China’s green bonds: Sprouting issuance, absent “greenium”
A key advantage of China’s onshore green bonds that sets them apart from other markets is the lack of price premium over comparable non-green issues.
Written by Martin Dropkin, Head of Asian Fixed Income, Alvin Cheng, Portfolio Manager, Vanessa Chan, Investment director, Yi Hu, Investment Writer and Qijing Tan, Investment graduate
Originally published in November 2021
New green bond sales are flourishing again in China following a pause during the Covid-19 pandemic. Strong policy support in a government-driven campaign to cut carbon emissions is the trigger. Chinese policymakers have been ramping up reforms toward a more sustainable economy. The green debt boom offers a way to tap the country’s growth while respecting the environment.
To global investors, a key advantage of China’s onshore green bonds that sets them apart from other markets is the lack of ‘greenium’, or price premium over comparable non-green bonds. An analysis by Fidelity of data on thousands of onshore Chinese new bond issues over the past four years found that greeniums have been practically non-existent in the market. Demand lagging supply in the market has led to unchallenging pricing. One explanation is that the country’s carbon neutrality targets have yet to translate into more incentives for green bond buyers, many of whom still see little difference between green and ‘brown’ issues. However, overseas investors must be mindful of the gap between Chinese and European green bond standards and the risk of greenwash.
In this article, we examine China’s green bond market from three main angles: the rapid growth in new issuance, the lack of greeniums in the primary market, and efforts to promote harmonisation with global standards.
A huge market blooms anew
Among the financial market fallout from the Covid-19 pandemic was a slump in green bond issuance in China, where a five-year growth streak was snapped in 2020. The government orchestrated the sale of more than 1 trillion renminbi ($156 billion) in pandemic control and relief bonds last year, capturing what remained of investor demand that had already been weakened by the public health crisis. As a result, the value of issuance meeting China’s green bond criteria, both onshore and offshore, plunged more than 20 per cent to 289.5 billion renminbi ($45 billion) last year.
But the green bond market has made a strong comeback this year, as the economic recovery continues and, more importantly, as China fires on all cylinders to cut carbon emissions. State-owned companies, from banks to asset managers and industrial firms, have linked green finance to their key performance indicators after Chinese President Xi Jinping announced the country’s carbon goals in a speech to the UN in September of last year: China will target peak emissions by 2030 and carbon neutrality by 2060.
In the first half of 2021, the value of Chinese green bond sales that comply with domestic definitions and criteria surged more than 50 per cent from the same period of last year to 242.5 billion renminbi, a half-year record. Similarly, the issuance of Chinese green bonds aligned with international standards jumped to a record 141.9 billion renminbi in the first six months, accounting for about one tenth of global green bond sales.
While global green bond standards focus on climate change, China has been using broader definitions and criteria that also cover pollution control, conservation, and biodiversity, with an aim of making ‘dirty’ sectors cleaner. The value of China’s internationally-aligned green bond issuance has ranked fourth in the world so far this year, after the US, Germany and France, according to Climate Bonds Initiative.
Most of the action is onshore. More than 80 per cent of Chinese green bonds are issued to domestic investors and denominated in renminbi, while the rest are primarily dollar bonds offered through the Hong Kong Exchange.
As policymakers step up their support for green finance, total Chinese green bond sales have continued to flourish and are currently on track for an annual record.
Putting a price on it
For green bond investors, earning desirable returns is often as key as environmental priorities, but the two goals can sometimes work against each other due to the existence of ‘greeniums’.
In Europe and America, green bonds often command price premiums over comparable brown issues, despite no difference in credit risk between the same companies’ green and non-green bonds. Yields offered by green bonds were often lower by 5 to 15 basis points than those of comparable brown issues in the last few years, according to many research groups, such as ING Think, Climate Bonds Initiative and Eurasian Economic Review.
Drilling down into individual European issuers also unearths visible greeniums, especially in ‘dirty’ sectors such as auto manufacturers where green bonds are less common. A surge in demand for eco-friendly assets in the wake of the pandemic has contributed to these pricing gaps in the West, although they have narrowed slightly this year amid an increase in green bond supply.
By contrast, in China’s onshore market, Fidelity’s own review of the data points to a clear lack of greeniums, which could be a boon to global investors searching for inexpensive green debt.
As the above charts show, the spread difference is negligible between Chinese green bonds and comparable brown issues of the same maturity. This lack of greenium appears to hold despite differing levels of rating quality, and even across sectors. For example, the same pattern is found both among AAA-rated (investment grade) bonds and among AA+ bonds. In China’s onshore market, around 80 per cent of credit ratings sit between AAA and AA in a distinct domestic rating system. Compared to global rating agencies, domestic Chinese evaluators attach greater weight to asset size and less weight to profitability, among other differences. We also analysed the top three sectors for green bonds issuance - banking, utilities and transport - and similarly found little trace of greenium at the sector level, another contrast with what’s been observed in the West.
