Considering its size, it is easy to forget China’s green bond market is still in its infancy. It took off only in 2016 — when, from almost nothing, issuance of green bonds rocketed to $36bn, or 39% of global issuance, according to a report by China Central Depository and Clearing (CCDC) and the Climate Bonds Initiative (CBI).
The market has kept up this momentum in 2017, with $11.5bn of green bonds issued in the first half and more expected later in the year.
But while the domestic market has blossomed, China has had less to showcase abroad.
In 2016, 72% of Chinese green bonds were issued onshore, a trend that continued in the first half of this year. China Three Gorges Corp, owner of the controversial hydro-electric dam, has so far this year been one of only two Chinese issuers to have sold a green bond in a currency other than the renminbi.
The state-owned company raised €650m from its first offshore green bond in June. It is the only Chinese green bond certified by the CBI, the London-based NGO that sets standards for bonds to promote the fight against climate change. The deal financed solar and wind energy, not hydroelectric.
This domestic slant may not matter — the local market is burgeoning. But green finance is a big topic in China, and its promoters are keen to join up the country’s environmental financing efforts with those taking place in the rest of the world.
Green Belt and Road
For China, there is nowhere better to start this project than with the Belt and Road Initiative. Commonly known as BRI, the initiative was launched in 2013 by President Xi Jinping to strengthen China’s trade routes, by land and sea, partly by a host of infrastructure projects, from ports to railways. It spans Eurasia, connecting countries producing roughly 30% of the world’s GDP, according to the Hong Kong Trade Development Council.
At the International Green Finance Forum in Beijing on September 5, Chinese policymakers seemed convinced that green finance was the key to making BRI a sustainable project — or, as Xi puts it, the “project of the century”.
“China will honour our commitment to reduce carbon emission and make more efforts to promote green finance globally, including facilitating green investment in the Belt and Road region,” said Yin Yong, deputy governor of the People’s Bank of China. “We believe green finance should be a key pillar of its success.”
This thrust is exciting, but it remains to be seen how it will be put into practice.
Representatives of industry bodies, including the Asset Management Association of China and the China Banking Association, then announced a series of guidelines for controlling the environmental risks of Chinese overseas investment.
They recommended investors evaluate environmental impacts when investing in sectors such as coal, mining and steel, and ask financial institutions to take into account environmental, social and governance (ESG) impacts before making an investment.
It is questionable whether these voluntary guidelines, co-launched by the Foreign Economic Cooperation Office (FECO) of the Ministry of Environmental Protection (MEP), have any teeth. An official from the FECO gave little detail when asked what the MEP would do to enforce the guidelines.
“We will work with the Green Finance Committee to provide policy support for pilot areas and further reforms in investing and fundraising in green finance,” said Yin Yong of the PBoC.
And even if they are implemented, environmental impact assessments do not prevent the construction of infrastructure that promotes carbon emissions, for example — as is all too clear in Europe, where they have long been mandatory.
Carrot or stick?
Nevertheless, China-watchers believe the government is serious about its change towards greener development, and that its intentions in environmental policy are moving on, from controlling air pollution to slowing climate change.
“If the [green finance] agenda wasn’t so important, the issuers wouldn’t bother to begin with,” says Clifford Lee, head of fixed income at DBS Bank. “The fact that they want to give it a green stamp shows there is pressure.”
But what worked in producing a short sprint is not always appropriate for a long race. For the market to keep up its growth in the years to come, regulators may need to give issuers more carrot, not stick.
“To encourage more such bonds, regulators can look at giving tax breaks or subsidies, to encourage companies to issue green bonds according to international standards,” Lee says. “A restrictive approach can limit the number of such bonds coming into the market.”
Meanwhile, CG Lai, head of global markets for Greater China at BNP Paribas, says investors, not issuers, hold the key to the long term growth of the market. “Ideally, you would have issuers selling green bonds not just for the sake of it… you would want to cultivate a culture of investing in green,” he says.
Lai reckons an influx of international investors could bring about that change of culture.
