Report from Beijing: PBoC Chief Economist Ma Jun’s green finance workgroups close to the finish line -ambitious proposals on the table

Beijing: Today, air quality is merely seven times WHO maximum safe limits. A relatively good day for this city. This year I’ve been yo-yoing to China working on how to develop green finance and green bonds in the country, much of which has been part of projects convened by Simon Zadek, co-Director of the UNEP Inquiry into the Design of a Sustainable Financial System. 

Yesterday morning was a presentation of a major new report on developing green finance in China by multi-Departmental workgroups convened by the People’s Bank of China Chief Economist, Ma Jun. I first met Ma Jun when we spoke on a panel together in June; by September I was joining a working meeting of his green finance project, of which Simon was co-convenor; yesterday, their report revealed important recommendations around green banks, green bonds, green lending and even differential risk weighting for green loans on bank balance sheets. It’s absolute heaven for green finance policy wonks! Details to come in December when they go public.

Recommendations are all well and good, but will they be implemented? Given the seniority of people involved in this project so far it’s got a very good chance - and President Xi Jinping has been sending very strong signals about his view of the urgency of tackling a transition to a green economy. We’ll keep you posted, of course.

One thing is clear: the extraordinary achievements of China – in bringing one billion people out of poverty with the fastest industrial transformation in history – must now, as their 5-Year Plan mandates, be replicated in an unprecedentedly rapid shift to a Green Economy.

That was just one of my remarks to the green finance meeting yesterday:

1.  The need to address environmental protection in China is well understood.

It’s enshrined in successive Five Year Plans, it’s part of regular policy announcements - and we’re reminded of it every time we go out into polluted air in Beijing.

2.  As the country’s shift to a market economy unfolds, green finance measures and green investment products are becoming essential tools of environmental policy.  

We’ve already seen that in the China Banking Regulator’s groundbreaking Green Credit Guidelines (although they still have some way to go to be fully implemented).

3.  Green finance and products like green bonds area simple concepts, easy to understand, both for citizens (potential retail investors) and institutional investors.

They provide a story, one that connects citizens’ concerns about the environment to their demand for investments and saving for their future.

One example of this was seen a few months ago: Massachusetts issued a green bond, and received US$260 million of retail (i.e. citizen) orders - an unprecedented amount. Interestingly, Massachusetts issued two bonds at the same time, one green and one “ordinary”, both rated AA-. On the strength of retail demand they received a AAA price for their green bond – a significant price benefit. Cynics might call this a price based on “sentiment”. Others might call this an urgent willingness to choose investments that address environmental challenges. That’s the green bond story.

Given the enormous concern about environmental issues in China, and the equally enormous national saving rates, we can expect similar strength of support among Chinese citizens.

But this isn’t just a matter of citizen concerns: pension funds and insurance funds are concerned as well. At the recent UN Climate Summit investors representing US$24 trillion issued a statement calling on world governments to quickly address climate change, which they see as a major risk to the long-term value of their investments.

The membership of our own Climate Bond Standards Board represents US$32 trillion of assets under management. Investors understand the critical importance of environmental protection and want to see investments they can make that address that issue.

4.  On the back of this “sentiment”, global green bond markets are growing fast, and China has the potential to capture the largest share of this market in the next few years.

This year we’ve already seen RMB 210 billion ($34 billion) of green bonds issued globally; last year it was only RMB 66 billion ($11 billion); the year before RMB 18 billion.

Next year we believe we will see RMB 600 billion ($100 billion) of issuance; and by 2018 triple that again to RMB 1.8 trillion. The only question is how big a share of this market China will have: It will be the largest market for green bonds in the world if we get the foundations of the market right during the next few months.

5.  An interesting feature of green bonds that we’re beginning to see: longer tenor – this would have macro-economic benefits for China.

Green bond buyers have a tendency to be “buy and hold” investors, holding onto their investments for a longer time than with other bonds. An example: When the Korean Export Import Bank’s secondary market bond price collapsed in the middle of a Korean crisis, the green bond price held firm. There was minimal trading in the green bonds because investors were committed to them for more reasons than just the return on interest – bond issuers call that stickiness, a highly prized feature.

