Since establishing the People’s Bank of China’s Green Finance Task Force in 2014, China has encouraged green financing mechanisms through a variety of pioneering initiatives. For example, the country has designated five green finance pilot zones, within which financial institutions are incentivised to provide credit and special funds for environmentally friendly industries.
However, investors have yet to take full advantage of these developments. The lack of uptake may in part relate to recommendations set out in the Green Task Force Final Report published in April 2015. In particular, recommendation 13 of the Report proposes imposing environmental lender liability on banks – the practical consequence of which is that banks and other financial institutions become liable for environmental pollution or damage caused by their borrowers. Although green projects are by nature less environmental risk-laden than other projects, they are not risk-free. As a result, investors have been hesitant to utilize the new financing mechanisms, and banks are equally hesitant to offer financing in the face of uncertain associated liabilities.
Moreover, Chinese banks typically limit loan periods to two years, requiring green project owners to raise funds as many as five times prior to project completion. Failure to obtain financing on one of those occasions could result in the shuttering of a major project. A further challenge is the lack of standardisation in funding rules across countries in the green finance space. For example, the fact that many European banks have their own market-based rules renders it difficult to compare green finance products between China and Europe.
Green bonds — so termed because they fund projects intended to offer environmental benefits — provide a possible solution. As the fastest-growing component of China’s green financial system, green bonds have emerged as an instrument capable of steering private capital and bond market capital to invest in green projects. The bonds are not restricted to the two-year funding terms of loan-based financing, and are issued subject to specific standards of regulatory authorities and stock exchanges. Consequently, investing in green bonds is a more transparent process than investing in other assets, such as green insurance or green funds. China’s willingness to embrace green bonds is therefore not surprising: while green bonds account for just 0.2% of the global bond market, in China this figure is 10 times higher.
The Chinese government has publicly endorsed the use of green bonds. Further, several major cities and regions — including Beijing, Shanghai, Qinghai Province, and Quzhou in Zhejiang Province — have implemented measures to support progressive green finance initiatives. As these initiatives gain traction and additional support from regional and central governments, investors will inevitably begin to capitalise on the tax advantages, green credit enhancements, and other opportunities available in China.
Read more on the development of China’s environmental policy:
This post was prepared with the assistance of Tegan Creedy in the London office of Latham & Watkins.