FOR OFFICIAL USE ONLY Report No: PAD3258 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF EURO 267.3 MILLION (US$300 MILLION EQUIVALENT) TO THE PEOPLE’S REPUBLIC OF CHINA FOR A CHINA RENEWABLE ENERGY AND BATTERY STORAGE PROMOTION PROJECT May 20, 2019 Energy and Extractives Global Practice East Asia and Pacific Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (Exchange Rate Effective April 18, 2019) Currency Unit = Chinese Yuan (Y) Y 6.71 = US$1 FISCAL YEAR January 1 - December 31 Regional Vice President: Victoria Kwakwa Country Director: Martin Raiser Senior Global Practice Director: Riccardo Puliti Practice Manager: Jie Tang Task Team Leader(s): Ximing Peng 1. ABBREVIATIONS AND ACRONYMS CDRESP China Distributed Renewable Energy Scale-up Project CHEEF China Energy Efficiency Financing Project CNAO China National Audit Office CPF Country Partnership Framework CRESP China Renewable Energy Scale-up Program DA Designated Account DLI Disbursement-linked Indicator DRE Distributed Renewable Energy E&S Environmental and Social EE Energy Efficiency EIRR Economic Internal Rate of Return ESCOs Energy Service Companies ESCP Environmental and Social Commitment Plan ESMAP Energy Sector Management Assistance Program ESS Environmental and Social Standard FIRR Financial Internal Rate of Return FYP Five-Year Plan GDP Gross Domestic Product GEF Global Environment Facility GFC Green Finance Center GHG Greenhouse Gas GRS Grievance Redress Service GWh Gigawatt Hours IFC International Finance Corporation JJJ Jing-Jin-Ji LCO Lithium-Cobalt-Oxide LFP Lithium-Iron(Ferro)-Phosphate M&E Monitoring and Evaluation MoF Ministry of Finance mtce million tons of coal equivalent NCA Nickel-Cobalt-Aluminum NDC Nationally Determined Contribution NEA National Energy Administration NMC Nickel-Manganese-Cobalt NPL Non-performing Loan NPV Net Present Value OM Operations Manual PCA Procurement Capacity Assessment PDO Project Development Objective PforR Program for Result PMO Project Management Office PV Photovoltaic RE Renewable Energy SEP Stakeholder Engagement Plan SERC State Electricity Regulatory Committee SGERI State Grid Energy Research Institute SMEs Small and Medium Enterprises SOEs State-owned Enterprises STEM Science, Technology, Engineering, and Mathematics T&D Transmission and Distribution TA Technical Assistance tce Tons of coal equivalent The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) TABLE OF CONTENTS DATASHEET ........................................................................................................................... 1 I. STRATEGIC CONTEXT ...................................................................................................... 1 A. Country Context............................................................................................................................... 1 B. Sectoral and Institutional Context ................................................................................................... 2 C. Relevance to Higher Level Objectives .............................................................................................. 8 II. PROJECT DESCRIPTION.................................................................................................... 9 A. Project Development Objective (PDO) ............................................................................................ 9 B. Project Components ...................................................................................................................... 10 C. Project Beneficiaries ...................................................................................................................... 12 D. Results Chain ................................................................................................................................. 13 E. Rationale for Bank Involvement and Role of Partners................................................................... 14 F. Lessons Learned and Reflected in the Project Design ................................................................... 14 III. IMPLEMENTATION ARRANGEMENTS ............................................................................ 15 A. Institutional and Implementation Arrangements.......................................................................... 15 B. M&E of Results .............................................................................................................................. 15 C. Sustainability .................................................................................................................................. 16 IV. PROJECT APPRAISAL SUMMARY ................................................................................... 16 A. Technical, Economic and Financial Analysis .................................................................................. 16 B. Fiduciary......................................................................................................................................... 20 C. Legal Operational Policies .............................................................................................................. 21 D. Environmental and Social (E&S) .................................................................................................... 21 E. Grievance Redress Services............................................................................................................ 24 V. KEY RISKS ..................................................................................................................... 25 VI. RESULTS FRAMEWORK AND MONITORING ................................................................... 27 ANNEX 1: Brief on Power Sector Reform in China ................................................................ 31 ANNEX 2: Implementation Arrangements and Support Plan ................................................. 33 ANNEX 3: Detailed Project Description................................................................................. 39 ANNEX 4: National Level Economic Analysis of Battery Storage Investment ......................... 46 ANNEX 5: Financial Due Diligence Review ............................................................................ 52 Bibliography ........................................................................................................................ 57 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) DATASHEET BASIC INFORMATION BASIC_INFO_TABLE Country(ies) Project Name China China Renewable Energy and Battery Storage Promotion Project Project ID Financing Instrument Environmental and Social Risk Classification Investment Project P163679 Substantial Financing Financing & Implementation Modalities [ ] Multiphase Programmatic Approach (MPA) [ ] Contingent Emergency Response Component (CERC) [ ] Series of Projects (SOP) [ ] Fragile State(s) [ ] Disbursement-linked Indicators (DLIs) [ ] Small State(s) [✓] Financial Intermediaries (FI) [ ] Fragile within a non-fragile Country [ ] Project-Based Guarantee [ ] Conflict [ ] Deferred Drawdown [ ] Responding to Natural or Man-made Disaster [ ] Alternate Procurement Arrangements (APA) Expected Approval Date Expected Closing Date 11-Jun-2019 30-Jun-2025 Bank/IFC Collaboration No Proposed Development Objective(s) The project development objective is to promote the integration and use of renewable energy through the deployment of battery storage systems and innovative applications of renewable energy. Components Component Name Cost (US$, millions) Page 1 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Investment Component 750.00 Organizations Borrower: China Implementing Agency: Huaxia Bank PROJECT FINANCING DATA (US$, Millions) SUMMARY -NewFin1 Total Project Cost 750.00 Total Financing 750.00 of which IBRD/IDA 300.00 Financing Gap 0.00 DETAILS -NewFinEnh1 World Bank Group Financing International Bank for Reconstruction and Development (IBRD) 300.00 Non-World Bank Group Financing Counterpart Funding 450.00 Borrower/Recipient 450.00 Expected Disbursements (in US$, Millions) WB Fiscal Year 2019 2020 2021 2022 2023 2024 2025 Annual 0.00 10.00 40.00 70.00 70.00 80.00 30.00 Cumulative 0.00 10.00 50.00 120.00 190.00 270.00 300.00 INSTITUTIONAL DATA Practice Area (Lead) Contributing Practice Areas Page 2 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Energy & Extractives Climate Change and Disaster Screening This operation has been screened for short and long-term climate change and disaster risks Gender Tag Does the project plan to undertake any of the following? a. Analysis to identify Project-relevant gaps between males and females, especially in light of No country gaps identified through SCD and CPF b. Specific action(s) to address the gender gaps identified in (a) and/or to improve women or No men's empowerment c. Include Indicators in results framework to monitor outcomes from actions identified in (b) No SYSTEMATIC OPERATIONS RISK-RATING TOOL (SORT) Risk Category Rating 1. Political and Governance ⚫ Moderate 2. Macroeconomic ⚫ Moderate 3. Sector Strategies and Policies ⚫ High 4. Technical Design of Project or Program ⚫ Substantial 5. Institutional Capacity for Implementation and Sustainability ⚫ Moderate 6. Fiduciary ⚫ Moderate 7. Environment and Social ⚫ Substantial 8. Stakeholders ⚫ Substantial 9. Other ⚫ High 10. Overall ⚫ High Page 3 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) COMPLIANCE Policy Does the project depart from the CPF in content or in other significant respects? [ ] Yes [✓] No Does the project require any waivers of Bank policies? [ ] Yes [✓] No Environmental and Social Standards Relevance Given its Context at the Time of Appraisal E & S Standards Relevance Assessment and Management of Environmental and Social Risks and Impacts Relevant Stakeholder Engagement and Information Disclosure Relevant Labor and Working Conditions Relevant Resource Efficiency and Pollution Prevention and Management Relevant Community Health and Safety Relevant Land Acquisition, Restrictions on Land Use and Involuntary Resettlement Relevant Biodiversity Conservation and Sustainable Management of Living Natural Not Currently Relevant Resources Indigenous Peoples/Sub-Saharan African Historically Underserved Traditional Relevant Local Communities Cultural Heritage Not Currently Relevant Financial Intermediaries Relevant NOTE: For further information regarding the World Bank’s due diligence assessment of the Project’s potential environmental and social risks and impacts, please refer to the Project’s Appraisal Environmental and Social Review Summary (ESRS). Legal Covenants Sections and Description Page 4 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Institutional Arrangements (Green Finance Steering Committee) Project Agreement, Schedule, Section I.A.1 (a): The Project Implementing Entity shall establish by no later than December 31, 2019, and thereafter maintain the Green Finance Steering Committee, responsible for providing overall policy, financial, and institutional guidance on green finance business, including Project implementation, overseeing the operations of the Green Finance Center and ensuring business cooperation among relevant departments. Sections and Description Institutional Arrangements (Green Finance Center) Project Agreement, Schedule, Section I.A.1 (b): The Project Implementing Entity shall maintain the Green Finance Center, with composition, powers, functions, staffing, facilities and other resources acceptable to the Bank responsible for day-to-day implementation, coordination, reporting, management, and monitoring and evaluation of the Project. Sections and Description Institutional Arrangements (Green Financing Institutional Strengthening Plan) Project Agreement, Schedule, Section I.A.2: The Project Implementing Entity shall by no later than December 31, 2019, prepare a Green Financing Institutional Strengthening Plan, in form and substance acceptable to the Bank, and thereafter implement said plan, in a manner acceptable to the Bank. Sections and Description Annual Work Plans Project Agreement, Schedule, Section I.B.1: The Project Implementing Entity shall: (a) prepare and furnish to the Bank by November 30 in each year, beginning in 2019, a draft Annual Work Plan for review and comment, summarizing the implementation progress of the Project for the said year and the activities under the Project to be undertaken in the following calendar year; (b) taking into account the Bank’s comments, finalize and furnish to the Bank no later than December 31 in each year, beginning in 2019, the Annual Work Plan, satisfactory to the Bank; and (c) thereafter ensure the implementation of the Project during the following calendar year in accordance with the Annual Work Plan agreed with the Bank and in a manner satisfactory to the Bank. The Project Implementing Entity shall not amend, suspend, abrogate, or waive said Annual Work Plans or any provision thereof without the Bank’s concurrence. Sections and Description Project Operations Manual Project Agreement, Schedule, Section I.B.2: The Project Implementing Entity shall apply the Project Operations Manual (“POM”) in a timely and efficient manner satisfactory to the Bank. The Project Implementing Entity shall not amend, suspend, or waive said POM or any provision or schedule thereof, without the prior written agreement of the Bank. Sections and Description Page 5 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Environmental and Social Standards Project Agreement, Schedule, Section I.C: The Project Implementing Entity shall: (a) ensure that: (i) that the Project is carried out in accordance with the Environmental and Social Standards, in a manner acceptable to the Bank; (ii) the Project is implemented in accordance with the Environmental and Social Commitment Plan (“ESCP”), in a manner acceptable to the Bank; (iii) the ESMS is: (1) maintained and operated; (2) applied to all Sub-borrowers under the Project; and (3) updated and/or revised as necessary, all in a manner satisfactory to the Bank; (iv) take all measures necessary on its part to collect, compile, and furnish to the Bank through regular reports, with the frequency specified in the ESCP, and promptly in a separate report or reports, if so requested by the Bank, information on the status of compliance with the ESCP, the ESMS and the management tools and instruments referred to therein, all such reports in form and substance acceptable to the Bank; (v) promptly notify the Bank of any incident or accident related to or having an impact on the Project which has, or is likely to have, a significant adverse effect on the environment, the affected communities, the public or workers, in accordance with the ESCP, the ESMS, the instruments referenced therein and the Environmental and Social Standards; and (vi) maintain and publicize the availability of a grievance mechanism, in form and substance satisfactory to the Bank, to hear and determine fairly and in good faith all complaints raised in relation to the Project, and take all measures necessary to implement the determinations made by such mechanism in a manner satisfactory to the Bank. Sections and Description Sub-loans Project Agreement, Schedule, Section I.D: The Project Implementing Entity shall: (a) select and approve Sub- borrowers in accordance with the eligibility criteria and the procedures set forth in the POM; (b) appraise, review, approve, and supervise Sub-projects in accordance with the criteria, conditions and procedures set out in the POM; and (c) make Sub-loans to Sub-borrowers in accordance with eligibility criteria and procedures acceptable to the Bank as set out in the POM, and shall only make the proceeds of the Sub-loan available to such Sub-borrower after the Project Implementing Entity has entered into a Sub-loan Agreement with the Sub-borrower on terms and conditions acceptable to the Bank. Sections and Description Mid-term review Project Agreement, Schedule, Section II.2: The Project Implementing Entity shall prepare, under terms of reference satisfactory to the Bank, and furnish to the Bank no later than August 31, 2022, a consolidated mid-term review report for the Project, summarizing the results of the monitoring and evaluation activities carried out from the inception of the Project, and setting out the measures recommended to ensure the efficient completion of the Project and to further the objectives thereof. Conditions Page 6 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) I. STRATEGIC CONTEXT A. Country Context 1. China has experienced fast economic growth in the decades to 2019 and this has contributed to a dramatic reduction in extreme poverty. Since China announced its ‘reform and opening’ policy in 1978, its gross domestic product (GDP) per capita has increased 25-fold in the intervening 40 years from about Y 2,548 (equivalent to US$380) in 1978 to Y 64,644 (equivalent to US$9,634) in 2018 (valued at 2018 price).1 Economic growth has taken 753 million people out of extreme poverty, with the number of poor people declining from 770 million in 1978 to 16.7 million in 2018. The Government of China has now increased its focus on eliminating poverty where it remains, especially in the northern and western provinces. 2. The steady growth of China’s economy has driven a rapid increase in energy consumption, leading to severe domestic and global environmental impacts. Primary energy consumption grew from 571 million tons of coal equivalent (mtce) in 1978 to 4,640 mtce in 2018, an increase of more than 8-fold. In the power sector, total installed capacity in China amounted to 1,900 GW, and total annual electricity consumption reached 6,994 TWh by the end of 2018. Installed capacity and electricity consumption have grown at annual average rates of 9.2 percent and 8.6 percent, respectively, over the past four decades. China faces ongoing challenges to: (a) further reduce the share of coal in the energy mix and address associated serious environmental pollution; (b) further reduce the energy intensity (energy consumption per unit of GDP); and (c) cap and reduce greenhouse gas (GHG) emissions to fulfill its Nationally Determined Contribution (NDC) to global action on climate change under the Paris Agreement. (a) China suffers from severe air pollution due to coal-dominated energy consumption. Although coal’s share in the primary energy mix has gradually declined from about 72 percent in 1978 to about 59 percent in 2018, coal remains the dominant energy source. High coal consumption has brought serious environmental pollution, making some Chinese cities among the world’s most polluted. Particulate matter and other local pollutants from coal combustion take a high toll in terms of deaths, morbidity, and associated economic costs (World Bank and PRC State Council Development Research Center 2013). The Government has placed a high priority on air pollution control and declared a ‘war on pollution’. A major part of this effort is to promote renewable energy (RE) and other clean energy sources to replace coal consumption. (b) Although reduction in energy intensity has declined beyond Government targets, it is still high by international benchmarks. Despite substantial progress in improving energy efficiency (EE), with energy intensity falling from 1,567 tce per million US$ in 1978 to 346 tons of coal equivalent (tce) per million US$ in 2018 (valued at 2018 price). Energy intensity remains much higher than the international average and more than double the level in the United States. 2 Along with 1 Source: China Statistic Yearbook 2018; and 2018 Statistical Bulletin on National Economic and Social Development. National Bureau of Statistics. 