For China an increase in tenor of debt would have macro-economic benefits. China’s debt market is currently 78% short-dated debt - very high compared to 28% in the US. As China moves to a more open market economy, having such short loans dominating is a recipe for volatility – it could lead to significant booms and busts as market conditions change and companies have to refinance every few years. Developing bond markets first with green products will skew them to long-dated investments, allowing a smoother transition from a highly centralized to a market economy: providing stability.

6.  Developing a green bond market in China requires three first steps:

Step 1: Market rules: What is green, monitoring and sanctioning.

Bond markets are fast moving, commoditized markets. They work on clear definitions and classifications of assets and projects.  The most common question I get asked about green bonds in China is “how do we (easily) tell what is green?”

In China, given investment policies are still largely driven by the central role of government, the next question is “what does the government think is green”.  I’ve spoken to senior executives in a number of major Chinese banks recently about potential green bond issuance; they are simply waiting for government guidance about what is green.

People currently look to the China Banking Regulatory Commission’s definitions for the Green Credit Guidelines. But these are far too vague for the bond market. Criteria they use like “rural and urban water projects” do not provide adequate direction: What sorts of water projects are good? Some “clean water” projects deplete stressed aquifers, or divert water from healthy river flows, or involve very high levels of energy usage, such as pumping water 100 kilometres instead of taking demand reduction measures – they are not good.

Clear and detailed guidance about what green assets are needed. The complexity of eligibility for green assets needs to be “under the hood”. What do we mean by this? Green bond definitions need to work like an electric car: sure, it’s complicated under that hood, but all you have to do as a driver is get in the car and turn on the keys.

Strict monitoring and supervision will be needed as well: we will indeed need a “Green Approval Channel” in China, as outlined in the green bond working group’s paper we saw today. We will need a Certification Board. We will need approved verifiers, rules on reporting. And we will need audits and legal protections. When you see what have in the past been described as “ecological civilization” projects here in China you know that green bonds will be at high risk of mis-selling. It’s not just about protecting consumers of financial products. The government is likely to introduce various fiscal incentives for green financial products (some already exist), so confidence in the green efficacy of a bond will be essential to the operation of government schemes as well. Our colleague from the People’s Bank of China legal department suggested that confidence will depend on provision for legal sanctions in cases of default on green credentials; we agree that in China this will be important.

Step 2: Demonstration issuance: International and domestic

We see three priorities here:

  • The issuance of green Renminbi bonds on the international market as flagships of the internationalization of China’s currency. The likely issuers are banks such as ICBC, now the world’s largest listed company, and China Development Bank, the world’s largest such bank.
  • Demonstration domestic issuance by development and commercial banks.
  • Demonstration issuance by leading cities and by corporations.

Step 3: Market education

For example, banks and issuers need help with “how-to do” green bonds, and need to understand the rules.

7.  China faces enormous environmental challenges; and so does the world, with climate change.

Global leadership is needed, and it’s wanted.

The extraordinary achievements of China – in bringing one billion people out of poverty with the fastest industrial transformation in history – must now, as the 5-Year Plan mandates, be replicated in an unprecedentedly rapid shift to a Green Economy.

That transition is the global challenge as well; China should take a domestic imperative and use that to shape its international leadership role, by sharing green solutions – and capital for those solutions -  with other emerging markets.

8.  Within China this will mean an extended green urbanization and green infrastructure projects, and taking inspiration from China’s long history of achievements.

China’s amazing, already established, high-speed rail network marked the start of that new green infrastructure story.

Now we’re seeing massive growth of clean energy.

Next must be Green Cities, clean water, and agriculture.

We need to bring meaning to what has generally just been the idea of “ecological civilization”.

China has a very long history.  My Chinese friends talk of the pivotal initiatives that changed the course of China’s history, such as the land reforms of the Qin First Emperor in 210 BC, or Emperor Sui Yangdi building the 2,500 km Grand Canal in 610 AD.  

Will these green finance initiatives come to be seen as important as the Grand Canal? Perhaps not. But I do know that that must be the scale of our ambition. China is ready for that.