BEIJING (CAIXIN GLOBAL) - In just three months of this year, Chinese companies have issued more than 80 billion yuan (S$16.5 billion) in carbon-neutrality bonds and asset-backed securities, putting China on its way to supplying a sliver of the enormous sums that will be needed to finance its transition to a low-carbon economy.

However, China's rapidly growing carbon financing market lacks clear and unified regulatory standards to guide financiers to worthwhile projects and help them assess the carbon-reduction benefits of their investments.

The need to clarify standards and fine-tune regulations shows how China's regulatory regime has lagged behind developments in the carbon financing market, a crucial tool for making the green transition necessary to meeting the country's goal to achieve net-zero carbon emissions by 2060.

"The investment in carbon-neutrality won't just come out of thin air... Every investment needs to be based on guidance and calculation," China's former central bank chief Zhou Xiaochuan said at a recent seminar.

Differing standards and definitions

Regulators have not set unified standards for financing carbon-neutrality projects, including for things like how much of the proceeds have to be spent on reducing carbon emissions.

China's interbank and exchange bond markets have become major sources of financing for projects that will help the country achieve carbon neutrality. The interbank bond market, which is regulated by the People's Bank of China (PBOC), is by far the largest. The exchange bond market is supervised by the China Securities Regulatory Commission and is run by the Shanghai and Shenzhen stock exchanges.

As at April 28, 65.9 billion yuan in carbon-neutrality bonds had been issued on the two markets, as well as 17.2 billion yuan in carbon-neutrality asset-back securities, according to Caixin calculations. The first batch of these bonds was issued in early February on the interbank market.

However, the two markets have different requirements for how much of the money raised through these bond issuances must be spent on carbon reduction.

In March, the interbank bond market's self-regulatory body announced that in principle issuers must spend all of the proceeds raised from carbon-neutrality bonds on projects that can help reduce carbon emissions, such as clean energy, clean transportation and sustainable architecture.

The central bank-backed National Association of Financial Market Institutional Investors (NAFMII) also told issuers that they have to disclose the estimated amount of emissions that will be reduced by their projects, and encouraged them to disclose a road map for achieving those reductions.

However, the exchange bond market regulator, which has not yet released clear rules for carbon-neutrality bonds, has allowed issuers to use up to 30 per cent of their proceeds to "replenish liquidity". At least one company that has issued such bonds has not disclosed any carbon reduction projections.

So for issuers of carbon-neutrality bonds, the amount of money they have to actually spend on reducing carbon emissions depends on which market they choose. Then there is the question of what actually qualifies as a carbon reduction project.

The government has a list of projects eligible to be funded by green bonds, and issuers on both markets have said the projects they are funding are included on that list, which was updated last month.

According to NAFMII, carbon-neutrality bonds are a subgroup of green bonds, and the projects funded by the proceeds should be on the official list or fall under international green industry standards.

However, some experts believe that the green bonds-supported list does not cover every kind of project that reduces carbon emissions, and suggest that financial support also be made available to activities that are not on the list so long as they help reduce carbon emissions.

"Traditional green bonds mainly support green economic activities, but achieving a country's carbon reduction goal also requires financial markets to support industries with high carbon emissions and high environmental impact to make the smooth transition to low carbon," Mr Xie Wenhong, China programme manager at the Climate Bonds Initiative, an international non-governmental organisation, told Caixin.

The idea is that there are some heavy emitting industries that will still be needed while the world transitions to a low-carbon future. For example, China will still need coal-fired power plants to ensure a steady supply of electricity while the country develops cleaner sources of energy, Dr Zhou Chengjun, director of the PBOC's finance research institute, said at a forum in Beijing in late March.

As a world manufacturing power, China has many high-carbon industries that need financial support to make the transformation to low-carbon emissions, he said. Carbon-transition finance can have more flexible requirements than green finance to better support this transition.

The concept of carbon-transition finance is a new one. There is no internationally accepted definition of the term or universal standard for its classification, according to Dr Zhou. "Transition finance is a new proposition," he said.

Another significant issue in carbon-neutrality finance is the lack of clear standards for the accounting of carbon emissions in the financial sector that regulators can use to effectively assess its carbon-reduction performance.

Although the Ministry of Ecology and Environment has set standards for calculating the carbon emissions of companies in key real-economy industries, there are no regulatory standards for carbon emissions attributed to the assets of financial institutions.

The standards for financial institutions should be different than those for industries in the real economy, said Dr Sun Tianyin, a researcher at the Research Centre for Green Finance Development at Tsinghua University.

Carbon-emission accounting in the financial sector seeks to measure how much responsibility a financial institution has for the carbon emissions created by a company that it does business with, Dr Sun told Caixin. For example, if a company emits 100 tons of carbon dioxide a year, a carbon accounting system will tell you how many tons is the responsibility of each financial institution that has dealings with it, he said.

Setting up a carbon-emission accounting system can offer financial institutions a way to lay a foundation for their carbon-reduction efforts and can help regulators create relevant appraisal standards, he said.

Also, a carbon accounting system could help financial institutions manage climate risks, Dr Sun said. As carbon prices are expected to rise, higher carbon costs could hurt businesses' liquidity and profits, weakening their ability to repay their debts. That in turn would threaten financial institutions' asset quality, Dr Sun and another researcher Zhu Yun from the research centre, wrote in an article published last month.

Regulators are considering setting up such an accounting system. In April, PBOC governor Yi Gang said the central bank had conducted a pilot programme that had financial institutions measure the carbon emissions of their projects. "We are... exploring the development of a national carbon accounting system and an evaluation system for the performance of financial institutions' green credit and green bonds," he said.

Financial institutions also need third-party agencies to certify projected carbon reduction benefits and to count the carbon emissions of the projects they finance. However, there should be an entry threshold for these third-party agencies, as well as unified standards for the quality and content of their certifications, Mr Ma Jun, the director of a central bank-backed think-tank's green finance committee, said at a seminar last month.

Incentives needed

Another obstacle to getting more debt issuers and investors to engage in carbon-neutrality financing is the lack of incentives and commercially sustainable projects, some experts said.

Bond issuers have not been particularly enthusiastic to join in the green bond market, as the prospects of such projects remain unclear and they require a high initial investment, a source close to regulators told Caixin.

For investors, green bonds have about the same collateral and risk provisions as typical bonds, so they do not have much appeal other than for those who already care a lot about green issues, the source said.

One expert from the Asian Development Bank has said that a higher price for carbon dioxide can create substantial incentives and constraints on investment.

A good sign is that more market entities are becoming aware of climate risks and the necessity to increase their allocations of green assets. It is going to be very difficult for companies to avoid making a net-zero emission commitment, Mr Bill Winters, chief executive of British banking giant Standard Chartered, told Caixin in a recent interview.

This story was originally published by Caixin Global.