Chinese green bonds survive the global volatility, what’s next?

Green bonds saw a big slowdown in European markets and the United States last year due to soaring interest rates and geopolitical conflicts. But China’s onshore green bond market-maintained momentum.

European markets have pioneered green bond market development since 2007 and are the major players. China joined the game late in 2014 and have since launched the inaugural national green bond guidelines issued by Chinese regulators at the end of 2015. China’s domestic green bond market has witnessed a growth from zero to hero and become the world’s largest market.

In 2021, China announced carbon dioxide peaking by 2030 and carbon neutrality by 2060. The strategic goal from top down facilitates to further the Chinese green bond market and its annual issuance boomed to $78.5 billion in 2021. Green bonds are becoming more and more popular both in China and globally.

The global issuance reached the 2 trillion milestone in 2022. However, the global sentiment went south rapidly in 2022. The high inflation rate forced central banks turning into tighten monetary policy. European and US green bonds market seems to have cooled down. While the yearly issuance size of German, Supranational and the Netherlands markets remain nearly unchanged, with France down by 42% and the US down by 52%, the Chinese green bond market remains momentum with a growth rate of 14%.

In terms of performance, comparing the index value of FTSE Global Green Impact Bond Index (Global Green) to FTSE Chinese Green Bond Index (Chinese Green) from the past five years, we can see the Global Green is much more volatile than Chinese Green. In Global Impact profile, there are 64.6% bonds denominated in EUR and 19.1% in USD, hugely affected by the global macroeconomic conditions. From 2015 to 2018, U.S. Federal Reserve (Fed) was gentle in hiking rates, preparing to return to normalcy.

The U.S. and China started a so-called ‘trade war’ in 2019, where Fed cut 75 bps interest rates as a 'mid-cycle adjustment’ and then cut further 150 bps in March 2020, leading the fed fund target rate range of zero to 0.25%, in response to Covid-19 recession. The strong stimulation did push up the value of almost all asset classes to its highest point, and Global Impact was up 12.0% to 123.3 high since the rate cut. Nevertheless, good time doesn’t last long, the geopolitical conflicts and overheating inflation forced central banks to raise interest rates across the globe.

In 2022, Fed aggressively raised 425 bps, just in nine months, costing Global Impact drops 9% from its peak. On the other hand, China maintained its monetary policy relatively stable, and we see the steady growth of China Green from 114.92 to 118.24 with a growth rate of 2.9% in 2022. China Green outperformed Global Green and showed strong resilience during the pandemic. Some investors are in favour of the Chinese fixed income market due to the lower volatility and low correlation compared to Developed Markets to hedge the portfolio.

Despite China being the largest issuance country in the green bond market, international investors may often find themselves lost in the pile of Chinese green bond guidelines. This largely reflects the fragmentation of China’s overall bond market regulations. Based on the issuer types and the bond characteristics, bond offerings are classified into different types, such as Financial Bonds (bonds issued by banks and other financial institutions), Enterprise Bonds (bonds issued by non-listed state-owned corporates), and Corporate Bonds (bonds issued by listed corporates). As the ‘green bond label’ only serves as an addition to the basic bond features, China’s domestic green bond issuers have still to be overseen by corresponding regulators. For example, Green Financial Bonds, just like all their vanilla peers, are still subject to the regulations of the People’s Bank of China.

As a result of regulators’ intention to incentivise green financing, each of them released relevant green bond guidelines for the types of bonds subject to their regulations. The key development in recent years, however, is the convergence of different guidelines, which has happened in two aspects. Firstly, the consensus on overall rules about issuing and managing green bonds, and secondly, the harmonisation of definition of eligible green projects that can be financed by a green bond. As a result, we have seen the release of China Green Bond Principles - although it still serves as a voluntary rule that does not replace the current regulations - that have bridged the gaps between the widely accepted ICMA Green Bond Principles and various Chinese green bond guidelines.

The release of China-EU common ground taxonomy has sent a positive signal for further harmonisation on the green projects, assets and activities definitions. Although we have seen many Chinese green bonds focusing on a wider environmental issue such as air pollution reduction, the guidelines on issuing Carbon Neutrality Bonds rolled out by both NAFMII and Shanghai Stock Exchange reflect that Climate Change mitigation has become a key priority contributing to China’s Net Zero commitment.

China aims to peak its carbon emission before 2030 and achieve carbon neutrality before 2060. This requires rapid transitions in certain industries, especially in energy and manufacturing. It’s estimated that China needs at least $14.7 trillion (RMB 100 trillion) over the next 30 years to achieve the targets, leaving a huge opportunity for climate change mitigation and transition finance in the form of debt financing.

The rising issuance of Carbon Neutrality bonds which are usually dedicated to climate change mitigation and the release of relevant guidelines has reflected the appetite in the market and regulators’ ambitions. However, despite the ambiguity around the ‘Carbon Neutrality’ naming, we expect green criteria in certain areas are becoming clearer and tighter to further align with international definitions. For example, eligibility criteria for energy efficiency projects that may adopt stringent thresholds and to exclude those that may potentially be linked to any fossil fuel projects.

On top of it, China remains one of the largest powerhouses of the global green bond market despite a slight year-on-year slow-down. Although China GBPs are only adopted on a voluntary basis, and it does not replace the current quasi-mandatory green bond guidelines made by regulators, it is expected that more issuers will decide to embrace them. FTSE Russell has launched the FTSE Chinese (Onshore CNY) Green Bond Index Series which measures the performance of the onshore Chinese yuan-denominated, fixed-rate governments, agencies and corporate debt issued in mainland China that are labelled green.

Alongside the market development, we will continue to provide research and introduce products that reflect key features. The newly launched FTSE Chinese (Onshore CNY) Green Bond Index – Carbon Neutrality covers a sub-type of green bonds whose use of proceeds are dedicated to projects that have carbon reduction benefits, aiming to provide a solution to help the client achieve their climate transition target.