Issuing with principle

IFR IMF/World Bank Report 2022
11 min read
Jonathan Rogers

Streamlined regulations set to propel China to the forefront of the green scene

China’s primary green bond market is on course to become the world’s largest as streamlined domestic regulations align with international norms. The recently published Green Bond Principles herald a watershed moment for the green bond market and underline China’s resolve to transform its industrial base as it aims to meet its “30/60” net-zero targets.

“China has invested more in renewable energy than any other country on the planet over the past 16 years, and that is set to increase, as will the funding for that investment,” said Sean Kidney, founder and CEO of the London-based Climate Bonds Initiative.

“There will be increasing measures to support issuance – finally, we’ve seen the China Green Bond Principles published in July and backed up by the Securities Commission. This is important because it means Chinese green bond regulations are now compatible with international regulations, making comparison easier.”

For those observers who buy into the thesis of Western declinism, and in particular the decline of the United States and Europe framed within the context of the “Green Industrial Revolution”, the dynamic of the seemingly unstoppable rise of China’s green bond market will possess particular allure. The data seem not to lie for those who support the thesis.

According to the Climate Bonds Initiative, green bond issuance from Europe declined from a dominant 54.8% of the total in the second quarter of 2021 to 41.7% in the same period this year, while US issuance collapsed from 19.1% to 8.4%.

Green bond issuance from China, meanwhile, more than doubled to US$23.9bn year-on-year, establishing its hegemony in the country issuance stakes and accounting for 21.5% of the US$111.6bn second-quarter global green bond issuance total.

“There’s a reasonable chance that by the end of next year China will be the world’s largest green bond market,” said the Kidney, citing the GBPs which will provide an issuance rubric that is partially the product of the China-EU Common Ground Taxonomy.

Falling short

Prior to the publication of the GBPs, green bond issuance in China followed the National Development and Reform Commission’s Green Bond Guidelines, under which up to 50% of proceeds could be used to repay bank loans and replace working capital.

A large proportion – as much as 40% – of domestic bonds classified onshore as “green” failed in that classification as defined internationally, principally with reference to the International Capital Markets Association’s Green Bond Principles.

According to data from Refinitiv, China issued a total of US$35.8bn-equivalent of green bonds domestically in the first half of 2022, via 154 deals, meaning issuance was on track to beat last year’s US$46.5bn total off 218 deals absent the publication of the GBPs. That total is set to rise significantly assuming the international compatibility provided by the GBPs is onboarded.

The GBPs are designed to operate alongside the Green Bond Catalogue, which was first published in 2015 and underwent its most recent iteration in July. The catalogue lays out endorsed projects for potential green bond issuers and is stringent in its exclusions of fossil fuel-related projects, extending from gas through to clean coal.

“The principles are a game-changer in terms of use of proceeds,” said Diana Parusheva-Lowery, head of public policy and sustainable finance at Asifma in Hong Kong.

“Whereas under the previous regulatory system only 50%–70% of proceeds needed to be fully green, while the rest could go towards refinancing or other purpose, now the entire financing must be aligned with the Green Bond Catalogue.”

Still, there remain concerns in certain quarters concerning a degree of ambiguity in the GBPs regarding use of proceeds which can be allocated to general working capital, wherein the language of the GBPs does not specify whether this capital must be green.

Fitch has alluded in a research note to the greenwashing risk of this lack of clarity, although market participants expect a stringent use of working capital related to green projects to be the new status quo.

The publication of the GBPs demonstrates the relentless march of “taxonomy culture”, and in this instance the nuance is its enshrining in documentation the closeness of China’s relationship to the EU when it comes to sustainability – the GBPs are designed to align with the Common Ground Taxonomy, which has been thrashed out between the two economic powerhouses since November 2021 and which was updated in June.

Out of the alphabet soup

The comparability and interoperability of taxonomies might seem somewhat arcane and perhaps unworkable, but the International Standard Industrial Classification of All Economic Activities (ISICI) methodology used in producing the Common Ground Taxonomy (CGT) accommodates discrepancies in the economic development model and industry structure across different economies, allowing for sector mapping.

