4.1 Green Finance: Serving or Guiding the Real Economy?

Internationally, green finance is generally defined as financial activities related to sustainable development. Most countries and international organizations define green finance based on the ultimate goals of financial activities, that is, a financial activity can be regarded as green if its ultimate goal is related to real-economy activities on sustainable development. However, these definitions might not be adequate to fully understand the significance of green finance. We believe two issues need to be discussed before we dive into deeper analysis.

First, what is the ultimate goal of green finance?

For the real economy, the core goal of green finance is realizing carbon neutrality, and the essence of achieving this target is to address carbon emissions that impact the world beyond the scope of time and space. We previously introduced the concept of green premium, an essential measure to realize carbon neutrality. Both accomplishing carbon neutrality and reducing the green premium are the goals of the real economy; however, coordination and support from financial activities are also indispensable to achieve these goals.

Second, how to understand the relationship between finance and the real economy?

In addition to the serving function, finance also guides the resource allocation of real economy. When finance mainly plays the role of serving the real economy, the latter takes the dominant position and financial activities should act in accordance with its development. However, finance is also an important means of resource allocation, and can guide the development of the real economy.

Combining the previous two questions, green finance can therefore be divided into service-oriented and guidance-oriented green finance. Both aim to reduce the green premium, albeit through different channels.

  • Service-oriented green finance: In this type of finance, real economy reform is the fundamental source of green premium reduction, and finance plays a supplementary role, providing financial services based on the demand of low-carbon transformation of the real economy. In this case, policy fine-tuning, technological advances and changes in social governance mechanisms all center on real-economy sectors. Actions to reduce carbon emissions in real-economy sectors would lower the green premium, and raise the relative cost of industries that produce high emissions or the relative returns of more environmentally friendly industries. Reflected in the financial markets, such changes in relative prices would lead to changes in the financing demand and prices of the low-carbon economy. Based on the principle of profit maximization, the financial sector will meet the financing demand of the real economy and provide corresponding financial services. The financial sector in this case mainly facilitates the green transformation of the real economy, indirectly helping reduce the green premium rather than directly.

  • Guidance-oriented green finance: Financial activities directly lower the green premium, and guide the low-carbon transformation of the real economy. In this case, the financial sector can also be the direct driver of green premium reduction. As important productive inputs, different ways of funding allocation can directly affect resource distribution of the real economy. Even without reforms in the real economy, the financial sector can fine-tune the relative production cost of high-carbon and low-carbon industries and hence reduce the green premium, if the financial sector could effectively distinguish emission-increasing financing activities from emission-decreasing financing activities and reduce the financing cost of the latter or increase the expenses of the former accordingly. During the process, reform of the financial sector will be the direct driver of lowering the green premium, and resource allocation of the real economy will follow the changes of the financial sector.

The development of green finance requires close collaboration between service-oriented and guidance-oriented green finance, suggesting an indispensable position for both. As we previously discussed, carbon emission is a complex externality issue influencing the whole world across different time and space, and it is much more difficult to address than any other externality issues. All means to address the problem of carbon emissions such as establishing a carbon trading market, imposing a carbon tax, promoting technological advances and implementing non-market-oriented measures, are very complicated undertakings with various uncertainties. Therefore, China still needs to promote guidance-oriented green finance and regard it as an essential strategy to reduce the green premium.

4.2 Green Finance in China

China has made preliminary progress in establishing infrastructure for green finance. In 2014, the People’s Bank of China and UNEP Inquiry jointly established the Green Finance Task Force, and proposed 14 recommendations for developing a green finance system. Following that, a number of documents have been released to help establish China’s green finance system, including the “Green Bond Endorsed Projects Catalogue”, “Guiding Opinions on Building a Green Financial System” and “Notice on the Establishment of a Special Statistical System for Green Loans” (Fig. 4.1).

Fig. 4.1
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Source Climate Policy Initiative, CICC Research

Major policies in China’s green finance reforms.

