By Paul Davies, Bridget Reineking, and Andrew Westgate

China has issued numerous green policies in an effort to support President Xi’s signature “One Belt, One Road” initiative, which aims to mitigate environmental and social risks arising from China’s overseas lending. Although few of these policies are legally binding, they reflect China’s heightened focus on environmental issues, both at home and abroad. However, given China’s increasing number of foreign direct investments over the last few years, more legally binding obligations may be necessary to better address resulting environmental and social risks.

China’s Green Credit Directive (GCD) is an instructive example. The GCD urges banks to “effectively identify, measure, monitor and control environmental and social risks associated with their credit activities”. Furthermore, the GCD recommends that funds be suspended or terminated if “major risks or hazards are identified”. As Latham has previously written, policies such as these demonstrate that Chinese leadership is taking steps to prioritise environmental, social, and governance impacts of their country’s investments overseas.

The GCD encourages banks to ensure clients develop environmental and social risk assessment criteria, take mitigation actions, implement risk response plans, and ensure that they uphold international environmental and social standards. This is a striking departure from previous policies and brings China’s outbound investment policies much closer to international standards. However, the GCD and other government initiatives relating to overseas investments generally only provide guidance as to best practices, and do not set out any legal consequences for non-compliance. Banks face neither rewards nor sanctions for failure to adopt these policies.

Legally binding standards, and a formal system for oversight of these standards, are critical to ensuring the sustainability of Chinese overseas investment. As China rapidly expands its influence in the developed world, sustainability of investment is increasingly important. For example, loans from China Development Bank and the Export-Import Bank of China have provided funds for projects with significant environmental impacts like oil drilling, hydroelectric dam construction, road building, and coal mining. In particular, a slew of Chinese direct investment into high-carbon projects in Latin America risks locking those countries in receipt of funds into a high carbon future.

Notably, there is a certain degree of oversight of overseas investment when companies or banks seek approval to send funds overseas from the Ministry of Commerce and then the State Administration of Foreign Exchange, which controls foreign currency exchanges. However, the Ministry of Commerce only restricts those transactions that fail to meet the host nation’s environmental standards. Mostly, therefore, the laws of host nations must control the environmental and social risks of projects with Chinese investors.

If China wishes to solidify its position as a global leader on environmental issues, the country cannot allow investors to ignore the environmental and social effects of their overseas investments. In addition to overhauling its own environmental regulation, China may need to consider whether initiatives such as the GCD require some “teeth” to ensure compliance. More legally binding standards may mean stricter lending requirements for Chinese banks, potentially presenting opportunities for projects seeking investments that have regard to environmental and social risks.

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This post was prepared with the assistance of Tegan Creedy in the London office of Latham & Watkins.