Uncovering China’s green finance pilot zones

China’s green central banking is experimenting at both the national/macro level and municipal/micro level, and a unique invention of the green finance development regime is the establishment of green finance pilot zones.

The objective of these zones is to try out different approaches to green finance in regions that reflect different economic and developmental situations, before rolling them out more widely. After five years of implementation, green finance pilot zones have expanded their scope and depth while presenting best practices in green finance standard designs, product innovations, disclosure, digitalisation among others. Now, the pilot zones are actively pioneering the climate transition through developing transition finance.

How green finance pilot zones work

In 2017, the People’s Bank of China (PBoC) and other six government ministries announced plans to create green finance pilot zones in eight cities across five different provinces, the most recent being Lanzhou in Gansu province. As an important approach to mainstreaming green finance in China, developing the pilot zones relies on the joint oversight and management by local governments, the PBoC, and other provincial or prefectural financial regulators.

The selection of pilot cities took into consideration factors such as economic structure, development stage, natural resource endowment and geolocation to capture opportunities and challenges faced by different regions in China. Therefore, priorities in innovating their local green finance agenda vary across the nine pilot zones.

With their distinct characteristics and priorities, these selected pilot zones work towards the overarching objectives of China’s overall green finance system, including raising awareness in the domestic financial system, innovating green financial instruments, strengthening policy frameworks, and incorporating environmental and climate consideration into financial risk management. Meanwhile, lessons learned from these prefectural cities will be useful and applicable to other emerging markets which face similar challenges.

Overall, green finance pilot zones have witnessed a boost in the volume of green debts – the percentage of green loans has increased in the loan portfolios of pilot zones, outperforming the other parts of the country.

As of 2020, the outstanding green loans in the pilot zones reached RMB 236.8bn (US$35bn), accounting for 15.1% of the overall lending portfolio. During the same period, green loans only took about 6.9% of the national lending portfolio. Meanwhile, green bond issuance in all pilot zones combined was almost equivalent to the total amount of all emerging markets apart from China. The issuance of green bonds in the pilot zones was RMB 135bn (US$20bn), while global green bond issuance by all emerging markets excluding China increased to US$22bn in 2020.

Huzhou: leading the way in green finance

Individual pilot zones have also achieved important milestones. Located in the east of China, Huzhou is well-known for its ecological landscape and cultural heritage. In more recent years, it is also known for green finance endeavours, especially on financial product innovation, fintech and standard setting.

Huzhou’s innovative green financial products share distinct characteristics of financial inclusion, seen in their dedicated support to small and medium-sized enterprises (SME), agriculture and rural areas, with support including low-interest loans and subsidies.

To name just a few examples: there are loans promoting solar power generation in rural areas as part of the effort to transform the local energy mix; loans to increase the energy efficiency of rural households; insurance products to ensure access for local SMEs to green financing; and index insurance products to safeguard agriculture mainstays such as tea, bamboo and plums against the impact of extreme weather events including droughts and floods.

On green fintech, Huzhou launched the first green finance information management system in 2019, with the aim to bridge the data gap of green financial flows and inform green investment decisions and policymaking. The system covers all 35 commercial banks in the city and provides six main functions: data analysis, management, visualisation, green banking performance evaluation, supervision and peer review. Business and credit statistics are incorporated on a real-time basis, which supports monitoring of the underlying green projects and mitigation of greenwashing risks.

Finally, green finance standards in Huzhou are developing rapidly. In addition to several green project financing criteria and guidelines which are aligned with national standards, at the end of 2021 Huzhou enacted legislation promoting green finance. Then in January, Huzhou developed its transition finance roadmap and published its transition finance taxonomy, becoming the first city in China to initiate such a standard. The taxonomy covers nine industries and 30 sub-industries, representing 80% of Huzhou’s total CO2 emissions.

Meanwhile, a list of sector-specific technical criteria – with the best available technologies and clear transition targets over the next three years – was included as part of the taxonomy. In relation to transition financing, the roadmap also specifies disclosure requirements and policy incentives such as interest subsidies and guarantee mechanisms. The list of eligible transition finance projects will be updated on a regular basis.

What’s next?

As a frontrunner among green finance pilot zones, Huzhou’s progress has ticked many boxes set by the PBoC when it created the pilot zones with the aim of mainstreaming green finance in China. The central bank also highlighted a strategic focus that extends beyond pure “green” to the low-carbon transition of high-emitting sectors.

Lining up to join the project are Beijing, Chengdu, Chongqing, Shenzhen and Shanghai, all of which are major financial centres and megacities in China. To distinguish themselves from previous pilot zones, the new volunteers will need to pinpoint their respective advantages and highlight the added values they might bring. For instance, according to its application, Beijing would strive to become an international green finance centre, leading the development of green technology and exploring cross-border green financing solutions, such as green asset-based securities and for a green Belt and Road.

The stories emerging from Huzhou are promising, although not all pilot zones have fully bloomed. Prefectural cities and regions face multiple challenges, and one of the biggest is a lack of expertise and capacity in green and sustainable finance. Shortage of talents and skills is a common challenge, even in big financial centres and economies where financial markets are relatively advanced.

Even so, China’s pilot zones have shown how green finance policies can be developed for a wide range of social, economic and environmental situations. While it may not be possible to directly apply these pilot zones in other countries, it is hoped that emerging markets in similar socio-economic situations will still be able to draw ideas and inspiration from this unique experiment.