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  • Firstly, preliminary classification standards for green industries, green loans and green bonds are in place. The National Development and Reform Commission issued the “Green Industry Directory Guidance” in March 2019, which provides a comprehensive classification of green industries. Based on the Guidance, various financing tools have established different classification standards, among which the standards of green loans and green bonds are relatively mature. China in 2013 released the “Green Credit Statistics System” that clearly defines what projects are eligible for green credit loans. It marked one of the first efforts to establish a green loan system in emerging markets. For green bonds, the definition of green industries or projects is mainly based on guidance or catalogues released by corresponding regulators. The guidance on green bond issuance released by the National Development and Reform Commission in 2015 stipulated that proceeds raised from green corporate bonds should be invested in projects related to green, recycling and low-carbon development. Other types of green bond projects mainly refer to those included in the green bond endorsed projects catalogue released in 2015.

  • Secondly, evaluation systems for investment and financing tools have gradually been established. Comparatively speaking, the evaluation system for green credit loans is the most comprehensive one in China. In 2014, the self-evaluation system for green credit was set up for banks, evaluating the extent of green credit development from a qualitative perspective, as well as setting the balance of loans for energy-saving and environmentally-friendly projects, “Two Highs and One Overcapacity” industry, and CO2 emission reduction as key indicators to assess performance from a quantitative perspective. In 2018, the People’s Bank of China increased the frequency of performance evaluations for green credit loans, introducing the central bank as an external evaluator and including the results of the evaluations in its macro prudential assessment. In addition, a rating system for ESG investment has basically been formulated. China Securities Index Company Limited in December 2020 released the CSI ESG rating method that thoroughly considers the industry characteristics and information quality of listed companies, comprising 3 components (i.e. environmental, social and corporate governance), 14 themes, 22 units and over 100 underlying indicators.

  • Thirdly, development of legal systems and regulatory rules has begun. Ecological civilization was included into China’s constitution in 2018 with legal status of green finance being recognized indirectly. From the regulatory side, the People’s Bank of China has launched the Green Finance Committee to regulate the development of green finance. Meanwhile, various regulatory measures have been adopted for different financing tools. For example, financial institutions that issue green loans need to report relevant data to financial regulators. On information disclosure, China has started to mandate listed companies to disclose information about major pollutants from production, major processing facilities for these pollutants and their capacity in recent years. Moreover, companies listed on the ChiNext are required to disclose information about social responsibility.

Amid the improving infrastructure, China’s green finance market has seen considerable development, mainly in indirect financing. Data from the People’s Bank of China shows that the amount of domestic green-financing totaled about Rmb13trn by the end of 2020, including Rmb12trn of green credit loans and Rmb870bn of green bonds. Meanwhile, the green equity market in China remains relatively small and PE/VC equity investment, green IPOs and follow-on equity offerings by green enterprises have just started. Green equity investment in China averaged Rmb42.4bnFootnote 1 over 2018–2019, well below the Rmb550bn for annual incremental green loans and green bonds.Footnote 2 However, growth of green financing has decelerated in recent years. The balance of green loans at banks rose at a CAGR of 12.3% between end-June 2013 and end-June 2020 from Rmb4.90trn to Rmb11.01trn. That said, growth of green loan balance (3.9% at end-1H20) was slower than overall loan balance growth in recent years (13% at end-1H20).

Green bonds currently do not have advantages in pricing and their financing terms are generally short. Based on the green bonds issued since 2020, we note that about 80% of green bond issuers had a positive interest rate spread compared with overall bond yields, especially for bonds with medium/low ratings. For example, over 90% of the AA+ rated green bonds had a positive interest rate spread.

From a term perspective, 1–3Y green bonds account for 43% of outstanding green bonds, while the 3–5Y and 5–10Y green bonds account for 37% and 11%, respectively. Generally speaking, the terms of green bonds remain relatively short, and thus cannot provide financing for the long-term investment required for developing green technologies and clean energies, or promoting carbon offset projects such as afforestation. Due to the lack of long-term funding, domestic PE/VC funds usually last for about 5–7 years,Footnote 3 but it may take about 7–10 years for green-tech companies to qualify for an IPO. As a result, domestic equity investment institutions are less interested in green-tech companies.

