international
project finance lenders, they are making
use of these to improve their understanding
of how (and why) to employ the more
rigourous due diligence and project
monitoring processes required by the new
guidelines. In doing so they are seeing how
these serve to reduce credit risk and so
improve the banks‟ performance.
Technical Equity
Project sponsors who can bring specialised
technical expertise to play may be the only
category of foreign players generally in a
position to make money from Chinese
infrastructure projects, albeit indirectly
through their equipment-making subsidiary
or partners.
Even for them it‟s hard work though, and
maybe the most important element for
success as project sponsors in China is to
know when and how to share the benefits
with the government side. It‟s not unusual
to see a second JV between the local
government (through a suitable state-
owned company) and the technical
sponsors for the supply of key equipment
or for the construction, thus managing to
extract cash from the concession without
showing high returns from the project itself
once it‟s operational and garnering
revenues from supplying services to its
public and/or government users.
While this approach of the
contractor/supplier being an equity partner
is also seen in other markets, it‟s not
normally as a joint venture with the local
government, and there‟s no doubt that in
today‟s business climate of increasing
vigilance on corporate governance the
handling of these relationships does
present a risk for international companies
as technical sponsors in Chinese
infrastructure projects. Such companies
would be well-advised to push for greater
pricing transparency (perhaps linked to
suitably adjusted international benchmarks)
rd
and/or 3 party monitoring of the project,
even though the latter may be resisted on
the Chinese government side for adding
“unnecessary” cost.
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Third-Party Equity
Infrastructure funds looking at medium or
long-term returns as their only source of
upside from Chinese infrastructure projects,
and particularly those entering projects only
during their operational stage, don‟t have the
same opportunities. Infrastructure investors
looking at China are multiplying, but most
seem to be finding deals worth doing hard to
come by. A few deals have been made (e.g.
Macquarie‟s toll road acquisition), but other
investors that have entered China with an
„infrastructure‟ label have ended up taking
stakes in assets such as supermarket chains
and construction materials suppliers, as
cashflows from Chinese infrastructure
projects themselves may typically only deliver
returns on equity of around 12%, which fail to
meet their portfolio return targets.
Moreover, despite China‟s vast requirements
for infrastructure projects most infrastructure
classes do not offer much scope for
increasing returns on equity from assembling
a portfolio of similar assets, being too
geographically dispersed to benefit from
savings in operations and maintenance costs
and hence not yielding much economy of
scale.
The key to success for these investors
therefore lies in improving their access to
potential deal flow through developing
beneficial relationships with project
developers and technical sponsors, and in
identifying within projects those with the
opportunity to increase investor value by
improving the risk-adjusted return, by adding
associated revenue-creating business lines
and/or by identifying and reducing operating
phase risks.
George Currie has been advising
governments, sponsors, lenders and
investors on developing and delivering
infrastructure projects throughout Asia for
the past 10 years.
George can be contacted at:
T +65 8121 8244
E george.currie@instrivas.com
Infrastructure • Investments • Enhanced