The AIIB: A multilateral development bank with Chinese characteristics?

July 8, 2015
The AIIB: A multilateral development bank with Chinese characteristics?
Richard Woodward
Richard Woodward Non-Resident Fellow - International Economics

On 29 June, the plenipotentiaries of 57 states attended a signing ceremony in Beijing’s Great Hall of the People for the inauguration of the new Asian Infrastructure Investment Bank (AIIB).  This occasion, at which 50 countries signed the Memorandum of Understanding on Establishing the AIIB (the seven remaining prospective founders were yet to receive domestic approval), followed intense and sometimes fractious negotiations over the bank’s Articles of Agreement. Perhaps inevitably the nascent organisation is a compromise between China’s desire to flex its leadership muscles and the insistence of important European players including Germany, France and the United Kingdom that the AIIB should not deviate radically from the model adopted by the existing multilateral development banks (MDBs). Indisputably China will be the pre-eminent player in the AIIB and there some novelties in the organisation’s governance structures. Nevertheless in many respects AIIB’s form and function mimic current MDBs and China’s power in the organisation is far from untrammelled. In short, the embryonic AIIB is poised to be an MDB with Chinese characteristics.

In terms of global governance the most striking thing about the AIIB is, in the words of Alexander Cooley, that it is “a multilateral institution, global in membership, whose agenda is not predominantly determined by the US and its Western allies”. In total Asian members hold 75% of AIIB shares. Moreover, the Articles of Agreement guarantee that should the organisation expand, this share will not dip beneath 70%. By contributing $29.78bn of the bank’s initial $100bn capital, China is AIIB’s largest shareholder by far. As such it also has the most clout in the AIIB’s decision-making structures. Its 30.34% shareholding translates into a 26.06% share of the vote, more than the combined firepower of the next five biggest investors combined (India (7.51%), Russia (5.93%), Germany (4.15%), South Korea (3.5%), and Australia (3.46%)).  Significantly China’s share of the vote affords it a veto over decisions requiring a ‘Super Majority’, defined by Article 28 as approval by two-thirds of the Board of Governors representing 75% of the total vote of the members. Thus a potential Chinese veto looms over important decisions including changes to the AIIB’s capital stock, the powers of the Board of Directors and the choice of organisation’s President.

The formalisation of the power to veto the appointment of the President is made more momentous because of the unusually strong position the office holds in the AIIB governance structure. The AIIB’s governance structure is comparable to those of other MDBs. At the apex will sit a Board of Governors composed of one representative nominated by each member state. They in turn will elect a twelve strong Board of Directors (nine of which must be from Asia) to oversee the AIIB’s day-to-day activities. Following the example of other MDBs the biggest contributors (the thresholds laid out in the Articles of Agreement suggest this will be China, India, Russia and Germany) will have seats of their own on the Board of Directors while other countries will form multi-country groupings each represented by one Director who will exercise their collective vote. It is interesting to speculate how the UAE might approach this issue. One possibility is to form a constituency with the AIIB members (Egypt, Jordan, Kuwait, Maldives, Oman, and Qatar) with which it currently shares an Executive Director at the World Bank. Overall this group would possess 4.77% with the UAE with $1.19bn in subscribed capital and 1.29% as the biggest member followed by Egypt (0.83%) and Qatar (0.79%). A second possibility would be to assemble a syndicate of GCC countries (only Bahrain of the GCC members is not currently an AIIB member). Such a consortium would have 5.89% of the overall vote with Saudi Arabia’s 2.47% of the vote making it the heftiest member. The UAE may therefore need to decide whether to be the primary member of a less powerful and less cohesive group or a secondary member of a more powerful and unified group.

Unlike other MDBs, however, the Board of Directors will not be in permanent residence at the AIIB headquarters. China maintains that a non-resident Board of Directors will be more efficient, economical and effective. The practical implication of this is that power is tilted towards the President and the AIIB’s Beijing based Secretariat (the AIIB’s location in Beijing is itself sign of and outlet for Chinese influence in the organisation). Article 29 promises the process for selecting the President will be “open, transparent and merit based”. Nonetheless that China has made it abundantly clear from the outset that it expects Jin Liqun, the AIIB’s interim leader whom it formally nominated this week, to be appointed to the post. As a former Vice-Minister of Finance who has represented China in senior posts at the World Bank and Asian Development Bank (ADB), he is eminently qualified. With responsibility for staff appointments and defining the detailed rules of operation, the President will be in a position to put his stamp on the new institution. The evidence from elsewhere demonstrates that the first executive head can, for better or worse, exert a potent and lasting impact on the culture, outlook and trajectory of their international organisation.