From an industry perspective, transportation and energy sectors account for a large portion of green financing. As of end-2019, green transportation made up 44% of total green loans, while renewable energy and clean energy represented 24%. By the end of 3Q20, transportation, warehousing and delivery accounted for 30% of green loans, while the power, heat, gas and water production and supply industries took up another 29%. The proportion of other sectors climbed from 24% in end-2018 to 41% in 3Q20, implying a diversified trend in sector distribution of green loans. In green bond financing, the financial sector has long accounted for the largest proportion, and that of green bonds issued by the industrial and utility sectors have increased significantly in recent years, accounting for 45%, 30% and 18% of green bond issuers in 2020 respectively. Other sectors represented less than 5%, mainly concentrated in heavy-asset industries that have abundant resources of financing.

4.3 How Much Investment is Needed to Achieve Carbon Neutrality?

Achieving peak carbon emissions and carbon neutrality are the two important targets for green development in China, and have been included in the 14th Five-Year Plan and the Long-Range Objectives through the Year 2035, which implies a substantial demand for funding. Proper assessment of the funding demand and its structure should allow the financial system to better serve and guide China’s low-carbon transformation. Our bottom-up analysis shows that China’s total green investment demand should reach about Rmb139trnFootnote 4 to achieve carbon neutrality, including Rmb22trn over 2021–2030 and Rmb117trn over 2031–2060.

4.3.1 Bottom-up Analysis of China’s Demand for Green Investment

It is a complicated task to estimate the amount of investment needed for carbon emission reduction for financial institutions, but from the perspective of the green premium, the investment needed is simply the amount of funds required to replace traditional technologies and equipment causing high carbon emissions with those that reduce carbon emissions. As shown in Fig. 4.2, we divide technologies and equipment into four categories, namely existing high-carbon technologies and equipment, existing low-carbon technologies and equipment, older technologies and equipment that need to be upgraded, and innovative low-carbon technologies and equipment. To reach peak carbon emissions and move toward carbon neutrality, we have to reduce the production capacity that relies only on high-carbon technologies and equipment (meaning no further investment), and increase capacity of the other three technologies and equipment. We can roughly estimate the amount of investment for each category of technologies and equipment at different times based on the changes in capacity and the investment/capacity ratio under anticipated progress of emissions reduction, and then add up to calculate the aggregate green investment demand.

Fig. 4.2
figure 2

Source CICC Global Institute

Methods for estimating green investment.

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To fully estimate the amount of investment, we select seven sectors with the highest carbon emissions in China and calculate the green investment demand from them. Based on data from China Emission Accounts and Datasets, the seven sectorsFootnote 5 accounted for over 85% of China’s total carbon emissions in 2017. They are also the major sectors with fixed asset expansion.

4.3.2 Aggregate Investment Demand and Structural Features

4.3.2.1 Annualized Green Investment Accounts for about 2% of GDP

Considering the investment demand of major sectors, we estimate that China’s green investment demand needs to total about Rmb139trnFootnote 6 to achieve carbon neutrality with annual green investment demand accounting for about 2%Footnote 7 of GDP on average.

Specifically, we estimate China’s annual green investment demand will hit Rmb2.2trn over 2021–2030 to reach peak carbon emissions, and reach Rmb3.9trn over 2031–2060 to achieve carbon neutrality. Over 2021–2060, China’s annual green investment demand needs to be Rmb3.5trn to achieve carbon neutrality (Fig. 4.3). According to GFMA’s (2020) assessment, global green investment demand will need to total US$121.7trnFootnote 8 to reach carbon neutrality, and China’s green investment based on our calculation will comprise 17%Footnote 9 of the global demand.

Fig. 4.3
figure 3

Source CICC Global Institute, CICC Research

Estimated green investment for China (based on 2020 prices).

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4.3.2.2 Investment is Most Needed for Power Sector

To accomplish carbon neutrality, green investment is most needed for the power sector, which requires investment of Rmb67.4trn, followed by Rmb37.4trn for the transportation sector and Rmb22.3trn for the construction sector (Fig. 4.4). The need for investment in the power sector mainly comes from the spending on clean power-generation equipment, including Rmb16.2trn for solar power equipment and Rmb14.3trn for wind power equipment. The need for investment is also high in the transportation sector. First, we expect China’s electric vehicle output to grow significantly driven by the replacement of traditional fuel vehicles, and this would increase investment in new energy vehicles and related energy production. Second, we also foresee high investment in the low-carbon transformation in aircraft and vessels, as well as the development of new energy infrastructure. In terms of the building sector, the investment needs mainly result from the utilization of environmentally friendly and energy-saving technologies as well as low-carbon equipment. Meanwhile, the need for green investment is relatively low for the steel and cement sectors, and we expect their share of green investment to decline amid China’s industrial restructuring.

