Since premier Xi Jinping’s pledge in autumn 2020 to peak mainland carbon emissions by 2030 and become a carbon neutral nation by 2060, China has placed climate change policy front and centre of the government’s agenda.
This has resulted in a boom in onshore and offshore green bond issuance, with Chinese corporates today accounting for 17% of the world’s total green bond supply. China is now the largest market for green bond supply, according to UK headquartered non-profit organisation, Climate Bonds Initiative (CBI).
“China has fixed the two main issues concerning definition (through the Green Bond Catalogue) and use of proceeds (through the Green Bond Principles). Its next priority will be around disclosure and management, to make sure its claims are not exaggerated by the respective issuers and verifiers of these products,” Wenhong Xie, head of the China programme at CBI, told FinanceAsia.
In particular, experts highlight three key policies that have contributed to China’s burgeoning green finance sector: the launch of the Green Bond Endorsed Project Catalogue, the EU-China Common Ground Taxonomy (CGT), and the China Green Bond Principles.
“The Green Bond Principles really bring China’s policy frameworks in line with international [investor] expectations, while CGT helps to bridge any gaps and provides a common language,” said Xuan Sheng Ou Yong, green bonds & ESG analyst at BNP Paribas Asset Management.
Introduced by the People’s Bank of China (PBOC) in July 2022, the principles require issuers in China to mobilise and allocate 100% of funds raised through green bonds to green projects, in line with International Capital Market Association (ICMA) principles. Earlier, just 70% of proceeds from corporate green bonds had to be allocated to green projects; the rest could be used for general business purposes.
In addition, the Green Bond Endorsed Project Catalogue – launched in 2015 and revamped in July 2021 – lays out projects deemed eligible for green bond financing. It brings them more in line with international standards, for example by removing fossil fuel projects from the list. However, China has kept nuclear energy in the catalogue, which reflects the market’s different priorities around energy security and its divergence from global standards, explained Hong Kong-based Clifford Chance partner, David Tsai.
The CGT, which was first published by a working group co-chaired by the People Bank of China (PBOC) and the EU Commission in November 2021, and further updated in June 2022, provides an overview of similarities and differences between the two parties’ frameworks. Xie expects an increase in the proportion of Chinese bonds that are aligned with EU standards to result from recent efforts. According to CBI data, currently only 40-50% of China’s green bonds are aligned with international standards, but Xie is optimistic that this number will grow to 80-90% in coming years.
Wider Awareness
So far, China’s action around sustainable finance has occurred in the context of much broader economic policies. These include the market’s publication of “1+N” guidelines for the decarbonisation of different industries, and its 14th Five-Year Plan, which promotes a low-carbon economy, explained Alexander Chan, head of ESG client strategy for Asia Pacific at Invesco.
In the loans sector, the PBOC has introduced various climate-focussed incentives. From November 2021, it introduced a carbon neutrality lending facility to provide subsidies to domestic banks lending to green projects, and the market’s national emissions trading scheme (ETS) has grown to become the world's largest carbon market.
“All of these policies and initiatives, by design, operate to foster an environment that encourages issuers who want to raise capital and investors who want to deploy capital, to do so in a manner that has a green upside,” said Xuan Jin, Hong Kong-based counsel at White & Case.
He added that similar incentives to promote a green finance ecosystem could be seen around the world, but noted that one key difference was the speed at which China had pushed through its green finance policies.
“All of this has happened within the last seven years,” Jin said, underlining how the country has taken more of a “top-down approach” relative to its Western peers. “A lot has happened within a very short time,” reiterated Chan.
Green Finance Boom
The Agricultural Bank of China issued the market’s first green bond, in London, in 2015. By the end of November 2022, Chinese issuers had cumulatively issued $71 trillion worth of green bonds. Issuance during the first 11 months of 2022 surpassed $270 billion ($271 billion as of November 18, 2022). This is almost four times the $68.2 billion issued in 2021 – itself a 186% increase on the previous year.
While the bulk of issuance – particularly onshore – has come from domestic banks, the sector is increasingly experiencing diversification, with more participation from non-financial corporates, Yong explained.
