China needs to close a regulatory loophole for state-owned enterprises issuing green bonds to end fragmentation of the market and ensure all proceeds are used for green projects that support the country’s climate goals, analysts have warned.
Despite “significant progress” by China to green its financial markets, investors should remain cautious about investing in Chinese onshore green bonds as not all of them “play by the same rules”, said Christina Ng, debt markets research and stakeholder engagement leader at the Institute for Energy Economics and Financial Analysis (IEEFA) last week.
China published its Green Bond Principles in July, which are closely aligned with international green bond standards and are aimed at unifying the formerly fragmented domestic market. One key improvement includes requiring that all of the proceeds from green bonds fund green projects, instead of the previous 50-70 per cent.
In addition, green bond issuers are required to track and report the flow of funds to green projects and their respective environmental impact, verified by a certified third party.
“This is a big step for foreign investors eager to invest in China’s domestic green bond market but who have concerns about greenwashing – inadvertently buying ‘green’ bonds that, in fact, support non-green projects,” said Ng.
However, despite the improvements, a “compliance gap” remains in China’s green bond market as enterprise green bonds – those issued by state-owned enterprises (SOEs) – have yet to apply the new Green Bond Principles, Ng warned.
Regulators including the People’s Bank of China (PBOC), the China Securities Regulatory Commission (CSRC), and the National Association of Financial Market Institutional Investors (NAFMII), require that all financial, corporate and non-financial corporate bond issuers comply with the new rules. But the National Development and Reform Commission (NDRC), which oversees enterprise bonds, has yet to mandate SOE adoption of the Green Bond Principles.
This means SOEs are still permitted to allocate up to 50 per cent of their green bond proceeds to non-green projects.
Earlier research by the IEEFA found that for SOE green bond issuance between 2016 to 2019, about US$95 million – or 47 per cent of the average proceeds per issue – was allocated to working capital, which could be used for maintaining a steady, if not growing, coal business due to the fossil-fuel focused nature of SOEs.
In addition, these green bonds are exempt from any requirement to monitor the use of the proceeds, including environmental impact and reporting, and verification before and after the issuance. This means foreign investors should remain wary until the NDRC mandates SOEs to comply with the new principles, said Ng.
“It’s well known that China SOEs don’t have a good track record with transparency. This reputation, coupled with the hold off on the adoption of the principles, raises more questions about their credibility,” Ng told the Post on Friday.
SOEs accounted for about half of onshore green bond issuance from 2019 to 2022, and many of them, including coal-dominated power producers China Huaneng Group, China Huadian Corporation and State Power Investment Corporation, are regular green bond issuers with a growing pipeline of coal projects despite also having big plans for clean energy, according to the IEEFA.
Adoption of the Green Bond Principles by SOEs would be beneficial for investors, particularly international investors, according to Jia Jingwei, associate director of ESG research at Sustainable Fitch.
However, even though the new principles have not been enforced by the NDRC, it does not mean that enterprise green bonds – often issued by local governments – are uninvestable.
“These local government entities and green bond issuances still have strong government policy mandates to direct capital towards green projects and infrastructure, such as city railway construction, infrastructure, and environmental protection projects,” she said.