2 In 2017, the energy intensity was 372.4 tce per million US$ in China, 163.9 tce per million US$ in the United States, and an average of 240.8 tce per million US$ globally, based on the data provided in BP Statistical Review of World Energy 2018 and World Economic Outlook Database (April 2019). Page 1 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) meeting the growing energy demand, actions are needed to further increase the efficiency in energy use and bring down energy intensity. (c) Continuous growth of energy consumption, dominated by coal, adds to the challenge of fulfilling China’s NDC commitments for 2030. China emits more GHGs per year than any other country, including the United States and Europe combined. In its 2015 NDC under the Paris Agreement on climate change, China committed to: (a) reduce the carbon intensity (carbon emission per unit of GDP) by 40–45 percent from 2005 to 2020 and by 60–65 percent from 2005 to 2030; and (b) to reach its peak annual carbon emissions by 2030. Although China has reduced its carbon intensity by 46 percent by the end of 2017 and exceeded its committed 2020 target, achieving the 2030 commitment will largely rely on both improvements in energy efficiency as well as RE development to replace coal. 3. To address the air pollution problem and achieve energy intensity and GHG emission reduction targets, China has embarked on an energy transition program to shift away from coal. The ‘energy revolution’ program, launched by President Xi Jinping, calls for radical changes in energy consumption, energy supply, institutional reform, energy technology innovation, and strengthening of international cooperation. The ‘Energy Supply and Consumption Revolution Strategy for 2016 to 2030’, issued by the Government in December 2016, requires more intensive RE development. Emerging transformative solutions that improve the integration, utilization and scale-up of variable RE include utility-scale battery storage, distributed renewable energy (DRE)3, and innovative RE applications such as geothermal and biomass for heating could play important roles. Key policy and institutional actions are yet to be taken to create an enabling environment and market to attract and expand investments in these solutions. B. Sectoral and Institutional Context 4. China’s energy revolution requires clean energy sources to compete with and displace coal and attain a much larger share of energy mix. As of 2018, China’s energy mix comprised 59 percent coal, 18.9 percent oil, 7.8 percent gas, 8.2 percent hydro, 4.1 percent (non-hydro) renewables and 2.0 percent nuclear. Phased targets in the long-term energy development strategy include: (a) by 2020, total energy consumption to not exceed 5,000 mtce and the share of nonfossil fuel energy (that is, renewables and nuclear) to reach 15 percent; (b) by 2030, total energy consumption to not exceed 6,000 mtce, the share of nonfossil fuel energy to reach about 20 percent, and the share of gas to be about 15 percent; and (c) by 2050, total energy consumption to be stabilized, and over one-half of the country’s primary energy consumption to be supplied by nonfossil fuel sources. 5. Despite having the world’s largest installed RE generation capacity, more intensive RE growth is needed to support the ongoing energy transition. The installed capacity of wind power and solar photovoltaic (PV) at 184 GW and 175 GW, respectively, by the end of 2018, is the highest in absolute terms globally. Nevertheless, nonfossil fuel sources still occupy a share below 15 percent in the energy mix. This has increased from 8.6 percent in 2010 to 14.3 percent in 2018, close to the Government’s 2020 3 Distributed RE refers to the decentralized renewable energy connected to the distribution networks directly and consumed locally. It comprises technologies and services at the level of electric power distribution grid and its users, including generation, energy efficiency, demand response, storage, and related information and communication technology systems (Hungerford & others 2017). Page 2 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) target of 15 percent. Some estimates4 indicate that there is potential to increase total installed capacity of wind power and solar PV to more than 700 GW and 730 GW, respectively, by 2035 and more than 970 GW and 1,270 GW, respectively, by 2050. This implies that the installed capacity of wind power and solar PV have the long-term potential to be scaled-up by four to seven times respectively. To achieve this potential, however, prompt actions are needed to address the causes of extensive curtailment5 faced by existing RE assets (described below) and to create the enabling environment to develop and integrate new RE capacity at scale. The Government has diversified its strategy for RE development beyond large- scale centralized RE bases to promote both DRE and innovative RE applications to achieve the intensive RE targets. 6. Current levels of RE generation utilization are very low owing to extensive curtailment, which may significantly slow future RE development unless properly solved. There has been serious curtailment of wind and solar PV energy generation since 2010 (Figure 1). This curtailment is mostly associated with the large-scale centralized RE bases developed in northwest China, in provinces such as Xinjiang, Gansu, and Inner Mongolia. To appreciate the extent of RE curtailment, the comparison between China and the United States is illustrative in 2015, China produced the same amount of electricity from wind as the United States, but with twice the installed capacity (Fairley 2016, see Figure 2). Reducing curtailment by 1 percent could increase annual RE generation by about 3,600 gigawatt hours, equivalent to reducing annual CO2 emissions by 2.9 million tons. The main causes of RE curtailment, and actions that are being taken to address them, are described in Box 1. Figure 1. RE Curtailment in China (2013-2018) Source: Energy Research Institute and China Renewable Energy Center 2019. 4China Renewable Energy Outlook 2018, China Renewable Center; Report by State Grid Energy Research Institute 2019. 5Brookings-Tsinghua Center defines wind curtailment as the reduction in electricity generation below what a system of well- functioning wind turbines are capable of producing. This definition can also be applied to PV systems. For this project, curtailment of RE refers specifically to curtailment of wind and PV as forms of variable RE. Page 3 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Figure 2. Installed Wind Capacity and Generated Electricity in China and the United States Source: Tsinghua University/Harvard University. Box 1. Causes of, and Solutions to, RE Curtailment in China Causes of RE Curtailment in China (a) Policy frameworks, institutional mechanisms, and Government oversight and regulatory arrangements are inadequate to enable and ensure efficient dispatch of RE generation and economic power exchange or trade across provinces. RE generation is concentrated in northern and western China whereas load centers are in the central, eastern and southern provinces. (b) Transmission bottlenecks prevent renewable capacity from being used and dispatched due to uncoordinated planning and construction of the RE capacity and associated grid infrastructure. (c) Power systems have inadequate operational flexibility to accommodate the variability of wind and PV. This is mainly due to large shares of inflexible coal-fired power plants, especially combined heat and power plants that must be run in winter for space heating. It is also due to limited storage capacity in the system. Solutions to Reduce RE Curtailment (a) The new phase of power sector reforms initiated in 2015 need to be pro-actively advanced. These include policy and institutional measures and pricing incentives to ensure economic dispatch of power plants that would limit coal-fired plant generation and increase RE generation. It would also be important to enforce economically efficient power trading across provinces, the absence of which prevents RE from displacing coal plants within the province. (Annex 1 provides an overview of historical and current power sector reforms in China). (b) New approvals for RE capacity development in provinces where curtailment is particularly serious, such as in western China, should continue to be reviewed more carefully to ensure that necessary transmission investments are also planned, approved and implemented. (c) Increase investments to upgrade transmission capacities, improve load-following capabilities of existing thermal power plants, and increasing energy storage applications (both battery storage and hydro-pumped storage power plants) to improve the flexibility of power systems. (d) Create and expand markets for transformative technologies such as grid-connected battery storage and innovative RE applications such as RE for heating and hydrogen production. Page 4 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Creating and Expanding Markets for Battery Storage 7. Battery storage can play a significant role in improving the integration of RE and reduce RE curtailment. Amongst the available energy storage technologies globally, battery storage is becoming a feasible solution to: (a) increase power system flexibility; (b) improve RE grid integration; and (c) improve the balancing of supply and demand with distributed generation at consumer level. Attractive characteristics of battery storage systems include their fast response, modularity, and easy of deployment. At the generation level, battery storage can help directly mitigate RE variability. At the transmission and distribution (T&D) level, battery storage can help flatten the load curve by increasing charging during off-peak hours and discharging during peak demand hours. This will help ease congestion in the network and also reduce RE curtailment. At the consumer level, battery storage enables higher utilization of DRE such as rooftop PV to meet local demand, reducing network congestion and avoiding costly investments in T&D networks. Several countries are pursing initiatives to capture the value of batteries, including the United States (in particular states such as California and New York), the Republic of Korea, the United Kingdom, Germany, Australia, and Japan. These countries are piloting innovative policies, regulation and incentives, while also investing in new battery technologies to lower costs, improve efficiency, and enhance safety. China intends to learn from these international experiences and to adapt and adopt appropriate policies and approaches to develop markets for battery storage. 8. Battery storage applications in China’s power system are still nascent and immature, and market development faces substantial institutional and financial barriers. Despite the huge potential for commercial battery storage applications at utility and consumer levels,6 adoption in China is still mostly at the pilot stage financed largely by sponsors’ or owners’ equity. The China Industrial Association of Power Sources estimated the total installed capacity of battery storage in power system applications is very small, amounting to about 1,038 MW by the end of 2018, of which 34 percent was deployed at the generation level, 24 percent at the grid level, 25 percent at the consumer level, and 17 percent installed with DRE and microgrids. 7 The pioneering first movers have typically been private enterprises at consumer level, and state-owned enterprises at the utility level. Small and medium-sized enterprises (SMEs) are very keen on investing in power system battery storage applications but face a series of obstacles. These include: (a) difficulties in accessing loans especially from state-owned commercial banks owing to the reluctance of these banks to finance SMEs in general and to finance specific technologies perceived to be risky; (b) lack of effective pricing mechanisms to monetize values of battery storage; and (c) lack of viable business models to cover the high up-front costs of battery storage. Moreover, there is a lack of policy and regulations on issues of access to the grid, environmental impacts and safety management, and battery recycling. These institutional and financial barriers are described below. 9. The policy and regulatory environment is yet to enable a commercial market for SMEs to invest in battery storage. Battery storage is a fairly new focus in China’s 13th Five-Year Plan (FYP) and related policy documents. Market players and policy-making agencies need to acquire the knowledge and experience to develop the appropriate policies and regulations for battery storage investments to become bankable and sustainable. Key barriers in this respect include lack of: (a) clearly defined market rules to 6 According to BNEF (2018), global battery storage capacity could increase to 942 GW/2,857 GWh by 2040. The total investment requirement would amount to US$620 billion; two-thirds of the market would be located in China, the United States, India, Japan, Germany, France, Australia, the Republic of Korea, and the United Kingdom. 7 Battery storage capacity in China to date has been led by first movers in the market. Government agencies have not yet developed adequate policies and regulations to spur the deployment of battery storage technologies in power systems. Page 5 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) regulate the behaviors of the market players with different roles and responsibilities; (b) regulations for grid access by third-party battery storage investors and services providers; (c) regulations for grid integration of consumer-side battery storage; (d) pricing mechanisms to capture the value of battery storage; (e) technical standards on grid integration, energy storage services, operation and maintenance, technology risk and safety; and (f) clear regulations on battery recycling. Given these large gaps in policy and regulations, most battery storage systems deployed today use equity investment from first movers to test the market; grid access is obtained case-by-case with strong local government interventions; and there exist only limited types of battery storage applications. 8 Adequate regulatory and pricing frameworks are needed to enable a market for SMEs and commercial banks to finance bankable investment in battery storage. The large gaps in relevant knowledge extend from policy makers to commercial banks, SMEs, grid companies, and consumers. 10. Access to financing for battery storage is a challenge as commercial banks are reluctant to provide financing to new and high-risk industries. Consultations with selected SMEs confirmed that SMEs have limited access to bank loans to finance investments in battery storage.9 According to the SMEs consulted, the average financial return of the early-stage battery storage projects was about 5–7 percent, while the cost of available bank loans for SMEs was in the range of 8–10 percent. Commercial banks’ caution in financing battery storage projects stems from the following concerns: (a) inadequate understanding of the battery storage technologies and business; (b) lack of sustainable policy support; (c) low return on battery storage projects; and (d) inadequate communication with battery storage enterprises and investors. The current state of and challenges with the battery storage market are quite similar to the EE market of the early 2000s when commercial banks were reluctant to finance the emerging EE investments in industries and EE service providers such as energy service companies (ESCOs) could not access financing from commercial banks. At that time, the World Bank had worked with the Government on policies and regulations, supported the establishment and operation of China’s first three major ESCOs, and identified and supported participating banks to open up new business lines in EE. These efforts eventually helped create the EE market in China, which now has more than 6,400 ESCOs, about US$17 billion investment per year, and annual energy conservation of about 39 mtce.10 Promoting Innovative RE Applications 11. Promoting innovative RE applications, especially to replace coal for heating, could become a new driver of RE development to help achieve China’s intensive RE targets. Complementary to the development of grid-connected DRE and centralized RE bases, the Government is promoting innovative RE applications such as geothermal and biomass energy for heating. These new RE applications can replace the conventional coal-fired boilers and help address severe local air pollution especially in northern China. In Gansu, Inner Mongolia, and northeast China, where curtailment rates are high, electric 8 Most battery storage systems deployed today involve only one of three main applications: energy shifting to reduce electricity charges, providing backup power, or increasing solar PV self-consumption. Some pilot applications provide ancillary services to the grid. 9 Data collected from 14 enterprises in their investment of battery storage in 2017 and 2018 showed that: (a) 10 SMEs invested a total of US$ 361 million, of which bank loans were only US$ 2.1 million and (b) four SOEs invested a total of US$ 204 million, of which bank loans were US$ 75 million. On average, the share of bank loans in total investment was only about 1 percent for SMEs and 37 percent for SOEs, much lower than the normal practice of about 70–80 percent for conventional power projects in China. 10 ESCO Committee of China Energy Conservation Association, January 2019. Page 6 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) heating supply is also being piloted to increase power generation from existing wind farms to meet heating demand and replace coal-fired boilers. The sustainability of this pilot has been raised and such solutions are being promoted by government authorities at different levels. Other emerging RE applications such as for hydrogen production have the potential to grow in coming years if technically proven and commercially accepted by the market. Access to financing by SMEs, however, remains one of the key barriers for scaling up such new RE applications. World Bank Group Engagement in Creating and Expanding Markets for RE Development 12. The World Bank has been supporting RE development in China for over two decades as a trusted partner. This support has covered: (a) market diagnostics and assessments; (b) definition of policy and institutional reforms; (c) piloting the deployment of projects investment to demonstrate the technology, economics and financial viability of renewable generation; (d) shaping the creation and development of markets for wind power, solar PV and biomass based power generation; (e) establishing technical standards, testing/certification processes and laboratories; and (f) knowledge exchange between China and other developed and developing countries. This World Bank support has been delivered with Global Environment Facility (GEF) and Energy Sector Management Assistance Program (ESMAP) funded projects/programs. These include: (a) the Renewable Energy Development Project (REDP – 1999-2007, for IBRD loan US$13 million and GEF grant US$27 million); (b) the China Renewable Energy Scale-up Program Phase 1 (CRESP 1 – 2005-2010, for IBRD loan US$173.33 million and GEF grant US$40.22 million); (c) the China Renewable Energy Scale-up Program Phase 2 (CRESP 2 – 2013-2020, for GEF grant US$27.28 million); (d) the forthcoming GEF China Distributed Renewable Energy Scale-up Project (CDRESP, approved in May 2019 for GEF grant US$7.28 million); and (e) support for demonstration investments in wind power, biomass and solar PV across China, including Chongming and Nanhui wind farms in Shanghai under REDP; Pingtan wind farm in Fujian, Rudong biomass power in Jiangsu, Huitengxile wind farm in Inner Mongolia, rehabilitation of 16 existing small hydropower in Zhejiang under CRESP 1; and Beijing Rooftop Solar PV Scale-up Project (2013-2019, for IBRD loan US$105 million). 13. Grant-financed activities are under way to strengthen policy and institutions to create an enabling environment for battery storage. Both the ongoing CRESP 2 (2013–2020) and forthcoming CDRESP (2019–2023), financed by the GEF with China’s National Energy Administration (NEA) as the implementing agency, support the development of required policies, regulations, and pricing or incentive mechanisms for renewable energy development, with different focuses. CRESP 2 focuses on the sustained growth of RE through improving RE efficiency and reducing incremental costs of RE for its sustainable development over the medium and long term to enable the commercial operation of RE. The CDRESP aims to promote the scale-up of DRE through supporting policies and regulations and pilots of innovative applications of DRE. Together, these two GEF-funded projects will help create the enabling policy and regulatory environment for RE, DRE, and particularly battery storage. The proposed Renewable Energy and Battery Storage Promotion Project will create and expand the market to identify and prepare bankable projects, test viable business models, and leverage both equity and commercial debt financing for both battery storage applications in power systems and innovative RE applications. 