Fig. 4.4
figure 4

Source CICC Global Institute, CICC Research

Estimated green investment needed for different sectors to accomplish carbon-neutrality targets (based on 2020 prices).

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4.3.2.3 Investment Demand is Likely to be Postponed for Sectors Facing Technological Hurdles in Emissions Reduction

Technological difficulty for emission reduction varies for different sectors. While the technologies are relatively mature for electric vehicles and EV chargers, it remains costly or not feasible for hydrogen-powered aircraft or carbon-capture technologies in cement production.

Variations in technological difficulty of emission reduction may lessen the incentive for emission-reduction investment in the early stages, thus increasing the risk of lagged investment accumulation. Table 4.1 shows the relative proportion of green investment for different sectors in 2021–2030 and 2031–2060. For sectors with greater technological difficulty in reducing carbon emissions, the relative proportion of green investment is lower for 2021–2030 and their investment demand is pushed to a later stage. This shows that select sectors anticipate technological advances that take place after reaching peak carbon emissions will lower technological difficulty for emissions reduction. However, a significant delay in investments may exacerbate the shortage of green investment and financing.

Table 4.1 Breakdown of green investment for different sectors
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4.4 New Targets Bring in New Challenges. What Are the Weaknesses in China’s Green Finance?

4.4.1 Mismatch Between Supply and Demand in Green Investment

4.4.1.1 Shortfall in Green Investment and Financing with Even Wider Gap After 2030

China is facing a sharp shortfall in green investment and financing, and the gap may widen after 2030. While the gap between green investment supply and demand narrowed in 2017–2019, the shortfall was still high at about Rmb600bn in 2019 (Fig. 4.5). Considering the current supply of green investment, we estimate that the shortfall in green investment and financing may expand to Rmb5.4trn in 2021–2030 with an annual average amount of Rmb0.54trn. In addition, the shortage may worsen after 2030 due to the possibility of investment being postponed as mentioned earlier. Without policy intervention, we estimate that the shortfall in green investment and financing may rapidly increase to over Rmb1.3trn/year after 2031.

Fig. 4.5
figure 5

Source China Green Finance Progress Report, CICC Global Institute

Supply and demand of green investment in China (2017–2019).

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4.4.1.2 Concentration of Green Financial Support in Certain Sectors

From the perspective of financing structure, certain sectors account for an excessively high proportion of China’s green investment and may affect the amount of green investment in other sectors. For example, green credit loans accounted for over 90% of overall green financing tools in 2018–2019, and more than 40% of the green credit loans went to the transportation sector in the 2 years (Fig. 4.6).

Fig. 4.6
figure 6

Source PBoC, CICC Global Institute, CICC Research

Breakdown of green credit loans in China (2018–2019).

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The high concentration of green investment in the transportation sector led to a mismatch in the supply and demand of green funding. The power sector has the highest need for green investment and financing, while the building sector has the third highest need after the transportation sector. This implies that the current green financing tools have not yet covered the industries with large green investment demand, and that the allocation of green funding does not match the green development needs of the entire society.

4.4.1.3 Unable to Meet Diversified Financing Needs with Limited Tools

In addition to the high concentration of green investment in select sectors, the development of green financial tools in China is also lopsided. From 2018 to 2020, green credit loans accounted for about 90% of total green financing in China, whereas green bonds and green equities only accounted for 7% and 3% respectively (see Fig. 4.7 left side)Footnote 10, Footnote 11. However, we estimateFootnote 12 that green equities and green bonds will account for about 40% of the green investment demand after 2030, which differs sharply from the current financing structure (see Fig. 4.7 right side). The dominance of credit loans and the limited availability of other green financial tools will partly depress green investment demand.

Fig. 4.7
figure 7

Source Wind Info, CICC Global Institute, CICC Research

Green credit loans account for about 90% of green financing, and sharp change in the demand structure of green financing is needed.

