Where developments in global bond markets are concerned, China has traditionally been a laggard rather than a leader. The country’s domestic bond market may now be the world’s third largest in terms of outstanding issuance, but at 1% of GDP, it still accounts for a very small proportion of its overall economy.
Its investor base is also not very diversified, with insurance companies, pension funds, and foreign portfolio investors all subservient to the banks, which dominate the interbank market in which most Chinese bonds are traded.
But China’s “war on pollution” is having a very positive effect on the development of green bonds as a global financing vehicle. The recent completion of Agricultural Bank of China's debut deal and imminent publication of government proposals to incentivise issuance should finally make the country a pacesetter for a key area of capital markets development.
Bankers hope other countries across the world will follow China and draft their own green financing proposals as a part of a legally binding and universal climate agreement, which the United Nations hopes to agree at a conference in Paris this December. This means Asia’s green bond market development is taking a different course to Europe where the market originated in 2007.
In Asia it is being shaped from the top down with the Chinese government at the forefront. In Europe, progress has come from the bottom up, with issuance defined by voluntary guidelines known as the Green Bond Principles drawn up industry players in 2014 and revised in early 2015.
Global green bond issuance totaled $40 billion in 2014 with market players targeting $1 trillion by 2020. The London-based Climate Bonds Initiative, which advocates capital markets solutions for climate change, believes China will become the biggest player by 2018.
Agricultural Bank of China has just spearheaded moves in that direction with its debut green bond offering, raising just under $1 billion on October 13. The three-tranche deal has provided a key benchmark for other offshore Chinese issuers and the wider region where issuance has still been fairly limited compared to Europe.
Export-Import Bank of Korea set the ball rolling in 2013 and Taiwan’s Advanced Semiconductor Engineering executed the region’s first corporate green bond in 2014. At first glance a semiconductor packaging and testing company is not an obvious green bond candidate but it is just the kind of company the embryonic market needs to entice and ethical investors need to embrace, according to bankers. ASE used the proceeds to fund a new energy-efficient plant.
“[The] guiding principal behind green financing should be about encouraging companies to do their bit to aid climate change,” Ulrik Ross, HSBC’s global head of public sector debt capital markets and sustainable finance, told FinanceAsia.
Some climate bond investors are still reluctant to buy green bonds from ‘brown’ companies with non-sustainable and environmentally unfriendly businesses, bankers said, but that attitude is changing as more of these companies come to market.
“There’s a big pipeline of potential deals building up,” Andy Liu, head of China DCM at Societe Generale, said. “We’re seeing a quite a bit of interest from oil and power sector operators, even some mining companies.”
The French bank was one of the lead managers on China’s first offshore corporate green bond earlier this year, a $300 million issue for wind turbine manufacturer Xinjiang Goldwind.
Green bond issues typically price flat to regular debt. The benefit for issuers is that they tend to attract a more diversified investor base, with bankers estimating 20% to 60% take-up by new investors in any given transaction.
The biggest downside is the additional cost. European guidelines, for example, require an independent second opinion to certify how the proceeds are used and the publication of regular reports to demonstrate how the funds are being managed.
Climate Bonds Initiative, which promotes environmental finance, is working on a certification scheme that should bring costs down. “It will remove some of the decisions, which need to be made by second opinion providers,” said Sean Kidney, who is chief executive officer of the London-based non-profit organisation.
Indeed, India’s Export-Import Bank was criticised in March when it set a $500 million benchmark for the country without paying for a second opinion. Bankers said it set a bad example for other domestic issuers, which may also now try and execute green bonds without one.
But shortly after, fellow Indian Yes Bank followed with its second green bond that did include a second opinion. It worked alongside the International Finance Corporation to ensure it followed the Green Bond Principles and issued a Rp3.15 billion ($50 million) deal to fund loans to the renewable energy sector. IFC purchased the offering with proceeds from a Rp3.15 billion green bond issued in its own name.
IFC’s global funding head, Ben Powell, said the World Bank unit would like to do more deals along these lines. “The beauty of the structure was that the proceeds were in rupees and we could pass them straight through to Yes Bank, rather than swapping back into dollars,” he said.
All eyes on China
But all eyes remain on China and the green financing measures it will take to improve its environmental footprint.
Bankers FinanceAsia spoke to who have seen the cross-regulatory steering committee draft proposal said it leans towards relaxing banks’ risk-weighted asset ratios, a point echoed by Climate Bond Initiative’s Kidney.
“They’ve already done it for rural loans, so the precedent is there,” he said.
That approach is not universally applauded. Some argue it would be better to scrap interest income taxes since meddling with risk-weighted asset ratios runs counter to Basel III. “We hope other countries will follow the US example where municipal bonds are exempt from Federal and in some cases State taxes,” one banker said.
One of the biggest issuers is likely to be China Development Bank, which has said that green bonds will form a quarter to a third of its future issuance.
At the end of 2014, China’s policy banks accounted for just under a quarter of the onshore bond market, with Rmb9.7 trillion ($1.6 trillion) of outstanding debt according to HSBC. Given that CDB accounted for 62% of policy bank outstandings, its issuance could tot up to about $330 billion over the coming years.
According to figures from the China Banking Regulatory Commission, Chinese banks as of June-end had extended $670 billion in overall green project lending. These loans are the result of central bank regulations requiring the classification of borrowers against green principles.
The headline lending figure looks high but execution has been patchy given the administrative headaches involved. “Banks had to set up board level committees and need to screen every single loan against CBRC criteria,” Kidney said. “Green bonds will be much easier for them to handle and a great way to burnish their credentials to a government, which has clearly made fighting pollution its priority.”
