The world’s biggest market is growing, as are the regulatory frameworks around it. We take a closer look.
We've recently noticed that questions have been publicly raised as to the quality of Chinese green bonds.
This is in the wider context of there being questions about all green bonds – ever-present since the beginning of the corporate green bond market in 2008.
At Climate Bonds Initiative we preach that scrutiny is required in order for the market to maintain its integrity, it’s a healthy check procedure and plays a positive role in overall investment governance.
Is there anything additional to worry about with Chinese bonds beyond the usual investor considerations around quality, risk and returns?
There are different views of green – this is common across international markets.
There are a number of different definitions of green across various markets:
As an example, the recent Repsol bond fits within the Green Bond Principles (GBP) definitions of green but not all investors saw it as green as the proceeds are financing efficiency improvements to oil and gas refineries.
This is allowable under GBP definitions but there are some differing opinions among investors as to whether this should qualify as a green investment. It wouldn’t qualify under the Climate Bonds Taxonomy and isn’t included within Bloomberg and other green bond indices.
Similarly in China, some areas which are seen as green in China – such as high-efficiency transport fuel (gasoline and diesel) production and “clean coal” may not be seen as green by all investors internationally.
As was recognized by the 2016 G20 Green Finance Synthesis Report endorsed by G20 leaders, different countries, when developing their domestic green finance markets, naturally would take into account their domestic environmental policy priorities into account.
In some countries where coal remains the largest source of energy and air pollution is very serious, clean coal technologies that can help reduce emissions of SO2 and NOX -the main contributors to air pollution- by 90% are most often considered as green by local investors and thus included in some domestic green definitions.
When it comes to the international green bond issuance, there is indeed a case for harmonising definitions and standards across different markets, as issuers have to meet the ‘common’ preference of international investors.
In addition, if harmonised standards are used, it can help avoid duplication of verification and certification, which would assist in reducing costs of green bond issuance.
In March 2017 the People’s Bank of China (PBoC) and the European Investment Bank (EIB) established a joint green finance initiative to harmonise the green definitions between China and those in the European market.
China is amongst the leaders of the global efforts in harmonizing green standards.
The regulation and structure of Chinese green bonds are amongst the most rigorous in the world
No national jurisdiction requires that all bonds must be approved by regulatory authorities, except in China – this takes away some of the uncertainty around aspects of self-regulation present in the international market.
To comply with PBoC’s rules, issuers are required to submit applications to the PBoC with information about nominated project categories, project selection criteria, decision-making procedures, management of proceeds and environmental benefits of the underlying assets/projects.
With PBoC’s approval, issuers can then label their bond as a “green bond” and commence issuance.
Other regulators in China’s green bond market include the China Securities Regulatory Commission (CSRC) and National Development and Reform Commission (NDRC). Both CSRC and NRDC have rules to be followed.
Guidelines from PBoC and CSRC also strongly encourage issuers to conduct an external review for their green bonds (remember that’s a regulator encouraging; hard to say no).
Over 93% of Chinese green bonds aligned with international green definitions have received external reviews at issuance. This compares to a global average of approximately 73% (improving to 85% in 2017).
Post-issuance external review will also be implemented as part of an issuer’s agreement with the verifier at issuance, and a spot check is conducted when necessary.
To ensure that proceeds have been allocated to green assets/projects after issuance, the PBoC is setting rules to check the post-issuance use of proceeds. Our latest discussions with PBoC also suggests that they are going to provide guidelines on procedures of external review for verifiers in China.
In another development, in early June PBoC and four other Ministries jointly published the Construction and Development Planning of the Financial Industry Standardization, to establish and implement standards for financial sector by 2020. This will include developing a standards and certification scheme for green financial products.
In some occasions a second opinion is absent from bond issuance procedures.
In the first quarter of 2017, several non-bank issuers did not engage external reviewers for their green bond issuance: Chongqing Longhu, Dongjiang Environment and Nantong Economic and Technological Development Zone Co.
However, these bonds are not free from scrutiny, as they are still subject to the regulations of the NDRC or CSRC.
Reporting requirements are mandatory and rigorous
Chinese banks are required by the PBoC to report quarterly (that’s right, quarterly) on the use of proceeds of green bonds, and corporate issuers need to report annually or semi-annually. This compares to the international best practice of at least annually.
Quarterly reporting enables investors to follow up more regularly on the commitments made at issuance. At issuance, most international issuers disclose only broad category-level information about how proceeds will be allocated.
With annual reporting if there is any uncertainty about what this means, investors may have to wait before the next round of disclosure gives additional information about which projects were financed. As quarterly reporting is the norm in China, investors are able to monitor and assess how proceeds are spent on a more frequent and regular basis.
Preliminary analysis of post-issuance reporting in the green bond market shows that Chinese issuers are amongst leaders in best practice with over 80% of issuers publicly disclosing information post-issuance. This compares to 50% of U.S. issuers and 73% across European issuers.
(Climate Bonds will be releasing more information on post-issuance reporting, in late June/early July 2017).
Greening balance sheets
Due to their long-term features, green bond are instrumental in addressing one of the major challenges of green lending – maturity mismatch.
Many green projects are long-term in nature and tend to have higher capex and lower opex than traditional projects.
