By Morgan Davis
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China made a name for itself as the global green-bond king last year, issuing $33 billion of a global total of $80 billion worth of green notes sold. This sudden surge was no accident.
In an unprecedented move, China established its own green-bond rules at the end of 2015, formalizing the structure and standards needed for issuers in the country. Globally, issuers considering green deals have relied on the green-bond principles outlined by the International Capital Market Association and the Climate Bond Initiative (CBI), which provide general, informal thoughts about what standards need to be upheld for a bond to be considered green.
The People’s Bank of China (PBoC) and China’s regulatory body National Development and Reform Commission (NDRC), with endorsements from other official Chinese entities, published China’s guidelines and kicked off the surge of issuance seen in 2016.
“Last year was really a transformational year for green-bond issuance, and that was really driven by China,” Beijia Ma, equity strategist at Bank of America Merrill Lynch, tells Asiamoney.
China issued $4.7 billion worth of green bonds offshore and $28.3 billion onshore in 2016, according to data from Dealogic. But as of early May this year, China had only issued $3.8 billion onshore and no offshore green bonds. During the same time frame last year, $8.3 billion worth of green notes had been issued.
“At the moment, the country’s gone Awol,” says Sean Kidney, CEO and co-founder of CBI. “This year things are worryingly quiet, since China went from zero to hero last year.”
One explanation for the decline could be that issuers want to avoid swapping proceeds from offshore bonds into renminbi for use onshore. But the slow start to 2017 doesn’t have the market too worried. Many still expect big players to roll out green bonds soon. Ma says BAML is bullish on issuance from China.
|Beijia Ma, equity strategist at Bank of America Merrill Lynch|
Realistically the country can’t double the size of the market annually, so the kind of growth seen last year is unlikely to be repeated year after year.
There is no reason to doubt Chinese enthusiasm for environmentally-friendly activity. The Chinese government’s green thumb goes well beyond just bonds.
“PBoC is looking at this as a holistic approach,” says Rahul Sheth, executive director of capital solutions at Standard Chartered. That means green projects in all industries. Businesses such as insurers will likely be next to pick up the green banner, he says.
Famous for its smog-choked cities, China has been clear it wants to become more environmentally friendly. China’s energy agency said earlier this year it would invest Rmb2.5 trillion ($62.5 billion) in renewable power generation by 2020. NDRC said in its five-year plan in December that Rmb1 trillion will be invested in solar power. Another Rmb700 billion is earmarked for wind farms and Rmb500 billion for hydro power.
The PBoC and the European Investment Bank announced an initiative in March to develop a combined framework for green finance. The hope is that a collaborative approach will provide more consistency, understanding and comfort to investors globally.
“As signatories of the Paris Agreement, the European Union and China are committed to strengthening the global response to the threat of climate change and enhanced transparency of green finance,” says Hans-Dietmar Schweisgut, EU ambassador to China. “Putting theory into practice through improving accountability and aligning the financial system with climate policies is crucial to successfully tackle climate change.”
China’s formal green rules are one of the main reasons it has led the way in green bonds. And those guidelines were just the first iteration of China’s efforts as it drives the country closer to global green finance standards.
“Given you don’t have captive investor demand, you need something else to start this,” says Sheth. The government’s vocal support, as well as tangible goals for cleaning up the country, help drive issuers to the green-bond market.
“China wants to maintain its spot as number one issuer,” says Sheth. The country led not only in the number of issuances last year, but also in the diversity of deal structures, he adds. Bank of China, for instance, sold a green covered bond in late 2016, an inaugural issuance for the region. China knows that diversity of products translates into diversity of investors.
Like the PBoC/EIB initiative, the CBI is also working on developing standards for green financing, including policy recommendations for the PBoC and collaborating on principles of responsible investment with the Asset Management Association of China. The CBI hopes the latter will help domestic issuers become more comfortable with marketing to international investors.
The Chinese government has been active but not heavy-handed in encouraging the growth of the green sector.
“There’s a lot of people in China who want to get on board with what the government wants to push,” says Kidney.
The soft approach is best in this case, says Sheth: slowly building an accessible green platform with encouragement and a relatively easy process. Issuers won’t respond well to actions like mandated quotas for green financing.
China knows its issuers, and its green-bond framework reflects that, even if it means ostracising some international investors at the beginning. China is heavily dependent on coal, and it includes so-called clean coal in green financing.
