Chinese regulators recently proposed eliminating so-called “clean coal" from the list of projects that can raise funds using green bonds. While this may not sound like a big deal, if it goes through, it could be the start of a much-needed transformation in China’s green finance market – and a move away from coal power, which still provides over half of the country’s installed power generation and is a major drag on global efforts to reduce greenhouse gas emissions.

If finalized, the proposal could serve as a model for harmonizing with the rest of China’s complex financial system which, despite green ambitions, still invests in the expansion of coal power. This momentum could lead to a broader, much-needed policy framework for mainstreaming climate action into Chinese domestic and foreign investment.

Disentangling China's Green Finance Criteria

Green bonds are financial products issued by financial institutions, corporations or governments to raise money for "green" projects. Proceeds must be used to finance certain categories of projects, based on definitions adopted by issuers on a voluntary or regulatory basis. The global green bond market has grown quickly, and in 2019 issuance of green bonds exceeded $250 billion.

The popularity of green bonds is growing in China, but some investors have expressed concern that China's rules and definitions for green bonds may be out of step with international standards. Clean coal is typically excluded from the list of permissible green bond categories around the world -- but not in China.

Companies, power plants, and infrastructure projects looking for investment capital often favor the "green" label, as it offers access to growing pools of investment earmarked for environmentally friendly projects. But definitions about what is "green" vary.

Some issuers still take the view that "less-dirty" technologies deserve inclusion, raising questions about the quality and integrity of financial products bearing a "green" or "sustainable" label. Indeed, inconsistent definitions have become one of the largest barriers preventing investors from increasing their green assets. (The EU, for example, has responded by developing its own sustainable finance standard.)

"Green" is defined differently in China, not just in the case of green bonds but also for different financial products, confusing market participants. In China, "green" finance can fund coal plants. Chinese authorities are discussing plans to prepare a reference guide for "green" financial products, but presently, existing standards do not share common terminology or criteria.

With respect to green bonds, the People's Bank of China (PBOC) and the National Development and Reform Commission (NDRC) each separately issued criteria for green bonds in December 2015, setting out eligible activities for the use of the proceeds from a green bond. These separate but overlapping taxonomies have co-existed side by side, making life more difficult for investors. The growing consensus among Chinese policymakers, financial institutions and their advisers is that this patchwork of standards and definitions must end.

This May, China's authorities took a step in that direction. The central bank (PBOC) and the NDRC proposed to merge their green bond criteria to create a unified green bond taxonomy. Importantly, this development is the first time China's financial regulators and economic policymakers have decided to exclude "projects related to fossil fuels" from a green taxonomy. If approved, this will set a precedent that can be applied to other financial products and economic activities, strengthening China's green financial sector and ultimately help reduce carbon emissions.

China Can Lead on Green Finance

Officially dropping clean coal from China's green bond standards could create broader benefits for China and the world.

Chinese authorities increasingly recognize the need to participate in global financial market rule-setting, including in green finance. As the explanatory notes to the PBOC-NDRC proposal point out, fossil fuel exclusion will bring Chinese green bonds in line with international standards and "increase China's voice in international green bond standards."

A bigger role in the development of such standards can help promote China's image in international financial markets and the smooth operation of its offshore financial operations. These developments mirror steps taken by Chinese banks, which have already moved to exclude fossil fuel projects from the green bonds they issue. 

The prospect of raising more finance in capital markets overseas provides further motivation.

Between 2016 and 2019, Chinese financial institutions and corporations raised $24.36 billion through green bonds offered in offshore markets. While this accounts for less than 16% of total green bond issuance from Chinese entities, the desire to attract more international investors may be prompting Chinese market participants to adopt international practices more openly.

For instance, three large Chinese green bond issuers, the China Development Bank (CDB), the Industrial and Commercial Bank of China (ICBC), and the Bank of China (BOC), which together accounted in 2019 for one-third of China's green bond issuance, have been using their own green bond frameworks, all explicitly excluding fossil-fuel-related projects. Regulators and other policymakers in Beijing may now be trying to do the same.

Finally, moving off coal is good for China and the world, both in terms of global GHG emissions reductions and avoided local impacts from fossil fuel plants.

Creating Consistency in China's Green Finance Taxonomies: Why Stop at Green Bonds?

Could the update to the green bond taxonomy serve as a launchpad for harmonizing the entirety of China's rules and standards for green finance? And could the next step be to exclude fossil fuel projects from other green finance in China, including from green credit and BRI investment?

China's green finance roadmap and accompanying workplan designate the PBPC as responsible for coordinating green finance taxonomies. The central bank could use the newly harmonized green bond taxonomy as the first step toward a broader, consistent definition of "green" that cuts across financial products.

Making all "green" labels fossil-free can put climate change at the center of other economic, financial and environmental policies, including China's greenhouse gas emissions-reduction targets, exclusion criteria for investments by state-owned enterprises and other entities, and ESG factors to prioritize carbon performances.

Another opportunity involves applying a unified "green" definition to Chinese banks' investments through the Belt and Road Initiative, particularly their loan books. This is urgently needed. Our analysis shows that from 2014 to 2017, fossil fuel-related investments comprised 91% of the energy-sector syndicated loans in which six major Chinese banks participated.

The proposal to exclude coal and other fossil fuels from green bond eligibility criteria is not yet final. But the central bank's ambition to play a larger international role and the more progressive practices of some Chinese financial institutions are building momentum for enhanced transparency and trust in the integrity of China's market for green finance. Chinese policymakers and investors are now better positioned to mainstream climate action into a harmonized green finance system and broader policy framework.