14. The World Bank has a successful track record in supporting commercial banks in China to establish and strengthen their clean energy financing business lines. The proposed Renewable Energy and Battery Storage Promotion Project will build upon these capabilities and skills and apply them to create and expand the market for battery storage. The World Bank has supported three commercial banks Page 7 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) (Huaxia Bank, China Export-Import Bank, and Minsheng Bank) to finance EE at the national level, and two banks (Shanghai Pudong Development Bank and Bank of Shanghai) to finance EE investments/upgrades in buildings at the municipal level. While all these financial intermediaries have performed well, only Huaxia Bank created a specialized Green Finance Center (GFC) to solely focus on green and emerging innovative technologies financing. Following a market review conducted during project preparation, the financial intermediary approach was chosen because it can expand the nascent markets for both battery storage and innovative RE applications by SMEs. As noted earlier, these enterprises have been financing the first batch of battery storage investments at the level of distribution grids and customer applications using largely their own equity. Huaxia Bank was selected as it: (a) has a good track-record of building innovative new business lines in the clean energy and green-financing space; (b) has national reach in all provinces with a good client relationships with a wide network of SMEs and SOEs; (c) has shown the capacity to enter markets that are perceived by other banks to be risky; (d) has committed significant counterpart financing of US$450 million to expand China’s battery storage market in partnership with the World Bank; and (e) has demonstrated a willingness to share knowledge and experience with other market players that is critical to creating a market. 15. The International Finance Corporation (IFC) has invested in selected battery storage manufacturers in China but is less interested in providing commercial loans to battery storage investment projects at this early stage of development. A recent IFC study concluded that battery storage deployment in emerging markets is expected to grow substantially over coming decades and will open new markets and offer tremendous opportunities for the private sector. To date, IFC has engaged in early-stage venture capital investments in battery manufacture, aiming to invest in capable manufactures and get high return on equity investment.11 Current barriers, however, prevent IFC from providing commercial loans to specific types of battery storage investment projects. IFC considers that the current cost of battery storage is still relatively high and restricts access to affordable financing. Innovative investment mechanisms, in coordination with improved industry standards and stronger support from the Government, are needed to unlock the transformative potential of battery storage. C. Relevance to Higher Level Objectives 16. The proposed project is consistent with the strategic themes of the World Bank Group’s Country Partnership Strategy for China, discussed by the World Bank Board of Executive Directors in November 2012, and with the Performance and Learning Review, discussed by the Board in February 2016. The proposed project strengthens the policy and institutional framework for greener growth and clean energy. A new Country Partnership Framework (CPF), which is expected to be presented to the Board in early fiscal year 2020, will reflect a reorientation to a more strategic and selective World Bank Group engagement, consistent with China’s 19th Party Congress priorities and with the World Bank Group capital package policy commitments. As part of the preparation process for the new CPF, the World Bank Group country team and Chinese authorities jointly reviewed the lending pipeline and removed projects that did not sufficiently align with the capital increase policy commitments, which emphasize “strengthening policies and institutions required for sustainable IBRD graduation.” The proposed project was maintained in the pipeline because it is consistent with the interlinked dimensions of clean energy transition in China 11Some of IFC’s noteworthy investments include: (a) Microvast, a China-based manufacturer of especially fast-charging lithium- ion batteries; (b) Fluidic Energy, a manufacturer of zinc-air batteries used to power telecom towers; and (c) AST from India which deploys PV solar plus batteries to power telecom towers. Page 8 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) that could benefit from the World Bank’s global expertise, with the potential for replication in other countries. These are: (a) development of an enabling environment to support power sector reforms; (b) design of new policies and regulations and financing of pilot projects to promote emerging innovative technologies; and (c) support for the design and piloting of innovative financing mechanisms to leverage commercial banking and crowd in private investors and developers. In addition, the World Bank will help further disseminate China’s successful experiences in scaling up and mainstreaming clean energy. 17. The proposed project also contributes to the World Bank Group’s global priorities in climate finance, clean energy, and batteries. The proposed project would contribute to the World Bank Group’s climate targets, announced in December 2018, to provide around US$200 billion over 2021–2025 in support of countries to take ambitious climate action. Climate action is also a key motivation for the World Bank Group’s ‘Accelerating Battery Storage for Development’ initiative. 12 This includes a commitment of US$1 billion in World Bank Group financing with an extra US$1 billion to be raised in concessional climate funds through channels such as the Climate Investment Funds’ Clean Technology Fund and at least another US$3 billion to be mobilized from the public and private sectors. 18. The World Bank’s program intends to accelerate the deployment of sustainable battery technologies in developing countries by supporting battery investments, policies that monetize the full value of batteries, and recycling practices and standards that favor environmentally friendly technologies. The initiative will convene a global Energy Storage Partnership bringing together national laboratories, research institutions, development agencies, and philanthropic bodies to foster international technological cooperation and training. The partnership will develop and adapt new storage solutions tailored to the needs and conditions of developing countries. The proposed project aligns with this initiative in substance and timing, and with the global program emphasis on safeguarding public benefits. II. PROJECT DESCRIPTION A. Project Development Objective (PDO) PDO Statement 19. The PDO is to promote the integration and use of renewable energy through the deployment of battery storage systems and innovative applications of renewable energy. PDO-Level Indicators 20. The proposed PDO-level indicators are as follows: • Increase in RE absorption by the grids (GWh/year) • Increase in RE use from innovative applications (GWh/year) • Reduction in GHG emissions (Metric ton /year) 12 http://www.worldbank.org/en/news/feature/2018/09/26/powering-new-markets-for-battery-storage Page 9 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) 21. Intermediate project indicators are as follows: • Installed capacity of battery storage systems (Megawatt hours, MWh) • Installed capacity of DRE (Megawatt, MW) • Co-financing leverage ratio (multiples of IBRD loan amount, Number) • Beneficiary satisfaction (scale of 1–5, Number) • Quality of subloan portfolio to SMEs (non-performing loans level, Percentage) 22. Definitions and values for all the above indicators are provided in Section VI. B. Project Components 23. The proposed project comprises an investment component, with an IBRD loan of US$300 million and co-financing from Huaxia Bank of about US$450 million, to support the expansion of financing for battery storage systems and innovative RE applications. The investment component will be implemented by Huaxia Bank. In parallel, technical assistance (TA) will be provided to Huaxia Bank and NEA through on-going GEF-financed projects and through support from ESMAP. In the event that funding for these activities from the parallel operations does not materialize, Huaxia Bank has agreed to use their own funds to cover them. 24. Investment component. The proposed project will principally support the installation of battery storage systems and innovative RE applications. The investments to be financed by sub-loans from Huaxia Bank to sub-borrowers would include: (a) battery storage systems to be installed: at the generation level in existing wind farms and solar PV plants; at the grid level in existing substations; and, at the consumer level such as in industrial and commercial zones; (b) installation of DRE capacity with battery storage; and (c) scale-up of innovative RE applications such as RE for heating (geothermal and biomass) and for hydrogen production. The main application of battery storage in power systems are illustrated in Figure 3, and details of all types of investment subprojects are described in Annex 3. 25. The attributes of battery storage that are particularly important in grid applications are duration, responsiveness, safety, recyclability, operability, robustness, and low toxicity. Research13 has confirmed that there is a significant market potential as well as investors seeking to invest in these technologies. Huaxia Bank and the World Bank have carried out a market sounding, consulted with potential investors, and identified a number of prospective subprojects that could be proposed for financing. 13Both international agencies (for example IRENA and Bloomberg) and local industrial associations have projected the potential market growth of battery storage in China. The China Industrial Association of Power Sources estimates that total installed capacity of battery storage could amount to 24 GW by 2025, with associated investments of over US$ 15 billion. Page 10 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Figure 3. Application of Battery Storage in Power Systems Source: World Bank staff. 26. The project’s Operations Manual (OM) defines the technical, financial, environmental and social (E&S) eligibility criteria for subprojects to be considered, as well as requirements on due diligence, procedures for appraisal of subprojects in line with World Bank requirements. These include, but are not limited to, procurement, financial management, safeguard procedures, and monitoring and evaluation (M&E). Sub-borrower selection criteria are also defined in the OM, including creditworthiness, technical competence, and a track record in the targeted types of project investments. 27. Two forms of support are being provided and implemented in parallel with the proposed project: (a) technical assistance to build proper due-diligence and implementation capabilities within Huaxia Bank; and (b) development of policy, regulations, and standards to create the institutional frameworks needed for market creation and development for battery storage systems. 28. Technical assistance is needed to build due-diligence and implementation capabilities within Huaxia Bank. This TA will include: (a) expert advice on subproject appraisal and evaluation with special focus on technical and safeguards issues; and (b) market survey studies, training, and expert advice to strengthen Huaxia Bank’s technical capabilities (Table 1). The TA is expected to be financed by about US$ 1.5 million from ESMAP, and additional funding sources will be explored. These funds are expected to be secured in the second half of 2019 and would allow these critical activities to be undertaken in parallel with the proposed project. In the event that funding for these activities from the parallel operations does not materialize, Huaxia Bank has agreed to use their own funds to cover them. Table 1. TA Activities and Proposed Budget Allocation Cost Estimation Types Activities (US$$ million) Due Diligence of Investment Subprojects Support from institutions on technical evaluation, E&S 0.40 management, M&E, and auditing Page 11 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Cost Estimation Types Activities (US$$ million) Experts support (technical, safeguards, and fiduciary) 0.60 Subtotal 1.00 Capacity Building for Huaxia Bank Studies and market survey 0.15 Training on battery storage 0.25 Consultations with potential sub-borrowers for business 0.05 development Lessons learned and dissemination 0.05 Subtotal 0.50 Total 1.50 29. Policy and institutional strengthening for battery storage applications. During preparation of the proposed project, NEA and the World Bank identified gaps in policy, regulations, and standards, and agreed to fund the work required to address these gaps in parallel with the proposed project. These activities (see Table 2) aim to create the required enabling environment for scaling up the deployment of battery storage and DRE through support from the ongoing GEF-financed CRESP 2 and CDRESP projects, which NEA is responsible for implementing. The proposed activities are critical not only for RE under the proposed project but also to scale up centralized and distributed RE under the two GEF-financed projects. Building on synergies among CRESP 2, CDRESP, and the proposed project, the corresponding activities will be implemented through NEA’s existing project management office (PMO) to coordinate and collaborate with relevant government agencies. The policy and institutional strengthening activities will be funded with about US$2.0 million of GEF grant from the ongoing CRESP 2 and GEF CDRESP projects. Table 2. Policy and Institutional Strengthening Activities and Budget Allocation Cost Estimation Type of Activities Description Funding Source (US$ million) Policies and regulations Development of policies and regulations to CDRESP 0.50 development address the grid access, pricing, and planning issues Technical and Standards on battery safety, reuse, and CDRESP 1.00 environmental standards disposal System operation Modeling system operation with the CRESP 2 0.15 guidelines with storage application of battery storage to serve for efficient dispatch Pilot of innovative use of Battery storage and other emerging CRESP 2 0.35 storage innovative storage technologies Total 2.00 C. Project Beneficiaries 30. The project’s main beneficiaries would be small and medium enterprises, which are key to the creation and expansion of markets for battery storage. Most SMEs in China are privately owned or in some cases owned by local governments. These SMEs do not have the same access to financing as established and well-connected state-owned enterprises, both in terms of cost and tenure of debt, as well Page 12 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) as the general willingness of many banks to lend to them. Much of the term financing in China is provided by large state-owned commercial banks that tend to prefer lending to large state-owned enterprises due to their perceived creditworthiness. This difference in access to financing has been recognized by the Government, and steps are being taken to address such constraints faced by SMEs. The proposed project also seeks to address this constraint. The project will also benefit Huaxia Bank by strengthening and expanding its green growth business lines to expand their business in both battery storage and innovative RE applications. Other beneficiaries include: (a) economic agents in the sector value chain including project developers, investors, utilities, equipment manufacturers and related service suppliers; (b) resident populations of the project areas where storage, DRE and innovative RE applications from cleaner energy use and reduction in local pollution; and (c) the global community from the reduction in GHG emissions and climate change mitigation. D. Results Chain 31. The proposed project focuses on financing for battery storage and innovative RE applications, while the parallel GEF-financed operations focus on implementation support and creation of an enabling policy environment. These activities contribute jointly to the achievement of project outcomes, including: (a) climate change mitigation; (b) innovation and knowledge sharing with global society; (c) sustainable development of battery storage globally to improve energy service; and (d) increased job opportunities. The results chain of the proposed project and associated activities in the parallel operations is illustrated in Figure 4. Figure 4. Results Chain of the Proposed Project Source: World Bank staff. Page 13 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) E. Rationale for Bank Involvement and Role of Partners 32. The World Bank has been a key partner with the Government of China in creating markets, regulations and standards for renewable energy technologies. The World Bank has supported the adoption and scale-up of RE technologies in China, such as wind, solar PV and biomass energy over the last two decades. Battery storage technologies are an important disrupter of power markets and enable increased integration and use of RE. The World Bank’s involvement seeks to transform battery storage markets in China, which are still at a nascent stage, through a combination of – investment support to demonstrate commercial viability of utility-scale applications at different levels (generation, grid and consumer-level) – as well as technical assistance and expertise to develop the policy framework, skills and capabilities of the market intermediaries. This would be a continuation of the World Bank’s role of bringing good international practices, business models and technological solutions to support the clean energy transition in China. F. Lessons Learned and Reflected in the Project Design 33. The principal experience-based success factors of market diagnosis and understanding, choosing implementation partners with execution capabilities and adequacy of policy development support were fundamental to the project design. (a) Market Research and Analysis – Experience with the World Bank’s successive engagements in helping introduce new technologies, delivery models and create markets at commercial scale, have shown that an adequate understanding of the local conditions and market is fundamental to designing interventions that are fit for purpose. Research on understanding of market constraints and needs, undertaken with World Bank support, includes: (a) consultations with the first movers (mainly SMEs) in battery storage on their lessons and views on the battery storage market; (b) working with NEA to conduct gap assessment study and consultation workshops; (c) assessment of Huaxia Bank’s commitment in green financing, especially the new battery storage market; and (d) research on the global development of battery storage. (b) Choice of Implementing Agency/Partner – Having a partner who is committed to the objectives of the project and has the requisite execution capabilities is another key success factor. The proposed project builds upon a sustained and successful partnership between the World Bank and Huaxia Bank. Recent collaboration with Huaxia has included two projects in the areas of EE and air pollution control: the China Energy Efficiency Financing Project (CHEEF), which was closed in 2016 with successful results, and the ongoing Innovative Financing for Air Pollution Control in Jing-Jin-Ji Program for Result Project (JJJ PforR). During the implementation of these projects, Huaxia Bank has exhibited the required qualifications to implement the operation and deliver results. These qualifications include: (a) shared vision on and commitment to future battery storage development; (b) proven track record and experience in clean energy financing; (c) strong management commitment; (d) qualified staff and dedicated teams; (e) internal organization conducive to making deals flow and managing risks; (f) existing nationwide client base; (g) demonstrated ability to generate solid green project pipelines; and (h) a good understanding and enforcement of World Bank procedures and policies. Page 14 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) (c) Adequacy of Technical Assistance for Policy and Implementation Support -- Previous World Bank engagements in clean energy deployment and scale-up in China confirm the value of having parallel/coordinated TA support. A coordinated set of institutional development and capacity- building tasks should be incorporated into the project to pursue the regulatory reforms and overcome the market resistance faced by battery storage technologies. As the implementing agency of the parallel GEF grant-funded activities, NEA has played a key role in convening and consulting with other concerned agencies and actors in the sector, and capacity-building activities are incorporated into the project design. III. IMPLEMENTATION ARRANGEMENTS A. Institutional and Implementation Arrangements 34. Huaxia Bank will be the project implementing agency. It has established, under its Corporate Business Department, a Green Finance Center to be responsible for the daily management of project implementation. A Green Finance Steering Committee will be established within Huaxia Bank to plan and guide the development of the green financing business of Huaxia Bank and coordinate the business cooperation among relevant departments. The GFC is the line department within Huaxia Bank to organize marketing of green finance business in Huaxia Bank and is the PMO to implement the World Bank projects. Huaxia Bank commits to build and improve its own capacity on both technical aspects and E&S management of the investment subprojects and will expand this practice to its other green finance business lines. External assistance will be provided as required, especially for technical review and to ensure compliance with safeguards requirements. 