Green shoots of new bond market

China is seen as having potential in an innovative kind of financial instrument that benefits the environment

China has the potential to become the world's largest market for green bonds because of its government's commitment to tackle pollution by setting up a green financial system, experts say. The government's move to promote green bonds could set an example for other countries, they say, and produce the critical mass for the green-bond market to take off globally.

Green bonds are a new but rapidly growing asset class, of which about $40 billion worth have been issued globally, but in China it is estimated that at least 2 trillion yuan ($300 billion) is needed to achieve China's environmental targets under the 13th Five-Year Plan (2016-20).

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Such figures demonstrate the enormous potential for China to become a world leader in green bonds. To make the most of these opportunities, the Chinese government established the Green Finance Task Force last year, for which rules and incentives are now being formulated to grow China's green bond market.

"China has a great need to improve the environment," says Klaus Eklund, an economist with the Swedish bank SEB. "Meanwhile, it has high savings ratios in private households, so a huge pool of capital can be directed into green projects. Finally, the Chinese government has realized that it needs to play a role in growing the green bond market under the 'new normal'.

"Developing a mature green bond market means that financial market forces can be redirected to make the environment cleaner. The previous growth strategy of China was founded on cheap capital, and China is now trying to reach a new normal with environmentally clean projects as one key focus."

The contribution of Eklund's team at SEB has been considerable. In fact it is credited with coming up with the idea of green bonds, which it presented to the World Bank in 2007. The bank later created guidelines for green bonds and issued the first ones in collaboration with SEB the following year.

The proceeds of green bond financing are channeled into climate change projects, and their rise has coincided with the increasing awareness of climate change issues and an increasing number of individual investors and funds willing to invest in such bonds.

The first green bonds issued were for a relatively small amount, in the tens of millions of dollars, and investors were few. But over the years many more government institutions, non-government organizations and private companies have issued them.

Last year, green bonds worth $36.6 billion were issued, more than triple the amount in 2013. But enormous potential still exists in this market, given that the International Energy Agency says $13.5 trillion must be invested in low-carbon energy by 2035 to reduce emissions.

Heike Reichelt, head of investor relations and new products at the World Bank, says that while the bank played an important role in setting the foundation for the green bond market, it has greatly diversified in terms of issuers and credit categories, and this will continue.

"The green bond market is also catalyzing a broader development of a more sustainable and responsible capital market in general. There is a very direct dialogue between investors and issuers, and investors are asking about the social and environmental impact of their investments, not just about the financial characteristics."

Since the World Bank developed the first green bond in response to demand from Scandinavian pension funds, it has issued more than $8 billion worth of green bonds in 18 different currencies and 90 different green bond transactions. A third of the projects that the World Bank's green bonds support are in China, Reichelt says.

Besides growing China's domestic green bond market, the emergence of renminbi-denominated green bonds in offshore markets could also play an important role in helping China to reform and open up its capital markets, and internationalize the renminbi.

Most green bonds worldwide are denominated in US dollars or euros, but last June the World Bank's private-sector arm, the International Finance Corporation, issued the first renminbi green bond in London. This was a milestone in adding a new currency to the global market for green bonds, and as the capacity for offshore renminbi bonds builds, that will also help to increase offshore renminbi liquidity.

The three-year bond raised 500 million yuan and was priced at a yield of 2 percent. It was listed on the London Stock Exchange and became a milestone for the internationalization of the renminbi.

Benjamin Powell, International Financial Corporation's head of funding, says that issuing the offshore renminbi bond has created an important signal in the market that it can be done, and he expects it may encourage other firms in the market to issue offshore renminbi bonds.

"From the transaction we have seen a great amount of investor appetite in the offshore renminbi market in London," he says, adding that the UK government's support for London to develop as an offshore renminbi hub also helped with International Financial Corporation's decision to issue this bond in London.

Powell says the proceeds of the offshore renminbi bond were swapped back to dollars to be used in International Financial Corporation's projects globally, although in the future it is possible that it could be kept in renminbi to fund green projects in China.

This would involve choosing specific green projects in China that have the same maturity as the bond issuance, and link the two, so the proceeds can be used in China projects directly, Powell says.

