Travel the Silk Road at your peril

Viewpoint

There’s no doubting China’s immense ambition in the project finance stakes, centred around its grandiose One Belt, One Road (or Belt-Road) scheme to revive the old Silk Road which used to connect China with the West in ancient times.

The brainchild of premier Xi Jinping, unveiled in 2013, the project aims to rope in the big investment banks to share the burden of financing what represents the biggest infrastructure project yet conceived.

Requiring US$4-8 trillion of investment, it is pitched at around 30 times the size of the Marshall Plan which rebuilt Europe after the ravages of the Second World War. And there is no shortage of takers from the Western banking sector.

The latest to sign up has been Deutsche Bank, which last week signed a memorandum of understanding with China Development Bank to commit to work together on Belt-Road projects worth up to US$3 billion. It’s hardly surprising really, given the reams of hype which surrounds the Belt-Road.

“Silk Road” bonds and other debt products are being marketed under that label, with a separate settlement system proposed for the debt, in a bid to create a discrete asset class – that process will help to bring punters to the table, both from the bond investor community and the banking community where balance sheet is available.

I’m reminded of what a seasoned loan banking veteran told me a long time ago about project finance loans: they either default or get refinanced. It was said with a tongue-in-cheek wry smile attached, but that piece of wisdom is worth bringing on board.

Construction risk is ever present in the project domain, with shoddy bidding procedures often dooming a project before the first spadeful of earth has been dug. Default and restructuring is commonplace, often as the result of lousy initial structuring.

If all that is the norm for project finance in general, it seems to me that for a conception as grandiose – dare I say, vainglorious – as the Belt-Road, it will be more of the same, writ large.

It doesn’t help that as the big state-backed Chinese banks have muscled into the international lending business, they have done so via relaxed lending standards, in terms of covenants, structures and margins in order to win market share. At least that is the opinion of the loan bankers with whom I regularly speak.

Lending standards exist for a reason: they represent years of experience in the business, or years of wisdom, if you prefer. You have debt covenants included in loan documentation for a reason, and that reason is that it has been proven on countless occasions that there are pressure points in terms of debt service which when breached tend to drive companies out of business.

It might be all the rage to jump on the bandwagon as it hurtles down this unfolding Silk Road. But I suspect the entire spectacle, while as exciting as it gets for cross-border project finance, may end up as one of the biggest sources of debt restructuring the world has known.