35. Huaxia Bank will onlend the IBRD loan to eligible final borrowers on commercial terms. The terms will be determined based on Huaxia’s risk assessment of both the sub-borrowers and investment subprojects. Given the risks associated with emerging markets, especially battery storage, TA activities have been agreed and funding sources are expected to be confirmed in the second half of 2019 to support Huaxia Bank in capacity building, business development, and due diligence review of all investment subprojects, following the requirements of the OM. 36. In the OM, details of business development, review processes within Huaxia Bank, contracting, fund management, and reporting have been defined, as well as both the technical and financial criteria to select investment subprojects. Subprojects selection criteria cover: (a) technology and technical standards and soundness; (b) cost-effectiveness; (c) contribution to RE integration; and (d) E&S requirements. Sub-borrower selection criteria are also included in the OM, including creditworthiness, technical competence, and track record in the targeted types of project investments. B. M&E of Results 37. Monitoring of the implementation of the proposed project will involve the evaluation of performance indicators as included in the Results Framework. Huaxia Bank will be responsible for monitoring project implementation and the World Bank will supervise accordingly. For investment subprojects, information to be collected and major indicators to be calculated or evaluated have been Page 15 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) included in the OM. Huaxia Bank will prepare due diligence reports to estimate the actual results of project indicators, and report on these in: (a) annual progress reports; (b) a mid-term review of implementation progress; and (c) an implementation completion report. The M&E system will cover all listed project indicators and will also collect available data on gender equality (mainly employment of women) under the investment subprojects. C. Sustainability 38. There is a high likelihood that the proposed project will be sustainable. China’s decision makers are paying close attention to reducing RE curtailment while system operators, investors, and service providers are committed to increasing the utilization of RE assets. Investors and service providers have demonstrated their interest in developing battery storage despite the risks stemming from the weak policy and regulatory environment as they expect that important investment opportunities will materialize as policies and regulations are developed, and costs continue to decrease, as forecast by most reputable international organizations. Huaxia Bank is likely to increase its support to the sector through the Green Finance Center, created after its earlier cooperation with the World Bank to sustain investment in EE and RE. IV. PROJECT APPRAISAL SUMMARY A. Technical, Economic and Financial Analysis Technical Analysis 39. Huaxia Bank will undertake technical due diligence of each investment subproject and ensure that the subprojects (a) comply with Chinese policies, regulations, and technical and environmental standards, particularly safe operation and battery disposal requirements; and (b) fully satisfy the technical eligibility criteria. Capacity building will be provided to Huaxia Bank during project implementation and technical experts will be hired under the arranged parallel TA activities to support Huaxia Bank in the technical assessment of investment subprojects and provide the necessary technical training. These requirements have been included in the OM. 40. The technical criteria for each type of investment subprojects, as defined in the Operations Manual, have been reviewed by the World Bank and are considered appropriate. The latest developments of different supported technologies supported under the proposed project, including battery storage, have been taken into consideration to define the technical criteria, based on the consultations with industrial technical experts. Proven technologies are considered for each type of investment subprojects. Parallel TA activities are considered to provide technical support to Huaxia Bank in conducting the required technical review of the soundness of the mentioned technologies. Economic Analysis 41. Analyses were carried out at the national level to examine whether investments in battery storage systems are economically justified, followed by cost-benefit analyses of each type of sample Page 16 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) investment subprojects. The evaluation of battery storage investment was based on installing 8 GW/32 GWh of battery storage systems in China (1 GW/4 GWh in each of the eight regional/provincial power systems) to assess their impact on increased RE dispatched (defined as a project indicator ‘Increase in RE Absorption’) and associated reduction in GHG (CO2) emissions. Other expected benefits of installing battery storage systems were also considered in the evaluation. The evaluation of innovative RE applications was based on cost-benefit analysis of sample investment subprojects. Lastly, an aggregated economic internal rate of return (EIRR) of the proposed project was estimated. Methodology to Quantify Increase in RE Absorption Contributed by Battery Storage 42. The proposed project is designed to promote grid integration and increase the use of renewable energy to reduce GHG emissions. The increased RE use will stem from improved RE integration through investment in battery storage in power systems and promotion of innovative RE applications. The climate change PDO indicator– reduction in GHG emissions– requires the calculation of increased RE dispatched (labeled as ‘Increase in RE Absorption’) in power systems and increased RE use from innovative RE applications. The latter is straightforward, as it can be calculated as the sum of additional RE consumption, metered at the subprojects level, but the former requires an estimation of incremental RE dispatched due to installation of battery storage systems. 43. In the study conducted at the national level, the China power system is divided into eight regions to estimate the incremental RE absorption, defined as the difference of RE dispatched in simulations of ‘with’ and ‘without’ battery storage cases. The simulations were conducted using an hourly production simulation model. The model has been used to support the State Grid Corporation to conduct the 2017 and 2018 annual review of RE integration in China and to support NEA in its studies to analyze RE integration in China. Reduction in CO2 emissions can be derived by applying regional carbon emission factors to the ‘Increase in RE Absorption’ resulting from battery storage. 44. The national-level study concluded that installing 8 GW/32 GWh battery storage systems in China could (a) increase RE absorption by 4,620 GWh annually; (b) reduce CO2 emissions by 3.8 million tons annually; and (c) reduce coal consumption by 1.42 mtce annually (Table 3). The average utilization capacity factor of battery storage was about 40 percent, while the installation of 1 GWh of battery storage could contribute to about 144 GWh increase in RE absorption annually. Table 3. Summary Results of the Economic Analysis for National-Level Battery Storage Study Annual Value Type Benefits (US$ million) Installed capacity of battery storage 32 GWh n.a. Increase in RE absorption (annual) 4,620 GWh n.a. Fuel saving (annual) 1.42 mtce 175.2 Reduction in CO2 emission (annual) 3.8 million tons 189.4 Energy shifting benefit (annual) 9,679 GWh (charging)/8,705 GWh (release) 841.3 Ancillary service benefit (annual) US$ 42.1/kW-year 336.9 EIRR — 8.8% Page 17 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Cost-Benefit Analysis 45. Cost-benefit analysis was used to estimate the EIRR from installing 8 GW/32 GWh battery storage systems at the national level. The costs include both capital investments and operational costs, while the benefits include: (a) reduction in CO2 emissions due to an increase in RE absorption; (b) fuel saving due to replacement of coal-fired power generation by increased RE absorption/generation; (c) energy shifting from off-peak to peak hours; and (d) provision of ancillary service. Taxes and duties are excluded in the calculation. Potential savings on transmission investment are not counted in the analysis. 46. In addition to the benefits of increased RE absorption and its associated benefits of fuel saving and CO2 emission reduction, other benefits were also estimated: (a) energy shifting, and (b) provision of ancillary service. With energy shifting, the electricity can be charged during off-peak periods and released during peaking time. Time-of-day tariffs in each region/province are applied to determine the electricity values to the systems at different periods of a day.14 The value of ancillary service is based on a recent study, carried out by Xi’an Jiaotong University, to assess the dynamic benefits of pumped storage in Zhejiang Province, including ancillary services. The results of this study are adopted as a proxy to estimate the value of ancillary service provided by battery storage. The two benefits were estimated at an annual US$841.3 million and US$336.9 million, respectively, from installation of 8 GW/32 GWh battery storage systems across China. 47. Based on the analysis, the EIRR of battery storage investments was estimated at 8.8 percent, higher than the social discount rate of 8 percent which is adopted in China as benchmark for infrastructure investment projects. So the project is economically justified given the conservatively estimated values of GHG emission reduction and air pollution and significant demonstration value of the project. Details of key assumptions considered are provided in Annex 4. 48. A sensitivity analysis demonstrates that the economic justification on battery investments is robust to plausible variations of key parameters. Sensitivity analysis was conducted with: (a) cost reduction of battery storage by 15 percent; (b) an increase in the average utilization capacity factor for battery storage from 40 percent to 70 percent; (c) no consideration of energy shifting benefit for battery storage at the generation level; (d) reduction of benefit of ancillary service by one-half; and (e) adoption of high values of CO2 shadow prices as indicated in the World Bank’s guidance note. The cost reduction and increase in the utilization capacity factor for battery storage, and adoption of high values of CO2 shadow prices will raise the EIRR to 12.6, 13.1 and 11.8 percent, respectively, while changes to other parameters will reduce the EIRR to 6.1–6.6 percent. 49. A cost-benefit analysis was also used to estimate the weighted EIRR of the whole investment project, including both battery storage and innovative RE applications. Based on (a) the fund allocation to each type of investment subprojects that was agreed with Huaxia Bank; and (b) cost-benefit analyses undertaken for each type of sample investment subprojects, the weighted average results were calculated to evaluate the economic justification of the project. The costs include both capital investments and operational costs, while the benefits vary by project types and are mainly: (a) carbon emission reduction 14It should be noted that battery storage to be installed at the generation level could be used mainly to adjust the outputs of RE to adapt to the grid needs so RE curtailment could be reduced. Under such a case, the energy shifting benefit could be reduced or not counted. Page 18 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) for all types of subprojects; (b) values of both energy shifting and ancillary service for battery storage projects; and (c) sales of products or service for subprojects of innovative RE applications. The EIRR of the whole project was estimated at 12.5 percent. The net present value (NPV) of the project was estimated at US$1,036 million, discounted at a rate of 8 percent. The NPV of the project benefits was estimated at US$1,404 million, of which carbon reduction contributes to 25 percent of total project benefits. Financial Analysis 50. The financial analysis was conducted for each type of sample investment subprojects. Cash flow analysis was undertaken to estimate the financial internal rates of return (FIRRs) for each type of sample investment subprojects to check its financial viability (Table 4). The FIRRs were estimated at 4.0–8.3 percent for different types of sample investment subprojects. Given that all the investment subprojects involve emerging innovative applications of battery storage in the power systems, investors are testing the market to gain knowledge and prepare for the long term as they are expecting substantial cost reductions on battery storage and a more stable policy and regulatory framework. From the consultations during the project preparation, the investors were not seeking high returns on their equity at this early stage. The FIRRs on investment in battery storage are considered as acceptable by the investors. Huaxia Bank commits to expand its support in green finance business and has included the battery storage and innovative RE applications in engagement strategy. Huaxia Bank anticipated higher financial returns of the subprojects, with the cost reduction and their anticipated policy support. Table 4. Summary Results of the Financial Analysis Type of Investment Subproject FIRR (%) Storage at generation level 4.8 Storage at grid level 5.5 Storage at consumer level 4.8 DRE with storage 8.3 RE for heating (geothermal, biomass) 4.0–8.1 RE for Hydrogen 7.5 Financial Due Diligence of Huaxia Bank 51. The financial due diligence review finds that, in principle, Huaxia Bank is qualified to act as the financial intermediary under the proposed project in terms of corporate governance structure, operational capacity, risk identification and management, financial soundness, and commitment to and experience in green finance. Huaxia Bank is, however, experiencing rising non-performing loan (NPL) numbers. A couple of substantial financial risks that have implementation implications have been identified. The first risk is a lack of bankable subprojects due to the uncertainties of the main target market (battery storage) and increased foreign exchange rate volatility (in relation to foreign currency denominated loans). The second risk, according to Huaxia Bank, is that battery storage projects have a lower yield (internal rate of return) than projects in the more developed RE markets such as solar PV. The second risk could increase the pressure on Huaxia Bank’s profit margin. Risk mitigation has been considered in the project design: (a) parallel operations are included to establish an enabling policy Page 19 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) environment for battery storage, and TA is planned to improve Huaxia Bank’s capacity in market development and due diligence; and (b) an OM has been prepared to define clear selection criteria for investment subprojects. Considering these mitigation features in project design and Huaxia Bank’s increased risk management capacities, the risks are manageable. The financial due diligence of Huaxia Bank has been reviewed and confirmed by the Bank’s Finance, Competitiveness and Innovation Global Practice. B. Fiduciary Financial Management 52. Huaxia Bank is the implementing agency of the operation as a financial intermediary, which will onlend the project funds at market rates to commercial enterprises for financing of eligible subprojects in accordance with Huaxia’s existing institutional arrangements, lending practices, eligibility criteria, fiduciary arrangements, and governance and risk controls procedures, as defined in the OM. Huaxia Bank will be responsible for repayment of the loan to the Government and will also assume all financial risks. The Green Finance Center has accumulated extensive experience with World Bank operations from the CHEEF project and the JJJ PforR project. Huaxia Bank will continue to: (a) take primary responsibility in marketing and developing the pipeline of investment subprojects under the proposed project; (b) appraise and approve potential subprojects against eligibility criteria outlined in the OM; (c) provide day-to-day project-related disbursement and financial management, including accounting and financial reporting; and (d) coordinate with the World Bank. A Designated Account (DA) will be opened and maintained by Huaxia Bank for advance deposits withdrawn from the IBRD loan account. 53. Huaxia Bank has demonstrated capacity and experience with the World Bank’s operations. It fully disbursed IBRD funds under the CHEEF project, and its fiduciary performance under the CHEEF project and the ongoing JJJ PforR project was satisfactory. Huaxia has adequate systems in place for oversight, appraisal, and supervision of subprojects to avoid misuse of the loan and to reduce the risk of NPLs. For subproject loan appraisal, Huaxia Bank will assess the reasonableness of cost estimates and the capacity of the sub-borrowers to implement the subprojects, including their financial management and procurement capacity. The financial management assessment, therefore, found that Huaxia’s fiduciary system can meet the World Bank’s requirements, and the fiduciary risk is rated ‘Moderate’. Procurement 54. The World Bank loan will be used by the sub-borrowers for the procurement of works, goods, non-consulting services, and consulting services. The major procurement activities under the project are described in the OM, and most of the procurement will be done through a competitive bidding process. The procurement capacity assessment (PCA) of Huaxia Bank identified that the company had accumulated rich experience in serving as the financial intermediary for previous World Bank-financed projects. The successful implementation of the earlier projects demonstrated that the company had adequate knowledge and expertise to implement the project. Moreover, the capacity-building activities would be prepared to assist Huaxia Bank to further improve its capabilities to manage the procurement activities. Under such circumstances, the procurement risk is rated ‘Moderate’. Page 20 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) 55. Advance contracting is considered for the project. Huaxia Bank could sign contracts to finance eligible investment subprojects on or after May 15, 2019, following the requirements in the agreed OM, and get the funds reimbursed from the World Bank. C. Legal Operational Policies Triggered? Projects on International Waterways OP 7.50 No Projects in Disputed Areas OP 7.60 No D. Environmental and Social (E&S) 56. The proposed project will bring positive environmental benefits, including the improvements in energy resilience and efficiency and reduced CO2 emissions through the integration of more clean electricity from renewable sources. At the same time, potential negative environmental impacts and safety risks are also expected depending on the type and efficiency of battery storage technology to be adopted and the effectiveness of implemented E&S management measures. 57. To better understand potential safeguards risks associated with proposed investments through Huaxia Bank, E&S due diligence has been conducted for the project during preparation. This covers the review of the existing Chinese legal framework, overall E&S performance of existing battery storage projects in China and their primary suppliers (battery producers and recyclers), and Huaxia Bank’s current ESMS and E&S performance. Based on project characteristics and the key findings of E&S diligence, ESS1 (Assessment and Management of Environmental and Social Risks and Impacts), ESS2 (Labor and Working Conditions), ESS3 (Resource Efficiency and Pollution Prevention and Management), ESS4 (Community Health and Safety), ESS5 (Land Acquisition, Restrictions on Land Use and Involuntary Resettlement), ESS7 (Indigenous Peoples/Sub-Saharan African Historically Underserved Traditional Local Communities), ESS9 (Financial Intermediaries), and ESS10 (Stakeholder Engagement and Information Disclosure) are deemed relevant to the project and the relevance of ESS6 (Biodiversity Conservation and Sustainable Management of Living Natural Resources) and ESS8 (Cultural Heritage) remains to be determined upon subproject identification during implementation. The assessment of ESS relevance and proposed mitigation measures are summarized below. 