China is shifting the green bond market with “green financing”
President Xi Jinping endorsed green finance yet again last week, this time on the country’s biggest stage at the twice-a-decade Communist Party congress. Meanwhile, Hong Kong’s de facto central bank is reportedly planning to issue a green bond next year to attract global investors and cultivate a local market.
The global green bond market has developed rapidly over the past decade, providing investors access to an asset class that satisfies responsible investing,cESG (environmental, social and corporate governance) mandates and is intended to deliver competitive returns.
Facing an imperative to address pollution concerns and finance sustainable development under its Belt & Road Initiative policy, China’s appetite for green bonds has continued to grow.
There is no single definition for what qualifies as a green bond, but the market generally accepts that the issuer will use bond proceeds to support projects that improve the environment. Such projects include flood and watershed management in China, mass transit development in Colombia and efficient irrigation use in Tunisia.
The world’s first green bond was issued by the European Investment Bank in 2007 under the banner of a €600 million (US$696 million) Climate Awareness Bond. Since then, more than 40 countries and supranational organisations have issued over 1,100 green bonds, representing over US$270 billion in total issuance.
China’s green bond market began to take shape in 2015 after the People’s Bank of China (PBOC) unveiled guidelines to incorporate the new asset class into the country’s financial system. The National Development & Reform Commission (NDRC) and China Securities Regulatory Commission (CSRC) have also released guidance on green bond standards. This focus has helped spur further regulatory advancements like the launch of benchmark indices that track the performance of Chinese green bonds.
Despite being a relatively new entrant in the global green bond market, China has already assumed a leading role. In 2016, China claimed seven out of 10 of the year’s largest green bonds and raised US$33.7 billion, accounting for more than a third of the world’s total issuance. To date, China’s green bond issuance exceeds that of any other country or supranational organisation.
China has made sustainable development a priority as it looks to reverse environmental challenges, and the country’s commitment to environmental protection and appetite for green bonds should continue. The Belt & Road Initiative could also help expand China’s green bond market as demand is set to grow significantly for new fixed investment to enhance the country’s land and sea links with the rest of the world.
This expansion of the green bonds market is occurring as ESG strategies have displayed a positive performance record. Invesco analysis finds that ESG-focused strategies can deliver attractive risk-adjusted returns compared with traditional non-ESG approaches.
In fixed income, higher returns are typically associated with higher risk (lower credit quality) issuers that must pay a premium to raise capital. But over the past 10 years, investing in best-in-class ESG IG corporate debt and emerging market sovereign debt generated similar returns to the broader, traditional indices.
Green bonds have emerged as a key component within responsible investment strategies. While they have been available for only a decade, early evidence suggests that they are a viable asset class for ESG-driven and non-ESG-driven investors alike.
For green bonds issued globally during the five quarters through March 2017, spreads tightened 28 days after the announcement date for 79 per cent of euro-denominated issues and 49 per cent of US dollar-denominated ones. Analysis from the Climate Bonds Initiative showed seven out of 10 issuances surveyed outperformed their corresponding indices 28 days after announcement.
Meanwhile, green bonds were found to behave more in line with the broader market in terms of subscriber interest. Average oversubscription was approximately 2.7 times for euro-denominated issues and 3.2 times for US dollar-denominated ones. Interest was generally higher for corporate green bonds.
In recent years, foreign investors have found it easier to access China green bonds. Foreign investment in Chinese fixed income markets had previously been constrained by various structural restrictions. Steps announced by the PBOC in 2016 to open the China Interbank Bond Market (CIBM) to international investors and in 2017 to simplify foreign access via Bond Connect appear likely to change this. These new policies create a vast pool of opportunities for foreign investors to access China’s green bond market.
Most of China’s green bonds are considered investment-grade by onshore ratings agencies. This could give foreign investors more confidence when doing due diligence ahead of a potential investment, particularly since Chinese green bond issuers face additional layers of oversight.
In terms of financial performance in the onshore market, China green bonds have outperformed central government bonds and the aggregate overall bond market. The China Central Depository & Clearing Co., Ltd. (CCDC), together with CECEP Consulting and the Climate Bonds Initiative, developed two indices to track green bonds issued in the onshore market: the ChinaBond China Green Bond Index and ChinaBond China Green Bond Select Index.
Both indices have generated higher returns with lower or similar volatilities compared to the onshore ChinaBond Aggregate Index and the ChinaBond Treasury Bond Aggregate Index.
Despite issuing its first green bond in 2015, China has already emerged as the world leader. In a short period, Chinese regulators and authorities have introduced the new asset class, created a market for it and unveiled comprehensive guidelines on how to use, manage and report proceeds.
The scale of development in the country’s green bond market makes it an asset class to watch for both ESG-driven and non-ESG-driven investors alike.