The Chinese green bond market has rapidly expanded demonstrating impressive ambition and demand for green financing in China. More analysis is needed, however, to understand what exactly is being funded, how these activities are contributing to climate mitigation and adaptation and whether Chinese policies are leading issuers to invest in more green projects. This is especially important in light of the fact that green bonds and other green finance instruments in China must scale substantially. For China to meet its commitment to the Paris Agreement, it must mobilize an estimated RMB 3-4 trillion (roughly USD450-600 billion) in green investment per year. Climate Policy Initiative’s report, The State and Effectiveness of the Green Bond Market in China provides a review of the Chinese green bond market. The key highlights of the report are as follows:

Investment trends

China’s domestic green bond market has nearly quadrupled in size from USD 29 billion in 2016 to USD 120 billion by the end of 2019. Including offshore issuances, China’s green bond market is currently the second largest in the world, representing 12 per cent of the global issuances with USD 34.83 billion issued in 2019.

Cumulative issuance in China’s domestic green bond market (USD billion)
Source: CPI

The size of green loan portfolios held by China’s largest banks indicates huge potential demand for green bonds in China, surpassing RMB 10 trillion (USD 1.4 trillion) in 2019 and accounting for 10 per cent of China’s total loan balance.

Of the nearly USD 100 billion green bonds issued in China from 2016 to April 2019, clean transportation and clean energy received the largest share of proceeds with USD 17 billion and USD 16 billion respectively. Within the clean energy sector, hydropower accounted for the largest share at USD 7 billion. China Three Gorges Corporation was a leading issuer of green bonds for hydropower, with around USD 1.9 billion going towards the construction of several large-scale hydropower stations with capacities of at least 10 GW each. Within clean transportation, urban rail transit contributed the largest share at USD 5.7 billion.

Allocation of proceeds, from issuers to allocation sector (2016- April 2019)
Source: CPI

Project-level use of proceeds

Within the share of green bonds that specify use of proceeds, 28% was reported as going to new projects and 10% towards debt refinancing or for existing projects. 51% was not specified, largely due to financial bond issuers not disclosing information at this level of detail or because final allocation is pending.

Eleven percent of proceeds went to replenishing working capital for the issuers. Working capital means that proceeds may be used for various short-term operating expenses of the issuer. However, working capital proceeds could potentially finance the issuer’s other non-green business lines. Even for “pure-play” green bond issuers (companies whose revenue is primarily derived from green business activities), the consensus internationally has been to move towards reducing the share of working capital allocations for green bonds. The major share of working capital allocations in the Chinese green bond market is partly due to the result of regulation for enterprise and corporate issuers, which allows up to 50 per cent and 30 per cent of bond proceeds to be dedicated to replenishing working capital, respectively.

Issuer and investor characteristics

Most issuers in China are large entities with strong credit ratings that have broad access to credit markets. Stringent issuance requirements have also led to a skewed distribution towards the upper end of credit ratings in the overall bond market.

Bonds are almost entirely held by domestic investors among which collective investment vehicles account for about 60%, followed by banks and securities firms.

Foreign investor participation in Chinese bond markets remains small at around 1.6 per cent of the total value of bonds outstanding, however experts expect that this share will increase in the coming years through the new Bond Connect Scheme, which grants overseas investors greater access to the Chinese mainland’s interbank bond market. Other positive trends include the inclusion of RMB-denominated bonds in global indices, such as the phased inclusion of Chinese sovereign and policy bank bonds into Bloomberg Barclays Global Aggregate Index starting April 2019. China has also been implementing a series of policies opening its financial market to foreign firms, including the lifting of foreignownership limits in its financial sector one year ahead of schedule, allowing foreign companies to rate and lead underwriting for a greater range of bond types, and scrapping quotas for foreign investment in local stock and bond markets.

Contribution to China’s energy transition

While the green bond market has potential to impact the green energy transition, as of now, it has shown a relatively small impact compared with other financing methods.

A number of energy-related companies have participated in the green bond market. This includes the subsidiaries of all top five power producers in China 31 as well as the “new energy” subsidiaries of other large energy companies. The participation of the top five energy producers is critical, as they collectively represent 26 per cent of China’s total coal capacity. Issuance from the subsidiaries of these top five energy companies by April 2019 represented 3 per cent of the total green bond market (USD 3 billion), with half the proceeds going to wind power (USD 1.4 billion), followed by hydro (USD 273 million) and solar (USD 23 million). The rest of proceeds went to working capital (USD 0.8 billion).

Renewable energy mix represented in green bond proceeds (USD billion)
Source: CPI

Accounting for all energy-related green bond issuers, collective issuance represented around 22 per cent of the total green bond market (USD 21.7 billion). Hydro accounts for a significant portion of the proceeds, mostly contributed by China Three Gorges Corporation. Meanwhile, solar has been lagging in green bonds proceeds allocation.

Overall, while the bond market’s scale of contribution to an energy transition remains relatively negligible, the participation of top energy producers in the market, especially those with coal-dominant energy portfolios, could be a positive sign indicating potential for change in the near future.

Conclusion and recommendations

Where is finance flowing? Most funded projects are in clean transportation (17 per cent), clean energy (16 per cent), pollution prevention (11 per cent), and energy saving (11 per cent). However, a large share of the bond issuances had not been allocated or did not specify the use of proceeds (31 per cent).

How is the market functioning? A majority of green bonds have very high credit ratings (78 per cent are rated AAA), reflecting the high credit rating requirements for bond issuances in China. We can draw two potential conclusions from this: One, due to rating differences between China and elsewhere, bonds get higher ratings in China than they would internationally; and/ or two, there may be a potentially large share of issuers who have not been able to enter the green bond market due to the high rating requirements.

International investors have not engaged meaningfully in the Chinese green bond market. Key reasons include differing expectations and understanding of the allowed use of proceeds, as well as China having a large closed capital account which limits capital flows in and out of the country. However, foreign investor participation is expected to rise in the coming years through the new Bond Connect Scheme that allows overseas investors from Hong Kong to trade in the China bond market through mutual access arrangements and the inclusion of RMB-denominated bonds in global indices.

Who are the key players and how are they incentivized? Bond issuance by financial institutions including commercial and policy banks dominates the green bond market. These make up 65 per cent of all issuances and are known as “financial bonds”. State-owned enterprises and corporates make up the remainder of the market (32 per cent). Participation by private non-bank issuers is negligible (3 per cent).

There are financial and non-financial incentives for green bond issuance in China. Financial incentives are predominantly applied at the local and municipal level. Non-financial incentives are primarily reputational benefits which are very important in China.

Are investors changing their behavior? Is there additionality in the market? The overall number of green-related issuances drastically increased since the publication of green bond guidelines and the project catalogue in 2015 and 2016. 181 unique issuers have participated in the market. Among these, 21 were repeat issuers that had previously issued bonds for financing green projects, while 160 were new issuers that had not previously engaged in green projects through green bonds.

The Chinese green bond market is in a clear upward trajectory expected to continue in the years ahead. However, there are opportunities for policymakers and investors to increase the rate of growth, broaden both the issuer and investor base, and increase the effectiveness of the market. This can be achieved by growing the market through clear guidelines and incentives; diversifying the issuer and investor base and strengthening the monitoring, reporting and verification system.

This article is based on Climate Policy Initiative’s report, The State and Effectiveness of the Green Bond Market in China. The full report can be accessed here