58. The proposed subprojects (mostly battery storage projects to be installed within existing facilities) are not complex and have small footprints. The environmental risks anticipated are mainly fire and explosion risks during operation and environmental hazards related to the disposal of used batteries containing hazardous waste. Although the existing battery storage projects visited during E&S due diligence have shown appropriate and sufficient safety management in full compliance with applicable national laws and regulations, the environmental risk for the project is still rated as substantial given the need for further development of battery recycling facilities and supportive technical standards to enhance safety and environmental management of the emerging battery storage industry in China, particularly among new and inexperienced SMEs and individuals. 59. Most installations will be smaller than existing premises and will be implemented within existing footprints or the perimeters of existing facilities (such as power generation facilities, substations, or Page 21 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) consumers' buildings/sites). Potential displacement impact, direct adverse impact on ethnic minorities, risks associated with labor and the working conditions of construction workers are considered low risk during the construction period. During operation, community safety risks that are linked to explosion, fire and electric shock will be strictly managed under China’s current regulatory framework and applicable ESSs. A multitude of projects located close to vulnerable communities may give rise to a limited degree of social conflict, harm, human security risk associated with perceptions of community endangerment and nonreceipt of benefits. The social impacts and risks are generally site specific with a low probability of serious effects to people and can be mitigated through strict eligibility criteria of subprojects, as well as enforcement of culturally appropriate stakeholder engagement and appropriate standards and regulations. 60. As the primary suppliers, battery manufacturers and recycling/disposal service providers play important roles in the management of E&S risks and impacts. According to the investigation, major battery producers and recycling enterprises have set and implemented high-level safety and environmental standards for their own long-term sustainable development in the sector, however, it was also found that there were still unsound “backyard” recyclers targeting used lead-acid batteries, and qualified recycling/disposal facilities are still to be developed for lithium batteries before their decommissioning from the first battery storage project in China (approximately around 2025). 61. In this context, the strict exclusion list and screening procedures established for the project under ESMS require that sub-borrowers are only eligible for sub-loans if they commit to the use of certified and licensed entities for battery collection, recycling and disposal. In addition, the TA activities in parallel with the project have been proposed to address E&S concerns associated with battery recycling and disposal through development of policy, regulations, technical and environmental standards. During project implementation, it is also anticipated that more stringent technology-specific environmental and safety standards (some currently being developed) and their enforcement will further eliminate disqualified SMEs and individuals from the market if they do not have appropriate technical expertise and oversight. 62. Huaxia Bank is the responsible financial intermediary for implementing the project and has acquired extensive experience on E&S risk management through preceding World Bank and Agence Française de Développement funded projects. Since 2008, Huaxia Bank has started to develop its ESMS system by adopting the World Bank’s safeguards policies and mainstreaming the E&S requirements into the project’s OM. 63. Based on the identified key environmental risks and impacts and current practice, an enhanced ESMS has been developed for Huaxia Bank to assure the project’s alignment with Environmental and Social Framework requirements throughout the subproject’s life cycle, and the Environmental and Social Commitment Plan (ESCP) has specified all the actions to ensure E&S management capacity and ESMS implementation. In addition, part of the grant-financed TA activities in parallel with this project is also designed to support Huaxia Bank to further strengthen internal and external expertise and capacity on E&S management. 64. Following the ESMS procedure, all subprojects will be firstly screened against the exclusion list and assessed for their E&S risks and impacts prior to financing under this project. Any subproject with the potential to have a significant impact on natural habitat and physical cultural resources will be excluded from the project financing following the eligibility criteria. All of the project-supported subprojects will be Page 22 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) prepared and implemented according to national regulations and ESMS requirements. Safeguard documents of subprojects, following the ESMS, will be prepared by the sub-borrowers, disclosed locally, and revised as needed according to the disclosure. The approved documents should be submitted to the Bank for disclosure. Regular clearance of safeguard documents will rest with Huaxia Bank’s in-house safeguards specialists and be subject to spot checks by the Bank as needed. Any subprojects involving potential land acquisition and resettlement; adverse risks or impacts on indigenous peoples; or significant risks or impacts on the environment, community health and safety, labor and working conditions, biodiversity or cultural heritage are to be classified as high risk or substantial risk. High-risk projects will be excluded from the project financing and the sub-projects classified with substantial risk will be subject to the World Bank’s prior review and clearance until Huaxia Bank can demonstrate its capacity to manage safeguard issues on its own. 65. As part of the ESMS, Huaxia Bank has developed a Stakeholder Engagement Plan (SEP) for the project, which is deemed consistent with the requirements of ESS9 and ESS10. The first draft of ESMS and SEP were respectively disclosed on Huaxia Bank’s website (in Chinese) on January 21, 2019 and the World Bank’s external website (in English) on January 22, 2019. Two rounds of consultations on the SEP and ESMS were carried out by Huaxia Bank, respectively in January and February 2019. The revised ESMS (including SEP) and the completed ESCP were disclosed on the World Bank’s website on April 16, 2019 and Huaxia Bank’s website on April 19, 2019. Gender 66. Gender analysis. Nationwide data in China indicates that a gender gap exists between men and women in terms of the longevity of their careers in science and technology fields. Retention of women in Science, Technology, Engineering, and Mathematics (STEM) in China (of which the RE workforce is a part) is a problem. Although over 40 percent of the workforce is female, 30 percent of women in the STEM field abandon it after the first year of employment. A case study, provided by U.S. nonprofit Center for Talent Innovation, shows that 68 percent of female STEM employees in China feel that they are evaluated differently from their male peers and have experienced discrimination, while over 57 percent think that women in the sector would definitely hit a glass ceiling in their careers. In RE specifically, however, a further gap exists in terms of gender specific data and knowledge. There is a need to fill this gap to more concretely understand gender-based employment gaps and women’s experiences in the sector workplace and, therefore, design suitable policies for RE developers to retain and promote female talent. 67. Gender activities. To address the identified gender gaps, a gender assessment will be carried out during the project implementation to collect quantitative and qualitative data from the investment subprojects on the employment and dropout rates and experiences of women in the RE workforce. This assessment will then be used to inform the design of policies that aim to increase the retention and promotion of female talent. These policies will be incorporated by Huaxia Bank into its borrower requirements. To facilitate the assessment, Huaxia Bank will take the following actions: (a) sub-borrowers of the investment subprojects will be required to provide information on the share of female employment in technical and managerial roles in their organizations when they submit their sub-loan application; and (b) Huaxia Bank will arrange training to its staff on international best practices in improving gender equity and will engage its sub-borrowers to improve their awareness. Page 23 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) 68. The proposed actions and interventions to address gender issues are consistent with the World Bank Group’s Gender Strategy 2016–2023. They are not linked to an indicator in the Results Framework and, as such, the project does not meet the World Bank corporate requirements for a gender tag. During implementation and as part of the mid-term review, the World Bank team will monitor and evaluate the implementation of the above measures to identify opportunities to strengthen them as appropriate, including further consultations under the Stakeholder Engagement Action Plan. The World Bank team will include a gender specialist to support Huaxia Bank to improve gender equality in hiring practices and promotion to build a skilled female workforce and increase their numbers in leadership positions of the sector. Beneficiary Engagement 69. The primary beneficiaries of this project will be SMEs and Huaxia Bank, while citizens and the public at large will benefit indirectly. Because of project implementation modality, specific citizens or their groups cannot be identified as project beneficiaries, therefore beneficiary engagement is focused on SMEs under the proposed project. 70. A survey on beneficiaries’ satisfaction, especially SMEs under the proposed project, will be conducted at project closing, focusing on their access to financing from commercial banks and other sources. A project indicator is included to assess the satisfaction level of the SMEs. The indicator will be used to capture beneficiaries’ feedback during implementation, and the result will be publicly disclosed. The requirement is described in detail in the project’s OM. E. Grievance Redress Services 71. Communities and individuals who believe that they are adversely affected by a World Bank supported project may submit complaints to existing project-level grievance redress mechanisms or the World Bank’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address project-related concerns. Project affected communities and individuals may submit their complaint to the World Bank’s independent Inspection Panel which determines whether harm occurred, or could occur, as a result of WB non-compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the World Bank's attention, and the World Bank management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate GRS, please visit http://www.worldbank.org/en/projects-operations/products-and-services/grievance-redress- service. For information on how to submit complaints to the World Bank Inspection Panel, please visit www.inspectionpanel.org. 72. Huaxia Bank has established its own GRS mechanism, and a hotline is provided to the public to handle the complains related to Huaxia Bank’s banking business. Huaxia Bank will maintain and publicize the availability of the grievance mechanism, in a form and substance satisfactory to the World Bank, to hear and determine fairly and in good faith all complaints raised in relation to the project and take all measures necessary to implement the determinations made by such mechanism in a manner satisfactory to the World Bank. Page 24 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) V. KEY RISKS 73. The project’s overall risk is rated High due to the lack of clearly defined sector strategies and policies and risk associated with the implementation of technical assistance activities. Risk factors related to vested interests, technology development, and environmental risks associated with the deployment of battery storage systems and innovative RE applications, are rated Substantial, and other risk factors are rated Moderate or Low. The measures to mitigate these risks and ensure the achievement of the PDO, outlined below, will be established during project implementation. 74. Investment in new areas would require adequate policies and regulations while these are still under review and development. Both battery storage and innovative RE applications are still at the stage of piloting and demonstration, and associated policy, regulation, and standards supports are inadequate and need to be improved to create an enabling environment for investments in battery storage and innovative RE applications. Parallel supports, especially GEF operations, have been considered to focus on policy and regulations to mitigate the associated risks. The piloting of battery storage and innovative RE applications invested under the proposed project will inform the policy and regulatory design as this is the typical process for policy work in China. 75. The technical assistance activities are critical to support the project implementation, but the resources are yet to be secured. Although funds could be available from ESMAP, competitive use for other purposes could reduce the amount of the available fund. In addition, China’s internal procedures to transfer the fund to Huaxia Bank for the planned TA activities need to be clarified with the Ministry of Finance (MoF) before signing the required grant agreement. Using Huaxia Bank’s own fund is also an option in case above funds are not secured, but this is not a preferred option. 76. Opposition from vested interests could have a negative impact on the achievement of the PDO and the likelihood and impact of this opposition could be substantial. Scaling up battery storage involves fundamental changes in operating power systems and in distributing the benefits to key players. Knowledge about battery storage is not yet comprehensive or widespread and associated costs and benefits face significant uncertainties. Large and influential stakeholders include incumbent central power generators, grid operators, and local governments, each of which may variously experience gains and losses from the scale-up of battery storage depending on provincial or regional system-specific conditions and pricing mechanisms. Activities supported under the project and other related activities will mitigate the risk of stakeholders’ opposition by engaging them in the design of a policy and regulation framework, particularly access to grid, system operation and dispatch, pricing mechanisms; and in the selection of subprojects, and directly addressing potential concerns. Continued efforts to coordinate and share knowledge will help reach consensus among stakeholders. 77. Technical risks still exist as battery storage is an emerging global application. Different types of battery storage technologies are at different stages of development. Both lead and lithium technologies are mature and have been widely used although their applications in power systems have just commenced. More types of battery storage technologies are under demonstration and could be commercialized in the coming years; however, it is still too early to tell clearly what technologies will dominate the market. Page 25 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) 78. Battery storage systems carry substantial environmental risks if not addressed properly. Different battery technologies involve materials that pose environmental and safety risks across periods of operation, recycling, and disposal. The risk exposure increases as new or inexperienced SMEs deploy distributed user systems in disparate locations close to people and communities. These can be addressed by enforcement of appropriate standards, strict eligibility criteria of subprojects, and strict safeguard procedures, supported by the technical assistance activities under the parallel operations. 79. Both the financial management and procurement assessment concluded that the fiduciary risk with Huaxia Bank is rated moderate. Huaxia will take the same role as in prior World Bank projects to onlend the World Bank loan to the sub-borrowers selected following commercial practice and based on credit control procedures in line with the World Bank’s rules and procedures as described in the OM. Procurement under the subprojects would be carried out using commercial practices acceptable to the World Bank. Huaxia’s GFC will be responsible for the project implementation and daily management. . Page 26 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) VI. RESULTS FRAMEWORK AND MONITORING Results Framework COUNTRY: China China Renewable Energy and Battery Storage Promotion Project Project Development Objectives(s) The project development objective is to promote the integration and use of renewable energy through the deployment of battery storage systems and innovative applications of renewable energy. Project Development Objective Indicators RESULT_FRAME_T BL_ PD O Indicator Name DLI Baseline Intermediate Targets End Target 1 Promote the integration of renewable energy Increase in RE absorption by the grids (Gigawatt- 0.00 120.00 300.00 hour (GWh)) Promote use of renewable energy Increase in RE use from innovative applications 0.00 440.00 1,100.00 (Gigawatt-hour (GWh)) Mitigation of Climate Change Impacts Reduction in GHG emissions (Metric ton) 0.00 320,000.00 800,000.00 PDO Table SPACE Page 27 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Intermediate Results Indicators by Components RESULT_FRAME_T BL_ IO Indicator Name DLI Baseline Intermediate Targets End Target 1 Investment Component Installed capacity of battery storage systems 0.00 300.00 700.00 (Megawatt hour(MWh)) Installed capacity of DRE (Megawatt) 0.00 100.00 235.00 Co-financing leverage ratio (Number) 0.00 2.10 Beneficiary satisfaction (Number) 0.00 3.00 Quality of subloan portfolio to SMEs (non- performing loans level) (Percentage) 4.00 4.00 IO Table SPACE UL Table SPACE Monitoring & Evaluation Plan: PDO Indicators Methodology for Data Responsibility for Data Indicator Name Definition/Description Frequency Datasource Collection Collection Aggregated annual improved RE absorption Collected from the contributed by the battery Once per feasibility study reports storage and DRE investment Huaxia Bank Huaxia Bank Increase in RE absorption by the grids year and evaluated in the subprojects. The indicator due diligence reports. will be calculated following agreed methodologies as defined in the project's OM Increase in RE use from innovative Total amount of annual Once per Huaxia Bank Collected from the Huaxia Bank applications energy produced by year feasibility study reports Page 28 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) innovative RE applications and evaluated in the for heating and other uses. due diligence reports. The indicator will be calculated following the methodologies in the project's OM Total amount of reduced GHG emission (tons Collected from the CO2/year), contributed by Once per feasibility study reports the investment subprojects. Huaxia Bank Huaxia Bank Reduction in GHG emissions year and evaluated in the The indicator will be due diligence reports calculated using the methodologies in the project's OM ME PDO Table SPACE Monitoring & Evaluation Plan: Intermediate Results Indicators Methodology for Data Responsibility for Data Indicator Name Definition/Description Frequency Datasource Collection Collection Provided in the feasibility study Total installed capacity of Once per Installed capacity of battery storage Huaxia Bank reports, and evaluated Huaxia Bank battery storage systems year systems in the due diligence financed under the project. reports. Provided in the feasibility study Total installed capacity of Once per Huaxia Bank reports, and evaluated Huaxia Bank Installed capacity of DRE DRE financed under the year in the due diligence project reports. Page 29 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Provided in the Total co-financing leveraged Once at feasibility study (including Huaxia's project Huaxia Bank reports, and evaluated Huaxia Bank Co-financing leverage ratio counterpart funds and closing in the due diligence equity) vs. IBRD loan reports Satisfaction level of the Government project beneficiaries agencies, especially SMEs, focusing on industrial improvement of their access Once at associations, to financing. A scale of 1-5 Based on third party project participating Huaxia Bank Beneficiary satisfaction will be used to assess the survey closing project satisfactory level (1 beneficiaries, unsatisfactory, 2 moderately and Huaxia unsatisfactory, 3 moderately Bank. satisfactory, 4 satisfactory, 5 highly satisfactory). The sub-loan portfolio's NPL level to SMEs under the Once at the Statistic data to be Quality of subloan portfolio to SMEs (non- project is equal to or lower project Huaxia Bank provided by Huaxia Huaxia Bank performing loans level) than the NPL level of Huaxia closing Bank Bank's overall SME loan portfolio ME IO Table SPACE Page 30 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) ANNEX 1: Brief on Power Sector Reform in China 15 1. China has adopted phased power sector reform since the mid-1980s, aiming to address different challenges in different periods. The overall reform can be divided into the following stages: (a) mobilizing investment needs for rapid growth in 1985–1995; (b) reforming the legal framework and adopting a single buyer model in 1996–2002; (c) introducing competition at the generation level during 2003–2014; and (d) facilitating transition toward competitive provincial and regional power markets (2015+). 