Definition deficit
Yet one thing impeding foreign investors from entering the Chinese green bond market is the gap between Chinese and international standards on what counts as green. Of that $36bn of Chinese green bonds issued in 2016, only about $25bn are recognised as such internationally.
The CBI explains that some Chinese green bonds allow less than 95% of the proceeds to be invested in green projects, or include among their eligible projects retrofits to fossil fuel power stations, or large hydroelectric installations — which, though low carbon, can involve serious environmental damage.
“If offshore investors want to invest in green bonds in China, the investment has to meet international requirements, or else it’s pointless,” says Lai.
One area of controversy is the role of coal in China’s green bond market. Owing to China’s reliance on coal as an energy source, regulators have permitted green bond issuers to use their proceeds for ‘clean coal’ projects.
Daming Cheng, a debt origination banker at China International Capital Corp, says it is difficult to completely iron out these discrepancies, since the Chinese bond market, not just its green segment, is at an early stage of development.
“It’s a little bit like the difference in standards between international and domestic credit rating agencies,” says the Beijing-based banker. Moody’s, Standard & Poor’s and Fitch often rate Chinese bonds lower than the AAA scores they get from domestic agencies.
This mismatch in standards will have to be addressed in the context of Belt and Road, if infrastructure project sponsors seek to raise money from international investors using green finance instruments, as Chinese policymakers suggest.
A consensus on defining green bonds is therefore needed for the BRI, argues a UK-China joint task force led by Ma Jun, the PBoC’s chief economist and the chair of the Green Finance Committee of the China Society for Finance and Banking.
“With a common green BRI language, principles and criteria, investors will be able to focus on the project pricing and financing, rather than time spent on rationalising green finance definitions,” the task force said in a September 4 report.
A project has been under way this year to harmonise the Chinese and Western definitions of what is green enough to be financed with a green bond. “In some of the agricultural areas their work is way ahead of what we have done in Europe,” said Sean Kidney, chief executive of the CBI. “On other things, such as coal, we are hoping there will be movement in China, in line with their shift to tackling climate change.”
Plugging into China
Not everybody believes the solution can be found along the Belt and Road. For some, the search for a bridge between Chinese and international green bonds leads back to the onshore market — to Bond Connect.
Launched in early July, Bond Connect is a market access scheme that allows foreign investors, through Hong Kong, to invest in China’s huge interbank bond market. Later, Chinese investors will be able to buy foreign bonds.
The interbank market is where 62% of Chinese green bonds were issued in 2016, according to CCDC and CBI.
Kidney says the CBI is seeking to exploit this opening by developing a Green Bond Connect initiative with Hong Kong Exchanges & Clearing (HKEX). This would allow Bond Connect users to see on their trading screens which bonds were certified as green by CBI — which would mean they met international standards.
“We’ve had some exploratory conversations with HKEX,” Kidney says. “We are hopeful that we’ll be able to launch this by the end of the year.”
CBI has not actually certified any Chinese domestic green bonds yet, but the idea is promising — and popular.
The UK-China task force made a proposal akin to CBI’s in its report, naming Bloomberg, Thomson Reuters and Wind data as possible candidates to provide such a service.
The International Institute of Green Finance at the Central University of Finance and Economics, one of the organisers of the September 5 forum, is pushing for a similar idea. Wang Yao, the institute’s director general, believes there will be strong demand for this service from Bond Connect investors. “These investors are likely to have an interest in ESG investments and expanding the proportion of green investments in their portfolios,” he says.
But the project is still at an early stage, says DBS’s Lee, who argues that it falls short of meeting the greatest challenge of all when it comes to green investment — pricing.
“Issuers need to be aware that green bonds may not necessarily be cheaper or attract a broader base of investors, at least not immediately,” he says. “But at the same time, they need not be more expensive or more onerous in terms of compliance. Most importantly, green bond issuances should be part of a broader ESG agenda for the issuer and not just a one-off exercise.”
The article was corrected on October 9 to note CG Lai's title as head of global markets for Greater China, instead of head of fixed income, at BNP Paribas.