The Asian Infrastructure Investment Bank: What next?
Legal News & Analysis - Asia Pacific - Construction & Real Estate
15 March, 2017
The Asian Infrastructure Investment Bank (AIIB) was established on 24 October 2014, pursuant to the “Memorandum of Understanding of Establishing AIIB”, signed by 22 prospective founding members. By April 2015, the number of prospective founding members had increased to 57 and by December 2015 its Articles of Agreement (Articles) had come into force.
At the time of its foundation, few details were known about the intended focus and policies of the AIIB and there was much speculation, particularly as to its governance structure, its level of co-operation with other funding institutions in the region and its approach to environmental concerns. Two years on from its official launch, we consider the policies that have been adopted to date and AIIB’s likely focus in the future.
As set out in its Articles, the purpose of the AIIB is to “(i) foster sustainable economic development, create wealth and improve infrastructure connectivity in Asia by investing in infrastructure and other productive sectors; and (ii) promote regional cooperation and partnership in addressing development challenges by working in close collaboration with other multilateral and bilateral development institutions”.
The AIIB’s mandate is therefore to focus on infrastructure financing rather than on poverty reduction, which differentiates it from other multilaterals such as the Asian Development Bank (ADB) and the International Finance Corporation (IFC). AIIB’s standpoint is that poverty reduction is a natural consequence of infrastructure development and will therefore still be a key benefit of its operations. AIIB has also emphasised that it intends to combine the best features of private companies with those of multilateral development banks, and that one of its core functions will be to encourage private investment in projects which contribute to economic development in the region, as well as to provide financing where private investment is not available.
The Articles permit the AIIB to fulfil its mandated purpose and function in financing specific projects or investment programmes, by making equity investments and by providing technical assistance, which is in line with other multilateral development banks.
AIIB TIMELINE: SELECTED HIGHLIGHTS
December 2015: Articles of Agreement enter into force, with an authorised capital of US$100 billion.
January 2016: AIIB declared open for business; Mr Jin Liqun elected as first President.
June 2016: First Annual Meeting held in Beijing. On the eve of the meeting, AIIB’s board approves a total of US$509 million in loans for the first four confirmed projects.
September 2016: Two further projects announced, as AIIB’s board approves loans to finance energy projects in Pakistan and Myanmar
October 2016: First meeting of the AIIB’s International Advisory Panel. The Panel comprises international leaders and experts who provide independent advice to the AIIB.
December 2016: Three additional projects announced, as AIIB’s board approves loans to finance infrastructure projects in Oman and a natural gas pipeline project running from Azerbaijan to Turkey.
The AIIB’s governance structure is three-tiered, with a board of governors, a board of directors and an executive management function.
Each member country is represented on the Board of Governors, which is required to meet on at least an annual basis, with the voting power of each member proportionate to its subscription amount. This means that China has the greatest voting power, at over 28 per cent, with India (over 8 per cent) and Russia (over 6 per cent) next in line, and a group of countries including the UK, Germany, Korea, Indonesia and Australia each with voting power of between 3 to 4 per cent each. The USA and Japan have not joined the ranks of members and therefore have no influence on its decision-making. While the Board of Governors is generally entitled to delegate its powers to the Board of Directors, it retains control of, among other matters, the admission of new members, any increase in the authorised capital of the AIIB, any amendments to the Articles and the election of the President.
The Board of Directors is composed of representatives of 12 members, 9 of whom are elected by the Board of Governors from Asia-based members and 3 of whom are elected by the Board of Governors from non-Asia-based members. The current Board of Directors consists of representatives from Australia, China, Egypt, Germany, India, Indonesia, Korea, Russia, Thailand, Turkey, Saudi Arabia and the UK. The Board of Directors is responsible for the direction of the general operations of the AIIB and is therefore mandated to establish the policies of the AIIB, to supervise the management and operation of the AIIB and to approve the strategy, annual plan and budget of the AIIB.
The executive management function of the AIIB is led by its President, Mr Jin Liqun, who was elected in January 2016 for an initial period of five years. Mr Jin Liqun’s previous roles have included serving as Chairman of China International Capital Corporation Limited, as Vice-President of the ADB in charge of programmes for South, Central and West Asia and private sector operations, and as Alternative Executive Director for China at the World Bank. He therefore brings with him valuable experience of the operations of other multilateral development banks.
