China – Green Light: Full Steam Ahead With Green Bonds.

Background

 

In January 2016, Shanghai Pudong Development Bank Co. hit the international markets with a CNY20 billion (US$4.3 billion) green bond offering to support clean energy and environmental protection. It was China’s first domestic green bond and it created a tornado of investor interest, with oversubscriptions of 250 percent. Industrial Bank Co., Ltd. followed hot on its heel with a CNY10 billion issue – the first green asset-backed securitisation, and most recently the RMB200 million green bond issuance by China Wind Power, the first international- standard green bond issued in China, and the first issuance by a non-financial institution under the new rules. On the back of this momentum, market participants are tipping China to become a major global green bond issuer over the next decade.

 

The development of the product is very much part of China’s response to the 2015 Paris Climate Conference, comments Nigel Pridmore, a Partner based in Hong Kong: “China has to find US$300 billion per year to meet its agreed targets by 2020 and the government wants 70 percent of that investment to come from the private sector.

 

The country has to invest in specific alternative energy production, including efficient buildings. They have to finance this commitment and that’s where green bonds come in. An alternative would have been some sort of tax or direct incentive. They’ve chosen to leverage financial institutions to get them there quicker.”

 

The development of this market is certainly in the national interest for China. “The government is defining this market and looking to actively promote green finance for very specific purposes,” says Anna Delgado, London-based Partner. “I think its focus will be wind power and new technologies that will lead to cleaner air quality. That’s China’s most pressing problem.”

 

Green rules

 

The three bond issues have been issued under China’s new official green bond rules, released in December 2015. The ‘Green Bond Guidelines’ and the ‘Green Bond Endorsed Project Catalogue’, published by the People’s Bank of China (PBoC) and the Green Finance Committee of China Society of Finance and Banking, detail disclosure requirements and guidelines around use of proceeds to ensure a transparent and robust market develops. They also establish key focus areas for green bond financing: energy saving, pollution prevention and control, resource conservation and recycling, clean transportation, clean energy and ecological protection and climate change adaptation.

 

Traditionally, domestic bonds issued by PRC corporates are subject to a debt ceiling dependent on the net assets of the Issuer. However, the rules have been relaxed for the recent issues of green bonds. “The government is seriously promoting them. It’s more about getting quick regulatory approval and more favourable treatment for green bond issuers, in particular the debt ceiling,” explains Jini Lee, Hong Kong-based Partner “Issuers still need to follow industry related rules. And compared to the international guidance-based rules for green bonds, the Chinese rules are still more prescriptive. But that’s because they want very specific environmental results.”

 

There are significant differences between the Chinese guidelines and international standards. The biggest area of difference is the eligibility of clean coal in China. The Climate Bonds Initiative excludes all fossil fuel related projects from green bonds, whereas this isn’t the case in China. To some degree this reflects the difference between emerging and developed economies. But China has already signaled some future flexibility on this issue. The PBoC notes that guidelines can evolve "according to technological advancement, policy adjustment, updated standards and changes in resource and environmental conditions".

 

Moving the definition of green from company to outcome

 

As China moves in a new direction, the rest of the world is also slowly evolving when it comes to green bond products. A key development has been the change from a focus on the nature of the company to the outcome, notes Anna-Marie Slot, a Partner based in Hong Kong. “Around the world, the rules are slowly solidifying as the market develops. People have accepted there has to be some common standard. But that has created some anomalies too.

 

Perversely, an oil major can now do a green bond to fund a wind farm, whereas a wind farm may not be able to raise green capital for an unspecified outcome such as general refinancing” she says.

 

Certainly monitoring the use of funds is becoming an issue everywhere. “There are green outcome principles but they’re not binding. There’s nothing you’re legally obliged to show in the documentation other than your use of proceeds language, which has to allude to some sort of project. You don’t even have to list a project,” comments Pridmore. But satisfying green investors’ criteria is a key driver for transparency and disclosure of proceeds.

 

“One of the principles that should solidify is demonstrating that you’re using the bond for a particular green project and that you have to report once a year on what you’ve done with that money”, continues Pridmore. “There are big questions around whether it’s for a project or refinancing and what you are doing with the money before applying it to the intended project. What are you investing it in? What sort of instrument are you putting it in? At the moment, there’s nothing to stop you going off and buying nuclear power company shares, but the force of investor sentiment is shaping the market.”

 

“More clients are currently talking about putting the green bond option into their programs so there’s likely to be steady growth of the green bond market internationally.”

Jini Lee, Partner (Hong Kong) 

 

The emergence of self-regulatory initiatives such as The Green Bond Principles (GBP) is reflective of this sentiment. Administered by the International Capital Markets Association, The GBP serves as a set of voluntary guidelines geared towards promoting transparency and disclosure around the approach to green bonds, and has garnered the support of both private and public sector green bond market participants.

 

Looking forward

 

The global green bond market has increased rapidly from US$11 billion in 2011 to almost US$42 billion in 2015, according to Climate Bonds Initiative data. The sector is currently dominated by Europe and the US. However, the launch of China’s green bond guidelines and project catalogue signal the entry of an important new player in the market.

 

This will likely change the dynamics of the global market. Ashurst has been involved in some of the most significant issues globally, including Shanks Groups’ first green bond issue to retail investors in Belgium and Transport for London’s first green bond. Issued in April 2015, the 10- year GBP400 million deal was focused on cycling initiatives, energy efficiency and capacity improvements at the busiest stations and new low-emissions buses.

 

"In the UK, home to many sustainable finance initiatives with organisations, such as Climate Bonds Initiative headquartered in London and London Stock Exchange becoming a preferred listing venue for green bonds (and an Observer to the Green Bond Principles), London is on the way to become a financial hub for green finance," comments Delgado.

 

In Australia, growth prospects are comparably strong. 2015 saw roughly A$2 billion in onshore green bond issuance, including the first ever green bond issued by an Australian company in the Australian market (NAB's A$300 million Climate Bond), on which Ashurst advised the Clean Energy Finance Corporation (CEFC) as the cornerstone investor. As appetite for onshore green bonds continues to rise, so too will the diversity of issuers and investors looking to get involved. In fact, CEFC analyses indicate the local market has already attracted interest from investors such as local councils, corporates and insurance companies.

 

“More clients are currently talking about putting the green bond option into their programs so there’s likely to be steady growth of the green bond market internationally. A growing variety of companies is issuing green bonds and there has been huge engagement from the International Capital Market Association,” says Lee.

 

The Chinese paradigm shift could reverberate around the world. Its focus on raising the capital to fund China’s transition to a green economy and insistence on project- specific outcomes could be setting much needed precedents on the international stage.