The bond market is set to play a critical role in ensuring that China reaches its ambitious target to become carbon neutral by 2060. Steering the world’s second largest economy towards a more sustainable future will require an enormous amount of capital, and debt securities like green bonds will help channel funds into environmental projects.
Paris Agreement emission targets for 2030 clearly illustrate the scale of the financial resources that China will need to mobilise over the coming years. To meet these intermediary goals, the country will need an estimated RMB3 trillion to RMB4 trillion per annum (USD424 billion to USD566 billion)1.
Chinese green bond issuance however slowed in 2020, with the disruption of the global pandemic deterring many issuers from going to market. Last year, USD22.4 billion was issued, just 70 per cent of the USD31.4 billion raised in 20192. That said, there could be fresh momentum after Chinese President Xi Jinping announced the country’s sustainability targets in September 2020.
In China’s onshore market, more carbon neutral bonds are being issued, with the proceeds used to fund industrial projects that will lower carbon emissions. While in the offshore dollar space, it has almost become the norm for Chinese property developers to issue green US dollar-denominated bonds, with over one-third of the green bond proceeds raised in Hong Kong allocated to low-carbon buildings3.
How investors can participate in China’s dynamic debt market was the subject of a session at HSBC’s eighth China Conference, which assembled a panel of experienced fund managers to discuss the need-to-know developments, as well as to give practical insight on ESG investment strategy.
Regulation – harmonisation and disclosure
On regulatory progress, the panel talked about how although China’s focus on sustainable finance came later than other parts of the world, the country was now a driving force in ESG for both equity and fixed income. One investor compared China’s approach with Europe, where the Sustainable Finance Disclosure Regulation (SFDR) is a major breakthrough that will likely be influential beyond the EU.
SFDR takes a bottom-up approach, where market participants can voice their concerns, he said. China’s regulatory progress however is more top-down in approach, based on the priorities of the government. Over time, he thinks the regulatory frameworks that exist in different geographies will gradually harmonise over time.
One example of how differences are being ironed out is China’s recent removal of so-called “clean coal” from the list of eligible projects that can be funded by green bonds. The new project catalogue, released last year, brings China more in line with international standards.
The panel also highlighted how rules relating to sustainable information disclosure for Chinese bonds lag stocks, where listed companies are required by law to publish the relevant information. This creates a challenge for foreign investors allocating funds to onshore debt securities, where many issuers are state-owned companies (SOEs) or local government financing vehicles (LGFVs) that are not used to disclosing ESG-related data. Even if information is available, it is often not standardised across issuers.
The solution is engagement, said the investors on the panel. Foreign fund managers can bridge the information gap by establishing relationships with issuers who might not be aware of how the process works. Once the necessary credibility is in place, investors are more likely to get information they need for an informed investment decision. There is a resources angle to engagement, as it is a time consuming, yet important part of the credit selection process.
Credit selection - understanding the greenium
Another subject of discussion was the so-called “greenium”, a phenomenon where green bonds attract a price premium. At its root level, scarcity is the explanation, due to supply and demand dynamics in particular sectors. The greenium is most evident in industries where green issuance is less common, and harder to find in other sectors where there is a ready supply of green-labelled securities. Whether or not this is a temporary market phenomenon will depend on whether supply for sustainable assets catches up with the differing levels of demand across sectors.
More broadly, the panel discussed credit selection styles. One investor highlighted the different approach for credit and rates. On the credit side, the investor said that the sustainability of an individual issuer is the main factor. Does it have strong ESG business practices? Will its governance structure impact its financial performance? For rates on the other hand, macro concerns are at the forefront – such as national climate change policy, demographics and regulations.
When looking at individual companies, different investors need to assess investments according to their risk profile. One panellist said investors who focus on issuers that have the best sustainability rankings tend to have the lowest spread and offer low returns. The trick, he said, is to identify the companies that are already on a positive direction of travel – for example, a utilities company that is on track to reduce its carbon footprint. That will lead to ESG alpha returns.
This material does not constitute Investment Research. It has not been prepared by HSBC’s Research Department. This material represents the best estimates or approximation as at the time of compilation and is not a recommendation. Investors must make their own determination and investment decisions.