The growing fixed income market in China is attracting the interest of many a global investor. And as they look for opportunities in the country, many ESG-friendly investors are increasingly considering the country’s green bond deals. 
 
Opportunities increasingly abound. China’s domestic bond market is growing fast, as its companies continue to grow. It is the world’s second-largest bond market, boasting Rmb117 trillion ($18.4 trillion) in outstanding bonds at the end of 2020 (115% of GDP). That was 18% higher than a year earlier.
 
As its overall bond market has expanded, so have green bond volumes. All-told, China’s onshore and offshore green bond issues accounted for around one-fifth of global new green bond deals in 2019, ranking top among all countries, according to a Fitch Ratings report in December 2020. 
 
Last year, Chinese companies issued more than 200 green bonds to raise a total of $37.6 billion, according to data from sources including Climate Bonds Initiative (see chart 1). It ranked the third in terms of bond issuance for the year, following the US and Germany, according to Climate Bonds Initiative (see chart 2).
 
While China’s total issuance volume last year was a little lower than it had recorded in 2019, the country came roaring back to post Rmb116.8 billion ($18.3 billion) of new green bonds during the first quarter of 2021 – more than half that total volume registered in 2020. 
 
More is likely. The Hague-based NN Investment Partners estimates the global green bond market will grow to €1 trillion ($1.22 trillion) by the end of 2021 and €2 trillion ($2.43 trillion) by 2023. If China’s borrowers comprise 20% of this once more, they will have issued €400 billion-worth by end of 2023.  
 
Yet while the potential for greater green bond issuance and investment for China is large, uncertainties still abound. Green bond standards and reporting levels remain opaque, while questions linger over the quality of green bond research from local credit agencies and research houses. 
 
International investors will likely require deeper and more transparent research and understanding of Chinese borrowers before they fully engage. 
 
GROWTH POTENTIAL
 
Beijing has been opening access to its bond market as part of an effort to gain higher foreign investors investing and to encourage more local investors to gain exposure to offshore assets. 
 
With international supply struggling to keep up with global investor demand, more fund managers are looking to invest into onshore Chinese bonds. The foreign ownership ratio of China’s bond market is set to surpass 3% this year, courtesy of a continuous relaxation of regulations and barriers to foreign investment. Back in 2018 was just 2.2%.
 
Martin Dropkin, head of Asian fixed income at Fidelity International, believes the foreign investor inflows into the country’s fixed income market will continue. 
 
“In general, international investors are finding attractive yields in Chinese bonds, compared with some other government bonds globally,” he told AsianInvestor. “[Plus,] the correlation of Chinese government bonds and Chinese corporate bonds is relatively low compared to other regions.”
China’s five-year and 10-year government bond yields stood at 2.97% and 3.12%, respectively as of June 10. In comparison, the US’s 10-year government bond stood at 1.5%. 
 
International investors have not yet had a “meaningful” exposure in China fixed income markets, added Sean Chang, head of fixed income from Ping An Asset Management (Hong Kong). Investors including pensions and central banks are still learning more before rising investments. 
 
Most of the world’s large pension funds, for instance, currently invest into China on an emerging market basis, which is typically a minority holding in their portfolios. As a result, their exposure to the country’s bonds is relatively low. 
 
Chai Chi Kit, the chief investment officer (CIO) of Ping An Asset Management (Hong Kong), believes a lot more is set to come, particularly as the country enjoys expanding inclusion into global bond benchmarks. 
 
“This is just the beginning of the journey and has a long way to go.  It will take a while for the benchmarks to fully reflect the enormous size of the Chinese markets,” Chai said. 
 
However, it will not happen overnight. Global investors will take time to fully familiarise themselves with China’s unique economy cycle and capital market. Chai noted that he will not be surprised if some of international fund managers and asset owners have a more cautious attitude towards investing in China, since it takes time for investors to learn and understand the market.  
 
Geopolitical tensions could also play a role. In January, for example, index provider FTSE Russell faced resistance from some Japanese asset owners, including the Government Pension Investment Fund, the world’s largest pension fund, over its plan to include Chinese debt into its World Government Bond Index, a widely used global bond benchmarks.
 
NATIONAL PUSH
 
As these investor flows rise, a sizeable portion is likely to target green bonds from China. 
 
Offering more environmentally friendly investments has become a key theme in China, as part of the government’s broader efforts to combat climate change after years of heavy pollution. 
 
The country is currently the world’s largest carbon emitter. The government says it anticipates that its emissions will peak before 2030 and then decline to the point that China achieves carbon neutrality by 2060. The policy details will likely unleash demand to fund new green projects, market experts believe.
 
“If China can make the economy greener to a global level, it could boost investors’ confidence. Also, foreign investors can use China and emerging market green products to diversify their current portfolio,” said Bram Bos, lead portfolio manager of green bonds at NN Investment Partners. 
 
He noted that key drivers of global green bonds market growth include the strong demand from investors wishing to ‘greenify’ their portfolios and the rapidly growing popularity of green bonds among European issuers. While he did not provide any prediction on China’s growth in bond issuance, he believes the country wants to achieve its stated ambition to reach carbon neutrality by 2060. 
 
However, questions exist about the level to which aspiring Chinese green bond issuers enjoy truly green projects. To meet such questions, Chinese policymakers are trying to improve the regulatory framework related to green bonds. 
 
On April 21, for example, the People’s Bank of China released a green investment guideline that included the latest rules on green bond issues, updating the previous 2015 version. 
 
Dropkin said that market is impressed by how much China’s regulators have been opening the capital markets with more standardised developments over the past few years. This could potentially drive development in ESG, and help the country catch up to other markets in terms of ESG rules and standards. That could ultimately provide a solid support for green products listing and subscription. 
 
Meanwhile, the plan of Hong Kong and China to open southbound trading via the Bond Connect scheme this year should entice China pension funds and insurers to target ESG and green bonds in the Hong Kong as well.
 
Indeed, Hong Kong looks to be a key beneficiary of China’s rising engagement in the green bond market. Last year, the city saw a record 18 green bond issues conducted locally, raising a combined HK$66.6 billion ($8.5 billion). 
 
This year activity is even busier. Over the first four months of 2021 Hong Kong Exchanges and Clearing (HKEX), the operator of the stock exchange, listed 30 green/ESG-focused bonds worth a total of HK$91.1 billion. Grace Hui, head of green and sustainable finance at HKEX, told AsianInvestor this could quickly become an even bigger sum, given multiple efforts from China and Hong Kong’s governments to encourage further deal flow. 
 
Hui notes that HKEX-listed green bonds are mostly issued by Chinese firms and tend to get well received by investors. 
 
“Both climate transition bonds and sustainability-linked bonds create more accountability and transparency in financial  markets, which reduces the risk of greenwashing,” she said.
 
This story was originally published in the summer 2021 edition of the AsianInvestor magazine.