Key to unlock dual-goal scale-up

China's green financial system needs refining so it can better support the efforts to realize the carbon peak and neutrality objectives

China's green finance market has grown rapidly over the past few years. At the end of September 2021, the outstanding amount of China's green loans reached 15 trillion yuan ($2.4 trillion), ranking first in the world. The cumulative issuance of green bonds in China reached about 2 trillion yuan from 2016 to 2021. And the growth of the green finance instruments accelerated in 2021. Green loans rose 28 percent year-on-year as of September, and green bond issuance rose nearly 170 percent in 2021 compared with the previous year. These rates far exceeded the overall growth of bank lending and bond issuance.

However, to meet the massive green financing demand arising from China's carbon peak and neutrality goals, the green finance market needs to be further scaled up－many fold－in the coming years and decades. A recent study, conducted by the Green Finance Committee of the China Society for Finance Banking, finds that China's green and low-carbon investment demand during 2021-50 could reach 487 trillion yuan (in 2018 constant price terms). This means that the annual average demand for green and low-carbon investment could amount to 16 trillion yuan per year during the next 30 years. The majority of these investments will go into projects such as renewable energy, energy efficiency, new energy vehicles, green buildings and low-carbon technologies for manufacturing. About 90 percent of the funds for these projects will need to be mobilized by the financial system, with only about 10 percent of the funding coming from the government.

Therefore, mobilizing private capital is the key to successfully achieving the carbon peaking and carbon neutrality strategy (the "dual carbon targets"). The study by the Green Finance Committee argues that some key elements of the current green finance framework need to be modified to enhance its ability to mobilize larger amounts of private capital and to be further aligned with the requirement of carbon neutrality.

It calls for refining the green finance taxonomies, according to the no-significant-harm principle, to ensure that all projects included in the taxonomies deliver some environmental benefits while doing no harm to any environmental goals, including the emissions reduction goals.

Mandatory environmental and climate information disclosure requirements should be introduced, based on the Task Force on Climate-related Financial Disclosures recommendations, for entities that are seeking finance from banks and the financial market. Key to effective disclosure is the requirement for corporates and financial institutions to report the carbon intensity (footprint) of their operations and the financial assets on their balance sheets.

Stronger policy incentives should be introduced to enhance the expected returns of green and low-carbon projects. These incentives could include targeted central bank facilities, interest subsidies and guarantees from the government, as well as the emissions trading system.

Innovation of green finance products, such as sustainability-linked loans and bonds, green mortgage loans, secured loans using carbon credit as collaterals and green supply chain financing, also needs encouraging. And a transition finance framework should be established to scale up funding for transition activities toward net zero. This framework should include a taxonomy of transition activities, disclosure requirements, relevant financial instruments as well as incentives pertinent to the climate transition.

Various pilot programs have already been launched in some of the above-mentioned areas. For example, the China-UK green finance task force has initiated a Task Force on Climate-related Financial Disclosures pilot among 20 Chinese and UK financial companies, and its experience has provided an important basis for the People's Bank of China's policy preparation on mandatory disclosure requirements. A few months ago, the PBOC announced a new incentive, namely the carbon emissions reduction facility (CERF), that provides low-cost financing via commercial banks for decarbonization projects. Huzhou of Zhejiang province, a green finance pilot city, is now working on a policy framework to support transition finance.

In addition to mobilizing private capital to finance green and sustainable activities, another major task of green finance is to protect the financial system from risks arising from low-carbon transition. As carbon neutrality policies are implemented, firms in carbon intensive sectors such as coal mining, coal-fired power generation, steel, cement, and petrochemicals may face significant pressures in the form of increased costs and/or revenue reduction. The deterioration of carbon intensive companies' financial performance may eventually lead to financial risks for banks and investment firms, as some of these companies could default on bank loans and see their equity valuations decline.

Recently, the PBOC has requested 21 major banks conduct a climate stress test exercise on financial risks arising from their exposure to assets in coal-fired power generation, steel and cement sectors. This is only the beginning of a more systemic effort of measuring and managing climate risks. Going forward, the sector coverage of the climate risk analysis should be expanded, a wider range of scenarios or policy/technological shocks should be considered, and other types of financial firms (for example, asset managers) should also be required to conduct such analyses. Once the climate risk exposures are identified, financial firms will then need to develop a strategy to manage these risks, including via limiting exposures, assisting the decarbonization of carbon-intensive companies, and employing hedging instruments against climate risks.

"The dual carbon targets "present huge opportunities as well as significant challenges to the Chinese financial industry. Grasping the opportunities and meeting the challenges require greater and collective efforts from all levels of the financial community and the corporate sector. The good news is that we have the great passion from financial market players to participate in this endeavor. In September last year, more than 400,000 people attended (most online) the Annual Forum of the Green Finance Committee of China Society for Finance and Banking, which focused on the topic of financing carbon neutrality.

The author is chairman of the Green Finance Committee of China Society for Finance and Banking, president of the Institute of Finance and Sustainability, and co-chair of G20 Sustainable Finance Working Group.

The author contributed this article to China Watch, a think tank powered by China Daily.

The views do not necessarily reflect those of China Daily.

If you have a specific expertise, or would like to share your thought about our stories, then send us your writings at opinion@chinadaily.com.cn, and comment@chinadaily.com.cn.