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4.4.2 Lack of Widely Accepted Green Standards

4.4.2.1 Absence of Unified Domestic Standards

Domestic green standards differ for various financial products, and several standards are not aligned with the carbon neutrality target. For example, the People’s Bank of China has removed “clean coal utilization” and other projects related with fossil energy from the catalogue of projects supported by green bonds released in July 2020. Nevertheless, this remains included in other green financial standards, such as the guided catalogue for green credit loans released in 2019. This leads to an inconsistency in the standards of China’s green financial system, and some of the green projects listed in the catalogue do not meet the zero-emission requirement of the carbon-neutrality target.

Discrepancies in standards and definitions also occur within the same financial tools because of multiple regulations. While the standards for green credit loans are relatively mature, they still differ in some areas. For example, nuclear power projects qualify for green finance according to the National Development and Reform Commission and the People’s Bank of China, but are not included in the green finance catalogue from the China Banking and Insurance Regulatory Commission. In addition, the People’s Bank of China, the National Development and Reform Commission and the China Securities Regulatory Commission in July 2020 issued an exposure draft for the catalogue of green-bond supported projects, which defined green bonds for the first time and set out the criteria. However, the finalized document has not been issued yet. In terms of green equity, it is still in its infancy with no clear definition or standards established in China.

4.4.2.2 Domestic Standards for Green Finance Still Below International Level

The domestic criterion gives a narrower definition to green credit loans than the international definition. To prevent greenwashing, China narrowly defines green credit loans as those for developing green industries and reducing carbon emissions, whereas the international standards of green finance tend to include loans for the green transformation of high-emission industries, and loans that consider environmental risks in the credit lending process (Table 4.2).

Table 4.2 Comparison between China’s green loan standards, the green loan principles and the equator principles
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For green bonds, despite the similarity in definition, classification and voluntary principles, domestic standards for green bonds differ from international criteria in project eligibility, use of proceeds and third-party assessment, etc. For example, green-bond supported projects in China almost do not cover climate adaptation or green service (such as climate monitoring and warning systems or trading services for environmental rights), suggesting a relatively narrow market coverage. In addition, the National Development and Reform Commission allows proceeds raised from green bonds to repay bank loans and replenish working capital, while international standards stipulate that all the proceeds from green bonds should be used in green projects. Moreover, projects need to be assessed by professional environmental evaluation institutions and third-party institutions to determine whether they meet the green standards before international green bonds can be issued. After the bonds are issued, institutions should monitor and evaluate the use of funds as well as their contribution to energy saving and emission reduction, which should enable the market to evaluate green bond issuers and the environmental performance of projects funded by green bond issuances. However, China has not provided clear guidance on these areas.

To better support the development of green finance, the government is currently working on the green standards that are aligned with international criteria and unifying the standards for different green financial products. We anticipate the unified standards will be released shortly.

4.4.3 Defects in Green-Information Disclosure System

A well-established green-information disclosure system is the basis of decision-making strategies about green products and preventing information asymmetry such as greenwashing. Green-information disclosure system includes two aspects, namely green-information disclosure for companies and for assets held by financial institutions, equity investment institutions, etc.

China’s green-information disclosure system suffers from a number of issues, including lack of mandatory requirement, absence of unified standards and unclear relationship between companies, financial institutions and regulators.

4.4.3.1 Lack of Mandatory Requirement on Green-Information Disclosure and Unified Standards

Listed companies are facing problems of unclear standards and limited coverage of green indicators for green-information disclosure. In 2016, seven regulators including the People’s Bank of China issued Guidelines for Establishing the Green Financial System, proposing to establish and improve a mandatory green-information disclosure system for listed companies with a three-stage implementation plan. However, there was still no clear or unified standard of green-information disclosure for listed companies in China as of 1Q21. For example, listed companies included in the CSI300 Index rely on numerous guidelines to compile their social responsibility reports, such as guidelines from the Shanghai Stock Exchange, the Global Reporting Initiative, the Chinese Academy of Social Sciences, and the Hong Kong Stock Exchange. The lack of unified, comparable and quantitative guidelines leaves room for data manipulation and selective disclosure, thus failing to provide comprehensive and reliable green information for investors. Moreover, even though the proportion of listed companies voluntarily disclosing ESG information has climbed in recent years in China, the range of green information disclosed is still far smaller than overseas peers, and mandatory information disclosure is only confined to selected environmental indicators such as air, water and solid waste.Footnote 13