In the initial months following its foundation a number of concerns were raised about the ability of the AIIB to remain independent of its largest contributing member, China. Subsequent appointees of Vice-Presidents may have helped to address this concern, with appointees being drawn from former members of the UK Government (Sir Danny Alexander, the former Chief Secretary to the UK Treasury), and the Indian and Indonesian Governments, in addition to ADB and the World Bank. The international credentials of the AIIB have been further boosted by the establishment of an International Advisory Panel, with members drawn from Africa, Hong Kong, Japan, Korea, Malaysia, Pakistan, Sweden, the US and the UK, whose role is to assist the President and executive management on strategy, policy and operational matters.
The AIIB promotes itself as “lean, clean and green: lean, with a small efficient management team and highly skilled staff; clean, an ethical organization with zero tolerance for corruption and green, an institution built on respect for the environment”. We will discuss the environmental limb of its modus operandi below. Recently, it announced a lean management team, and the number of staff is still limited as it focuses on the recruitment of strategic staff. However, with reports of a large purpose-built headquarters planned to accommodate up to 6,000 staff it is not clear how long it will maintain its “lean” operations. Its focus on remaining “clean” has included early adoption of governance policies, rules and procedures, and later in 2017 it has plans to put in place a mechanism for the independent investigation of complaints relating to non-compliance with policies, and institutional arrangements to give effect to its policy on prohibited practices. These actions, together with the recruitment of an experienced executive management team and further collaboration with other multilateral development banks, will help to allay any concerns about whether governance standards will suffer in the push to meet its strategic goals quickly.
Competition or collaboration?
One question which was being asked two years ago was whether the AIIB would act in collaboration, co-existence or competition with other multilaterals, export credit agencies, commercial banks and other infrastructure investors.
The hallmark of the first two years has been collaboration. The Articles refer to infrastructure development in Asia being met more adequately “by a partnership among existing multilateral development banks” and, as noted above, to the AIIB “working in close collaboration with other multilateral and bilateral development institutions”. In the past year alone, we have seen a co-financing framework agreement signed with the World Bank (April 2016); a Memorandum of Understanding signed with the ADB to “strengthen cooperation for sustainable growth”(May 2016); an agreement to co-operate with the European Bank for Reconstruction and Development (EBRD) (May 2016); and the signing of a co-operation framework agreement with the European Investment Bank in order to jointly finance projects (May 2016). At its first Annual Meeting, the AIIB stated its intention of further strengthening its collaboration with other multilateral development banks, which will include setting quantitative objectives with the World Bank, ADB and other institutions for high-quality infrastructure investment, and its recently published summary of its 2017 Business Plan and Budget again highlights its intended partnership with multilateral development banks, governments, private financiers and other stakeholders.
This focus on collaboration will help AIIB to build up its experience and portfolio of projects more quickly and efficiently (as evidenced by the high number of its initial projects being approached as co-financings) and also to establish credibility and reduce concerns over the standards and practices to be applied on AIIB-funded projects.
Living up to its “green” promise
As noted above, AIIB is promoting itself as a “green” institution. A key question raised at the time of AIIB’s foundation was the extent to which AIIB would adopt robust environmental standards and social safeguards, equivalent to those adopted by other multilateral development banks. To answer this question, AIIB moved quickly to adopt its “Environmental and Social Framework” in February 2016 following a consultation process. This framework aims to address the environmental and social risks and impacts of the projects financed, either wholly or partially, by AIIB. The framework consists of a “vision” (setting out the objectives and aspirations of AIIB); an environmental and social policy (setting out mandatory environmental and social requirements for each project financed by AIIB); three supporting environmental social standards (covering environmental and social assessment and management, involuntary resettlement and indigenous peoples); and an environmental and social exclusion list of those activities that AIIB will not knowingly finance. The policies and standards set out in the framework are broadly similar in nature to those of other multilateral development banks, which will have given comfort to those who feared that less robust standards might be adopted. The key issue now for AIIB will be to show that it is rigorous in applying these standards to its projects, including those where it is not co-financing with other multilateral development banks and is therefore not able to rely on the existing tried and tested policies and practices of its co-financiers.
