TODAY’S STUDY: CHINA’S NEW ENERGY FINANCING GAP

Shaping China’s Climate Finance Policy

March 2013 (The Climate Group)

INTRODUCTION

China, like many countries, is grappling with the challenge of how to finance the transition to a sustainable, low carbon economy. Complicating this challenge is the fact that the country is still going through the twin processes of industrialization and urbanization. As a result, many institutions – both public and private – have been focused mainly on poverty reduction or material imrovement.

Environmental protection and sustainable development by contrast have tended to rank further down the list of institutional priorities. In addition, the shift towards a market based economy is on going, which means the government continues to act as the key player in the economy. The net result is a financing system that does very well in some respects (eg, rapidly moving large sums to strategic industries when needed), but underperforms in others (eg, efficient allocation).

Despite this, much has been achieved in terms of financing low carbon development in China. The economy’s carbon intensity has fallen dramatically over the last 20 years through energy efficiency improvements, and more recently through the expansion of renewable energy. Public sector financing – through direct government spending and the investment of the large state-owned banks – has been instrumental in making this happen. China’s prodigious domestic savings rate (currently around 50%) has provided the state banks with huge volumes of low-cost funds.

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But the scale of change still required in China is enormous. Public funding – as it is currently managed and used – will be insufficient to the task. As government funding for social services increases and as the economy moves away from saving towards greater consumption, the challenge will only increase. China therefore needs to reform both its public and private financing systems if it is to adequately finance climate action, restructure its economy and build the ‘eco-civilization’ its leaders have called for. In practice, this means: a) better management and efficient use of public funds, and b) the creation of the necessary frameworks and incentives for driving private sector capital (domestic and international) away from high carbon investment and into low carbon assets and developments instead.

The remainder of this briefing is in four main parts. The first gives an overview of current sources, institutions and applications of climate finance in China, while the second looks at the challenges ahead. The third section identifies options for improving the system, while the fourth looks at ways of widening sources of climate finance.

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OVERVIEW: CLIMATE FINANCE SOURCES

Climate finance in China comes from both domestic and foreign sources, which can be grouped into five basic categories:

— Public finance (domestic and international)

— Carbon market finance (essentially through the Clean Development Mechanism)

— Mainstream private sector finance (such as domestic and foreign bank loans)

— Direct investment (domestic and foreign)

— Charitable and NGO finance

Figure 1 on the following page illustrates the flows and relationships of these different sources. Domestic climate financing currently dominates total investment, as highlighted in Table 1 below. China’s state-owned banks in particular play a central role. At the end of 2011, the climate finance loan balance from these public institutions totaled approximately US$294 billion. Direct government climate spending was around US$41 billion for the year by comparison, while private sector investment was at least $US10 billion. Green bonds, private equity (PE), venture capital (VC) and stock market listings through initial public offerings (IPOs) all played a role. These domestic figures dwarf overseas sources of climate finance, both public and private. OECD government funding between 2006 and 2009, for example, was around US$1.68 billion. Multilateral funds meanwhile provided just US$0.29 billion for the period 2008-12. The extent of foreign private sector debt financing for climate action is unclear, but is likely to only account for a fraction of the US$70.5 billion of total foreign lending that occurred in 2011. The UN’s Clean Development Mechanism (CDM) has been a more significant source of low carbon financing, pulling in an estimated US$9.3 billion up to 2012.

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MAJOR CLIMATE FINANCE INSTITUTIONS

Figure 2 on the following page identifies the main domestic and foreign institutions that are involved in climate finance in China. The relative importance and roles of these institutions continue to shift as China’s economy grows and its climate financing needs become more sophisticated.

Bilateral institutions, for example, have grown less important as a source of funds, not least because China itself has become a provider of climate finance to poorer developing countries. Relationships with developed countries, meanwhile, are now increasingly based around strategic partnerships, rather than a ‘donor-recipient’ model. Engagement with multilateral institutions is also changing.

Although the World Bank Group has played a limited role in climate finance in China, other multilateral banks, such as the European Investment Bank, are now providing funding on favorable terms.

