Greening Finance, Financing Green

Reforms and international co-operation will likely mean that China can raise the green finance needed to solve the country's chronic environmental problems, writes UNEP's Simon Zadek 

China’s natural environment is in a mess. Some 20% of China’s agricultural land is considered toxic to human health, yet much of this remains part of the human food value chain.

One estimate suggests that over 1 million people die prematurely in China each year as a result of air pollution, with lung cancer rates increasing by almost 500% in the last three decades.

Fixing the problem will cost a lot. Investment needs across key green sectors in China will be about US$460 billion per year from 2015 to 2020, or about US$2.8 trillion from now to 2020, according to a report launched at the China Development Forum by the Development Research Center of the State Council.

The International Institute for Sustainable Development and the UNEP Inquiry into Design Options for a Sustainable Financial System contributed to the report.  

Most of that finance needs to come from private sources of finance, as much as 85%, according to a second report on green finance to be released next month by the People’s Bank of China, based on work undertaken by a Green Finance Task Force established in mid-2014 and co-convened by the UNEP Inquiry.

China’s current financial system is, however, not well suited to financing the transition to a climate resilient, low carbon economy. Only 9% of current bank loans outstanding comply with the Green Credit Guidelines according to the China Banking Regulatory Commission, an improvement over past performance but still far less than needed.

Fortunately, there is good news. China’s high profile climate agreement with the US will make a difference, as well as reflecting growing ambitions to manage carbon emissions.

China’s coal consumption fell by over 2% in 2014, signaling the most important fossil fuel peak in modern times. Clean energy investment in China jumped 32% in 2014 to a record US$89.5bn, as compared to US growth of 8% to US$51.8bn, and a meagre 1% growth across Europe. Even Beijing’s infamous smog levels fell in 2014, according to the municipal Environmental Protection Agency, though pollutants remained far above acceptable levels.

Such advances provide ground for optimism, but more is needed. Greening reforms to China’s financial system may offer part of the answer. Financial market reform is central to China’s overall economic reform efforts.

Familiar reforms are under development that if successful will deliver a better governed, and more extensive and diversified financial and capital markets. Until recently, however, such reform plans have not explicitly embraced the policy goal of greening China’s development.

This may now change. Pan Gongsheng, Deputy Governor of the People’s Bank of China, writing in the forthcoming report of the Green Finance Task Force findings, states that “The People’s Bank of China is spearheading the drafting of the 13th and development of China’s financial sector; and green finance will be a key element of this plan”.

Wide-ranging options have been considered in this and the Development Research Center reports. In banking, recommendations include allowing eligible green loans to be given preferential tax and regulatory treatment. China would under the proposals establish an enabling framework for developing a green bond market, including standards, incentives and penalties for non-green use of proceeds, and the greening of credit ratings.

Best practice

Stock exchanges would mandate investor-relevant environmental reporting, and encourage the development of green indexes and linked exchange traded funds. Policy banks, including newly-established development banks focused on international investments, would match international best practice in environmental principles and risk management. Lender liability for environmental pollution by borrowers would be introduced, and environmental liability insurance would become mandatory for selected industries.

Monetary policy, and other central bank operations such as refinancing, would be environmentally sensitised.

These and other recommendations could be the world`s most ambitious experiment in systematically greening a major financial system. Centrally, As the Development Research Centre report argues, “greening a country’s financial system is not an “additional” performance requirement but concerns the efficiency and effectiveness of the whole system.

A lack of green financing, after all, delivers poor allocation of capital, mispriced risks and weaker long-term economic growth, creating stresses that ultimately lead to financial market instability and underperformance”.

G20 hosts in 2016

Such a systematic approach to greening China`s financial system could filter into the international architecture of financial governance, especially if China chooses to promote such approaches through key policy venues, such as the G20, which it hosts in 2016.

Moving beyond domestic action could in part be encouraging national action elsewhere, including linkages to cross-border investment and even trade and investment agreements. Here again the news is quite positive, in that the UNEP Inquiry has identified significant green finance innovations, especially in emerging markets, including Bangladesh, Brazil, Indonesia and South Africa. Moreover, China could seek to embed green finance in the heartland of international standards, encouraging action on this front by key institutions such as the Bank of International Settlements, the Financial Stability Board and the International Monetary Fund and World Bank.

Greening the financial system will not be easy, especially at the international level. Success, however, could be a game changer in advancing a financial system fit for purpose in delivering what is needed in shaping an inclusive, sustainable economy for the 21st century.