At a time when funding sources for coal projects are generally dwindling, many Asian governments and developers active in the region have also been keen to understand what AIIB’s policy is and will be towards the financing of fossil fuel power projects. In October 2016, AIIB launched the first round of public consultation on its “AIIB Energy Strategy: Sustainable Energy for Asia – Issues Note for discussion” and in January 2017 it published its “AIIB Energy Sector Strategy: Sustainable Energy for Asia – Discussion Draft for Consultation” as part of the second round of consultation (the Consultation Draft). The final approved Energy Strategy is intended to be formally adopted by mid-2017.
The Consultation Draft provides that the Energy Strategy will embrace and be informed by the principles underpinning: (1) the Sustainable Energy for All (SE4ALL) initiative led by the United Nations Secretary-General to ensure universal access to modern energy services, double the share of renewable energy in the global energy mix, and double the global rate of improvement in energy efficiency; (2) the 2030 Agenda for Sustainable Development’s set of 17 aspirational “Sustainable Development Goals” including one calling for access to affordable, reliable, sustainable and modern energy for all by 2030; and (3) the agreement reached during the UNFCCC Conference of the Parties (COP 21) to limit the world’s rise in average temperature to “well below 2 degrees Celsius above preindustrial levels and pursue efforts to limit the temperature increase to 1.5 degrees Celsius”.
Under the Consultation Draft, AIIB makes clear that it will support development of renewable energy including wind, solar photovoltaic, geothermal and hydropower in order to reduce fossil fuel consumption. In terms of its approach to fossil fuel power generation, AIIB states that it only intends to support coal-fired plants which replace less efficient capacity or are essential to the reliability of the system or if no viable or affordable alternative exists, particularly in low income countries. It seems that AIIB will not, therefore, adopt a blanket prohibition on the funding of coal-fired power projects. It will instead adopt an approach similar to that agreed by OECD member nations which are party to the Arrangement on Officially Supported Export Credits (the Arrangement), whereby export credit agencies from OECD member nations that are party to the Arrangement are limited in their ability to offer finance to support their country’s exporters investing in, or supplying parts for, certain less efficient coal-fired power plants, but with exceptions in certain cases for projects utilising “clean coal” technology or located in emerging markets where less carbon-intensive alternatives may not be viable.1
Interestingly, AIIB makes clear in the Consultation Draft that nuclear plants will not be considered by AIIB at this stage, although it could consider engagement “should demand arise for very special case of support in safety enhancement/upgrading”. This policy is explained on the grounds of a lack of capacity within AIIB at this early stage to finance such complex and capital-intensive projects.
THE NINE AIIB PROJECTS APPROVED IN 2006
Co-financing with the World Bank of the Indonesia’s National Slum Upgrading Project, an urban infrastructure project, with AIIB contributing a US$216.5 million loan.
Co-financing with EBRD of a US$105.9 million project to rehabilitate a 5 km section of the Central Asia Regional Economic Cooperation Corridor 3 connecting Dushanbe in Tajikistan to the border with Uzbekistan. EBRD will be the lead financier and the project will use EBRD’s Environmental and Social Policy.
Co-financing with ADB and the UK Department for International Development of a US$273 million project to construct 64 km of a four-lane section of the motorway linking Shorkot to Khanewal in the Punjab province of Pakistan. The project will use ADB’s Safeguard Policy Statement.
A US$165 million loan to support an electricity distribution system upgrade and expansion project in Bangladesh.
Co-financing with the World Bank of a power house at the fifth tunnel of the Tarbela Dam in Pakistan. The World Bank will be the lead financer and the project will use its environmental and social safeguard policies. The AIIB intends to contribute a US$300 million loan.
Co-financing with IFC, ADB and commercial lenders of the Myingyan 225 MW Combined Cycle Gas Turbine Power Plant Project in Myanmar, with the AIIB intending to contribute a US$20 million loan.
Co-financing with the World Bank of a dam operational improvement and safety project in Indonesia. The World Bank will be the lead financier and the project will use its environmental and safeguard policies. The AIIB intends to contribute a US$125 million loan.
A US$265 million loan in support of the Duqm Port Commercial Terminal and Operational Zone Development Project in Oman.
Co-financing with the World Bank and others of the Trans Anatolian Natural Gas Pipeline Project in Azerbaijan. The World Bank will be the lead financier and the project will use its environmental and safeguard policies. The AIIB intends to contribute a loan of US$600 million.
