China’s rapidly evolving green finance system over the past few years was underpinned by coordinated macroeconomic policy, regulatory, institutional and technological developments. Deutsche Bank’s Macro Strategist for China, Linan Liu looks at the key aspects of China’s green finance system and what China could do to develop its green finance infrastructure to the point where it can support the country’s transition to a green economy.
Green Finance: The China approach
There are now over 130 green investment funds that collectively manage assets worth 69 billion renminbi. In addition, 22 local government-sponsored green industrial funds have been launched with assets worth over 46 billion renminbi.
China’s green bond issuance grew from 240 billion renminbi in 2016 to 386 billion in 2019, its green bond market the world’s largest by annual gross supply in 2019; there are 1.2 trillion renminbi outstanding green bonds currently in the market. The issuance of green asset-backed securities exploded by 350 percent to over 50 billion renminbi. Furthermore, green stocks have emerged as green enterprises tapped into China’s equity market for financing. Other new products such as green insurance, green trust, green PPP, and green leasing products have started to develop.
The next step
Surging demand for green finance and rising appetite for ESG and green investments means the following aspects deserve greater policy attention in order to develop a more robust green finance system in China.
1. Strengthen monetary, fiscal and regulatory incentives for green investment -
Create dedicated green medium to long term liquidity facilities for commercial banks to obtain direct liquidity support from the central bank, collateralised by eligible green loans and bonds. Second, relax capital requirement on green loans: Lowering the risk weighting will release capital which will allow commercial banks to deploy more resources to green lending.
2. Develop a comprehensive green finance structure to support China’s medium to long-term “dual circulation” growth strategy:
- Incentivise small and medium banks to join large banks in providing green credits, particularly to green private business and green small and medium enterprises.
- Better align green investment interests with long-term investors such as domestic insurance companies and pension funds by promoting responsible investment and incorporating ESG investment into performance assessment of insurance companies.
- Third, a missing piece in China’s green finance market is the carbon emission trading market. It is likely China will launch such a new market before 2025.
3. Improve secondary market liquidity of green finance products.
China’s green finance market is largely for primary financing and most existing green products (loans and bonds) are not tradable in the secondary market, restricting the ability of effective risk pricing and risk management on green investment and limiting potential investment inflows. Potential solutions include securitization of green loans and favourable terms of repo eligibilities of green bonds.
4. Implement mandatory environmental ESG disclosure requirements for the financial services sector.
The EU has already moved ahead by enacting the Disclosure Regulation which required sustainability-related disclosures in the financial service sector as at the end of 2019 and is expected to apply the new regulation in April 2021. It is likely China will adopt international practice and apply similar mandatory ESG disclosure requirement in its financial services sector over the next five years.
5. Integrate China’s green finance into the global green finance market.
China is expected to gradually integrate its green finance market with the global market in taxonomy, financial and regulatory incentives, and green products specifications.
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