The Chinese veto may also become important in areas where the Articles of Agreement are vague or silent. Formally the AIIB will become operational once ten signatories whose subscription comprises at least half of the bank’s paid-up capital have deposited their instruments of ratification. The Chinese hope that this will happen by the start of 2016. However, before the bank can become fully functional some critical operational decisions about the bank’s day-to-day governance must be taken. For example, as Scott Morris has observed, the role of the Board of Directors and its relationship with the AIIB senior management team are left “largely unspecified” in the Articles of Agreement. China has insisted that decisions in this realm are subject to the Super Majority rules rather than requiring a simple majority. These leaves open the door to a relationship where the Board of Directors would have a subordinate role and bestow greater freedom over operational decisions to the management team directed by the (Chinese) President.

Although most attention has been lavished on China’s veto, it is likely to be used sparingly if at all. As with the US at the World Bank, the power of the veto comes from its existence rather than its use. Many decisions at MDBs are approved by consensus. However the knowledge that a formal vote could be taken and a veto exercised lingers over the consensus building process and is often sufficient to persuade recalcitrant states to moderate or drop their objections.

Regardless of the veto, China’s weight will be felt in the everyday running of the AIIB, particularly in decisions about which the projects the organisation chooses to support. Article 11 of the AIIB agreement envisages the usual mix of assistance offered by MDBs including direct loans, investment in equity capital, loan guarantees and technical assistance. Project approvals will be subject to a simple majority vote. While it has no veto, the magnitude of China’s voting share has amplified anxieties that it will harness this influence to channel AIIB lending to projects that will support China’s national interests, irrespective of their environmental effects or the recipient country’s record on democracy and human rights. Moreover, although the Articles of Agreement outline the organisation’s high-level principles the kinds of rules and procedures needed to translate these ambitions into concrete lending programs will be developed by the AIIB Secretariat headed by an interim Chinese Secretary-General with a relatively high proportion of Chinese staffers. Notwithstanding the fact that international civil servants pledge their allegiance to the organisation rather than their country, “personnel is power” and the history of MDBs is replete with examples where bureaucrats have stifled or “slow walked” policies favoured by lesser shareholders.

Nevertheless, China’s ability to steer the organisation will be more constrained than critics fear.  As my previous contribution on the AIIB argued, China has already made concessions to woo OECD countries not least basing the organisation on the architecture of existing MDBs and reining in its aspiration to possess a majority shareholding. Apprehensions that Chinese dominance will result in lending to inappropriate countries or projects are mitigated by a number of factors. First, AIIB is short of the knowledge and expertise needed to take potential projects off the drawing board and deliver them on the ground. To this end the AIIB is undertaking a global search for talent that will check Chinese dominance of the Secretariat. Indeed initially the AIIB may have to rely on the aptitude of the World Bank. Similarly, again borrowing from the existing MDBs, Article 31(2) states that only economic considerations will be relevant in lending decisions. The fact that MDBs have a far from glorious record in this regard is a cause for concern. Nevertheless, financial markets will restrain China’s room for manoeuvre. Like other MDBs, the AIIB will not be lending its own capital for projects. Rather the AIIB will use its members’ subscriptions as collateral to raise additional funding from the financial markets. The implicit sovereign guarantees given by members enable MDBs to borrow cheaply, a saving which is passed onto their own borrowers in the form of subsidised loans.  Commercial borrowing makes it imperative that the AIIB retains investor confidence. For instance, the African Development Bank was briefly stripped of its investment grade credit rating owing to the high default rates on its loans. In other words, financial markets will not countenance the AIIB launching a string of ill-conceived disbursements that undermine the quality of its loan portfolio. Indeed financial markets rather than states could provide some of the sternest curbs on Chinese power in the AIIB.

The AIIB symbolises an evolution rather than a revolution in the architecture of global development governance. In fashioning the AIIB, China has borrowed extensively from the norms and governance structures of established MDBs, choices that will inhibit its freedom of action. That said the AIIB will be the first major international organisation in which China will play the foremost, perhaps even hegemonic, role. This will present China with an exceptional opportunity to forge a distinct institution, infused with subtly different ideas and governance structures. While much of the attention has focussed on the Articles of Agreement, China’s influence over the detailed rule making may do more to affect the AIIB’s culture in the longer term. Exactly how far China’s can influence the organisation may rest upon the elephant that is not in the room: the United States. A growing number of American commentators are advocating US membership of the AIIB, not least because will afford an opportunity to counter Chinese influence at a moment when the philosophy and processes of the organisation are at their most fluid and malleable. Indeed a prospective American application could present the AIIB’s Chinese leadership with its first major challenge: how to admit the US without diluting the Asian quota beneath the 70% fixed in the Articles of Agreement. China might be about to find that international leadership is harder than it looks.