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How the improved quality of China's onshore green bonds is boosting investor confidence

A combination of stricter requirements in allocating bond proceeds and higher bond yields has made China’s onshore green bonds an increasingly attractive option, says Sustainable Fitch.

Green bonds have continued to dominate China’s green, social, sustainability and sustainability-linked bonds (GSSS) market in 2023 so far. Onshore green bond issuances reached CNY376 billion (approximately US$51.6 billion) in the first five months of the year — equivalent to 48% of the amount issued in 2022 — benefitting from relatively lower interest rates and government support.  We expect overall issuances in 2023 to either stay at the same level as 2022 or exceed it. Financials, industrials, and utilities continued to comprise the bulk of the onshore green bond market, buoyed by government policies to scale up domestic green finance.

Offshore green bond issuances are slowly picking up after a sharp decline in H2 2022. Interest rate hikes, a strong US dollar and higher inflation are some of the main factors that affected offshore debt-raising activities in 2022.

We have observed pricing discounts and higher yields of Chinese onshore green bonds against non-green bonds. This contrasts with the “greenium” seen in developed markets, where investors need to pay higher prices to accept lower yields in exchange for sustainable impact.

This is largely due to the lower demand and willingness to purchase green assets in the onshore market. The supply of onshore green bonds has risen rapidly, driven by China’s carbon neutrality targets. However, demand remains moderate since domestic investors, other than policy banks, state-owned commercial banks and insurance companies, are generally less incentivised to hold green assets.

Onshore green bonds have shown noticeable improvements in terms of allocating bond proceeds to eligible projects since July 2022. The China Securities Regulatory Commission (CSRC) and the People’s Bank of China (PBOC) published the new Green Bond Principles, setting stricter standards requiring 100% of bond proceeds to be used on green projects.

Nearly all new green bonds issued after July 2022 that are regulated by CSRC and PBOC, notably corporate bonds and financial bonds, are now able to meet the 100% green Use of Proceeds (UoP) requirement by aligning with domestic and/or international green taxonomies.

Financial market reforms announced by the Chinese central government in March 2023 may help to reduce the regulatory gap across the onshore green bond market. The CSRC will retain its oversight over the securities sector, while taking over the responsibilities of approving enterprise bond issuances from the National Development and Reform Commission. This organisational restructuring may improve the quality of green enterprise bonds, as they will soon face the same 100% UoP requirements as their corporate and financial counterparts.

EU’s carbon tariff may accelerate the expansion of national carbon market

The potential impact of the EU’s Carbon Border Adjustment Mechanism (CBAM) on Chinese exported goods will grow as the sector coverage expands and EU emissions trading systems (ETS) prices rise in the future. So far it only covers a small range of raw materials, such as iron, steel and aluminum.  

The CBAM may put pressure on China’s national ETS to accelerate sector expansion and improve trading activities to drive up domestic carbon prices. This could help to lower carbon tariff costs on exported goods once the CBAM comes into effect, although carbon prices in the national ETS are much lower than those in the EU ETS.

China's environmental regulator intends to resume the operations of its domestic voluntary carbon market, China Certified Emission Reduction (CCER), within 2023. Registration and approval for CCER projects have been suspended by the NDRC since 2017 due to oversupply and lower eligibility of carbon-offset projects that led to low trading prices.

Demand for CCER projects will be particularly high from entities in carbon-intensive industries, where carbon abatement is costly or hard to achieve. Sector expansion of national carbon market and the tightening emission intensity benchmarks of the national ETS over time will also drive up demand for CCER as more corporates pledge net-zero targets.

New HKEX ESG rules can enhance sustainability reporting for Chinese corporates who wish to raise offshore capital

We believe the new HKEX’s climate-related disclosure rules could influence onshore-listed mainland companies to enhance sustainability governance reporting if they intend to raise offshore capital. International investors often struggle to assess the financial and impact materiality of ESG factors for Chinese companies due to limited experience and knowledge regarding ESG reporting.

The exchange plans to tighten climate-related disclosure rules, mandating all issuers to report climate metrics in accordance with ISSB standards from January 2024. A range of climate-related metrics will be subject to disclosure, such as Scope 3 GHG emissions, cross-industry metrics and internal carbon pricing.

The strategic importance of Hong Kong as a key offshore fundraising hub for Chinese companies continues to grow — 1,409 of the 2,257companies listed on the HKEX were Chinese as of Q4 2022, contributing to 77% of market capitalisation.

Chinese domestic onshore stock exchanges have yet to mandate any form of ESG disclosure for A-share entities, leading to a divergence in ESG reporting capability between on- and off-shore listed companies.

For more information, please contact Aaron Wei, director, ESG and sustainable finance business and relationship management at Fitch Ratings on [email protected] and scan the QR code to read more.


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