Source: China Daily    Published: 2016-5-17

 

 

Jurgen Conrad.[Photo provided to chinadaily.com.cn]

Editor’s note: In a long-ranging interview with China Daily website, Jurgen Conrad, head of economics unit at the Asian Development Bank in China, discusses the opportunities and challenges created by the fast-paced growth of green bonds. He also recommends China to take the leading role to formulate an international standard for green bond at the G20 summit in Hangzhou city, China, this year.

Massive investment has made a phenomenon:

The green finance in China has become quite appealing for both domestic and international investors recently. At the Green Finance symposium in Washington, Zhou Xiaochuan, governor of the People`s Bank of China (PBOC), said: "According to our estimates, China will need to invest about $600 billion per year in the coming five years in green sectors. This means that we need to double our annual green investment over the current level." He also emphasized that green finance will be a special topic at September`s G20 meeting in Hangzhou.

Last year, the PBOC established a green bond market and published a guideline to regulate the market. Mark Schwartz, Vice-Chairman of Goldman Sachs Group, said China was the first country to publish national guidelines on the issuance of green bonds.

One of the major reasons behind the green finance push is the government’s determination to tackle environmental problems. Green bonds can help the country show its seriousness about the issue.

For instance, for the first time in the CPC’s history, green finance was written into the 13th Five-Year Plan in November.

Current standard:

To develop a mature comprehensive green bond market, there is a long way to go; though the volume has been impressive (China issued $7,900 million worth of green bonds in the first quarter of 2016, nearly half of all green bonds issued globally, putting the country as number one regional issuer for the first time, according to Moody’s report.).

The question comes up first is whether there is a universal international definition or standard, especially when the process is still evolving. The most well-recognized one is Green Bond Principle announced by International Capital Market Association (ICMA). For the domestic market, the Preparation Instruction on Green Bond Endorsed Project Catalogue published by the Green Finance Committee of China Society of Financing and Banking could be used as a concrete and practical codes for companies and institutions to refer.

Whether international or domestic, three common grounds need to be covered, said Jurgen: Whole project cycle needs to be assessed based on criteria. Reports should be transparent and filed regularly. Quality of management and internal control systems should be maintained.

Problems that worry investors:

(1) A tracking system for issuers

Investors who don’t know much about green bond could well ask how to guarantee the money will flow into green projects. As for the issuers, an internal risk control system and disclose spending of bond proceeds are needed. Different ways are available, Jurgen named several categories: sub-accounts, sub-portfolio, information about temporary investment instruments. In a word, a tracing system would be a key condition.

Establishing green bonds is more about labeling bonds in a credible way. So information disclosure is essential. However, cost considerations have to be taken into account. Running business in an environmentally way already involves additional cost, disclosure adds it. Right balance needs to be found between effective labeling and cost consideration. The Basel-based Financial Stability Board currently works on an international disclosure standard to be released by September 2016. Chinese authorities closely involves in this work.

Jurgen warned that two things are crucial: For the issuer, the proceeds should be traceable. For the investors, the systems should be strong enough to instill confidence. Investors should be realistic enough to understand they can’t monitor everything, confidence in the management and systems of the issuer needs to fill the gap. Disclosure helps it.

(2) Independent green certification

Apart from the corporate credit rating and bond credit rating for normal bonds’ issuing, there still need a third-party of certification authority to give green certification.

CICERO, said Jurgen, has been very active for years in providing assurances that bonds are green, the consulting firm Ernst & Young has provided certificates for most green bonds issued in the PRC, and the rating agency Moody’s has recently made headlines by publishing a green bond assessment methodology.

(3) Issuers need do quantitative assessment of environmental benefits

Jurgen said that investors ultimately care about profitability. And it’s issuers’ responsibility to prove it’s environmentally accepted. That involves environmental impact assessments. Government should establish a regulatory framework and policy to enforce the rules. Internalizing externalities talked among economists need long way to go by reducing the cost-disadvantage enterprises have that behave in an environmentally friendly way.

(4) Focuses should be balanced

Though the scope of green projects has a great variety, while in reality, the issuers usually focus on some certain areas, like renewable energy sources and energy conservation are two areas that developmental financial institutions give priority to : they account for 80.6% and 17.4% respectively in European Investment Bank’s green projects; International Finance Corporation’s focuses on clean energy (54%) and recycling resources (40%); African Development Bank’s renewable energy sources projects account for 96%; Agriculture development and green Transport account for 70% in International Bank for Reconstruction and Development’s projects.

Jurgen said things are changing these days. Initially, international organizations were the main issuers of green bonds and focused on energy efficiency and renewable energy. But other areas are now gaining ground quickly, such as transport sector or climate change adaptations. By the way, IFI’s are not the main issuers any more, but private sector financial institutions.

(5) Maturity mismatches between bonds and return period

If we see from scale of green loan from banks, green development still lacks of fund; and also there’s a potential risk that the loan period of green credits usually could not match with return period of projects. So currently the great scale of green bonds’ issuing in the future may help make up these two bottlenecks.

Jurgen said it’s never easy to mobilize resources and long-term funding is particularly scarce. However, the savings rate in China and most other Asian countries is still very high, so the challenge is to organize financial intermediation in a way that ensures savings find their way in the most productive projects and make environmental considerations be taken more seriously.

As to maturity mismatches, in contrast to bank loans, bond are tradable, which is why they have longer maturity periods but still shorter than the project live, that brings in refinancing risk. Various financing techniques could help, including structured finance, securitization, and also guarantee schemes.

(6) Government subsidy may distort the market

Jurgen said that usually issuing a bond is more expensive than get bank loan, bond is essentially the financial instrument to be issued by big companies. SMEs should depend more on self-financing and bank loans.

Anyone who tries to attract green financing, one thing fundamentally is that doing thing environmentally is more expensive,especially the business model. Throwing the trash away without proceeding is cheap for the companies but expensive for the society. So the government should not make the issuing extra expensive or adding more requirements. A compromise should be found.

Government could also come up as the guarantee schemes, certification of issuance site, even subsidy. But this should come as the last way, cause the subsidy always distort the competition and are expensive for government.

(7) A collective learning process could help educate investors and market

Investors who’re interested need have better analytical skills and risk management, while it remains as a huge challenge, especially in China.

Jurgen said a collective learning process may help. A crucial element of the learning curve at this stage is the dialogue between potential issuers and the providers of second/third party assurances, and then the dialogue between stakeholders could be conducted during roadshows, for instance. However, for future generations, learning needs to start earlier at schools. The objective would be raising awareness for the environmental more broadly.

Conclusion

Rising star need time and space to grow mature, what government could and should do right now is to cultivate the market in a relative regulative way, so to foster the confidence from various stakeholders naturally. Jurgen said his wish is that this year, China should take the valuable chance. During G20, China act as presidency and should help to put forward defining a international standard for issuing of green bond. A better coordinated effort at G20 level. If something guideline and principle come from G20, then all other governments and organizations within the G20 framework can draw on that. And also the guideline should be translated into international law, and fits the feasibility.