2. Before the reform (up to the late 1970s), electricity was considered a social service. Investments were fully funded through budget allocations, and the sector was administratively controlled by the Government. The service was provided through central administrative units with bureaus at the regional, provincial, municipal, and county levels. Prices were fully controlled by the Government and barely covered the operating costs of the system. Private ownership of power assets was illegal. 3. First wave (1985–1995): This wave focused mainly on the need to mobilize funds for expanding power systems to alleviate power shortages and enable the power sector to meet fast growing demand. Progressive transformation had been conducted to separate government and enterprise functions and shift funding for the development of the power sector through budget allocations to equity and debt obligations incurred directly by power companies. A ‘new plant new price’ policy was introduced. Experimentation with foreign investment was piloted in the forms of joint ventures, with the result that power shortages were largely addressed in China by the mid-1990s. 4. Second wave (1996–2001): This phase commenced with the promulgation of the Electricity Law in early 1996, which established the legal framework to adapt to the needs of the evolving power sector. The Electricity Law clearly defined its purposes as: (a) introducing the social market economy into the power sector; (b) ending the ‘command and control’ regulation in the power sector; and (c) protecting consumers. The State Power Corporation of China was established as a single buyer to manage the electricity supply business, with the provincial and regional companies as its subsidiaries, while the policy functions of the sector administration were managed by different line government agencies. Reform at this stage contributed to increasing the commercial orientation and corporatization of the provincial and regional companies; however, monopoly power abuses and ‘provincialism’ overflowed from expert circles to the public domain. The ‘single buyer’ model and ‘provincialism’ were discredited, and the move toward competition gained momentum. 5. Third wave (2002–2014): This phase was marked by release of a comprehensive reform program (Document 2002/No. 5) after approval by the Government in April 2002. The decree outlined a long- term vision of expanding competition—starting with generation—and called for initiating regional market trials. The State Power Corporation of China was restructured into five major generation companies, two grid companies, and four supporting business companies. A new regulator—State Electricity Regulatory Committee (SERC)—was established. Government-regulated tariffs were still applied: (a) ‘benchmark’ on- grid tariffs at the generation level were applied in each province; (b) assessment on T&D tariffs were conducted; (c) categorized tariffs at the consumer level were applied, in the form of time-of-day tariff, 15 Berrah 2009. Page 31 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) two-part tariff, and so forth; and (d) supportive feed-in tariffs have been applied to both wind and solar power development. 6. Mixed results were achieved in the third round of reform. These included the following: (a) competition at the generation side provided incentives to expand the installed capacity quickly; (b) trial regional markets in both northeast and eastern China were stopped due to a new round of power shortages since 2002 and objection of vested interests; (c) the new regulator SERC could not play an effective role as it was not empowered adequately and the planned markets did not materialize. In the new round of government institutional reform in 2013, SERC was merged into the NEA; and (d) RE has experienced an unprecedent growth since about 2005. 7. Fourth wave (2015+): A new round of power sector reform was revived in 2015 when President Xi called for an ‘energy revolution’ and required the pricing of energy products as commodities. The Central Committee of the Communist Party and the State Council jointly issued Decree No. 9 on their Opinions to Deepen Power Sector Reform: (a) gradually phasing out generation quotas for coal-fired thermal; (b) abolishing the single buyer model for grid companies so they will be service providers of T&D services and establishing T&D prices; (c) establishing relatively independent power trade centers; (d) establishing power sales companies; (e) gradually establishing competitive power markets; and (f) opening investment of new distribution networks to more investors other than the two major grid companies (State Grid and China Southern Grid). Consumers’ participation in this round of power sector reform could be a breakthrough. 8. The progress of the power sector reform by the end of 2018: (a) relatively independent power trade centers have been established in all provinces; (b) T&D prices have been established in all provinces, and cross-provincial transmission prices have been issued in five regional networks and for specific transmission projects; (c) about 3,600 sales companies have been registered; (d) more than 300 pilot ‘incremental’ distribution networks have been initiated, and the investment is opened to interested parties including the private sector; (e) non-quota generation through ‘market competition’ amounted to about 25 percent of total national electricity consumption; and (f) pilot spot market development has been launched in southern China. 9. Impact of power sector reform to RE integration (and battery storage applications): (a) Deepening the reform would bring more opportunities for RE development: (i) reduction of generation quota for coal-fired thermal; (ii) mandatory RE quota policy that is under discussion and would be issued to guarantee minimum RE consumption in each province; (iii) incentives for cross-provincial power trade; (iv) participation of competitive power market when RE has zero fuel cost; and (v) more flexible power system due to all technical measures (including battery storage). (b) Current drivers of applications of battery storage in power systems: (i) investors expect long-term high return and tap into the industry at its early stage of development; (ii) time-of-day tariff in some provinces enables business opportunities; (iii) ancillary service compensation mechanisms have been applied in some provinces; and (iv) RE developers installed battery storage at the generation level to reduce the RE curtailment. The reform could open more opportunities for the business of battery storage. Page 32 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) ANNEX 2: Implementation Arrangements and Support Plan 1. As the project implementing agency, Huaxia Bank has established under its Corporate Business Department a Green Finance Center that will be responsible for the daily management of the proposed project. A Green Finance Steering Committee will be established within Huaxia Bank to plan and guide the development of the green financing business of Huaxia Bank and coordinate the business cooperation among relevant departments. The GFC is the line department within Huaxia Bank to organize marketing of green finance business in Huaxia Bank and is the project management office to implement the World Bank projects. The institutional arrangement within Huaxia Bank is illustrated in Figure 2.1. Figure 2.1. Institutional Arrangement of Huaxia Bank Source: World Bank staff, based on information provided by Huaxia Bank. 2. Huaxia Bank has committed to build and improve its own capacity on both technical aspects and environmental and social management of the investment subprojects under the proposed project. Experienced staff hired within the GFC will be responsible for the technical review and E&S management, and training will be arranged to improve their capacity. Third parties will also be contracted to assist Huaxia Bank on the quality of due diligence review of the investment subprojects. Huaxia will expand this practice from the proposed project to its other green finance business. Page 33 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Financial Management 3. Huaxia Bank is the implementing agency of the proposed project as a financial intermediary, which will onlend the project funds at market rates to commercial enterprises for financing of eligible subprojects in accordance with Huaxia’s existing institutional arrangements, lending practices, eligibility criteria, fiduciary arrangements and governance and risk control procedures, as defined in the OM. Huaxia Bank has demonstrated capacity and experience with the World Bank’s operational procedures and process. On-lending Arrangements and Budgeting 4. The Loan Agreement will be signed between the World Bank and the People’s Republic of China through its MoF. The Subsidiary Loan Agreement to onlend the World Bank loan will be signed between the Government of China through its MoF and Huaxia Bank which will be final debtor. The overall implementation arrangement and funds flow is illustrated in Figure 2.2. Figure 2.2. Implementation Arrangement and Funds Flow Source: World Bank staff. 5. The total cost of the proposed project will be US$750 million, of which US$300 million equivalent will be the IBRD loan and US$450 million will be from Huaxia Bank. For the IBRD loan, the project expenditure occurs when Huaxia releases the sub-loans to the sub-borrowers. All the project funds will be included in Huaxia’s existing budgeting system. Huaxia’s scale of loan delivery should first follow the bank loan ratio required by the central bank for risk control, while Huaxia’s management will decide the annual credit guidance and business priorities based on the Government’s development Page 34 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) strategy and target. To ensure the availability of the project counterpart funds, Huaxia plans to earmark the project funds in its annual lending envelope. Project Accounting and Financial Reporting 6. Huaxia Bank will maintain all copies of the project accounting records. Project financial reporting is required to meet the project oversight needs. As such, the financial report—including the project expenditures and withdrawal status of the IBRD loan—should be furnished to the World Bank by Huaxia on a semi-annual basis and no later than 60 days after each calendar semester. 7. Huaxia Bank developed the computerized integrated credit control and accounting system, which links Huaxia Bank’s headquarter and branches. The system covers the credit application, review, approval, release, and disbursement procedures and process record. In addition, the sub-loan is automatically recorded in the accounting system upon release from the credit control system. The system can provide reasonable assurance on the appropriate use of Huaxia Bank’s credit funds and E&S requirements on its assets. The project funds and expenditures will be recorded and reported in an accounting system specifically set up for the project. 8. Similar to the practice undertaken under CHEEF and the JJJ PforR project, several mitigating measures have been agreed with Huaxia Bank to meet the reporting requirements for the proposed project: (a) the GFC sets up the memorandum records for the project to record each sub-loan released and related reference information for ease of tracking the record in the corporate accounting system and the original supporting documents; (b) reconciliation is made between the GFC and the accounting division on a quarterly basis; and (c) the GFC prepares the project-specific financial reports according to the format specifically tailored and agreed with the World Bank for the proposed project on a semester basis and submits it to the World Bank. Funds Flow and Disbursement Arrangement 9. Two disbursement methods—advance and reimbursement —will be available for the IBRD loan. Advances will be provided in no more than US$ 56.12 million equivalent (€ 50 million) and will be pooled with Huaxia’s general foreign currency account but one subledger account that tracks the receipt and use of the World Bank’s loan will be maintained. Applications for reporting expenditures and replenishment of the segregated DA will be supported by withdrawal applications prepared by Huaxia Bank. The funds flow for the project is described in Figure 2.2. The World Bank loan would be disbursed against eligible expenditures (inclusive of taxes) as in Table 2.1. Table 2.1. Disbursement Categories Financing Amount of the Loan Allocated Expenditure Category Percentage (inclusive of (EUR equivalent) Taxes) (1) Sub-loans under Part 1 of 266,631,750 100% of amounts disbursed the Project (2) Front-end Fee 668,250 Amount payable pursuant to Section 2.03 of the Loan Agreement in accordance Page 35 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Financing Amount of the Loan Allocated Expenditure Category Percentage (inclusive of (EUR equivalent) Taxes) with Section 2.07 (b) of the General Conditions (3) Interest Rate Cap or 0 Amount due pursuant to Interest Rate Collar premium Section 4.05 (c) of the General Conditions Total 267,300,000 10. Retroactive financing is considered for the project. The total amount of the retroactive financing would not exceed an amount of EUR53.46 million equivalent for the payment/s made before the signing date of the Loan Agreement, but the sub-loan agreements would be signed on or after May 15, 2019. Internal Control 11. Huaxia Bank, as a publicly listed bank, has good governance and internal control systems in place for risk management, payments approval, proper segregation of duties and internal audit to mitigate the Bank’s fiduciary risks. In addition, the project-specific implementation and management requirements on institutional arrangement, eligibility definition, lending practice, fiduciary management and risk control are included in the OM. Huaxia’s internal audit is a key function in relation to the overall control process. There is an independent Internal Audit Department in Huaxia Bank and the proposed project will be included in its scope for review. External Auditing 12. The China National Audit Office (CNAO) has been identified as the auditor for the project. One annual audit report will be issued by CNAO and will be due to the World Bank six months after the end of each calendar year. The CNAO has extensive experience with auditing World Bank-financed operations. According to the World Bank’s policy on Access to Information, the audit report for all investment lending operations for which the invitation to negotiate was issued on or after July 1, 2010, must be made publicly available on time and in a manner acceptable to the World Bank. The audit report will be made publicly available on the website of CNAO. Following the World Bank’s formal receipt of the audited financial statements from the borrower, the statements will also be made available to the public in accordance with the World Bank’s Policy on Access to Information. Procurement 13. The World Bank loan will be used by the sub-borrowers for the procurement of works, goods, non-consulting services, and consulting services. The major procurement activities under the project are described in the OM, and most of the procurement will be done through a competitive bidding process. The PCA confirmed that Huaxia Bank would be capable of conducting the project procurement. Taking advantage of the institutional requirement by the earlier World Bank-funded project, Huaxia Bank had already set up a designated division under its Corporate Business Department, namely the GFC, to manage the project activities financed by the World Bank, including procurement functions. The key staff members of the GFC were involved in the implementation for the closed CHEEF project and the ongoing JJJ PforR project, in which Huaxia was the financial intermediary. In the latter, the loan proceeds are Page 36 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) onlent to the sub-borrowers, with local commercial practices applying for the procurement of goods and works. In view of the similarities in procurement activities between the proposed project and previous operations, Huaxia Bank has acquired adequate knowledge and expertise to implement the new project. The staffing of the GFC is expected to be kept stable during the life cycle of the project. Moreover, the capacity-building activities would be prepared to assist Huaxia Bank to further improve its capabilities to manage the procurement activities. 14. The procurement risk is rated ‘Moderate’ based on the PCA undertaken through the field visit and interview with Huaxia Bank during the project preparation. The key procurement risks identified in the project risk assessment are the following: (a) the contract is awarded to an ineligible company because the sub-borrower lacks awareness of the World Bank’s sanction listing; (b) serious violation or noncompliance is overlooked due to inadequate monitoring and review; and (c) the adopted commercial practices are in conflict with the Bank’s core procurement policy and are deemed unacceptable. To mitigate the risks identified above, the following actions will be taken by Huaxia Bank: (a) continuously enhancing the capacity of its procurement staff; (b) taking the Bank’s procurement training during project implementation; (c) including specific requirements for procurement under sub-loans in the OM; and (d) incorporating relevant requirements in the standard template for the sub-loan agreement and corresponding sample contract provisions will be furnished to the sub-borrowers. 15. The GFC housed at Huaxia Bank headquarters will be held accountable for undertaking and monitoring the overall project management and implementation. The GFC is also in charge of the implementation for the ongoing World Bank-funded JJJ PforR project. The procurement activities of the proposed project will be undertaken by the sub-borrowers following the commercial practices that are deemed acceptable by the World Bank. 16. The commercial practices that are applicable for this project have been defined in the OM as well as the role of stakeholders, including their responsibilities on procurement. Huaxia Bank has set up an internal two-tier mechanism to ensure that the procurement rules for sub-loans specified in the OM are followed by the sub-borrowers: (a) the first tier is Huaxia Bank branches that are marketing the sub-loans and identifying the qualified sub-borrowers who should do the due diligence to assess if the relevant requirement on procurement can be met; and (b) the second tier is the GFC that will review the documentation forwarded by Huaxia Bank branches before the approval of sub-loans. 