“Multinational investors don’t want to touch something that has coal in it,” says Kidney. Many institutional mandates explicitly exclude coal. “It’s a counter-productive investment,” as many investors want to move to clean energy, he says.
|Sean Kidney, CEO and co-founder of CBI|
Universal frameworks, like one between China and Europe, will help harmonize green standards within the next couple years, Kidney anticipates. “If you want to increase capital flow, you have to decrease friction,” he says.
But Sheth doesn’t think coal will be leaving China’s green notes any time soon. “Many of China’s green bonds have included clean coal because it’s an important part of China’s growth story,” he says.
China’s green guidelines are still young, and will take time to develop according to market demand. With other regions shunning coal, it wouldn’t have been an oversight for China to keep the commodity in either. Sheth reckons coal was retained as a qualifying energy after careful consideration in China.
The PBoC isn’t the only one laying out green standards. Other market regulators, namely the NDRC, the National Association of Financial Market Institutional Investors (NAFMII) and the China Securities Regulatory Commission (CSRC), have nuanced differences to the PBoC green-bond guidelines.
“The general standards are similar but the specifics may be different, as different regulators have different focuses,” says Tiecheng Yang, partner at Clifford Chance.
For instance, issuers who want to borrow offshore will have to deal with the NDRC, an agency that will look for green efforts to fall in line with China’s Belt and Road initiative, and will drive funds back to onshore green projects, explains Yang.
Adhering to these standards though will be a win for issuers. “The approval process will be simplified,” says Yang. If an issuer can tick the prioritized boxes, China wants them out in the market.
The PBoC, which focuses on the interbank bond market, is understood to expedite an issuer’s approval process if they are applying to sell a green bond.
China’s regulatory efforts to build supply and demand for green bonds have influenced others. The Indian Green Bonds Market Development Council, a public-private initiative, announced in early 2017 that it would be drafting policy recommendations for India to develop its own green-bond market, in a nod to China’s guidelines.
Similarly, the Securities and Exchange Board of India finalized its green-bond standards this year. Singapore too came out with an initiative this year to provide a small grant to help green-bond issuers cover the costs of getting green verification.
Although the government authorities encourage issuers to issue green bonds outside of China, issuers have to consider the funding costs- Tiecheng Yang, Clifford Chance
In Greater China, Hong Kong and Taiwan may follow China’s example too. Both markets have developed fairly naturally and independently; there is little reason to think they can’t continue to do so in the green sector.
“Hong Kong is still small, but it should be big,” says CBI’s Kidney. Only two companies, MTR Corp. and Link Finance, have issued green bonds from Hong Kong. Chief executive-elect of the territory Carrie Lam is understood to be supportive of green finance, and the city’s infrastructure projects will be easy fits for green bonds, Kidney says.
Similarly, the Taiwan market is set to grow, said Sheth. Taiwan’s Financial Supervisory Commission announced last October that green financing would be a priority for the country.
The country has been relatively quiet since Advanced Semiconductor Engineering issued the first corporate green bond in Asia in 2014, only reopening recently with the small sales of two US dollar and two Taiwanese dollar notes from four separate banks in mid-May. Bank SinoPac, CTBC Bank, E. Sun Commercial Bank and KGI Bank’s green debuts totalled the equivalent of about $171 million.
Many of China’s green issuers have government connections and are well-known names. Bank of China has been a leader in green-bond issuance. This is just the first wave, Ma points out. Private-sector issuers and smaller local governments are going to be increasingly involved in the push, she reckons.
In the west, local governments and sub-sovereigns use green bonds to finance water and waste projects or transport modernization. New York City’s Metropolitan Transport Authority, which runs the city’s subway, and London Underground have both issued green bonds. China could easily do similar projects.
But issuers aren’t always as keen to borrow offshore as the government would like. Issuing green bonds offshore isn’t as appealing as onshore issuance, a possible reason behind the dearth in offshore green bonds this year.
The issuers are encouraged to seek dollars or euros, and to then swap the revenues back to renminbi for onshore green projects. But, renminbi depreciation, which began in 2015, kills much of an issuer’s motivation to do so.
For Geely Holding Group, issuing a green bond had little to do with government initiatives, but was driven by an offshore project. The company, which makes London’s black cabs, sold a $400 million green bond last spring and used the proceeds for the production of electric taxis. The deal came with a standby letter of credit from Bank of China’s London branch to attract investors.
The green-bond option came up in conversations with banks when Geely began looking at issuing debt in relation to the taxi project.
Frank Li, vice-president at Geely Holding Group, tells Asiamoney: “The project by nature was green, and then we realized there was a green bond available, and we thought it would be perfect for this project.”
