China’s onshore green bonds may reverse course and outperform this year as the prospect of greater policy support to promote green financing and an improvement in market standards drive demand.
Green bonds share the same characteristics as regular bonds but are issued to raise capital specifically for climate-related or environmental projects.
Chinese investors bought US$6.8 billion of green bonds in the second quarter, making it the largest market globally, with the United States in second place on US$5.8 billion. However, Chinese issuers accounted for 21 per cent of issuance worldwide, a figure described by Moody’s Investors Service as “reasonably muted” compared with the 35 per cent in the whole of 2016.
Chinese regulators have closed the gap between domestic and international standards for green bonds
Jason He Qi, partner, KPMG China
Efforts by the authorities to stabilise capital outflows earlier this year, and liquidity pressures in the interbank markets which led to tighter financial conditions and higher yields, have weighed on both China’s green bond and ordinary bond markets, analysts said.
“While 2016 was a ‘break-out’ year for China’s green bond market, we expect to see a more sustainable pace of expansion in the second half of 2017 and beyond, supported by strong policy momentum,” said Rahul Ghosh, vice president, credit strategy and standards at Moody’s.
The People’s Bank of China (PBOC) estimated that an annual investment of 2 trillion yuan to 4 trillion yuan (US$297 billion- US$594 billion) will be required to address environmental and climate change issues.
Last year Chinese energy major Datang announced there was a leak at the evaporation pond of its loss-making Duolun coal and chemical plant in Inner Mongolia. The Duolun spill, which caused severe environmental damage, especially around water supplies and treatment, was just the tip of the iceberg for the government in tackling companies bypassing environmental regulations, according to Greenpeace.
Meanwhile the opening of the mainland’s domestic bond market to foreign investors through the new bond connect scheme via Hong Kong is likely to increase the flow of money into Chinese green financing instruments, according to Debashis Dey, a partner at law firm White & Case. About 72 per cent of Chinese green bonds were issued in the mainland, compared to 27 per cent offshore. One per cent were green panda bonds, denominated in yuan and sold by overseas entities in China’s onshore bond market.
We expect to see a more sustainable pace of expansion in the second half of 2017 and beyond, supported by strong policy momentum
Rahul Ghosh, Moody’s
Transparency and disclosure on the use of proceeds are key challenges to all green bond issuers, not just those in China. According to Climate Bond Initiative, about 83 billion yuan (US$12.4 billion) in Chinese green bonds – 34 per cent of total issuance – did not meet international definitions in 2016.
The PBOC’s green definitions include some project types that would not be considered green by international standards, such as retrofits to fossil fuel power stations and “clean” coal.
So far this year, the Chinabond Green Bond Total Return Index posted a modest return of 0.6 per cent after last year’s outperformance of 1.6 per cent.
In comparison, the Bloomberg Barclays China Aggregate TR Index, which tracks government, policy bank and corporate securities on the domestic interbank market, outperformed with a 3 per cent return this year after last year’s 5.17 per cent loss.
But China’s determination to address environmental challenges – such as air, soil and water pollution – and to encourage greater capital flows into green projects, are likely to improve investor confidence and the performance of green bonds, analysts said.
The market does not expect Beijing to join the Philippines, Nigeria, Bangladesh and Morocco on the list of potential green bond issuers this year, following Poland and France’s sovereign green issuances, Dey said. Nevertheless, policy support in environmental, social and governance (ESG) standards is expected to increase.
In March, the China Securities Regulatory Commission issued new guidelines for a “green channel” that will accelerate the approval of green bond sales. Last year, it announced rules requiring listed companies of designated environmental zones to disclose their emission levels in their financial reports.
The market also expects the PBOC to issue new standardising metrics and targets of environmental impacts in the coming year or so. And the State Council is working together with local governments to develop five new green finance pilot zones, said Ghosh.
Moreover, market players are focusing more on voluntary, market-led and independently developed “best practice” standards by Chinese bond issuers rather than mandatory, enforced government standards, according to Dey.
More Chinese issuers are using external verification for their information disclosure and assessment reports despite not being required to do so by the PBOC. This is improving the confidence of investors and boosting the performance of green bonds.
“Chinese regulators have closed the gap between domestic and international standards for green bonds,” said Jason He Qi, a partner at KPMG China. “Companies are also starting to employ qualified third-party assurance agencies for their information, such as the big four accounting firms, helping investor confidence.”