ometimes timing matters more than time. Three months is not long, even given the short history of the world’s green bond market, which did not exist until 2007. But it turned out to be enough time for China to replace the US as the world’s largest green bond issuer. The first green bonds in China certified by third-party verifiers were issued at the end of January 2016, a month after China officially launched the market.
By the end of March, nearly half of the new green bonds worldwide were issued by Chinese institutions, and China’s place at the top remained unchallenged by the end of September, according to reports by the rating agency Moody’s Investors Service. Other sources have shown similar results. Moody’s estimates China’s offerings could push the world’s total issuance for the whole year to double the record annual value achieved in 2015.
It is a good time for Chinese and international green bond issuers. Moody’s attributed the surge to the rising momentum of addressing climate change which was “echoed in the speed with which the Paris Agreement on Climate Change went into force.” The People’s Bank of China released the first instructions defining green projects on the interbank market two weeks after the Paris Agreement was reached on December 12, 2015. Regulators of non-financial corporate bond issuers in China laid out their own rules in the following months.
Chinese analysts of green bonds generally highlight the role played by the G20 in driving the rapid rise of the bonds in China. The framework of a green finance system, including bonds, was approved by the Party’s top decision makers four days before China declared it would ratify the Paris Agreement on September 3, the eve of the G20 Summit in Hangzhou. As a China-driven initiative, green finance was high on the agenda for the G20 for the first time. Green bonds were the only financial tool that was singled out in the green finance part of the communiqué issued by the summit.
While China’s readiness to join the global environmental push – even to lead it – can provide a partial explanation for the surge in green bonds, it can’t explain why these, rather than the previously introduced green credit system, won China first place as global green finance champion. China’s own formidable environmental, economic and financial challenges, according to both observers and designers of the system, have created a window of opportunity for green bonds in China. But there is both skepticism and optimism about how far the surge can go.
A New Star
Green finance in China was started back in 2006 with a grant given for green credit by the Industrial Bank of China with the support of the International Finance Corporation, a member of the World Bank Group. Green credit was officially launched the following year, and now accounts for about 10 percent of China’s total outstanding bank loans, according to remarks made by Xiao Gang, vice governor of the PBOC, at an international green finance seminar in Shanghai in early September. Ye Yanfei, an official of the China Banking Regulatory Commission, said at a press conference in Shanghai on September 2 China had become “one of the world’s leaders” in green credit, which stood at about US$1.1 trillion by the end of June.
Ma Jun, chief economist of the PBOC’s Research Bureau and Co-chair of the G20 Green Finance Study Group, told NewsChina that China’s green bonds make up only 2 percent of total bond issuance in China. A joint survey by HSBC and the Climate Bond Initiative (CBI), a London-based investor-focused not-for-profit organization shows that the total of China’s outstanding green bonds, including labeled, unlabeled and those issued overseas, was US$244.6 billion when the report was released in July. Even defined so broadly, the value was only about one-fifth of the US$1.1 trillion in outstanding green credit. But the Chinese bonds would go on to take the top place within just a few months, even as a latecomer to the market.
Green bonds in China enjoyed a better climate at birth than green credit did. Kelly Yu, senior advisor of the China Program of the International Institute for Sustainable Development (IISD), a Canada-based non-profit organization providing solutions for integrating environmental and social priorities into economic development, noted the higher significance that’s been given to green finance over the last few years. Pollution has become a social and economic problem for China. Sustainable development which aims at balance between society, economy and environment provides a solution. Green growth has become a national strategy.
This period also saw Chinese policy makers putting the development of the country’s bond market much higher on the agenda. Bonds are often cheaper than bank loans, easing costs for companies. They help diversify risk throughout the financial system, easing the current Chinese concentration of danger in the banking sector. The PBoC has made it clear that outstanding bonds should total 100 percent of China’s GDP by 2020, from 70 percent in 2015.
Ma Jun has repeatedly given his view that green bonds are a good solution to the “problem of a maturity mismatch between short-term bank loans and long-term green projects.”
In July 2015, Xinjiang Goldwind Science and Technology Co., a wind turbine manufacturer listed in Hong Kong, issued the first green bonds from a Chinese company. It was followed by the Agricultural Bank of China’s green bond issuance on the London Stock Exchange in October the same year. Both bonds received orders several times the value of the money they originally scheduled to be raised. Their success brought a lot of confidence to potential Chinese issuers, who were previously unaware of how popular green bonds were becoming. Yu described the success as a “warm-up” for the green bond market within China.
With all this preparation, the unexpected exponential rise of China’s green bonds comes “at the right time,” she stressed.