Being one of the first Chinese issuers in the field came with challenges. “It’s certainly more work, given that it’s a new product,” says Li. “Not many banks have done a green bond, so it takes a lot of working together.” Geely had to educate its own staff, as well as investors, about what having a green label meant for a bond. “If we do a green bond again, I would look for banks that have a track record in this space,” Li adds.
He says that any future green bonds from Geely will also be project-specific. But he suspects the opportunities for such will become more common as the development of the auto industry lends itself more to environmentally friendly advances.
“I’m repeatedly asked why we issued a green bond,” says Li. “There’s not much economic benefit of being a green-bond issuer.” Green notes are generally priced on par with conventional bonds, but have added costs associated with getting green verification.
“We took the green-bond issuance as a marketing event,” Li says. The notes created headlines for the company, giving it publicity not just for its new notes and the company, but also for its electric taxi project.
“Green bonds in themselves are still an incredibly new concept globally,” says Ma at BAML. “There’s not enough education in what green bonds are yet.”
But education takes time. White papers, conferences, roundtable discussions between banks and clients will all create a better understanding of the sector, she says. It’s still rare to have a green-bond panel at conferences in Asia, which means little opportunity to discuss the products or have questions answered.
In Europe, the green-bond client base is more developed, and many investors have explicit green or socially responsible investment allocations as part of their mandates. But in many cases these investors are also reluctant to invest in Asia, or more specifically in China. There aren’t many mandates for renminbi-denominated green bonds, says Ma. Developed-market investors would prefer to wait and see when it comes to emerging market green notes.
Asset manager Amundi announced in April that it would team up with the World Bank’s International Finance Corporation for a $2 billion emerging-market green-bond fund, a breakthrough for Asian countries.
The asset manager will invest in bonds issued by financial institutions, which it sees as active players in green financing as providers of loans and other funds for green projects. The fund will be diversified across emerging markets, with a 20% cap imposed for investment in any one country.
China is the undeniable issuer of most emerging-market green bonds, but Amundi is also careful that it only invests in bonds that meet the international green-bond principles, says Jean-Jacques Barbéris, Amundi’s global head of central banks and sovereign wealth funds. That means clean coal is out, an automatic barrier for investors looking at China.
Amundi sees massive opportunity in the green market globally. “Three years ago, green finance was about saving the world. Now it’s about risk,” says Barbéris. Long-term investors, such as pension funds, are looking at how climate change will affect investors within their lifetimes. Governments are conscious of the changes as well, forcing many institutional investors to include a climate profile of their investments, pointed out Barbéris.
An ultimate goal of international green-bond backers is for the market to hit a kind of autopilot, Sheth. If asset managers start dedicating a specific percentage of their portfolios to green products, issuers will reorient themselves to hit new investors, and investors will see green investments as easy fits to their mandates.
But the pool of Asian investors is limited. Some of Asia’s push is coming from heightened individual awareness about pollution and global warming, which falls in line with China’s holistic approach to the greening of the country.
“Once that link is actually created, it will be much more natural that people will turn to green bonds,” says Ma. Long-term investors, such as sovereign wealth funds, are natural green investors as soon as they understand the products.
Investors lack a simple apples-to-apples comparison with conventional bonds that gives clear indications about the financial benefits of investing in green bonds. “You’re not giving up returns by investing in green, so why wouldn’t you do this?” Ma asks.
“From the investors’ perspective, it isn’t that much different,” says Geely’s Li, adding that investors are generally open to green notes.
“We do see, being a green-bond issuer, that we are a specific target of some investors,” says Li. There hasn’t been a sudden surge of new, socially responsible investors, he says, but investors from Europe that like green projects and haven’t considered Geely before are now watching the company.
Regulators still have a long way to go before their work is done. Should the new issuance market take off, as the government hopes, regulators will need to turn their attention to verifying just how effective their efforts have been.
Green-bond guidelines ease the identification of a bond as green for the sake of issuance, but they do not guarantee that issuers will follow through with their promises to use revenues for green projects. It’s too early to determine if most of the companies that have issued green bonds are following through, but regulators can, and should, start periodic check-ins with the issuers, says Yang.
“We need authorities to be active, and then the punishment is a real punishment,” he says.
Issuers who siphon money into other projects or who lie about the nature of their green notes should be blacklisted, making it extremely difficult for them to issue new notes again.
After a bumper year in 2016, China’s green bonds will inevitably be in the spotlight.