While the US takes a back seat, China takes the lead in green bonds

The days when Chinese parties used sustainable bonds to finance ‘clean coal’ are now behind us. The country is becoming an increasingly important force in the market for green loans, especially now that the US is largely dropping out. Yet Western institutional investors are not yet jumping on board en masse.

Big, bigger, biggest—that seems to be the mantra in Chinese construction. Apartment complexes for tens of thousands of residents, a viaduct more than 160 kilometres long, and a multifunctional building with a floor area four times the size of Vatican City all showcase how Chinese construction companies have broken several records in recent decades.

With the Three Gorges Dam, nestled in the middle of the Yangtze River, China also has the largest hydroelectric power plant in the world. However, it wants to go one step further in the coming years. Last year, Beijing gave the green light for an even larger dam in Tibet, which is expected to generate almost four times as much energy as the Three Gorges Dam.

This will require an extraordinary amount of money, estimated at $167 billion. Analysts at the American investment bank Citi say in a memo that this is a golden opportunity for the bond market. They argue that the project would fit nicely within the concept of green financing, for example with green government bonds.

‘Greenhushing’

In recent years, China has established itself as one of the biggest names in the growing market for green bonds, alongside the EU and the United States, according to figures from the Climate Bond Initiative. Countries and companies are keen to use green debt instruments to make production processes or infrastructure more sustainable, partly because they are popular with institutional investors.

Under Donald Trump, green is now taboo, and in the bond market, people are talking about greenhushing—or concealing the green aspect of an investment. Last year, US parties brought the highest amount of green debt to the market. In the EU, the issuance of sustainable loans has been disappointing in recent months.

China's share, on the other hand, is poised for further strong growth. This year, Chinese parties issued $81 billion in green bonds and loans—more than the US or Germany, according to Bloomberg Intelligence.

Two-thirds solar and wind projects

In recent years, Beijing has formulated large-scale plans to eliminate CO₂. This is desperately needed, as China is the world's largest emitter, although it has frequently been in the news in recent years with record expansions in solar and wind energy—two-thirds of the wind and solar projects under construction worldwide are Chinese.

Nevertheless, last year, 60% of the electricity generated in China still came from coal, compared to around 30% from renewable sources such as wind, solar, and hydroelectric power, according to data from the non-profit organisation Ember. Last year, the country built an average of one coal-fired power plant per week and licensed two per week. Meanwhile, the steel, cement, and fertiliser sectors, in which China plays a major role internationally, face major sustainability challenges.

Last spring, the People's Republic issued its first green government bond, which it also listed overseas for the first time—on the London Stock Exchange. State-owned energy companies and the national grid operator have already issued green debt securities on several occasions to build cleaner projects.

“This underscores the growing importance of green bonds in financing the energy transition in China,” says Diana Tang, head of Sustainable Solutions Group at ING Asia Pacific.

Ethical objections

An increasingly wide range of private companies are also finding their way to the green bond market, says Tang. Whereas previously it was mainly Chinese banks and real estate companies that found the market, now food and dairy companies, tech giants such as Xiaomi, laptop manufacturer Lenovo, and search engine Baidu are also entering the market.

However, the green debt securities that Chinese parties bring to the market often remain within their own borders. There are a number of reasons for this, says Thomas van Galen, Chief Strategist at Achmea Investment Management. First of all, the majority of issues are primarily intended for the local market, he says. These are known as onshore bonds.

On the other hand, there are offshore bonds for the international market. But foreign investors are not easily attracted to green bonds there. Issues by Beijing or state-owned companies in particular encounter ethical objections from Dutch and other European investors and are often rejected on the basis of ESG policy.

“We exclude Chinese government bonds from our investment universe because of China's classification as an authoritarian regime in the Economist Intelligence Unit's Democracy Index,” says MN, one of the largest asset managers for pension funds in the Netherlands. MN does not invest in corporate bonds.

Dim sum bonds

What remains for many European investors are Chinese private companies. These often issue debt in their own currency, the renminbi—also known on the market as dim sum bonds.

These are less interesting to European investors than dollar or euro bonds, says Van Galen.

“Ultimately, this leaves a small percentage that is interesting for us to invest in, although this is still far from falling within the usual investment categories for most investors.”

If investment volumes in these bonds increase in the long term, this may change, says the strategist.

Converging standards

What does help is that China's standards for green bonds are increasingly aligning with the requirements set by European investors. In recent years, it has taken various steps to better align the rules for green bonds with international standards.

“Europe is still a major regulatory power,” says Van Galen. “Although you can see that this is also increasing in China.”

Chinese companies that issue their green bonds offshore are already more likely to follow international standards, says Tang. Three years ago, China introduced its own version of international standards for green bonds. Since then, 100% of the proceeds from green bonds must also go to green purposes. Tang points, for example, to an international working group with the EU and China, which aims to improve the comparability between Chinese and European bonds.

‘Clean coal’

This comparability has not always been the case. Until 2021, Chinese rules for green bonds were much more lenient than in Europe. Until then, Chinese companies were still allowed to issue ‘green’ bonds for ‘clean coal’.

These are projects in which companies attempted to reduce emissions of harmful substances from the combustion of highly polluting coal. According to climate groups, investments in such projects slow down the transition to truly green options such as wind and solar power.

Now that China is tightening its rules, green debt securities from the country could become more attractive to a wider range of investors. The country also has something to gain from this. “Demand in the market for green bonds still exceeds supply,” says Van Galen. “That high demand is extremely interesting for Chinese companies, which see potential in European capital.”

Whether the mega dam in Tibet will partially meet that demand remains to be seen. Hydropower may be green, but whether the dam also meets all ecological, social, and biodiversity requirements is another matter, says Tang. “We will have to look beyond CO₂ standards; extensive due diligence is still necessary.”

Originally published on Het Financieele Dagblad: Opens in a new tabhttps://fd.nl/financiele-markten/1566379/terwijl-vs-greenhushen-neemt-china-plek-in-groene-obligaties-over