The exponential growth of green investment opportunities in China provides both a guiding light and a beacon of opportunity, but international investors may still need to be convinced, writes Paul Davies
China has experienced unparalleled economic growth in the past four decades. However, a by-product of this success is that the country has become the world’s biggest carbon emitter, accounting for more than a quarter of global carbon emissions. China’s unprecedented urbanisation has also contributed to significant environmental pollution, which has increasingly become the subject of public concern.
Since launching its “war on pollution” in 2014, the central government has prioritized environmental protection. In order to transition to a development path facilitating environmentally sustainable economic growth, China has widely promoted “green finance” and pursued a comprehensive and co-ordinated approach to “greening” its financial system.
For the purposes of this article, green finance means financial services provided for economic activities that support improvement of the environment, mitigation of climate change, and more efficient use of resources (as defined in the Guidelines for Establishing the Green Financial System, issued by the People’s Bank of China [PBC]).
Widespread implementation of green finance initiatives presents both challenges and opportunities for companies. As sustainability becomes increasingly important to investors, so too do opportunities for companies to tap green-minded investors and maximise growth potential by demonstrating corporate sustainability. Green finance therefore has great potential as a tool for providing finance not only for typically “green” companies, but also for companies transitioning from less sustainable practices to a more sustainable development path and seeking more generally to improve their sustainability performance.
GREEN FINANCING STRATEGIES
The PBC’s green finance task force was established in 2014, and has since marshalled the development and implementation of several pioneering plans and initiatives. In May 2015, the Central Committee of the Communist Party of China (CPC) and the State Council issued the Opinions on Further Promoting the Development of Ecological Civilization. The opinions set out a number of suggestions, such as enhancement of tax initiatives for energy efficiency and environmental protection, and the promotion of green credit.
In September 2015, the State Council and the CPC Central Committee issued the Overall Plan for the Reform of Ecological Civilisation System, specifying that China would establish a green finance system in order to create an ecological civilization.
The central government continues to send clear signals to the market with respect to its commitment to a greener economy, indicating to the private sector that preserving the nation’s environment is a long-term political priority. Published in March 2016, the 13th Five-Year Plan for Economic and Social Development of the People’s Republic of China formalized the goal of establishing a green financial system, and was China’s first five-year plan to consider climate change — offering specific guidance on energy consumption control.
In September 2016, China held a G20 summit for heads of state in the city of Hangzhou — the first time that the country had hosted the summit. In addition to maximizing China’s role as the host nation and highlighting the country’s position as an economic superpower, China leveraged the summit to promote its continued commitment to combating climate change and showcase its market-leading role in green finance.
During the summit, the PBC and six other government agencies — the Ministry of Environmental Protection, the Ministry of Finance, the National Development and Reform Commission (NDRC), and China’s regulatory commissions for banking, insurance and securities — published new green finance guidelines. The guidelines outlined various strategies for building a green financial system, such as subsides for green loan-supported projects and the launch of a national-level green development fund.
The new guidelines complement burgeoning national support for China’s transition to a greener economy. China must develop strategies to ensure that its new priorities translate into specific policies and quantitative criteria that officials will understand and utilize to progress sustainable development.
Green bonds are the fastest growing component of China’s various green finance initiatives. China became the largest country of origin for green bonds in 2016, with a total of US$30.5 billion in issuances, according to the Climate Bonds Initiative, an international organization. Data from the China Central Depository and Clearing Company reveal that China issued RMB79.39 billion (US$12 billion) of green bonds in the first half of this year – a 33.6% increase from the same period last year, and accounting for 20.6% of the global total. This rapid growth is particularly remarkable given the first Chinese green bond listed on an exchange was issued as recently as July 2015.
Chinese companies have increasingly used green bonds to attract new investors. Sustainable finance products have been in high demand in the past several years, particularly from European and American funds that increasingly operate with preferences and mandates related to non-financial factors (such as environmental impact). Chinese companies can provide an attractive investment opportunity to these investors with a green bond that satisfies both Chinese and international standards.
International standards for green bonds are based on market acceptance, rather than bright-line rules. This exposes green bond issuers to risks that investors will characterize the green label as “green washing”, or raise securities law or fraud claims. Chinese companies face the added complication of several different Chinese law regimes that are applicable to green bonds, depending on the nature of the issuer and the listing venue.
The primary concern for Chinese green bond issuers looking to tap international bond markets is therefore adequate disclosure on the green bond, rather than compliance with any regulatory safe harbours. The key disclosure questions are:
- To which underlying sustainable activity will the bond relate?
- How does the bond relate to that underlying sustainable activity?
To disclose the underlying sustainable activity, a typical green bond provides a list of “eligible green projects” that the bond will finance. The list’s content is critical for the market’s acceptance of the bond as green, and should be narrowly tailored to avoid activities insufficient to support a green bond in international markets. This can mean, in some cases, omitting activities that Chinese green bond regulations specifically permit, such as certain clean-coal projects included in the PBC-eligible project catalogue.
To disclose how the bond relates to the sustainable activity, a typical green bond will specify that the bond’s proceeds will be used to finance or refinance the sustainable activity. For example, this can take the form of financing greenfield project development for a renewable power facility, or refinancing existing indebtedness used to develop a wind farm, or lending proceeds to third parties that will use the funds in an eligible way. When the use of proceeds includes on-lending to third parties, disclosing the manner in which projects will be selected, and how the proceeds will be managed prior to being loaned, is important.
An issuer should also bear in mind that green bond investors will require not only standard financial reporting, but reporting on the bond’s sustainability effects as well. Typically, issuers disclose the extent to which they intend to report in their offering materials – and failing to offer sufficient reporting can damage the market’s acceptance of the bond as green to the same extent as choosing an inappropriate underlying sustainable activity.
Many countries have developed targeted green finance initiatives, but few have succeeded on a national scale. However, Green finance in China is unique and has developed from the top down, with the introduction of increasingly concrete regulatory measures.
The longer-term market opportunity for China is, therefore, significant. Yet, while Chinese investors may welcome policy signals such as the guidelines, particularly in the green bond market, international investors require detailed sustainability data, clear and predictable definitions, and greater company disclosures.
Paul Davies is a partner in the London office of Latham & Watkins. Aaron Franklin, Bridget Reineking, Andrew Westgate, associates of Latham & Watkins in London, Washington DC and New York, respectively, also contributed to this article