For green bond issuers, the biggest issue is the absence of unified standards for green-information disclosure. The People’s Bank of China, the Shanghai Stock Exchange, the Shenzhen Stock Exchange and the National Association of Financial Market Institutional Investors have all released standards on information disclosure for green bonds, providing many but ununified disclosure mechanisms in effect for different types of green bonds. Notably, China has set clear criteria for information disclosure for green financial bonds, requiring quarterly disclosure on the use of proceeds raised, the incremental green projects invested (amount and number) and fund management, as well as annual disclosure about the environmental benefits from the projects invested. Other types of green bonds are also mandated to disclose related information, but requirements are not clear in terms of exactly what categories of green information should be disclosed, leaving room for improvement.

In addition, there is a lack of unified standards and effective supervision for non-listed companies (except for heavy-polluting companies). Third-party institutions responsible for certifying green enterprises and quantifying the environmental benefits brought by green projects are also not in place.

In terms of financial institutions, there is no mandatory green-information disclosure mechanism in effect. Various regulators have provided guidelines on green-information disclosure for key entities in the financial markets, such as banks, insurance companies and funds. Requirements have also been made for banks to strengthen ESG information disclosure and fund managers to provide self-evaluation reports on green investments. However, a mandatory green-information disclosure mechanism is absent for banks, asset management companies or equity investment institutions such as PE and VC firms in most regions of China. There is also no quantitative indicator for performance evaluation, i.e. exposure to green assets, the proportion of green funds in total funds, operating models or development targets. Moreover, actual use of funds and their environmental benefits are not effectively supervised or evaluated.

4.4.3.2 Unclear Relationship Between Companies, Financial Institutions and Regulators in Green-Information Disclosure System

Close cooperation among companies, financial institutions and regulators is essential to establish an effective green-information disclosure system that monitors and shares green information. However, the relationship of the three parties and their respective responsibilities in the green information disclosure system are not well defined.

The development of green-information disclosure system in China should address the absence of an incentive mechanism, and the unclear division of rights and responsibilities, in our view. Companies, financial institutions and regulators all play critical roles that could potentially affect each other in the green-information disclosure system, and if any of the three fails to function properly, it may render the entire system ineffective. For example, it may become challenging for regulators to design a well-functioning green information disclosure system if companies are not aware of the necessity of disclosing green information voluntarily. Lack of unified standards from regulators makes it more difficult for financial institutions to carry out green assessment, which may further impede the green transformation of companies if financial institutions are not interested in investing in green financial products due to inadequate information. In addition, the relationship and responsibilities of the three are not well defined in the green information network: A number of financial institutions have taken the corporate responsibility of reviewing information disclosure, thus increasing their cost of investing in green projects. We believe the green information network and investment process will become more streamlined if companies and third-parties can share this cost in the future.

There also lacks an environmental data sharing mechanism among companies, financial institutions and regulators. In China, governments, third-party institutions and companies cannot effectively share environmental data among themselves at present, and environmental regulators have not yet started data sharing with financial institutions, which hinders development of the green investment market and full information disclosure. Some of the institutions have cited confidentiality as the reason for not disclosing information in the past, but we believe that disclosure of green information is inevitable amid the clear target for green development. From our point of view, earlier information disclosure will facilitate troubleshooting and system improvement, which can help reduce losses caused by environmental and other risks.

4.4.4 Weak Guidance from Financial Institutions

4.4.4.1 Upside Potential in Guidance from Domestic Financial Institutions

Funding support from financial institutions such as banks, insurance firms, investment banks and asset management firms is indispensable for the green transformation of industrial companies. However, the penetration rate of green investment ideas remains low in the investing activities of domestic financial institutions. According to the 2021 Global Institutional Investor Survey released by MSCI, 75%, 59% and 56% of the investment managers from Canada, Japan and Europe respectively have adopted ESG frameworks in their asset management, while the penetration of ESG investing was as low as 16%Footnote 14 among Chinese fund management institutions in 2019.