17. The minimum requirements on procurement in the case of adopting commercial practice are included in the OM, including the following: (a) The World Bank’s Anti-Corruption Guidelines shall apply. In particular, the contracts to be financed by the proceeds of the sub-loan shall include relevant provisions on anticorruption. (b) The contracts cannot be awarded to Bank-debarred firms or individuals.16 (c) There is provision in the contract permitting the World Bank to inspect all accounts, records, and other documents relating to the procurement process, selection and/or contract execution, and to have them audited by auditors appointed by the World Bank. (d) The procurement should prevent interest conveying and conflict of interest. 16 The listing of debarred firms can be found on the World Bank website: www.worldbank.org/debarr. Page 37 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) (e) Depending on the risk rating build-up on the grounds of capacity assessment, a set of thresholds has been set up to the effect that, for any contract exceeding the thresholds, the commercial practice would not be applicable. 18. Advance contracting is considered for the project. Huaxia Bank could sign contracts to finance eligible investment projects on or after May 15, 2019, following the requirements in the agreed OM, and get the funds reimbursed from the Bank. Page 38 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) ANNEX 3: Detailed Project Description 1. Further to the general project description in Section II.B, this annex provides details of the various types of investment subprojects to be supported under the investment component, and key activities to be carried out under parallel grant financing. 2. Investment component. The proposed project will principally support the installation of battery storage systems and innovative RE applications. The investments to be financed by sub-loans from Huaxia Bank to sub-borrowers would include: (a) battery storage systems to be installed: at the generation level in existing wind farms and solar PV plants; at the grid level in existing substations; and, at the consumer level such as in industrial and commercial zones; (b) installation of DRE capacity with battery storage; and (c) scale-up of innovative RE applications such as RE for heating (geothermal and biomass) and for hydrogen production. Investment Subprojects Types with Battery Storage 3. The major types of application of battery storage in power systems are illustrated in Figure 3 and a brief description of the application of battery storage in China is provided in Box 3.1. Box 3.1: Application of Major Battery Storage Technologies in China The current stationary battery storage market in China is dominated by lithium-iron(ferro)-phosphate (LFP) batteries, with 83 percent of the installed capacity in 2018. Other technologies, such as lithium- cobalt-oxide (LCO) and lithium nickel-cobalt-aluminum oxide (NCA), have a higher energy density than LFP, but this attribute is less critical in grid applications than in transportation or mobile applications. The stable chemistry of LFP batteries enables safe operation at high temperatures and makes them a preferred lithium-ion solution for grid applications. Lithium nickel-manganese-cobalt oxide (NMC) are good all-around versatile batteries, typically used in electro-mobility applications (such as, electric vehicles and e-bikes), but also in industrial and grid- connected applications (for example, Tesla Powerwall 2.0). In China, 8 percent of the new grid-connected battery capacity is NMC. Lead-carbon batteries are a type of advanced lead-acid batteries with distinct advantages over conventional lead-acid batteries. The lead-carbon batteries have greater conductivity, higher charge acceptance and longevity than lead-acid batteries. They enable more ‘energy’ (rather than power) applications including at grid scale. In China, 8 percent of the new grid-connected battery capacity in 2018 was lead-carbon, including several large demonstration projects in Guangdong (3 MWh), Jiangsu (40 MWh), Qinghai (4 MWh), and Zhejiang (4 MWh). Flow batteries can deliver long-duration power output (> 8 hours) and operate at high temperatures without requiring forced ventilation. They use cheap and abundant electrode materials (iron and vanadium) and are suitable for stationary grid applications. Nevertheless, flow batteries have a very low energy density, typically requiring more space than lithium-ion and lead-carbon batteries. In China, 1 percent of the new installed capacity in 2018 was flow batteries, yet their potential is significant, particularly in applications such as energy shifting requiring a high volume of energy storage. Page 39 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Application Type 1: Battery Storage at Generation Level: 4. Battery storage systems can be co-located with RE generators to avoid generation curtailment and provide more controllable and firm generation, ancillary services, and capacity reserve (IRENA 2019). Batteries can be coupled with an existing generator through their own inverter or directly connected to the DC line, improving the overall efficiency of RE and the battery hybrid project. Figure 3.1. Battery Storage at the Generation Level Source: World Bank staff. Application Type 2: Battery Storage at the Grid Level 5. Batteries can be installed at different points of the transmission network to provide back-up energy storage during a contingency, alleviating congestion in the grid, and avoiding overload. Utility- scale batteries can be used to shift energy—storing excess power during nonpeak hours and releasing to serve peak demand—and defer the need for new grid investments. Batteries can also be used to provide ancillary services such as frequency regulation, increasing the overall flexibility of the power system and enabling more capacity to absorb new RE. Long-duration batteries can be used for energy shifting, while short-duration batteries can be used for frequency response. Figure 3.2. Battery Storage at the Transmission Level Source: World Bank staff. Page 40 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) 6. As in the previous case, batteries can be installed at the distribution level to alleviate congestion in the distribution grid and to defer grid investments. Similarly, utility-scale batteries can modify the load curve, reducing the peak load and shifting energy from off-peak to peaking hours. When paired with DRE, battery storage can enable the efficient integration of local RE generation to unlock the benefits of distributed generation, smooth the load profile, and cut the cost of distributed renewables by maximizing self-consumption (IRENA 2019). Figure 3.3. Battery Storage at the Distribution Level Source: World Bank staff. Application Type 3: Battery Storage at the Consumer Level 7. Battery storage at the consumer level (also known as ‘behind-the-meter’) can store electricity during periods of surplus generation, facilitate demand-response services, enable the participation of consumers in ancillary service markets, and provide flexibility to the power system. In China, behind-the- meter battery storage is primarily used by industrial and commercial consumers to reduce the electricity bill by engaging in price arbitraging, or to defer transformer expansion in industrial parks (BNEF 2019). Figure 3.4. Behind-the-Meter Battery Storage Source: World Bank staff. Page 41 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Application Type 4: Battery Storage with DRE 8. Battery storage combined with DRE such as PV can enhance electricity supply services to the customers, as electricity generated by variable distributed PV can be shifted by battery storage to balance the supply and demand and require less real-time balancing service from the main grids. Battery systems installed in microgrids or distribution grids can complement DRE generation and other services to enable DRE to supply peak demand and better integrate with the grids. Figure 3.5. DRE with Battery Storage Source: World Bank staff. Investment Subprojects Types with Innovative RE Applications 9. Innovative RE applications involve a configuration of technologies that are proven but not yet deployed in scale. All such technologies produce or use various forms of energy ultimately derived from renewable sources (wind, solar, geothermal and biomass), and contribute to the achievement of further RE development in China. Primary or secondary outputs may include electricity, chemical energy stored and transported for later use as a fuel (for example, hydrogen), thermal energy for space heating or cooling and so on. Application Type 5: Renewable Energy (Geothermal and Biomass) for Heating 10. Biomass energy can be used to produce heat for residential use and industrial processes; in some cases, renewable electricity for heating is also being piloted to increase wind power generation where serious RE curtailment exists. According to the IEA report (2018), renewable heat production has increased globally in recent years, excluding the traditional use of biomass, but only 10 percent of heat consumed in 2017 was from renewables. IEA anticipated that renewable energy for heating will increase substantially in the coming years globally. In China, a five-year (2017-2021) clean heating plan for northern China was adopted in December 2017 to use renewables and other clean sources to replace coal consumption for heating. Page 42 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) 11. Besides biomass and renewable electricity, innovative uses of geothermal for heating are also emerging in China. The innovations in geothermal energy at pilot stage in China (for example, Xi’an) include the use of borehole heat exchangers at depths of up to 2,000 meters to supply thermal power to a district (Figure 3.6). In this application, a fluid flows down a borehole through a closed-loop pipe with a conducting outer wall to extract heat from the surrounding rocks or water. From the bottom of the borehole, a pump draws the heated fluid back up to the surface through a well-insulated inner pipe. Unlike traditional ground source heat pump technologies, which use the underground heat of about 100 meters, the RE application uses the geothermal resources at about 2000 meters underground. Figure 3.6. Innovative Geothermal for Heating/Cooling Source: World Bank staff. Application Type 6: Renewable Power for Hydrogen Production 12. Hydrogen is a fuel with applications as wide as natural gas in multiple sectors, but with the distinct advantage that it does not emit carbon dioxide or any other pollutants when combusted. Like natural gas, hydrogen can be liquefied, stored and transported for use in industrial processes. Stored hydrogen can be used to produce electricity in a fuel cell as a form of energy storage systems such as for emergency back-up power in industry and households, however, producing hydrogen in the first place requires an electrolyser that consumes large amounts of electricity. Coupling an electrolyser with renewable electricity enables the production of hydrogen (also known as ‘green hydrogen’). This is possible at sites with renewable electricity that would otherwise not be consumed, such as large-scale centralized or dispersed PV or wind plants with peak output in excess of the nearby grid’s capacity. Page 43 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Figure 3.7. Renewable Power for Hydrogen Source: World Bank staff. Parallel Grants-financed Activities on Policy and Institutional Strengthening 13. Two forms of support are being provided and implemented in parallel with the proposed project: (a) technical assistance to build proper due-diligence and implementation capabilities within Huaxia Bank; and (b) development of policy, regulations, and standards to create the institutional frameworks needed for market creation and development for battery storage systems. During the preparation of the proposed project, NEA and the World Bank identified gaps in policy, regulations, and standards, and agreed to fund the work activities required to address these gaps in parallel with the proposed project. These activities aim to create the required enabling environment for scaling up the deployment of battery storage and DRE through support from the ongoing GEF-financed CRESP 2 and CDRESP projects, which NEA is responsible for implementing. 14. Policy and Regulation Development (US$0.5 million). Some policies and regulations regarding battery storage have been issued in the last few years by different government agencies, but these policies and regulations are often piecemeal and not comprehensive and systematic. After intensive stakeholder consultations, it was agreed that studies will be carried out in the areas of planning, grid access, pricing, market design, and business models for generation, T&D, and consumer-side battery storage solutions. These studies will inform NEA and other concerned government authorities to prepare policies and regulations on battery storage and innovative RE applications that are consistent and supportive of ongoing power sector reform. 15. Technical and Environmental Standards (US$1 million). This will mainly focus on ‘Battery Safety, Reuse, and Disposal’. It will not only ensure the successful implementation and sustainability of the proposed project but also contribute to the development of battery storage in the power systems globally. Safety issues involve not only the battery itself but also the system design, construction, testing, Page 44 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) commissioning, operation, and maintenance of the battery storage system as a whole. The activities will, therefore, support safety-related standards development from a wide spectrum, including operation and maintenance, and M&E—particularly when involving the reuse of retired batteries. 16. Battery disposal is currently the most important and socially and environmentally sensitive part, and also the weakest point, of the supply chain of battery storage in China. In most cases, the social and environmental benefits from the treatment and recycling of batteries are difficult to internalize in the prices of batteries, so the Government’s intervention is needed through policy, regulation, and standards measures. Although the Government has a regulation framework in place, enforcement for lead-acid batteries is weak while, for lithium-ion batteries, the regulation on reuse and disposal is still in its infancy. 17. System Operation Guidelines with Storage (US$0.15 million). This part will support activities related to the performance improvement of power systems with battery storage. Simulations with models will be carried out to evaluate the performance of the power systems with the battery storage systems connected to the grids. Different simulation scenarios will be developed to evaluate the interaction between battery storage and the grid, and to optimize the power system to absorb more variable RE. A concept of ‘virtual power plant’ may be piloted with advanced IT and artificial intelligence technologies and demand-side management measures. 18. Pilot of Innovative Applications of Storage Technologies (US$0.35 million). There are many emerging storage technologies for energy use which, in most cases, currently focus on batteries, compressed air, flywheels, superconductors, and pumped storage. Most of these technologies convert electricity into another form of energy for storage. The stored electricity is then reconverted into electricity for delivery to the power or heating systems when it is needed. These technologies have different characteristics and can serve different purposes and have different investment returns under different policy and market conditions. Pumped storage is a mature and traditional technology (not financed under the proposed project), while compressed air and flywheel and superconductors are all used with limited scale and are not yet commercialized at this stage for various reasons, including cost, efficiency, and life span. 19. Battery storage has experienced rapid development in the last few years in terms of installation and a steep drop in the unit cost along the learning curve but it is still difficult to make investment projects bankable. The activities will mainly support the scale-up of battery storage and will also finance the studies on other emerging use of storage in areas such as molten salt, space heating, high temperature phase-change materials, thermal storage, and hydrogen and ammonia for chemical storage, in combination with uses of RE. Page 45 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) ANNEX 4: National Level Economic Analysis of Battery Storage Investment 1. Analyses were carried out at the national level to examine whether investments in battery storage systems are economically justified. The evaluation was based on installing 8 GW/32 GWh of battery storage systems in China (1 GW/4 GWh in each of the eight regional/provincial power systems) to assess their impact on increased RE dispatched (defined as a project indicator ‘Increase in RE Absorption’) and associated reduction in CO2 emissions. Other expected benefits of installing battery storage systems were also considered in the evaluation. 2. Cost-benefit analysis was used to estimate the Economic Internal Rate of Return from installing 8 GW/32 GWh battery storage systems at the national level. The costs include both capital investments and operational costs, while the benefits include: (a) reduction in CO2 emissions due to an increase in RE absorption; (b) fuel saving due to replacement of coal-fired power generation by increased RE absorption/generation; (c) energy shifting from off-peak to peak hours; and (d) provision of ancillary service. Taxes and duties are excluded in the calculation. Potential savings on transmission investment are not counted in the analysis. 3. Installing battery storage systems will promote the grid integration of variable RE and reduce CO2 emissions. The climate change PDO indicator ’reduction in GHG emissions’ requires the calculation of increased RE dispatched (labeled as ‘Increase in RE Absorption’) in power systems due to installation of battery storage systems. The estimation of the incremental RE dispatched and associated reduction in CO2 emissions was carried out following the framework described in Figure 4.1. Figure 4.1. Quantifying Reduction in CO2 Emissions Due to Battery Storage A. Estimation of Increased RE Absorption Benefit 4. The national-level power system study was carried out by State Grid Energy Research Institute (SGERI) using a ‘Multi Areas Production Simulation System’ model developed by the institute. The model can be used to carry out 8,760 hourly production simulations in a year, considering all major types Page 46 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) of power plants (including pumped storage and battery storage) and demand loads. The SGERI has used this model to support the State Grid Corporation to conduct the 2017 and 2018 annual review of RE integration in China and evaluate RE integration in the 13th FYP (2016–2020). The SGERI also used the model to support NEA in its studies to analyze RE integration in China. 5. In the study, the China power system is divided into eight regions to analyze the impact of battery storage systems at generation and grid levels on incremental RE absorption. The study was carried out for 2020; the planned generation mix and demand loads used in the study are shown in Figure 4.2 and 4.3 and are in line with the regional plans. The weekly profiles of both wind power and solar PV in northwest China are depicted in Figure 4.4. Figure 4.2. Installed Capacity by Regions in China (2020) Source: Plot based on data provided by the SGERI. Page 47 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Figure 4.3. Peak Load and Electricity Demand by Regions in China (2020) Source: Plot based on data provided by the SGERI. Figure 4.4. Weekly Profile of Wind Power and Solar PV in Northwest China Source: Plot based on data provided by the SGERI. Page 48 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) 6. Simulations were carried out assuming ‘without’ and ‘with’ 1 GW/4 GWh of battery storage in each region. The difference in RE absorption in both cases provides an estimate of incremental RE dispatched (RE absorption) in the systems due to the investments in battery storage. The reductions in carbon emissions were calculated based on the emission factors provided by the concerned government authorities to the United Nations Framework Convention on Climate Change. This shows an annual increase in RE absorption of 4,620 GWh and annual reduction in CO2 emissions of 3.796 million tons (Table 4.1). Table 4.1. Increase in RE Absorption by Region (2020) Installed Capacity of Carbon Emission Increase in RE Reduction in CO2 Region Battery Storage Factor (ton Absorption (GWh) Emission (tons) (GW/GWh) CO2/MWh) North 1 GW/4 GWh 1,070 0.8405 899,282 East 1 GW/4 GWh 60 0.7265 43,592 Central 1 GW/4 GWh 150 0.7539 113,078 Northeast 1 GW/4 GWh 940 0.9139 859,066 Northwest 1 GW/4 GWh 1,250 0.7674 959,281 Southwest 1 GW/4 GWh 220 0.6894 151,674 Western Inner 1 GW/4 GWh 850 0.8405 714,383 Mongolia South 1 GW/4 GWh 80 0.6894 55,154 Total 8 GW/32 GWh 4,620 — 3,795,510 Note: The carbon emission factors were published by the Ministry of Ecological and Environment on an annual basis. 