China’s green bond market has been dominated by state-owned issuers and investors who closely follow government policy directives, while private-sector interest lags far behind. On the supply side, government units and state-owned enterprises (SOEs) together account for nearly 90 per cent of onshore green bond issuance. On the demand side, as sustainable investing and environment, social and governance (ESG) considerations are relatively new concepts in the country, private-sector bond investors tend to focus almost exclusively on credit quality and yields, and are generally reluctant to pay greeniums. Lukewarm demand has contributed to moderate green bond pricing. That translates into the mutual fund market as well: there are few green bond products offered by Chinese onshore asset managers.
The People’s Bank of China has recently included green finance in the evaluation of Chinese commercial banks, providing a key impetus for green bond supply. But there is plenty of room for more policy support, such as allowing tax benefits for green bond investments and providing credit enhancement for green projects through government guarantee. Still, as ESG awareness continues to grow and foreign flows into China gather pace, greeniums are likely to emerge in the Chinese market in the near future.
Many shades of green
The gap in green bond definitions between China and the West remains a challenge to global investors. European standards have a prime focus on climate change, but China defines green bonds more broadly, covering pollution control, energy saving and biodiversity, among other areas.
Two official catalogues have set out the guiding principles for defining Chinese approaches: the People’s Bank of China’s catalogue on endorsed projects and the National Development and Reform Commission’s catalogue on the green industry. They are often compared to the EU Sustainable Finance Taxonomy for shaping the domestic green finance industry.
The catalogue from the PBOC, China’s central bank, has listed six categories of green projects: (1) energy saving and environmental protection, (2) clean production, (3) clean energy, (4) ecological environment, (5) green infrastructure upgrade, and (6) green services. By comparison, climate features in two of the EU taxonomy’s six environmental objectives: (1) climate change mitigation, (2) climate change adaptation, (3) sustainable use and protection of water and marine resources, (4) transition to a circular economy, (5) pollution prevention and control, and (6) protection and restoration of biodiversity and ecosystems. European definitions appear stricter and more detailed when it comes to screening criteria. For example, China has set no carbon emission thresholds for issuers, whereas European regulators have specified limits. And, unlike the European rules, the Chinese catalogues offer no clear guidance on how to measure contributions to key environmental objectives.
Significantly for investors focused on promoting ESG outcomes, Chinese rules also appear looser on the use of proceeds, allowing issuers to allocate up to 50 per cent of funds raised to loan repayment and working capital, while international standards usually require full allocation to green projects. This leaves loopholes for possible misuse of funds in the Chinese market.
In July, state-owned China Energy Investment Group raised 5 billion renminbi selling three-year green bonds to fund some of its wind power, hydrogen and solar projects. About 13 per cent of proceeds were used to repay bank loans. In April 2020, Nanjing Metro Group sold five-year green bonds for 3 billion renminbi, with one third of the proceeds being used to replenish working capital and the rest going into railway construction.
Recognising these differences, China has been making efforts to harmonise its green bond standards with international ones. Last year, the PBOC removed so-called ‘clean coal’, which involves a purifying process to boost the fuel efficiency of coal, from its green bond definitions. Under European green finance rules, fossil fuel activities are generally excluded. For Chinese policymakers, removing loopholes for clean coal represents a bold move given the country’s heavy reliance on coal-fired power. Currently, coal accounts for about half of China’s energy use, compared to only around one tenth in the US.
This year, the Chinese central bank has followed European regulators in adopting the ‘do no significant harm’ principle in updating its catalogue. The move is key to filtering out projects that bring environmental benefits in some ways but cause damages in others. For example, a waste treatment project that consumes excessive energy may have been considered green under old rules, but its negative impact on energy saving may disqualify it for green bonds based on the new catalogue.
Change will take time, but the direction the market is developing in is clear. In the first half of 2021, green bonds aligned with Climate Bonds standards, which are based on the EU taxonomy, accounted for 58 per cent of the total value of Chinese green bonds - a small increase on 54 per cent in 2020 and 57 per cent in 2019.
It pays to be early in China’s green debt space, where we think the greenium-free days are numbered. The price of entry is bound to rise with demand. As China further opens its capital markets and aligns its green bond standards with the world, capital flows will ramp up and the current boom should have plenty more room to run. This is one case where the grass probably will grow greener, and no less costly, on the other side.
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