Insurance firms, pension funds and social security funds are inclined to invest in the long term, which is a natural fit for the long development cycles of certain green projects and green companies. However, the participation of long-term funds in green investment is limited in China. In mature markets overseas, long-term funds, in particular large institutional investors such as pension funds and insurance firms, are frontrunners in ESG investing due to their large investment, long investment cycle and demand for entrusted management. Their investment concept and requirement for asset management institutions usually set an example for the entire market. However, long-term funds in China are relatively cautious about ESG investing. Data from UN-PRI (Principles for Responsible Investment) shows that only two Chinese pension funds are signatories of the UN-PRI as of March 2020, showing that ESG investing concepts are still relatively new to Chinese insurance and pension institutions.

4.4.4.2 Coordination Mechanism is Absent for Financial Institutions Looking to Play a Guiding Role in Green Finance

The lack of a coordinated guidance mechanism for Chinese financial institutions may weaken financial institutions’ ability to guide corporate green development. For example, commercial banks can guide green transformation of companies through two measures, namely providing credit loan support for green companies or green projects, and restricting credit loans for non-green projects such as those from high-emission industries, forcing them to conduct green transformation. However, it remains voluntary whether banks guide the green development of companies (such as adopting the Equator Principles). As a result, some banks may seek short-term economic returns by providing loans for high-emission projects rejected by others, thus impeding other banks from guiding the green development of companies. A unified coordination mechanism may provide constraints on the behavior of all commercial banks, and thus contribute to concerted efforts to channel funds for supporting green projects.

4.5 Turning Challenges into Opportunities: How to Address the Weaknesses in China’s Green Finance?

Achieving carbon neutrality is a challenge as well as a new opportunity for China, and green finance needs to play a vital role in serving and guiding the green transformation of the real economy. Given the weaknesses in China’s green finance and its need to cut carbon emissions, we review international experiences and offer corresponding suggestions on the policy-making for the development of green finance.

4.5.1 Setting a Unified Green Standard in China

A well-established standard is essential to the sustainable development of China’s green financial system. Currently, the system has issues with multiple supervisions, inconclusive regulations, and incompatibility with international standards. Therefore, we suggest improvements for setting a unified green standard in China from these three perspectives.

First, clearer and more systematic standards for green financial products should be established. In the short term, the government may need to first establish a unified standard for financial products, laying the foundation for green financial products’ healthy and sustainable growth. In the medium and long term, we believe a systematic green financial system framework should be built to reduce differences in the classification standards of green products and boost balanced development between different types of financial products, thus bridging the gap between supply and demand in green investment. Second, domestic standards should align with international standards. For green credit loans, the internationally accepted idea of sustainability-linked loans could be gradually introduced to eliminate the difference between Chinese and global standards. With respect to green bonds, we suggest that the government could set a green bond standard that is aligned with international standards, expanding green bonds’ coverage and establishing a green bond system with external assessment, information disclosure as well as duration management. Third, introducing third-party attestation institutions should also be an important measure, especially in bringing in international institutions. Third-party attestation institutions play a vital role in promoting the healthy and sustainable development of China’s green financial system, enhancing a green company’s reputation and the attention from corporate and investment institutions through the independent attestation reports. In addition, independent third-party attestation institutions will help reduce information asymmetry in financing and investment, and lower the credit risk and information searching costs of China’s green financial system. Moreover, if third-party attestation institutions adopt international standards, Chinese green financial products could be more recognized by the global market and be more attractive to investors overseas. This may further reduce financing cost of green industries and improve availability of funding.

4.5.2 Establishing a Binding Green-Information Disclosure Mechanism

Given the green-information disclosure mechanism and industry attributes, we offer the following suggestions. For listed companies, mandatory green-information disclosure mechanism should be improved, and a clear and quantitative green-information disclosure standard system that is in line with international standards needs to be established. For green bond issuers, barriers between regulators should be removed to establish a unified information disclosure system for green bond issuers. For non-listed companies, improving the information disclosure mechanism and building an information sharing platform are the key ways to reduce information asymmetry in the launch of green products. For financial institutions, establishing a green-information disclosure mechanism will help to quantify and assess green products’ environmental benefits with regards to the participants of the green finance market.

