As pollution in China’s main urban areas reaches crisis point, domestic companies have been increasingly issuing green bonds to finance restorative measures. Now they are looking to tap more overseas investors, but they will find the latter group more exacting in their investment criteria than local players.

A green bond is an instrument from which the proceeds will be exclusively used to finance green projects, according to guidelines set by the London-based International Capital Markets Association.

What really started out as a market for supranational issuers – such as the World bank or its private-sector arm, the International Finance Corporation (IFC) –has evolved to the point where there is significant corporate issuance, municipal issuance and, in recent months, sovereign green bonds.

“There’s been a dramatic change in approach, and it’s been particularly evident in the fixed income market,” said Steve Liberatore, lead manager for environmental, social and governance (ESG) fixed income at TIAA Investments in New York.

According to TIAA, which manages $18 billion in ESG-mandated strategies in total, global green bond issuance was $90.2 billion in 2016, 85.6% more than the year before. Chinese issuance comprised almost 30% of the total, with financial institutions accounting for 91% of the mainland total.

Since Chinese wind power company Goldwind raised $300 million in the country’s first green bond issue in 2015, the market has grown strongly. China issued ¥255 billion ($36.9 billion) of green bonds in 2016, according to data compiled by the Climate Bonds Initiative and China Central Depository and Clearing.

The People’s Bank of China estimates that as much as ¥4 trillion ($640 billion) of investment is needed annually to tackle the country’s chronic pollution and environmental degradation issues. China has committed to reducing greenhouse gas emissions by 60% from 2005 levels by 2030.

Chinese issuance is expected to rise this year in overseas markets. That said, mainland green bond rules are more relaxed – they count coal-powered infrastructure as eligible investments, which will be a stumbling block in the US and Europe, noted experts.

“Green bonds that finance clean coal are unlikely to find green investors in the US or Europe,” said Marilyn Ceci, New York-based head of green bonds at JP Morgan.

Most green bond issuance still comes from Europe, where the integration of ESG policy into institutional investment frameworks is advanced and looks set to become an even more mainstream activity this year.

TIAA, for instance, doesn’t hold any Chinese securities in its $1 billion Social Choice Bond Fund at the moment. This is partly because of the cost of swapping renminbi back into dollars and partly because many Chinese securities do not offer a sufficient level of data and reporting, said Liberatore (pictured left).

JP Morgan's Ceci said 2017 would be the year for governments to drive additional green bond issuance, with Europe again ahead of the curve. Poland was the first sovereign to issue a green bond €750 million, in December, followed last month by France, raising €7 billion from the sale of green bonds.

Liberatore and Ceci admitted there was still a lot of mistrust of the ESG investment sector, but Ceci pointed to rising demand from investors and growing involvement of sovereign and corporate issuers.

“We are seeing an increase in country-specific green bond guidelines emerging in countries such as Brazil, Morocco, China and India,” she noted.

Significantly, she expects Chinese issuers to expand into the US in 2017, where she expects to see demand. “A lot depends on the use of the proceeds and the sustainability transition story of the issuing company,” said Ceci.

Certain larger American institutions, such as California Public Employees Retirement System, will have around 10% of their total portfolio committed to green bonds.

Moreover, US-based bond giant Pimco last month launched a dedicated ESG platform to develop solutions for its fixed income clients. In the process, it has launched a global bond ESG fund and is refining the investment remit of its socially responsible investment strategies across the board.

The fund managers spoken to said it was difficult to be precise about the yield potential of green bonds. Ceci commented that green bonds trade on top of traditional debt. "The credits, which determine the credit spreads vary from AAA to unrated.”

Liberatore said the variety of green bonds now available present attractive total return potential “with the underlying spread and corresponding yield appropriate in our view for the security’s risk/return profile.”

For newcomers to the asset class, Liberatore said it would easier in future for them to get exposure, because larger deals are now being issued.

“Many more deals are index-eligible [now] and you are getting a much wider array of issuers,” he noted, “so it should become easier for investors to get exposure to securities that hopefully have a good total-return profile or meet whatever criteria they have in place.”