Domestically, climate financing remains at a relatively immature stage among some state institutions. China’s state-owned banks, for example, consider climate related investment as a corporate social responsibility issue and have yet to include climate impacts as key considerations of business development. However, the China Energy Conservation and Environmental Protection Group, an important policy investment platform, is a major investor in energy efficiency and clean energy technologies. It has developed a number of industrial parks dedicated to showcasing energy saving and environmental protection industries.

Commercial financial institutions are also beginning to provide climate related services and products. Some large commercial banks have established carbon asset management services and funds to make direct or indirect investment into emission reduction programs. As China begins to develop its own domestic carbon market, these organizations will also play a key role, helping to develop the secondary financial instruments, such as options and futures that are needed for the efficient functioning of the market. Insurance companies have an important role too. Specialized agricultural insurances companies, for example, have started to offer climate insurance, although this is still a very new and niche market. And, as institutional investors, insurance companies can have a major impact by directing their investments towards low carbon businesses.

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APPLICATION

To date, most climate finance in China has been directed towards mitigation activities, particularly for renewable power and energy efficiency. Over the course of the 11th Five Year Plan (FYP) (2006-10) for example, China invested approximately US$256 billion5 in the new energy sector and US$127 billion in energy efficiency. Under the 12th FYP (2011-15), the government has estimated a need for close to US$800 billion of investment in clean technology, renewable energy, energy efficiency and environmental protection. The majority of this funding will come from the private sector with the government expecting to leverage four times as much private capital for every Yuan of public funding it invests.

Private capital has followed public finance into mitigation sectors. Unsurprisingly, investment has gone where returns have been the greatest. This has meant more funding for renewable power, such as wind and solar, clean tech manufacturing and industrial energy efficiency. Less investment has gone into energy conservation for buildings and transportation, which have required higher upfront costs and longer payback periods.

Flows of capital for adaptation have been much lower than for mitigation. Incomplete disclosure of information makes it difficult to estimate the overall scale of national adaptation investment. However, a review of relevant accounts in the national budget suggests that public expenditure was about US$7.5 billion in 2012. It is clear that this public investment plays a major role, with funding going into agriculture, water resources, marine management, health and meteorological activities.

The fact that much of this could be considered as traditional infrastructure investment, underlines why it is difficult to distinguish additional climate adaptation spending. A recent development in China’s climate financing regime has been the emergence of China as a donor and financier to poorer developing countries. In 2011, a ‘South-South’ Cooperation Fund of around US$31 million was established to support capacity building and donate energy saving products. China’s state banks have also been active. The China Development Bank10, for example, has a special loan facility of US$774 million for small and medium enterprises (SMEs) in 29 African countries…

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CONCLUSION

The purpose of this briefing has been to provide an overview of the main elements and challenges that define the climate finance landscape in China today. It is clear from preceding pages that China faces a variety of challenges. These must all be addressed if the country is to finance the transition to a sustainable, low carbon economy over the coming decade and beyond. But the main conclusion is undoubtedly that the solutions to China’s climate financing gap can be found in the hands of its policy and decision makers.

Although the gap in finance identified is a substantial figure, it is also true that it represents around a relatively modest 2% of GDP. As this summary (and the original Chinese report) demonstrates, China’s leaders have the tools to close this gap. Reforms in public funding governance, and new or improved incentives for private sector institutions and investors, can create the environment that shifts investment from high to low carbon activities.

Because of China’s economic and political influence, these domestic reforms will have global implications. They will of course benefit China directly by attracting greater foreign investment as improved transparency and clearer incentives lower risks for overseas financial institutions. But they will also send a powerful message to both investors and other governments about the direction of China’s economy. By moving now in implementing reforms, China could create the tipping-point in global financial and political attitudes towards low carbon investment.

The good news is that China’s transformation over the past three decades has demonstrated its ability to deliver profound economic and social change when the right incentives and frameworks are in place. If China is to build the ‘eco-civilization’ its leaders have called for and restructure its economy around the principles of sustainable development, then implementing the kind of financial reforms and recommendations laid out in this briefing will be essential. As with so many issues relating to China, this matters not just to its own future prosperity, but to the world’s as well.

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