EPC finance evolving for China's 'Belt-and-Road-Initiative'

Data compiled by Boston University's Global Development Policy Centre has identified a sharp reduction in the availability of finance from two traditional sources. In the last 10 years, the annual value of China's oversea loans peaked at $37.5 billion in 2014, while two banks provided loans to 97 projects totalling $35bn in value in 2016. Both the value of loans and the projects supported dropped in 2018, to $8bn and 27 respectively, and further declined to $3.7bn and four projects in 2019, according to the data. A Financial Times report suggested that uncertainty from the trade war between US and China may have resulted in the reduction. 

One of the widely acknowledged key strengths of Chinese EPC contractors is their ability to bring competitive financing to the table. As such, if Chinese 'Belt-and-Road Initiative' (BRI) loans fell then it follows that Chinese EPCs must also fall. However and interestingly, this is not the case. From China's officially reported numbers, China's outbound foreign direct investment and newly agreed EPC contract numbers appear to be steady. 

For the first half of 2020, China's Ministry of Commerce (MOCOM) reported 0.7% drop in China-outbound non-financial foreign direct investment and a 5% growth in newly signed China-outbound EPC contracts. Notably, China's investments in BRI countries grew by almost 20% year on year, and investments in ASEAN countries grew by a staggering 53.1% year on year. The value of EPC contracts also increased, with over 83% of all newly signed EPC contracts having a value of $50 million or more, and almost 45% having a value of $100m or more.

More recent data from the China International Contractors Association (CHINCA) dated 10 December 2020 reported that newly signed China-outbound EPC contracts for the period of January to October 2020 fell by just 4.4% year on year. 

Reconciling the apparent anomaly

It is worth pointing out that the data compiled by Boston University is limited only to some lending activities by China Development Bank (CDB) and The Export-Import Bank of China (CEXIM). As the research team clearly noted, 243 projects were not included in the scope of its research. 

Chinese commercial lenders, many of which have significant involvement in BRI, were not included in the dataset. The general feedback that received from Chinese commercial lenders is that while there is a significant slow down in lending activities, the downturn is not as severe as those reported for CDB and CEXIM. 

Besides, deferred payment mechanisms, receivable financing facilities and other seller's credit arrangements, which are extremely hard to account for, were not included in the dataset. The Covid-19 pandemic in 2020 has resulted in a liquidity squeeze and higher borrowing costs in China. Chinese lenders and Sinosure also appear to have adopted a conservative and much more selective approach, as they rightly should given the circumstances. As a result, potential borrowers and Chinese EPC contractors have found it difficult to source financing at internationally competitive rates. 

Three developments

Contractors have increased their use of deferred payment mechanisms, receivable financing facilities and other seller's credit arrangements. This helps with bridging the financing gap but results in a cost to the contractor that has to either be passed on or absorbed. For liquidity reasons, one would also expect increased interest in factoring and/or receivables financing arrangements in the short to medium term.

Chinese contractors are quickly turning to non-Chinese lenders for financing. Funding costs and terms from non-Chinese lenders are currently highly competitive and many non-Chinese export credit agencies have also been actively to boost their cooperation with Chinese contractors. However, given the different organisational culture, working assumptions and practices, it remains to be seen whether Chinese contractors will be able to quickly find a way to effectively partner with these lenders.

Chinese lenders have trialled with syndicated lending and risk participations for a number of years, but overall simpler bilateral and club facilities have been preferred. USD facilities have also been the dominant currency. This appears to be changing. Pinsent Masons' recently successfully closed the RMB6.8 billion (approx.$1bn) project financing of a stainless steel integrated project in Indonesia, which is comprised of a nickel mine, power plant, foundry and mill, port and associated infrastructure and backed by syndicate of 11 Chinese and offshore lenders and a multi-layer security package spanning four jurisdictions, is one such example. 

Higher funding costs and increasing regulatory scrutiny is forcing Chinese lenders to significantly up their game. Going forward it would be expected to see fewer but more sophisticated deals from China. Renewables is another area attracting significant attention – particularly in areas such as offshore wind, energy storage, hydrogen and floating solar.