4.5.3 Improving Incentive Policy to Boost the Overall Development of Green Financial Market

We attribute the gap between supply and demand of green investment to the low ROI, long investment cycles and high risks associated with green investment projects. To further encourage the development of green finance, the People’s Bank of China, China Banking and Insurance Regulatory Commission and China Securities Regulatory Commission can introduce incentive policies from the following aspects (Table 4.3). From the liability side, expanding funding sources and reducing liability cost should be considered to address issues related to term matching and asset pricing. With regard to the credit cost side, the government should expand the green insurance product portfolio, initiate and invest in guarantee funds, reduce the cost of bank credits and credit debt defaults, and support credit financing products through insurance or guarantee funds. Regarding taxation, preferential taxes for green investors could be introduced to enhance their interest in green investment. From the capital cost side, it is important to reduce capital consumption of green products. From the trading cost perspective, potential suggestions could be lowering administrative approval requirements and increasing exit potential of green projects.

Table 4.3 Measures for transforming positive externalities into business incentives
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4.5.4 Strengthening Education of Green Concept; Financial Institutions Offering Both Services and Guidance

The support of long-term funds and asset management institutions as well as the general public is indispensable for the long-term sustainable development of the green industry. To better facilitate green development, financial institutions need to guide funds towards green projects, which relies heavily on education about green investment. One of the typical fields that requires guidance from financial institutions is ESG investing. Therefore, we propose the following policy suggestions following the experience overseas.

Firstly, based on the nature of funds and institutions, mandatory administrative requirements and market-oriented incentives could be used to guide fund flows into the ESG field, thereby enhancing the awareness of the public and asset management institutions about responsible investment as well as long-term investment. It also guides the green finance system to shift from the top-down government-dominated ESG investing into the market-oriented stage. Secondly, we also encourage asset management institutions to voluntarily join the Principles for Responsible Investment (UN-PRI). The government could encourage asset management institutions to join responsible investment organizations or establish their own ESG investment systems in the near term and offer favorable policies. For example, the government can open green channels for product application for asset management institutions incorporating ESG principles, and/or provide them with additional credit in performance reviews.

4.5.5 Incorporating Environmental Risks into Prudential Regulations

Amid the green transformation of the economy, financial regulators should pay attention to two kinds of environmental risks: extreme climate change’s impact to the real economy, and the erosion of valuations of traditional-energy companies, thus weighing on the stability of financial institutions.

When managing environmental risks, financial regulators can release prudential regulatory policies and incorporate systemic environmental risks into the macro regulatory framework. For example, the central bank of Brazil sets different reserve requirement ratios according to the amount of green loans issued by private banks. It also requires commercial banks to incorporate environmental risks into their governance framework, and assess environmental risks when calculating capital demand, thus internalizing the transition risks of carbon-intensive assets by incorporating environmental risks of carbon-intensive assets into macro prudential indicators.

Financial regulators can add environmental factors into the asset evaluation criteria. The central banks of Switzerland and Norway have included ESG indicators in the evaluation criteria for asset investment and collateral. The central bank of Norway manages the government pension based on the ESG principle, purchases green bonds as proprietary investment, and has stopped investing in assets that are related to coal production or companies that seriously damage the environment. The central bank of Switzerland adopts ethical standards for foreign equity purchases. Similar principles can also be applied to the collateral business of the central bank. For example, the central bank can stop taking collateral with serious environmental damage, or offer differentiated haircuts based on the collaterals’ environmental risks.

Regulators also need to establish a risk exposure and disposal mechanism for brown assetsFootnote 15 to maintain financial stability amid the green transformation. We should prevent impacts from transition risks on the real economy and the financial system. To assess the financial system’s exposure to environmental risks and the impact of the green transition, the central bank should regularly assess the financial institutions’ tolerance to impacts. During the green development, the value of traditional assets with high carbon emissions may drop, affecting the real economy and the financial system (this is a transition risk). By assessing the financial institutions’ tolerance to such impacts, the central bank can effectively improve the information transparency of green finance, internalize environmental risks into financial risks, and allow investors to understand the investment risks they are facing. This measure can also help fine-tune the prudential regulatory framework, identify possible weakness in the system and incorporate it into the regulatory mechanism.