Projects that may benefit from AIIB funding
A Brookings Institution study from July 2015 suggested that AIIB could be lending US$20 billion annually by 2020 (putting it on a par, Brookings suggests, with lending by the World Bank’s International Bank for Reconstruction and Development).2 Naturally, it has had a more modest start, with nine projects approved totalling US$1.73 billion of lending in 2016. These approved projects are predominantly in the transport and energy sectors and are generally being undertaken on a co-financing basis with other multilateral development banks, indicating that AIIB is keen to build its capacity and expertise by learning from the practices of existing funding institutions.
In a recent interview with Bloomberg, AIIB President, Jin Liqun, indicated that the AIIB will be focusing on achieving a better balance across countries, regions and sectors in 2017, although the specific details of what this might mean are not clear. AIIB’s 2017 Business Plan and Budget, published in December 216, promotes three thematic priorities for its investments in 2017, including the promotion of “green infrastructure” to support countries to meet their environmental goals, the promotion of cross-border infrastructure including roads,rail, ports, energy pipelines and telecoms across Central Asia and the maritime routes in Southeast Asia, South Asia, the Middle East “and beyond” (there have been references in some reports to financing extending to projects in Africa) and, finally, the development of “innovative solutions that catalyse private capital”. These thematic priorities indicate that, in addition to investing in projects to support its green credentials, AIIB appears to be supporting those initiatives that promote China’s “one belt one road” initiative, as many predicted at its foundation.
At its foundation, there was a perception that China would dominate the AIIB. While it is true that China holds the highest proportion of voting rights, AIIB’s founding membership base was diverse, with several countries unexpectedly breaking with US foreign policy to join, and its Board of Directors and executive management team include representatives from across the globe. A further 30 countries have applied to join the AIIB, perhaps a sign that its efforts to establish its credibility and to put in place robust policies and standards have been well received internationally. At the time of writing this article, Donald Trump’s inauguration as the 45th President of the USA had just taken place. The members and executive team of AIIB are no doubt waiting with interest to see whether the US’s position on membership of AIIB will change and whether Japan might also consider joining in the future. While China is, and will continue to be, a very large and important presence in the AIIB, the amount of continuing interest in obtaining membership should, over time, lead to a diversity of views, influence and projects.
When the G20 Leaders established the “Global Infrastructure Hub” in Sydney in November 2014, the three-year mandate was to address an expected global infrastructure deficit estimated to be up to US$20 trillion by 2030. It is all too clear that, just over three years later, this gap in infrastructure spending still remains and, with just US$1.73 billion committed so far, it is not clear how quickly the AIIB might be able to make a material difference in terms of closing this infrastructure gap. As much as this funding gap urgently needs to be addressed, and as important as the funding of otherwise unbankable projects by multilateral development banks such as the AIIB might be, a key driver to delivering better infrastructure for the Asia region and to closing this infrastructure gap will be for multilateral development banks and other stakeholders to work with national governments to develop a pipeline of well-structured, bankable projects. ADB has been devoting ever greater resources to assisting governments with this, and in engaging the private sector in a wider range of projects, and it is to be hoped that the AIIB’s focus on private capital mobilisation, in partnership with other stakeholders, will provide even greater impetus to these initiatives.
The AIIB has made a promising start since its foundation, moving quickly to establish a credible executive management team and set of governance policies and operational standards, thereby helping to allay many of the initial concerns raised at its foundation. It has taken a sensible approach to the approval of its initial base of projects, with most being undertaken on a co-financing basis, allowing it to increase its capacity to undertake complex projects quickly and to apply international environmental and social practices to its projects. This co-financing strategy should also help to position it as a collaborator and partner with existing funding institutions, rather than a competitor. Moving further into 2017, governments in Asia will be hoping to see a continued steady stream of projects approved. Given its thematic focus on “green infrastructure”, many stakeholders will also be awaiting with interest the final, approved Energy Strategy, to see if it retains its current approach to fossil fuel power generation. However, perhaps the biggest question of the year for the AIIB will be whether Donald Trump’s presidency will change the US’s position on the AIIB. Stakeholders in the region continue to watch with interest.
For further information, please contact:
Anna Hermelin, Ashurst