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Chinese bonds struggle to go green

Yet Beijing needs foreign debt investment to help finance environmental improvements

Cleaning up China's polluted air, waters and land is a huge, costly undertaking. To help pay for the work, Beijing has rapidly become one of the world's two biggest issuers of green bonds.

Yet as reaffirmed by China's commitments at the global climate change conference in Poland in mid-December, the country's ambitious antipollution program will need funding on a vast scale. This is critically important not only for China but also for its neighbors and countries further afield as China's emissions of chemicals, dust and carbon dioxide drift outward. 

Even with the rapid growth of the country's domestic credit markets, local investors cannot fully absorb the volume of green debt finance Chinese issuers need to sell. But while Beijing has begun welcoming foreign investors into its debt markets, Chinese green bonds have so far met with a wary reception.

"Green" for Beijing often does not mean green for international buyers. Also, many issuers have yet to build up the credibility to be trusted to use funds as promised. China must address these gaps so that it can better tap global financial markets in its environmental drive.

While the People's Bank of China published its first guidelines for green bonds only in December 2015, the country soared to the top of issuer rankings the following year. Though the surge of green bonds from China has continued, the country has slipped behind the U.S. in total issuance. Through Sept. 30, China's total reached $21.52 billion according to a report by the U.K.-based group Climate Bonds Initiative and China Central Depository & Clearing.

According to a study by the Chinese central bank and the UN Environment Program, China needs to spend a minimum of 2 trillion yuan ($290.58 billion) a year to meet its self-proclaimed goals of green development and "building an ecological civilization." The two organizations estimated that at least 85% of the sum required would have to come from private capital.

Domestic banks have so far been both the biggest issuers and the biggest buyers of Chinese green bonds. Only a sixth of last year's green bond proceeds came from overseas issues even though offshore interest rates have generally been below domestic levels.

Most Chinese green bonds issued last year will mature in three years. Environmentally beneficial projects are usually long term. It would thus make sense for Chinese issuers to look more at the offshore market for takers of longer duration bonds.

Yet international demand is no sure thing. As it stands, green bonds represent just 2% of the global bond market. On top of that, while there are no global standards for green bonds, China's rules allow many issues to be called "green" that could not be in Europe or the U.S.

According to S&P Global Ratings, only 62% of the $37.1 billion in Chinese green bonds issued last year met international definitions. This standards gap is dampening potential interest from environmentally focused wealth managers and institutional investors in the West.

Greenness depends principally on whether proceeds from the issuance of a bond will be used to fund environmentally beneficial projects. The Climate Bonds Initiative, for example, only counts bonds where at least 95% for the proceeds go to approved uses and no more than 5% is allocated for working capital.

China's standards by contrast allow for half of proceeds to go to working capital or the refinancing of bank loans. In China, green uses can include nuclear power generation, construction of large hydropower plants, and so-called clean coal projects which would not count as "green" in the West where the top environmental priority is arresting climate change. But in China, the priority is cleaning up the air, rivers, lakes and soil that have been fouled by the last few decades of breakneck development so projects that improve the efficiency of coal use can still be environmentally beneficial.

The green finance committee of the China Society for Finance and Banking, a research group affiliated with the central bank and headed by former governor Zhou Xiaochuan, has been negotiating with foreign counterparts on creating common standard for green bonds.

Yet even if China's green bond standards become more compatible with those of the West, some investors are likely to question how they are enforced. Chinese issuers must assure foreign investors that bond proceeds are going to the green projects to which they were allotted. Issuers may need to employ a major accounting firm or other third party to monitor and certify how bond funds are deployed.

Beijing could also provide sweeteners for foreign investors. Ma Jun, chairman of the Chinese green finance committee and a member of the PBOC's monetary policy committee, suggested earlier this year that the government could subsidize interest payments on green bonds. The governments of Hong Kong and Singapore are already drumming up activity on their markets by offering to reimburse issuers for green certification costs.

To get international investors to back its environmental cleanup, China will need to convince them it is serious about going green.

Michael Edesess is an adjunct associate professor in the Division of Environment and Sustainability of the Hong Kong University of Science and Technology, chief investment strategist of advisory company Compendium Finance and a research associate of the EDHEC-Risk Institute.

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