Fixed Income Markets - Green Versus Normal Bonds in China

Fixed income markets:

Green versus normal bonds in China

Executive Summary

Green bonds in general are debt instruments used to finance green projects with environmental benefits, primarily climate change mitigation and adaptation, which are issued by commercial bank, non-financial corporates, asset-backed securities (ABS) and policy bank, with 33.6% YOY of the size. Green bonds are rated primarily based on the Environmental, Social and Governance scores. Also China has different tools to rating the green bond. The credit rating agencies have three rating tools. According to those three rating tools to evaluate each green bond. In addition, China will focus on four dimensions: project green level, use of proceeds, project evaluation & selection and information disclosure. In the future, Chinese leaders and corporations are doing more to reduce their impact on the environment, and the transition to a greener, more sustainable future.

For the valuation of green bond, three bonds issued in 2017 by China Development Bank are selected as our valuation targets, as the CDB is one of the most representative issuer for Chinese financial green bonds issuance. We evaluated their spreads, duration, convexity and other basics.

The main risk exposure of green bond are environmental risk and regulatory risk. In terms of the default probability, as a policy bank under the direct jurisdiction of the state council and supported by the government, the China development bank has no possibility to default. To reduce the risk the government should have a uniform definition of green bonds and the information disclosure standards should also be settled down.

As for performance analysis, we calculate the return and volatility for each of two Green Bond and one Plain Bond, as well as the sharpe ratio of each bond. We come to conclusion that during the same period, the sharpe ratios of green bond are a little larger than that of plain bond. Also, these two green bonds outperform the government during this period.

As for spread analysis, to analyze performance of SDBC Green Bond [1702001] and SDBC Green Bond [1702002], we compare the G-Spread, CDS spread, ASW, Z-Spread with the plain bond issued by the Development Bank of China [170206]. We find that all the absolute values of spreads for green bonds are lower than those of a plain bond.

A. Introduction on China Green Bond Market

1. China green bond market overview

1.1 Definition in General

Green bonds in general are debt instruments used to finance green projects with environmental benefits, primarily climate change mitigation and adaptation. A green bond is differentiated from a regular bond by its commitment to use the funds raised to finance or refinance “green” projects, assets or business activities. Green bonds can be issued by either public or private actors up front to raise capital for projects or for refinancing purposes, freeing up capital and leading to increased lending. ^[1]

1.2 Definition of the Chinese “Green”

According to People’s Bank of China (PBOC)’s Green Financial Bond Guidelines for green bond issuance by financial institutions. The “Green Financial Bonds” refers to the securities issued by financial institutions with legal person status (development bank), policy banks, commercial banks, finance companies and other legal financial institutions), for the purpose of supporting green industries and with principal redemption and interest payment effected as agreed between the parties concerned.^[2]

According to the green definitions from Green Bond Endorsed Project Catalogue, green projects in China will cover the following sectors: (1) Energy Conservation (2) Pollution Control (3) Resource Utilization (4) Clean Transport (5) Clean Energy (6) Ecological Protection and Climate Change Adaptation. ^[3]

1.3 Issuer and Investor

The issuance has been diverse, including commercial bank, non-financial corporates, asset-backed securities (ABS) and policy bank. Offshore bonds are available on international stock exchanges. Onshore bonds available to domestic investors and qualifying international investors.[pic 1]

The main driving force has been commercial banks, contributing 82% of the total issuance in 2016. More non-bank issuers emerged in China’s green bonds market in 2017. 38% of bonds were issued by non-financial corporates and 24% of bonds by policy banks; commercial banks made up 38% of the market in 20174.

 1.4 Size

Green bond issuance from China increased in 2016 from almost zero to RMB238bn (USD36.2bn), accounting for 39% of global issuance in 2016. 5^[4]At the end of June, issuance for 2017 totaled USD11.52, representing a 33.6% year on year growth from the first half 2016 and 20.3% of global green bonds. ^[5]