And emerging from this veritable alphabet soup is something that is catching on fast: according to research from Natixis, some Asian market participants have begun to label green financial products as CGT-aligned.

“Under the principles, issuers must allocate 100% of proceeds to green projects, and international issuers will now be able to use the EU/China common Ground Taxonomy as the basis for this,” said Dan Wiseman, head of APAC policy at the UN-supported Principles for Responsible Investment.

“These measures have the potential to both strengthen the already fast growing Chinese green bond market and help somewhat to address increasing greenwashing and credibility concerns.”

The use of proceeds was a cornerstone of the greenwashing barbs which have flown at China’s green bond market since it began to take off in earnest around five years ago. According to Refinitiv data, China onshore green bond issuance averaged around US$25bn per year from 2018 to 2020 before almost doubling last year, and under the prevailing regulations it is estimated that only 30%–50% of proceeds went to financing green projects.

While the transition to net zero – the 30/60 scheme announced in 2020 by President Xi Jinping under which CO2 emissions will peak by 2030 and carbon neutrality be achieved by 2060 – contains a plethora of economic and social challenges, interestingly, China is not yet actively promoting the use of transition finance in capital markets, unlike Japan.

“Transition is not yet significant in China, but the PBoC and the other regulators are looking at it and you will see guidelines coming through. Some transition thinking will not work, such as in the gas sector where IPCC and IEA reports say very clearly new gas is not compatible with Paris Agreement targets. But others, such as transforming a traditional steelmaker into a low-carbon steelmaker over five to seven years are,” said Climate Bonds Initiative’s Kidney.

The hope among DCM bankers is that China’s domestic bond markets can open up to green bond issuance from foreign entities, and in particular that the Common Ground Taxonomy can tease European issuers into the onshore market under the encouragement of Chinese policymakers.

“There is a serious intention to go green within China’s political complex and the dynamic has moved beyond just the need to mitigate pollution. Europe is undoubtedly a driver and its local subsidiaries in China are moving to transform along the lines unfolding in the EU,” said Asifma’s Parusheva-Lowery.

FIGs on a roll

A notable feature of domestic China green bond issuance under the Green Bond Guidelines has been the dominance of financials, although it has been on a declining trend.

In 2018, according to Refinitiv data, 72.7% of issuance was booked by financials, whereas only 11.4% came from the crucial – in green finance terms – energy and power sector. This year so far, financials account for 52.9% and energy and power 25% – a virtuous dynamic which is set to continue as the GBPs kick in.

Financials have undoubtedly been market leaders in terms of innovation in China’s green bond market, with Bank of China in September 2020 bringing the first blue bond to be issued by a commercial bank via a US$942m dual-currency Reg S deal.

Blue bonds are regarded as a green bond subset and the asset class is expected to experience strong growth out of China. The blue economy was stressed as a highlighted national developmental priority in 2020 in China’s Government Work Reports, and in January 2020, the China Banking and Insurance Regulatory Commission requested stakeholders to explore innovative green financial products including blue bonds in order to support development of low-carbon and circular economies and to mitigate pollution problems.

“Blue bonds, with their specific use-of-proceeds and structuring elements, have very strong potential to be a viable financing option to bring more attention and discussion around sustainable blue projects in the capital markets and eventually fulfil the role of attracting more capital flows into these activities,” said Carmen Tsang, head of sustainable banking, Greater China, at Credit Agricole, who is based in Hong Kong.

The stage is set for booming green bond issuance out of China’s onshore market, with a ream of boxes ticked, not least the interest rate backdrop – China is easing while the US and EU are tightening – ongoing foreign capital allocation thanks to the inclusion of China’s bond market in major international indices, the assumption of full ownership of securities JVs by foreign investment banks and the harmonisation of taxonomies and standards.

“The outlook for issuance is so good it’s incredible. By the fourth quarter, at the current run rate, the China market will double in primary issuance volume – on the basis of what we recognise as internationally compatible, which is 40% more now given the new regulations,” said Climate Bond Initiative’s Kidney.

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