Bonds are playing an increasingly larger role for private enterprises and government-backed projects in China, where the financial system has long been dominated by bank loans. China has been trying to tackle environmental problems, by-products of its unusually rapid economic development since the late 1970s. It is also one of the countries heavily promoting drivers of sustainable economic growth which has given rise to green bonds becoming an important vehicle to finance environmentally friendly projects and activities.
China has quickly emerged as a key player in green bond issuance since its central bank released the green bond guidelines in 2015. The growth in domestic green bond issuance was partly boosted by the fast emerging securitization market in China, according to China’s central bank. China is also raising increasingly more foreign-currency green bonds to fund both international and domestic projects. Through Bond Connect, launched in 2017 to connect the bond markets of the mainland China and Hong Kong, China aims to attract more international investment to the green market on the mainland.
The rapid rise of the green bond issuance is to a great extent driven by the efforts of the Chinese government. A large portion of financing to environmentally friendly projects is directly allocated through the state-controlled channels such as state-owned banks, local governments financial vehicles, which have been major players in financial resources allocation, and state-led international projects like the ones under the Belt and Road Initiative, an ambitious global infrastructure project that claims to have taken environmental, social and governance (ESG) factors into consideration. State-owned enterprises, especially state-owned banks and other financial institutions, account for the majority of China’s green bond market. To encourage enterprises and financial institutions located in their jurisdictions to issue green bonds, some local governments provide subsidies and other incentive programs to the issuers of green bonds in addition to favorable policies and support services. China’s central bank began to accept green bonds as collateral for bank lending in 2018.
While China’s green bond issuance has been growing fast, investors, especially international investors, are highly concerned with green claims of underlying projects or assets and the credit quality of the bonds.
The green bond standards that Chinese issuers follow vary. The domestic standards for green bonds are very different from the widely adopted international principles. And domestic banks and corporations are subject to different regulations. There is a big contrast in the use of funds between the Chinese standards and the international ones. While the international norm requires 95% of proceeds to be invested in green projects, issuers in China are allowed to use up to 50% of the funds raised for working capital needs, according to the regulation issued by National Development and Reform Commission (NRDC), the regulator of corporate issuers, in 2016. In 2018, the Shanghai Stock Exchange, one of the two domestic stock exchanges, began requiring at least 70% of the proceeds to be invested in green industries.
Some green projects by Chinese standards, such as “clean” coal projects, are considered unacceptable by the international standards.
The total issuance of green bonds based on international standards has been growing faster than those following Chinese standards. A considerable portion of green bonds issued in China still don’t meet the international standards. Only 62% green bonds issued in China in 2017 met international green definitions, according to Climate Bond Initiative.
The credibility of the environmental or climate benefit claims and credit risks of the bonds by Chinese issuers are another major concern for investors. In 2018 about 14% of the total green bonds issued in China didn’t have any external pre-issuance reviews, according to the 2018 annual report published by Climate Bond Initiative. One reason is that green bond issuances approved by the National Development and Reform Commission, do not require external reviews.
China has a high percentage of post-issuance reporting as it is made mandatory by domestic green bond guidelines. China’s central bank requires green bond issuers to disclose the use of proceeds to the market on a quarterly basis. 89% of Chinese green bonds by value reported on climate and environmental impacts in 2018. Environmental disclosures have also been made compulsory for large emitters of greenhouse gases and other heavy polluting companies that are listed on local stock markets and their subsidiaries. But the self-reported information by both private and state-owned companies in China has long been scrutinized for reliability. And the post-issuance reporting is much lower coming from corporates than larger financial institutions.
Given the differences between the domestic and international standards and the lack of reliable information for determining the “greenness” of the China-based projects or assets, or the credit risk of green bonds, it’s not surprising to see investors seeking alternative information sources for due diligence and additional investment research on China-based green projects and assets.
Thanks to the recent advances in information technology industries like artificial intelligence, increasingly more types of digital data are being explored by the newly emerged data technology developers, and some develop tailor-made products and services for investors.
The latest improvements in artificial intelligence and other related information technologies have helped with the expansion of information types and volume and the analytics capabilities with the data collected. Techniques like image recognition and natural language processing are used for the extraction and classification of unstructured text or information that was previously unavailable. Some of the newly emerged data vendors are developing models to automatically generate ratings or reports on the environmental impact and other performance factors of companies or projects, or provide real-time or high-frequency monitoring capabilities.
China is considered having an advantage when it comes to digital data. China has a big and advanced digital economy. Apart from those voluntarily generated by businesses and individuals, more and more information is being released by the public sector as China aims to build a world’s leading AI industry fueled by digital data. The Chinese governments of all levels are encouraged to digitalize and share as much information they are allowed as possible, and some are building data sharing platforms. While the easily quantifiable information like penalties and emission levels is limited, the data and analytics services developers are now able to explore more data from sources ranging from formal sources like websites of governments and other organizations to social media with the technologies mentioned above.