In order to avoid excessive maturity transformation (i.e. over-reliance on short-term funding to support long-term loans), some banks tend to limit exposure to financing these projects.
Green bonds help issuers bring in longer term funding, and through debt refinancing, help issuers to better manage their balance sheets.
There is a misconception in the investing space about green bonds being the antidote of maturity mismatch between long-term infrastructure projects and the much shorter tenors of wealth management products.
In reality, eligible green bond issuers can only be those who comply with the green bond rules set forth by PBoC, NDRC or CSRC; and most importantly, the underlying projects and assets must be green.
The global market relies on the integrity of the issuer: this is not a uniquely Chinese phenomenon.
Fundamental to any market is that regardless of the standards or regulation in place, investors and market commentators rely on issuer disclosure and transparency to determine whether proceeds have been directed to green projects.
This requires a level of trust of the issuer that is very difficult for investors to confirm without undertaking physical audits on issuers. At the heart of it, all investors rely on the integrity of issuer reporting and verification or audit processes to make decisions.
Partly for this reason, investors tend to inherently trust issuers in their own market more than they do in other markets where their knowledge base may be lower.
In China, trust is a particular problem - possibly due to the barriers for international investors to enter the market. There also remain gaps in information and knowledge and possibly a lack of trust in Chinese issuers. Without long term experience of investing in China, some investors are nervous or are inherently cautious about increasing the direct or indirect exposure.
Chinese regulators have made positive steps, particularly in the last few years to address these concerns, by putting in place new regulatory frameworks for issuing of green bonds but investors also need to do more to bridge this information gap.
Most reporting is in Chinese and channels for finding information are different
To date, the majority of Chinese issuance has been for the domestic market with accompanying disclosure in Chinese and reported through different channels to that of regular green bonds. This means that without Chinese-language staff members, many investors and market commentators are often unaware of the wealth of information that exists.
A lukewarm first quarter?
The green bond market in China saw a slowdown in the first quarter of 2017. This was largely due to domestic interest rate volatility as a result of monetary and macro prudential policy actions, the AAA rated bond yield was up by 150bps compared with a year ago and that affect the entire domestic bond market.
Interest from banks and corporates in issuance of green bonds remains very strong and we expect green bond issuance to pick up in the second half of this year and interest rates to become more stable.
That said, we have also seen more non-bank issuers emerging in China’s green bond market. Among the eight Chinese entities that issued green bonds in the first quarter of 2017, three were from non-financial sector, as opposed to the purely bank based issuance in the first quarter of last year.
Climate Bonds has excluded three of China’s green offerings from its international listing because they were not aligned with the Climate Bonds Standard and Taxonomy. That includes China Development Bank’s RMB 5bn green bond.
China is taking the lead in green finance
From the requirement of China’s 13th Five Year Plan for a green financial system to be developed, to the roll-out of national Guidelines for Establishing the Green Financial System, and the release of green bond guidelines from various regulators such as PBoC, NDRC and CSRC over the past two years, the Chinese government has shown its ambition to lay the groundwork for financing a greener economy.
Under China’s presidency of the G20 in 2016, the Green Finance Study Group (GFSG) co-chaired by the People‘s Bank of China and the Bank of England was formed, and a global green finance work stream was established for the first time, with the aim to address and overcome the key issues around mobilising private capital for green economic transition.
China has helped drive the rest of the world with its market momentum, and demonstrated international leadership on green finance as part of the global policy agenda.
Thanks to strong policy support, China became the largest green bond market in 2016, with issuance totaled CNY 238 billion, accounting for 39% of global issuance.
In just one year, China’s green bond market reached a size that would have taken other markets 5 years or more to attain.
With the United States withdrawing from the Paris Agreement, and retreating on climate policy at the G7 and G20 level, the world is now looking to China and EU nations to lead the way on climate action. China is poised for that.
On June 14, the Chinese central government – the State Council – approved regional green finance pilot programs in five provinces, including Zhejiang, Guangdong, Jiangxi, Xinjiang and Guizhou. Some of these provinces are larger than mid-sized countries in terms of GDP. Each of these provinces have produced or are preparing aggressive policy initiatives to support green finance locally.
Greening the Belt and Road
Looking ahead, it is expected that the global investor community would increasingly become aware of the vast investment opportunities emerging as countries seek to meet the Paris NDC goals and step up green development.
We have already seen a number of climate-conscious investors responding to the call. In April, International Finance Corporation and Europe’s largest listed asset manager Amundi, launched a USD 2 billion green bond fund to support the financing of low-carbon investments in emerging markets, including China.
At the Belt & Road summit last month President Xi Jinping proposed to other world leaders the establishment of an international coalition for green development on Belt and Road, coupled with the “Road” jointly issued by four Ministries, which identified fortifying environment management of overseas investment and developing green financial systems as one of the main objectives.
How China is going to pave the “Belt and Road” with green finance could be the next big thing to watch.
The Last Word
While it is fair to scrutinise the global green bond market and its largest participant, it’s also fair to recognise the progress China has made to date in a comparatively short space of time.
The need for progress on standardisation and harmonisation, the fundamental importance of international market integrity is generally accepted by all stakeholders. The move towards these objectives in the worlds’ biggest and fastest growing green bond market should also be acknowledged.
'Till next time,
A Chinese language version of this post is available here.
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