March 25, 2015
Talking about climate change is pointless without discussing the United States and China—the two largest economies in the world that are also its two largest polluters. Given their enormous environmental footprint, any potentially successful plan to combat climate change must involve both countries.
While calls for environmental reform have steadily grown in the United States over recent decades, the same cannot be said for China; in its rush to industrialize, China has by and large ignored the environmental consequences of its actions. The government’s argument has been simple: other countries were not constrained during their industrialization.
However, pollution levels have climbed to such dangerous heights that China is starting to seriously consider its environmental impact. For instance, in late 2014 the Chinese government, for the first time, entered an agreement with the United States outlining steps to reduce future greenhouse emissions. More importantly, the recent documentary Under the Dome highlights the growing domestic movement to green the Chinese economy.
As a new report from the Climate Bonds Initiative highlights, China’s sudden turn toward environmentalism, combined with its quickly growing bonds market, represents a significant opportunity for the climate bonds movement. The Chinese government estimates that green investments must double in the coming years, and climate bonds could serve as a vehicle to achieve this.
While China may seem poised for a climate bonds expansion, Western investors should proceed cautiously. It is possible, given the rising demand for Western capital and the growing desire of investors to hold green assets, that Chinese firms will quickly attempt to expand climate-themed bonds. As always, investors should approach new opportunities warily.
In China, as in other climate bond markets, the largest potential pitfall is in metrics and certification. While the Climate Bonds Standard lays out guidelines for certifying potential green bonds, it seems unlikely that Chinese firms will place any more importance on certification than American or European firms have—due diligence will fall to investors.
Verifying Chinese climate bonds seems poised to be a particularly difficult task. It is likely that the majority of these bonds would help finance the ongoing construction boom. However, the Chinese building boom has often relied on low-quality construction, and plenty of examples exist in which catastrophic failure rendered investments useless.
Even more significantly, as the Chinese climate bond market grows, it will become increasingly important to establish guidelines to evaluate the total impact of projects funded by climate bonds. For instance, it has yet to be determined whether the renewable power generated by the Three Gorges Dam outweighs the environmental and cultural damages of its reservoir. Given the Chinese inclination toward such grandiose projects, finding better ways to quantify the impact of climate-bond-funded projects is paramount.
China is beginning to recognize its role as an environmental steward, and the investment necessary to preserve the environment represents a significant opportunity for green bonds and climate finance.
However, as with any new market, investors should tread carefully.