In 2021, non-financial corporates overtook financial corporates as the biggest source of supply for the first time. Many debut green bond issuers hailed from the industrial and utilities sectors, including Shenzhen Metro Group, Kunming Rail Transit Group, Capital Airports Holding Company, Huaneng Power International and Fujian Huadian Furui Energy Development.
More recently, three provincial governments – namely, Shenzhen, Guangdong and Hainan – completed the issuance of three offshore green bonds, in Hong Kong and Macau.
Maintaining Pace
In order to sustain this momentum, China will need to ensure the credibility of new issuances, observers believe.
Despite having eased capital restrictions – in 2017, China launched the Bond Connect Scheme which enables overseas investors to trade in mainland China and vice versa, and in 2020, it eliminated quotas under its Qualified Foreign Institutional Investor (QFII) and Renminbi QFII (RQFII) schemes – foreign investor participation in China’s onshore bond market remains low.
Xie thinks this could reflect concerns around the robustness of China’s domestic green bond framework and transparent use of proceeds. “The [Bond Connect Scheme’s foreign investor] quotas remained unfilled,” he said.
A report published by the Hong Kong Stock Exchange in 2022 revealed that at the end of July 2021, international investors held just 3.2% (RMB3.86 trillion) of the total amount of outstanding onshore China bonds.
“There is definitely some space to strengthen China’s green bond framework in terms of disclosure,” Xie suggested. Despite China’s ostensibly forceful regulatory oversight, investors are often not aware of where to look for information around the use of proceeds, he explained.
Addressing Ambiguity
Fuelling such concern is the recent emergence of thematic bonds. These types of bonds go beyond the “green” label in offering detail about intended use of proceeds, but they may be hard to verify and subject to less scrutiny than traditional green structures. “Issuers are increasingly looking to make “first-of-a-kind” issuances, particularly as the green bond premium decreases with increased supply…. But some of the claims [of these thematic bonds] might be exaggerated; it's hard to ensure the credibility of these products going forward,” Xie said.
“Growing innovation has been seen in structuring these thematic bonds. Essentially, these are still green bonds,” added Jingwei Jia, associate director of ESG research at Sustainable Fitch. “A lot of the time, they [issuers] seek to be headline-grabbing.”
Examples of thematic bonds rolled out by the Shenzhen Stock Exchange last year include carbon-neutral bonds, blue bonds, and “rural revitalisation” bonds.
Both Xie and Jia acknowledged that greenwashing is not particular to China. According to CBI data, 25% of bonds in Asia ex-China are labelled “thematic”. The pair noted that the government has begun to explore ways to address greenwashing and other ambiguity-related concerns, by strengthening labelling guidelines.
Experts have also pointed to the emergence of price wars in China’s second party opinion (SPO) market as being problematic. Originally developed to strengthen the perceived credibility of a particular issuer, SPO employs the use of third-party market expertise to assess whether a green, social or sustainability bond aligns with international standards. In China, this has prompted a race-to-the bottom pricing approach among emerging providers.
“This will be an issue going forward: how to compensate for the current market failure that encourages domestic providers to dilute the quality of their services in order to produce an external review more cheaply,” Xie said.
CBI’s website lists 15 approved SPOs in China, while BNP Paribas’ Yong cited data from the International Institute of Green Finance (IIGF) that counts 18. “There is certainly room for consolidation in the space,” he opined.
GDP Gap
Finally, China will need to provide clarity around the use of green finance among corporates participating in high-emitting sectors, which currently account for around 70-80% of the country’s GDP. Investors remain cautious about the reputational risk associated with providing capital to polluting industries.
Following approval of a proposed transition finance framework at the G20 in Bali in November 2022, in which China participated as co-chair of the G20 Sustainable Finance Working Group, the Chinese government is set to release a finalised framework transition finance, with the support of the People’s Bank of China, Xie explained.
“There might be some risk of fossil fuels – which were removed from the Green Bond Principles – being added to the transition taxonomy without much justification… so this is a space we are watching.”
As the world’s second largest economy, China’s role in the global fight against climate change is pivotal and its respective 2030 and 2060 pledges alongside efforts to improve its sustainable bond framework, are certainly steps in the right direction. As experts suggest, how China works to address greenwashing risk and market failure in the SPO space should be key priorities for its policymakers going forward. Replicating progress made in the green finance space to the transition finance should swiftly follow.