China has enormous potential to develop its green bond market because of the government's determination to build up green finance, and the scale of green projects available in the country, he says.

But at the same time the Chinese government needs to play an important role in ensuring the market for green bonds is as transparent and effective as possible, he says, adding that it can learn lessons from the international market on how to establish transparent processes, and ensuring that investors receive full disclosures on how the issuers manage the proceeds of the bonds.

"I think there is the scope for government endorsed verification agents to be established in China, so that the government gets behind an entity that is there to verify the green program of new issuers," Powell says.

The global market for green bonds has surged because there is a growing number of issuers both from the public and private sectors and multinational organizations, he says.

The growing number of green projects globally means there is an increasing number of projects ready to take on the proceeds of green bonds issuance.

"National agencies and corporates are all seeing the effects of climate change around them, and they are trying to push investments to mitigate the effects of climate change. The process started with public sector agencies creating products and frameworks so that other investors can build on it."

The importance of China's green bond agenda has attracted interest from governments such as the City of London Corp to work closely with China, lending its expertise in the bond market to help China grow its green bond initiatives.

When the then Lord Mayor of the City of London Fiona Woolf visited China last year, she spoke with representatives of the People's Bank of China about green finance. She said she believed it would be a great catalyst for further promoting China-UK green finance initiatives if a Chinese government issued a renminbi green bond in London.

"That would also be a big endorsement for London's capability as a key offshore renminbi center. It would make financial sense given that London's renminbi liquidity makes renminbi bond issuance easy and cost-effective.

"It will be a fantastic signal to London and the rest of the world that the Chinese government is taking the green agenda seriously. It could also unlock the potential for cities that struggle to raise finance from national governments."

Mark Boleat, policy chairman of City of London Corp, says London has a unique advantage in building up the green bond market because of the concentration of financial experts in the city, which already has a large bond market.

"Green bonds represent a new market, and one I think many people would find attractive. Our government has a strong commitment to improve the environment, and we have lots of expertise on bonds here in London, so all this makes London a natural center to grow the green bond market."

Despite the rapid growth of green bonds globally, there are still many challenges to growing the market globally and in China.

Eklund says a major challenge arises as to whether the standards of green bonds can be upheld. "There are many different kinds of issuers, and this is a challenge for the investors because there is no fixed international framework. Anyone who issues a bond can call it green."

In mature Western capital markets, green bonds are generally audited by an independent body to check that the proceeds from the bonds are indeed used for green projects. This has led to investor trust, and it is proven that the green credential of the bonds have made it easier for the issuers to raise the finance needed for projects.

However, in a market such as China, green bonds are not vetted by independent bodies or government departments, meaning there is a high risk that issuers are exploiting the market by falsely labeling bonds as green.

In China, the number of so-called green bonds is still small, and they are mostly issued by railway companies, although the green credentials of the projects are not guaranteed, Eklund says.

Eklund says one important thing is for China to try to emulate the green bond market of the West, meaning the market must be transparent, and there must be a standard check on what is said to be green.

Second, liquidity is needed in China's green bond market.

"This could be done by using regulations to incentivize existing banks or to create a green investment bank."

Finally, China should consider giving economic incentives to green bonds, or green finance initiatives, so as to give a good start to the growth of this market.

Eklund says Western green bond markets grew on the basis of market forces, but that in China the government needs to play a bigger role to explicitly grow this market, because China's financial system is less mature.

"The Chinese financial market is much more regulated and much more government-controlled, so the government needs to play a role in setting up the rules and regulations," he says.

"Currently many state banks are channeling investments into state-owned enterprises at low interest rates, but this is changing, and the government needs to channel more finances into green projects, and encouraging the growth of a green bond market is one way to achieve this."

To push forward the development of China's green bond market, the Green Finance Task Force was set up last year jointly by the People's Bank of China Research Bureau and the UN Environment Program to look into the design of a sustainable system.

In a report published by the task force in March, the deputy governor of the People's Bank of China said the Chinese government is directing financial incentives toward developing green projects. For example, the bank has worked to improve the interaction between credit policies and industrial policies by increasing credits to energy conservation and environmentally friendly sectors.

cecily.liu@chinadaily.com.cn

(China Daily Africa Weekly 05/15/2015 page16)