7. The national-level study showed that RE absorption due to battery storage varies substantially among the regions. Installation of 1 GW/4 GWh of battery storage led to increase in RE absorption ranging from 60 GWh in east China to 1,250 GWh in northwest China, with an average of 144 GWh per 1 GWh installed capacity of battery storage, implying that the average utilization capacity factor of battery storage could be about 40 percent of its full potential, assuming one full daily cycle of charge and release. The average coal consumption per kWh of coal-fired generation in 2018 (308 gram of coal equivalent per kWh) was used to estimate the replaced coal consumption due to increased RE absorption. This shows that the installation of 8 GW/32 GWh of battery storage systems in China would reduce coal consumption by 1.42 mtce annually. B. Estimation of Energy Shifting Benefit 8. With battery storage, the electricity can be charged during off-peak periods and released during peak time. It should be noted that battery storage installed at the generation level could be used mainly to adjust the outputs of variable RE to adapt to the grid needs so RE curtailment could be reduced. In such a case, the energy shifting benefit could be only counted partially. 9. To estimate the energy shifting benefit, it was assumed that battery storage systems will: (a) be installed mainly at the generation level to reduce RE curtailment in northwest China and Inner Mongolia where serious RE curtailment occurred; (b) be installed mainly at the grid level to shave peaking in eastern and southern China where RE curtailment was not a major issue; and (c) balance distribution at both generation and grid levels in other regions. The battery storage was assumed to use one-half of its Page 49 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) capacity for energy shifting at the generation level while it can be used fully at the grid level. One full cycle charge and release was assumed each day. Based on the above assumptions, a total of 9,679 GWh of electricity could be charged by the 8 GW/32 GWh battery storage systems at off-peak and the released electricity amounted to 8,705 GWh during peak hours, assuming an average efficiency of 90 percent. C. Estimation of Provision of Ancillary Service Benefit 10. The value of ancillary service is based on a recent study carried out by Xi’an Jiaotong University to assess the dynamic benefits of pumped storage in Zhejiang Province, including ancillary services. The results of this study are adopted as a proxy to estimate the value of ancillary service provided by battery storage. In the Zhejiang study, the value of providing spinning reserve by pumped storage was estimated at US$33.80 per kW-year and the value of load following by pumped storage was estimated at US$8.30 per kW-year. The provision of ancillary service benefit was, therefore, quantified as US$42.10 per kW- year for battery storage. These two types of services can be provided by battery storage systems as well. D. Cost-Benefit Analysis 11. The methodologies that were used to monetize the above estimated benefits are the following: (a) Reduction in carbon emissions: The shadow prices are based on the Guidance Note on Shadow Price of Carbon in Economic Analysis, issued by the World Bank in November 2017. The low values of CO2 shadow prices are used in the calculation as conservative estimate. (b) Fuel saving: The average market coal price in 2018 was adopted to estimate the benefit. (c) Energy shifting: Time-of-day tariffs in each region are applied to determine the electricity values to the systems at different periods of a day. (d) Provision of ancillary service: The results of the pumped storage study in Zhejiang was used as a proxy to estimate the value of ancillary service provided by battery storage. 12. Based on the assumptions considered, the EIRR of battery storage investments was estimated at 8.8 percent (Table 4.2), higher than the social discount rate of 8 percent which is adopted in China as benchmark for infrastructure investment projects. So the project is economically justified given the conservatively estimated values of GHG emission reduction and air pollution and significant demonstration value of the project. Table 4.2. Summary Results of the Economic Analysis for National-Level Battery Storage Study Annual Value Type Benefits (US$ million) Installed capacity of battery storage 32 GWh n.a. Increase in RE absorption (annual) 4,620 GWh n.a. Fuel saving (annual) 1.42 mtce 175.2 Reduction of CO2 emission (annual) 3.8 million tons 189.4 Energy shifting benefit (annual) 9,679 GWh (charging)/8,705 GWh (release) 841.3 Page 50 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Annual Value Type Benefits (US$ million) Ancillary service benefit (annual) US$42.10 per kW-year 336.9 EIRR — 8.8% 13. A sensitivity analysis was conducted with: (a) cost reduction of battery storage by 15 percent; (b) an increase in the average utilization capacity factor for battery storage from 40 percent to 70 percent; (c) no consideration of energy shifting benefit for battery storage at the generation level; (d) reduction of benefit of ancillary service by one-half; and (e) adoption of high values of CO2 shadow prices as indicated in the World Bank’s guidance note. The cost reduction and increase in the utilization capacity factor for battery storage, and adoption of high values of CO2 shadow prices will raise the EIRR to 12.6, 13.1 and 11.8 percent, respectively, while changes to other parameters will reduce the EIRR to 6.1–6.6 percent. Page 51 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) ANNEX 5: Financial Due Diligence Review 1. In accordance with the Bank Policy OP10 on Investment Project Financing, a due diligence review of Huaxia has been completed which includes desktop reviews of Huaxia Bank’s 2015-2017 annual reports with audited financial statements and the Huaxia’s 2018 annual reports, as well as field interviews of Huaxia Bank management. The selection of Huaxia Bank is based on the commercial bank’s green finance track record in collaboration with the World Bank. The due diligence review covers: (a) priority target market, (b) macroeconomic and financial sector context, and (c) Huaxia’s corporate governance, risk management and financial soundness. The financial due diligence of Huaxia Bank has been reviewed and confirmed by the Bank’s Finance, Competitiveness and Innovation Global Practice. Main Findings 2. The due diligence review finds that, in principle, Huaxia Bank is qualified to act as the financial intermediary under the proposed project in terms of corporate governance structure, operational capacity, risk identification and management, financial soundness, and commitment to, and experience in, green finance. Huaxia is, however, experiencing rising NPLs. Measures are being undertaken to address the problems, such as a sizable capital increase at the end of 2018, the 2017 reorganization of risk management functions in line with international best practice, and the application of more comprehensive and connected databases and models to evaluate borrower creditworthiness and to support credit policy making and risk monitoring. 3. A couple of substantial financial risks have been identified that have implementation implications. The first risk is a lack of bankable subprojects due to the uncertainties of the main target market (battery storage) and increased foreign exchange rate volatility (in relation to foreign currency denominated loans). The second risk could increase the pressure on Huaxia Bank’s profit margin. Risk mitigation has been considered in the project design: (a) parallel operations are included to establish an enabling policy environment for battery storage, and technical assistance is planned to improve Huaxia Bank’s capacity in market development and due diligence; and (b) an operations manual has been prepared to define clear selection criteria for investment subprojects. Considering these mitigation features in project design and Huaxia Bank’s increased risk management capacities, the risks are manageable. Table 5.1. Due Diligence Summary Subject Areas Main Features Potential Risks Priority target market Rising industries with great A lack of bankable investment potential; few banks have tapped projects. the market; lower returns. Macroeconomic context Undergoing Further economic slowdown; forex restructuring/rebalancing in a less rate fluctuations; sharp drops in favorable external environment price of real estate and securities. although the economy remains resilient. Banking sector context Tightened regulation on shadow Competition for intermediate banking; increased NPLs and businesses and deposits. squeezed profit margin, but Page 52 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Subject Areas Main Features Potential Risks systemic risks still under control. Huaxia Bank soundness Corporate governance Basic framework and practices in No major risk to the project compliance with the requirements identified at this time. of publicly listed companies and commercial banks. Operational capacity 27 years in operation; 65th largest No major risk to the project bank in the world; specialized identified at this time. green finance unit; nationwide branch network; well-educated workforce. Risk management Improved oversight of all major Implementation lapses. risks; standardized quantitative credit risk assessment. Liquidity Liquid with improved liquidity No major risk to the project coverage ratio. identified at this time. Assets quality Rising NPLs with increased loan Control measures lapses. provision rate; control measures under implementation; intensified loan workout efforts. Profitability Profitable profit remained stable. No major risk to the project identified at this time. Capital adequacy Adequate capital base. No major risk to the project identified at this time. 4. The main findings and their elaborations in the following paragraphs are based on information provided/disclosed by Huaxia and publicly available information. Huaxia Bank Soundness 5. Overview: Huaxia Bank has been in operation since 1992 and is a sizable bank. It has a network of 42 branches covering 108 municipalities, with the north and the northeast branches taking close to 40 percent of the loans. It holds shares in four small financial institutions, including three village banks and one financial leasing company. About 95 percent of Huaxia’s 40,000 plus employees hold relevant higher education degrees. Table 5.2 provides a bird’s-eye view of Huaxia Bank. Table 5.2. Huaxia Bank at a Glance (Y, millions) Aspect 2018 2017 2016 2015 Total assets 2,680,580 2,508,927 2,356,235 2,020,604 Total loans and advances 1,613,516 1,394,082 1,216,654 1,069,172 Total liabilities 2,461,865 2,339,429 2,203,262 1,902,216 Deposits 1,492,492 1,433,907 1,368,300 1,351,663 Equity 15,387 12,823 10,686 10,686 Operational income 72,227 66,384 64,015 58,844 Page 53 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Aspect 2018 2017 2016 2015 Operational profit 26,688 26,117 26,109 24,934 Net income 20,854 19,933 19,756 18,952 Source: Huaxia Bank’s audited financial statements (http://www.Huaxia.com.cn/index.shtml) 6. Corporate governance: Huaxia Bank’s corporate governance structure is in line with applicable Chinese laws. Huaxia Bank is a national joint stock commercial bank. In 1992, the predecessor of Huaxia Bank was solely incorporated by the state-owned Capital Iron and Steel Corporation which was the sole owner (the predecessor of the Shougang Group Co. Ltd.). In 1996, Huaxia Bank was reestablished into a joint stock company and changed its name to Huaxia Bank Co., Ltd. In 2003, Huaxia Bank was listed on the Shanghai Exchange. Over the years, the ownership structure has undergone various changes but the Shougang Group Co. Ltd. remains the largest shareholder. After the capital increase at the end of 2018, the three largest shareholders are the Shougang Group Co., Ltd. (20.28 percent), State Grid’s Inda Control Group (19.99 percent), and the People’s Property Insurance Company (16.66 percent). Top five shareholders of Huaxia Bank are state-owned companies. In the financial periods reviewed, Huaxia Bank has complied with the regulatory requirements on single borrower and largest borrower exposures . Huaxia Bank is regulated by China Banking and Insurance Regulatory Commission (banking operations) and the People’s Bank of China (interest rate regime and market operations). 7. Huaxia Bank’s corporate governance structure is in line with applicable Chinese laws. Documentation on the basic corporate governance framework is disclosed on Huaxia’s website, such as the company chapter, the rules of proceedings of shareholders’ meetings, the board and its committees. Published annual reports and audited financial statements contain information for investors and interested observers on Huaxia’s business strategy, financial position and performance, regulatory compliance, operational results, risk exposures, and challenges. 8. Operational capacity: Huaxia Bank has the operational capacity to implement the project. In terms of total assets, Huaxia is ranked number 8 in its peer group of 12 joint stock commercial banks (which form the second tier of banks in China’s banking system). In terms of the core tier-1 capital, Huaxia is ranked number 65 among the 1,000 largest banks in the world (https://www.thebanker.com). There are five main business lines: corporate (close to 75 percent of total loans outstanding), microenterprises, individual (23 percent of the total loans outstanding), financial markets (over 30 percent of total assets), and electronic banking. 9. Huaxia’s green finance has registered double-digit growth in recent years and is one of the six strategic areas Huaxia plans to expand. A Green Finance Center has been established at the headquarter to be in charge of the internal and external coordination, marketing, and product research and innovation. As of end 2018, credit extended under several green finance projects reached Y 57.8 billion. In addition to the credit products, Huaxia also provides green leasing, off-balance sheet fund raising, and underwriting of green bonds. The GFC will act as the PMO for the proposed project. 10. Risk management: Huaxia Bank has benefited from an improved institutional arrangement for risk management. In 2015, Huaxia Bank established its Risk Control Department to enhance risk monitoring and management in an integrated way. Under the enhanced risk management framework, the previously fragmented risk control arrangements have been integrated: policy research on, and risk analyses of, all eight groups of risks (credit, liquidity, market, operation, compliance, IT, reputational, and Page 54 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) country risks) are put under the Risk Control Department. A platform is built to integrate and share data on the risks. According to Huaxia Bank managers interviewed, they have benefited from the new organizational set up and the integrated database as the changes provide an overall picture of potential risks to Huaxia, especially with regard to identification of government policy implications and market risks. Huaxia Bank has also linked staff evaluation with their performance in risk management. 11. At the headquarter and the branches, multiple departments conduct credit risk management activities, mainly the Risk Control Department, the Credit Operation Department, the Credit Approval Department, the Asset Protection Department, the Consumer Banking Department, and the Inclusive Finance Department. These departments cover the front, middle, and back offices of the whole credit process. An internal credit rating system (that went live in 2015) is used to assess corporate and micro-, small- and medium-sized enterprises borrowers’ creditworthiness, and based on the rating, to determine the pricing of the relevant loans. The ratings consider both financial (for example, liquidity, leverage ratio, repayment capabilities) and nonfinancial factors (for example, economic environment, competitiveness, and management of operations). This system has been applied to credit policy making, authorization and limit management, in addition to supporting credit approval and post-loan management. 12. Liquidity: Huaxia Bank’s liquidity ratios are well above the regulatory requirements. The liquidity coverage ratio improved to over 100 percent in 2018. Normally, Huaxia Bank should be able to meet its short-term local or foreign currency payments needs. 13. Assets quality: Huaxia Bank’s assets quality has experienced a similar trend as its peers and the changes are manageable. China’s banking industry has seen a rise in NPLs over the last three to four years in tandem with the slowing down of economic growth. Banks have taken various steps to improve assets quality. In 2015-2018, Huaxia’s NPLs grew by 6.79 percent on average, although the pace of increase slowed down from 2016 onward. Loans are mainly collateralized with real estate (<55 percent) and securities (>44 percent). The migration to loans classified as substandard declined (by more than 26 percent, 2017), but the level of loans classified as doubtful is expected to increase as the migration rate was on the rise (2017). At the end of 2018, the NPL rate was 1.85 percent. 14. According to Huaxia Bank managers interviewed, the assets quality is expected to be further stabilized as Huaxia Bank is actively readjusting the assets structure. For instance, Huaxia’s loans to individuals grew much faster (by 11 percent in 2015-2017) than that of the traditional business lines. In terms of capturing the true situation, Huaxia management has tightened up the control of deviations in loan classifications. More active disposal and writing-off of bad loans have also helped improve assets quality. Of the main business lines, green finance credit has a much lower NPL level (0.004 percent, 2018). According to Huaxia Bank, this is due to two factors: firms that seek green finance credit are usually in a better financial situation; and the green industries are a rising market. It should be noted that most green finance loans have longer terms and the low NPL level might also be attributed to the newness of the portfolio. 15. Profitability: Huaxia Bank’s operating profit is stable. It has maintained a certain level of operating efficiency, strengthened the management of interest rate spread, expanded the intermediary business lines to further improve the income structure, and tightened cost control. As a result, the cost- to-income ratio decreased by 2.18 percent over 2015-2018. Page 55 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) 16. Capital adequacy: Huaxia Bank’s capital adequacy ratio complies with the regulatory requirements and the internal management needs. Its capacity for internal capital accumulation is increasing. Huaxia completed a private placement of Y 29.2 billion capital increase at the end of 2018 which led to a substantial increase (>13 percent) of the capital adequacy ratio and enhanced Huaxia Bank’s capital strength. 17. Performance indicators: Table 5.3 provides data on Huaxia Bank’s financial performance in 2015- 2018. Table 5.3. Huaxia Bank Financial Performance (%) Aspect 2018 2017 2016 2015 Regulatory requirement (Huaxia Bank) Liquidity ratio (≥25%) 52.32 45.12 31.59 40.14 Single borrower exposure ratio (≤10%) 2.35 2.92 3.47 2.96 Largest 10 borrower exposure ratio (≤50%) 16.00 16.96 19.51 18.32 Capital adequacy (Huaxia Group) Core T1 CAR (capital adequacy ratio) 9.47 8.26 8.43 8.89 Capital adequacy 13.19 12.37 11.36 10.85 NPLs and provisioning NPL as % of total loans outstanding 1.85 1.76 1.67 1.52 Provision coverage rate 158.59 156.51 158.73 167.12 Profitability (Huaxia Group) Cost to income ratio 32.58 32.96 34.50 34.76 Net weighted average return on assets (%) 12.67 13.54 15.75 17.18 Return on equity 10.81 12.36 14.56 17.19 Other (Huaxia Group) Leverage ratio 7.06 5.85 5.61 4.86 Liquidity coverage ratio 107.14 93.43 86.37 75.54 Page 56 The World Bank China Renewable Energy and Battery Storage Promotion Project (P163679) Bibliography Berrah, N. 2009. “Reforming China’s Power Sector: In the Middle of the River.” Working Paper 392, Stanford University Center on Global Poverty and Development, Stanford, California. 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