China’s green finance strategy: much achieved, further to go

By Wang Yao, Director General of the International Institute of Green Finance, Central University of Finance and Economics, Beijing

China’s embrace of green finance has been one of the key factors driving sustainability considerations to the top of the global financial policy agenda. In this post for the Sustainable Finance Leadership Series, Professor Wang Yao takes stock of the progress made since 2016 and identifies the steps that still need to be taken to bring finance in line with the country’s ambitions to build an ‘ecological civilisation’.

In 2012, the Chinese government approved a far-reaching policy goal of building an ‘ecological civilization’. This goal is driven partly by the urgent need to clean up the consequences of rapid industrialisation, as well as by the desire to build a more harmonious growth model.

Realising this ambition requires green finance – the full range of financial services that support the environmental transformation of the economy and the efficient use of resources. The scale of capital required is immense: an estimated RMB 3–4 trillion (US$ 433–577 billion) each year in green investments from 2015 to 2020, according to research by the Ministry of Ecology and Environment and the China Council for International Cooperation on Environment and Development.

The Guidelines for establishing the green financial system, a comprehensive plan to channel this investment, were released on 31 August 2016 by seven finance-related ministries and commissions, including the People’s Bank of China (PBOC). Four days later, the Chinese government hosted its first G20 summit in Hangzhou, where, for the first time in the G20’s history, all heads of state agreed on the shared goal of promoting green finance.

A top-down model, promoted through macro-prudential and monetary policy

Unlike the Western ‘bottom-up’ approach, which rests on market innovation, China’s construction of a green financial system has a ‘top-down’ nature, based on government guidance, as epitomised by the 2016 Guidelines for establishing the green financial system and programmatic documents.

As the central bank, the PBOC has taken a number of steps to promote green financial development through a combination of macro-prudential and monetary policy. Since the third quarter of 2017, the PBOC has begun to incorporate green finance into the macro-prudential assessment system, including through positive incentives for commercial banks to increase their stock of green credit and boost green deposits to supplement green credit. In June 2018, the Bank decided to include green loans with an AA rating as collateral in the medium-term loan facility (MLF). And in July 2018, the PBOC issued the Green credit performance evaluation plan for banking deposit financial institutions (trial), which further refines the evaluation criteria for the green credit performance of banking financial institutions.

Building on the foundations laid in the green bond market, financial standards are maturing as well. In June 2017, the PBOC and other ministries and commissions jointly issued the country’s Financial industry standardisation system construction development plan (2016–2020). This plan includes ‘green financial standardisation’ as one of its main projects, with a focus on product standards, information disclosure standards and green credit rating standards for financial institutions.

China has also become a key advocate of promoting green finance internationally. Green finance was the only new topic that China added to the agenda of the G20 finance track when it held the presidency in 2016, with China co-chairing the Green Finance Study Group together with the UK. In addition, China was a founding member of the Central Banks and Supervisors Network for Greening the Financial System (NGFS) and is a strong supporter of both the Sustainable Banking Network (SBN) and the Task Force on Climate-related Financial Disclosures (TCFD). A critical issue for international green finance is the alignment of China’s Belt and Road Initiative, the world’s largest infrastructure programme, with high standards of environmental sustainability.

China’s green financial development still faces many challenges

Two years on from the launch of China’s green finance roadmap, the policy momentum is clear. But a range of practical challenges remain. Finance is still not flowing in sufficient volume because environmental externalities are not yet fully internalised in market prices. Externalities can be positive, such that they bring environmental improvements to green projects, or negative, causing environmental damage from polluting projects. At present, due to imperfect Chinese laws and regulations, green benefits cannot be included in investment income and environmental damage is not fully reflected in investment costs.

The lack of consensus on a definition of ‘green’ is also holding back progress. At present, China has two sets of green bond standards and two sets of green credit standards. In addition, various departments have standards for green agriculture, green buildings, and green manufacturing and technology, but there is no coordination between them.

Disclosure of environmental performance information remains insufficient. Within the financial sector, environmental risk analysis capabilities need to be developed. At the same time, due to the lack of tools for environmental risk identification and quantification, some financial institutions underestimate the risks that polluting industry investments may bring. Moreover, most practitioners lack professional knowledge of green industries.

All of this means awareness of green finance – or, indeed, broader environmental, social and governance (ESG) factors – has yet to become mainstream. Most financial institutions are still waiting for China’s financial regulatory authorities to introduce additional preferential measures for green investment.

The outlook for green finance in China

Thankfully, these challenges are not insurmountable. Improvement of key laws and regulations are critical next steps. It is necessary to strictly implement the Environmental Protection Law and promote the Regulations on Compensation for Ecological Protection to clarify how the financial system should manage environmental externalities. At the same time, legislative amendments in the financial sector also need to be promoted, such as the inclusion of green and relevant ESG elements into the Commercial Banking Law, Securities Law, Insurance Law, and pension fund regulation.

Environmental information disclosure by listed companies needs to be rolled out by the Government. This includes improving information statistics and data disclosure across all asset classes and financial services (including bonds, equities, insurance, funds, loans), as well as providing data support for green financial policy evaluation, business evaluation of relevant institutions, and future policy revision.

The promotion of green finance needs to involve not only the financial regulators, but also related government institutions dealing with political reform, environment, agriculture, housing construction, industry, information technology, and science and technology.

This commentary is published as part of the Grantham Research Institute’s Sustainable Finance Leadership Series.

The views in this commentary are those of the author and do not necessarily represent those of the Grantham Research Institute.