Category: Asia, China, Global
By Paul Smith*
The next big opportunity
In a defining moment for the Paris climate change accord between nations earlier this year, China joined the US in pledging to cut environmental pollution. But greening the world’s second-largest economy – and arguably one of the world’s largest polluters – is a gigantic task, and Beijing will need to call on private capital to make the change a reality.
Government estimates show the cost of cleaning up China’s environment could be as high as over US$600 billion a year over the next five years. That bill isn’t too hard to believe, given China’s massive economic expansion of the last couple of decades and the ensuing air, water and ground pollution. Publicly ratifying the Paris agreement is one way the government has helped found sentiment that it is addressing the problem, but the harder work is getting capital to flow towards new green projects.
Given the magnitude of the problem and the scale of the solution, it’s in the cards that China will lead the global financial community in developing green finance.
High on its policy and regulatory agenda for clean initiatives is its support for green bonds. The country’s central bank, the People’s Bank of China (PBoC), established the Green Finance Committee (GFC) last year as part of recommendations made by a task force it created in collaboration with the UNEP Inquiry a year earlier. The task force spans regulators, government departments, financial market players as well as local and international experts that offered recommendations for the establishment of a green financial system in China.
The task force has made a strong push for the development green bonds. China has since positioned itself as a global leader in the development of green securities. In the first seven months of this year, the country issued a total of 120 billion RMB (US$17.43 billion) in green debt or over 40% of total global green issuance, overtaking the US to be the largest issuer of green bonds.
The GFC has set up a working group to undertake the research on green definitions, policy incentives, as well as rating and certification of green bonds. That allowed the PBoC to establish regulations, including guidance on the management and use of proceeds from green bonds as well as reporting requirements. China’s macroeconomic management agency, the National Development & Reform Commission (NDRC), also set some guidelines for corporates issuing green securities, providing a list of qualifying green projects and proposals for policy incentives.
As interest grew for the environment-friendly bonds, more guidelines emerged. The Shanghai Stock Exchange and Shenzhen Stock Exchange have set up rules for green bond pilot programs for listed firms earlier this year. Other regulatory authorities including the China Securities Regulatory Commission (CSRC) and the National Association of Financial Market Institutional Investors (NAFMII) are also working on green guidelines for other bond types in China. The PBoC’s decision early this year to lift the quotas for foreign investors in the domestic interbank market is also creating momentum for foreign capital to access the Chinese green bond market.
A new approach
China has been opening up its domestic bond market to global investors to help finance the transition of its economy toward services and high technology and away from smokestack industries. In line with this vision, China has said it will launch a national cap-and-trade program involving six of its largest carbon-emitting industrial sectors, starting with coal-fired power generation. The national scheme will also cover iron and steel, chemicals, building materials including cement, paper-making and nonferrous metals that together account for a large share of China’s carbon pollutions.
The program is expected to limit the amount of pollution that companies can emit, while requiring them to pay a price for a share of the carbon emission quota. Companies that do not use their entire quota can sell the remainder, while those that need more can purchase carbon permits. It would probably take years of effort to build a substantial market that will play a major role in curbing emissions, but the initiative holds a lot of promise.
China has made huge strides in green finance, but challenges remain. The imperfect market mechanism and limited liquidity in China’s green bond market, for example, are a concern. For now, the initial challenge for Beijing is aligning national and regional planning for green projects to make them truly effective. Next comes laying the groundwork for legal and institutional frameworks that will help attract green financing.
Even in the current crop of listed companies, disclosure of accurate information on environmental risk has been lacking, and this need for greater transparency must be addressed for investors. The government must also consider long-term incentives such as subsidies or preferential terms for instruments, as well as introducing means to promote the adoption of green practices. To ensure the health of the market, China should encourage a mature rating system with high governance standards that include a full environmental, social and governance (ESG) assessment as well as credit review.
At the CFA Institute, we facilitate the development of green finance globally by enhancing our members’ understanding of social and environmental issues. ESG has been in the curriculum in various forms for nearly a decade, and we constantly update our knowledge to make sure we keep up with best industry practices. Each year, over 200,000 candidates learn about integrating ESG data into their analysis as a part of the investment process.
Our plan is to further update our 2017 curriculum to include greater focus on corporate ethics, risk management and ESG issues. Over the past few years, global investors have increasingly looked to emerging ESG standards to help drive investment decisions. This new lens of determining investment value is now growing in importance in Asia, where corporate stakeholders and the investment community alike are delving into ESG issues.
The findings of the institute’s annual survey of 2,000 global investment managers confirmed that trend. When asked how they take ESG issues into consideration in their investment analysis and decisions, 57% of survey respondents said they integrate ESG into the whole investment analysis and decision-making process, while 38% stated that they use best-in-class positive alignment, and 36% use ESG analysis for exclusionary screening. All of this reflects a growing awareness in the investment community that this emerging standard may, at the very least, be a barometer for good management and shareholder value.
The institute is part of the larger discourse on green finance. To boost our participation, we are seeking to join China’s GFC as an Invited Global Organisation. Recently, the GFC, NAFMII and CFA Institute jointly organised the Green Finance Roundtable in Beijing inviting 100 senior officials, policy-makers and leading experts from government agencies, regulators and financial institutions, as well as senior CFA members to participate in the forum to discuss China’s national policy and to kick off the next phase of cooperation with the GFC.
The CFA Institute’s membership to the GFC will be a continuation of a cooperation that began in 2015 when the institute participated in the committee’s research project that directly led to relevant national policies and the G20 China Communiqué on green finance. Our contribution to this project further strengthened the thought leadership on green finance and ESG with key employers and regulators in China.
* Paul Smith, CFA, is president and CEO of CFA Institute