A good beginning is half the battle, but is not enough to win the war. The total stock of China’s green bonds remains too small to attract big institutional investors, according to Guo Peiyuan, chairman of Syntao Green Finance, a Beijing-based consultancy that was China’s first verifier accredited by the CBI. He told NewsChina that issuers enjoy fast-tracked issuance of green bonds, but have to spend more time and money on third-party verification and stricter information disclosure than for ordinary bonds. His research has found that major market players hope that fiscal support, for example, subsidies, can encourage more green bond issuance.
Professor Wang Yao, dean of the International Institute of Green Finance of the Central University of Finance and Economics, thinks that this goal can be more easily achieved through using local resources than by changing taxation rules from the top. She also stressed that market-oriented tools would be more effective than fiscal support.
Meanwhile, Chinese investors seem less keen on the bonds than issuers do. Environmental risks have not been included in risk assessment models used by financial investors, and thus have little impact on investors’ forecasts of potential profits. This remains a common practice both in China and internationally.
The difference is the attitude towards green investment. Profit remains the single most important factor in Chinese financial investors’ business decisions, a founder of a private equity firm in Beijing, who asked for anonymity, told NewsChina. By contrast, institutional investors in developed markets have a much stronger interest in green investment, which is why some Chinese issuers have chosen to issue green bonds overseas, Guo, the Synatao chairman, stated.
Business and regulatory incentives are not yet strong enough to make up for the weak awareness of green issues among Chinese investors. Guo said it would be very helpful if investors can borrow more from financial institutions using their green bonds as collateral, and argued that this is a more market-based incentive. The private equity fund manager also confirmed that this could be a key encouragement for investors. But Guo believes it would be difficult for financial regulators to make this decision, as the practice can increase financial risk.
Insurance companies and social pension funds are leading investors in green bonds in every market as they are big and pursue long-term, stable returns. In addition, Guo said, their role in providing welfare for the public means they naturally assume a bigger role than other institutional investors in promoting social responsibility, including investing more in green projects. He hopes that this can be realized by regulatory pressure.
A Bowl of Spaghetti
But there are other concerns. Wang Yao is concerned about possible defaults on China’s green bonds. As she explained to NewsChina, those bonds labeled as “green” are from sectors supported by the national industrial policy and are subject to higher standards of information disclosure. They are regarded by investors as safer than similarly mature bonds with the same rating that aren’t green. China Chengxin International Credit Rating also confirmed that most green bonds issued in the first nine months of the year enjoyed lower interest rates, an indicator of investors’ lower risk expectations, than comparable non-green ones.
However, this does not immunize green bonds from default risks. While defaults are entirely normal in any debt market, the problem, Wang said, is that in such a new, niche market, even a single case of default can hit hard the confidence of investors who expect safer returns from green bonds.
A single scandal involving fake green bonds could have dire consequences. This risk, according to Kelly Yu, cannot be played down as there are no penalties in the existing rules to deter fraudsters.
All this means that solving the problems in standards and third party verification are crucial issues. The bond market itself is fragmented and thus subject to different standards defined by different regulators. For green bonds, the central banks’ guidance and catalogs have been adopted by the inter-bank market and stock exchanges. Green bonds issued on other markets have to be approved by the National Development and Reform Commission (NDRC). Wang Yao said this will cause confusion and inconvenience for issuers and investors, as the same bond could be recognized as green by one market, but not by another. Third party verification and issuers’ information disclosure are not required by the NDRC standards. Putting the decision at the discretion of government officials has always aroused questions over professionalism and corruption.
And the old question arises; who watches the watchmen – or rather, who verifies the verifiers? The independence of third party bodies has always been a tricky issue, as seen in the role of world’s leading rating and auditing agencies in the global financial crisis, where many accused them of colluding with the very people they were supposed to audit. With green bonds, there’s the extra issue of auditors’ own lack of expertise in these new products, according to Yu, adding that this is especially true for Chinese verifiers as China’s green bond market has only just taken off.
For green bond auditors and issuers in China, there is another dilemma. The biggest divergence between China’s and the CBI’s international standards lies in the clean coal sector. Sean Kidney, CEO of the CBI, told NewsChina that international investors are keen on diversifying their portfolios into China assets, but definitely won’t buy any coal-related Chinese bonds, even if they are labeled as green by Chinese standards. Kelly Yu believes that including clean coal in the national catalog of green bonds sends the “wrong signal” to the market that the use of coal is “encouraged.” She stressed that such a message conflicts with China’s commitment on reducing coal consumption.
Coal provides more than 60 percent of China’s energy. Wang Yao argued that this energy structure means improving efficiency is more important for China at this stage.
She noted that without considering this reality, the potential of environmental benefits from efforts in this regard will be missed. China hopes to develop its own standards that may even be adopted by other emerging markets with a similar energy structure. “Our debate [with our international colleagues] on this will go on,” she said.
Most of the issues have been on the task list of China’s green finance designers. As the last nine months have shown, timing success right will depend on using the time well.