Climate Bonds Initiative report for China’s State Council on ‘How to Grow Green Bonds in China’, 2014
The report was prepared for the Development Research Centre (DRC) of the State Council of China as part of a joint project with IISD.
The report makes proposals to implement the Chinese Government’s already strong commitment to develop green financial products – and green bonds – to help meet their “challenging” environmental objectives: clean air and water as well as their 5 Year Plan’s green growth objectives.
Key points are outlined below.
The report needs to be read in the context of China’s current financial products and property bubble. Proposals to grow a market of green financial products are about liberalising financial regulation in such a way as to attract the very high levels of domestic savings that are currently pursuing unregulated and high risk investments in unregulated wealth management products and in property accumulation, into a regulated market of green investments in projects that have material benefits to productive capacity: clean water, clean energy, clean transport.
The report was produced in the light of the State Council’s August announcement that it would grow a “corporate green bonds market”, and the promulgation earlier last year by the Chinese Banking Regulatory Commission of the astounding Green Credit Banking Guidelines.
It was part of a larger project on “Greening China’s Financial Reforms” by the Development Research Centre of the State Council and the International Institute for Sustainable Development; the hyperkinetic Simon Zadek was lead.
Key points from the China Green Bonds paper:
1. China’s government has signalled its intent to reform financial markets, including to open bond markets, so as to:
- Introduce greater transparency into financial markets and reduce the risk of systemic volatility.
- Provide more financing options for non-state entities and to improve economic stability. For example, China’s listed firms market has one the world’s largest short-term debt ratios at 78 per cent, compared to 28 per cent for U.S. firms. A shift from that short-term to longer-term debt will improve economic resilience and stability.
- Tap into the country’s huge pools of domestic savings, currently the world’s largest, that at present have limited opportunities for investment leading to a leakage of savings into unregulated investments.
2. Over the past 10 years, a range of programs have been developed around the world to use bonds to channel capital to investments important to addressing environmental challenges such as climate change. We identify some US$346 billion of bonds outstanding relating to climate change solutions in 2013. Over $20 billion have been marketed as green or climate bonds, with the majority of issuance from development banks, but a growing corporate component. Governments have developed a range of support measures that have seen a growth in green bond issuance in renewable energy, energy efficiency and transport sectors.
3. Under its economic development objectives, China has ambitious plans to improve energy intensity, grow environmental industries and reduce environmental stress. This will require the mobilization of huge amounts of capital. Among many measures towards that end it has decided to direct the banking sector to develop green financial products; in August 2013 the State Council announced plans to grow a corporate green bonds market in China as part of meeting the objectives of the 12th Five-Year Plan (State Council, August 2013).
4. There are a number of areas of action in China to implement that decision:
- A program of government support for green bond issuance, from interest rate support and tax incentives to driving investor demand and regulatory support for bond structures such as bonds and green asset-backed securities.
- Allowing selected state-owned companies and local governments to issue green bonds to initially develop the market
Kick-starting any new bond market requires government support, typically in the form of initial liquidity and trading volume from government-backed bond issuance, or through other forms of credit support, until investors become familiar with opportunities. Developing a corporate green bonds market will need the same.
State-owned corporations and state entities should be allowed to develop “demonstration programs” of green bond issuance that serve to illustrate the concept and, most importantly, to create trading volume and liquidity at a superior investment grade.
In particular, dual recourse green covered bonds can be used to introduce transparency to bonds offered by such entities; issuance can then shift to asset-backed bonds in the medium term.
- Helping build a domestic investor base by instituting a system of green bond certification against clear and transparent criteria for green investments. This will support integrity within a green bonds market by setting targets for green bond purchasing targets for public funds such as the National Social Security Fund (NSSF) and by encouraging green bond trading markets. Definitional work is already being done in Europe could be adapted for China’s special situation.
5. There is also an important opportunity to:
- Use covered bonds to introduce greater levels of transparency—without risking instability—to assets financed at regional government and bank levels. Green covered bonds can bridge a market made up of bonds that are explicitly or implicitly government-backed to one that first introduces recourse to underlying assets, and eventually moves away from government guarantees. This would simply require refinancing green assets owned by state and semi-state actors to shift to using covered bonds, then move to full revenue-backed bonds, as in the US municipal market or asset-backed securities. This approach could be especially useful in the local government sector.
- Take a leadership position with the issuance of green bonds for the international market as a way to demonstrate China’s commitment to environmental improvements. This paper proposes opening a Foreign Direct Investment (FDI) window specifically for green bonds as part of China’s gradual enlargement of the Qualified Foreign Institutional Investor program. The window should be tailored to meet the needs of long-term, institutional investors such as pension funds, sovereign wealth funds and insurance funds. These actors will help improve risk management practices and governance in the investment system and increase liquidity by introducing more buyers to secondary markets. To ensure a smooth process of uptake, this window would initially focus on offering green bonds from state-owned enterprises, including covered bonds, gradually allowing more offerings from corporate issuers.
6. Developing a green bonds program will require:
- Developing clear definitions for investments linked to bonds that will qualify as green, along with a government-endorsed system of providing assurance for both investors and regulators about the green claims of corporate bond issuers and to avoid “interpretation” of what is green to suit issuer needs.
- A self-funding and self-policing verification and enforcement system that relies on common standards and criteria set at a central level and a requirement for verification of green claims. The verification review and policing process should be delegated to market actors
7. State measures should be put in place to establish a market that:
- Provides effective coordination of regulatory measures to promote a green bond market. Coherent regulation will ensure smooth growth.
- Pilots green bonds through different issuer types, including policy banks, provinces/cities, state-owned enterprises and commercial banks.
- Uses state-backed issuance to provide demonstration issuance and initial liquidity, along with selective state support for corporate issuance in the form of selective guarantees or first-loss incentives for companies whose majority of revenues come from green products.
8. The development of a green bonds market that provides a selection of improved yield opportunities for savers, also provides an opportunity to:
- Increase the supply of low-cost capital for green industries.
- Increase transparency to underlying assets within the financial system.
- Channel household savings into a strong retail bond market by tapping into public desire for a greener environment.
- Channel international foreign direct investment into long-term debt in line with green growth goals.
- Ensure savings are invested responsibly to meet a country’s environmental objectives.
- Pilot the introduction of bond-market reforms in a limited fashion that is highly focused on government environmental policy priorities.
- Gain international recognition for green growth and investment and the government’s commitment to a sustainable economy.
Green bonds provide an ideal opportunity to pilot transparency measures in fixed income markets, while helping achieve the Government’s ambitious environmental goals. They also provide an opportunity to demonstrate China’s leadership position in addressing environmental protection challenges.