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June 2019

GREEN BOND CHANNEL: A BRIDGE BETWEEN CHINA AND EUROPE

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The Luxembourg Stock Exchange launched its first Green Bond Channel in partnership with the Shanghai Stock Exchange two years ago. With the establishment of the Green Bond Channel, opportunities were created for investors outside China. The cooperation between the two exchanges focuses on providing important information in English about Chinese Green Bonds to international investors, bridging the gap between the Chinese bond market and potential international investors.

THE RESULT OF A LONG-TERM RELATIONSHIP

“The Green Bond Channel didn’t happen overnight. It is the result of a long-term relationship between China and Luxembourg,” says Robert Scharfe, CEO of the Luxembourg Stock Exchange.

The first contact between the Luxembourg Stock Exchange (LuxSE) and the Chinese
financial industry date back to 1986, when the Bank of China listed its first international bond on the Luxembourg Stock Exchange. The People’s Republic of China subsequently listed its international bonds on the LuxSE in 1994.

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The Green Bond Channel didn’t happen overnight. It is the result of a long-term relationship between China and Luxembourg.

The next major development happened in 2011 when China decided to open up its
currency market. This meant that the RMB could now be used for international financial deals outside of China. That same year the LuxSE listed the first so-called Dim Sum bond outside greater China. This led to frequent interactions which developed over the following six or seven years, especially in the Green Bond market.

“Unknown to many people is that the Chinese Green Bond Market is very developed. That is where our bilateral relations have developed too. In 2016, we set up the Luxembourg Green Exchange, a platform entirely dedicated to green financial instruments that started with Green Bonds. We concluded that a major part of the market, which is Chinese, had to be made accessible to international investors too. We believed in the progressive opening up of the Chinese capital markets to the international investors which initially lead to the stock connect and then to the Bond connect. In this context, we said why don’t we focus specifically on the green aspect of that part of capital markets?”

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Unknown to many people is that the Chinese Green Bond Market is very developed.

The LuxSE therefore turned to the Green Bond market in China and looked at the
various counter-parties that might be interested in developing this market. Clearly, setting up such a channel would present a number of challenges.

Robert Scharfe

THE GREEN BOND CHANNEL: A CHALLENGE

The Chinese market functions completely differently to the international market. There is significant variance in market practice in comparison to what an international investor might be used to, and language barriers and local knowledge can result in information asymmetry. Talking to investors, it became clear that they had an interest in investing in the Chinese Green Bond market but would need some help in doing so.

“Firstly, we had the language hurdle to overcome. International investors can buy Chinese bonds through different mechanisms which have a certain degree of complexity. But above all, there was a need to educate the international investor as to what Chinese securities are. While we know that they are green bonds, the documentation only existed in Chinese. The challenge was to convince not only the exchanges with whom we have started to develop this Green Bond Channel, but also the issuers that it would be in their interest to helping translate the key documentation and make it available to the international investor,” he says.

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We don’t judge the greenness of a bond, but we require the information to be made available to the investor.

On the website of LuxSE, all data is available without restrictions and free of charge. That has stimulated additional demand from foreign investors to buy Chinese securities. Transparency is the key to all investments, especially green investments. For conventional instruments, there are all kinds of regulatory requirements that need to be fulfilled. The green part of a green
security is purely voluntary as there are no mandatory disclosure requirements. When it comes to China, where the standards are different, the definitions are likewise different. This makes it even more important to have access to the information and make clear in which way they differ from one another.

“We don’t judge the greenness of a bond, but we require the information to be made available to the investor. We’re just making sure that all the documentation is available to the investor who then, on that basis, can make his or her own investment decision.”

BIG STEPS

Through the introduction of the Green Bond Channel, Chinese issuers are now
more visible to the international investor. By coming to Europe, they have taken a big step in the direction of the investor, for whom Europe remains the platform for international securities trading. Having this information available on the LuxSE platform also promotes Chinese domestic products and brand names. Many of these issuers are in the meantime also raising funds directly in the international markets. By adopting international green standards, the international and domestic Chinese standards became not only comparable with each other but they are also progressively converging.

MORE CHOICE, MORE DIVERSITY FOR THE INTERNATIONAL INVESTOR

For European and international investors, these initiatives provide access to a very important market. To be complete, one should add that the Green Bond Channel has been initiated with the Shanghai Exchange.

“We recently signed an agreement to also extend the Channel to green bonds listed on the Shenzhen Exchange and, just as important, we have also displayed in the meantime the first bonds to be traded on the China Interbank Bond Market. The Chinese Interbank Market (CIBM) represents more than 75% of the overall market. That means the international investor gets information access to bonds coming from various different segments and thus get a much wider choice of investment opportunities than if they were restricted only to the international part.”

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The Chinese Interbank Market (CIBM) represents more than 75% of the overall market.

It is above all a question of having more choice, enabling investors to diversify their sustainable investment portfolios getting access to securities denominated in RMB and gain exposure to the Chinese currency.

EAST MEETS WEST

Currently, the Exchanges have established the Eastbound connection: international investors accessing the Chinese market. In the future, the aim is also to make international securities, including in the green domain, available on the platforms of the exchange in Shanghai to Chinese investors – in other words, creating a link which ideally works in both directions. Currently there are still restrictions for Chinese investors in what products they can buy, so this is work in progress.

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The Connect project is creating visibility for Chinese companies, making their securities widely available and by opening them up to global markets, introducing them to international standards.

“The Connect project is creating visibility for Chinese companies, making their securities widely available and by opening them up to global markets, introducing them to international standards. Looking at last year, 74% of the Chinese Green bonds already conformed with international standards. We believe that the number will continue to rise, which would be a very positive development. At the end of last year ADBC displayed 85 domestic bonds on our platform for the counter value of more than 500 billion Euro. To put this in perspective we typically list some 11.000 new bonds annually for a counter value of 1 to 1.2 trillion Euros.”

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Looking at last year, 74% of the Chinese Green bonds already conformed with international standards.

Of course, the trend towards sustainable investing benefits the green bond market. It is becoming more and more important for investors to understand where their money is going and what purposes it is being used for. Where conventional instruments are concerned, you do not always know what impact the cash generated through a bond issuance has. You know who the borrower is, but you do not know what is happening with the money. Green bonds provide clarity. That is the key motivation and a key trend in the market.

GREEN BONDS: THE FUTURE

There is a clear understanding at a political level that responsible investments and sustainable finance needs to be promoted further. Investors are interested in understanding what impact their money is having, even more so for the younger generations. We have seen the initiatives from the EU on its Action plan for sustainable finance and the work that is currently being done, not only in Europe but across the world. This starts with the taxonomy, defining what green activities and assets are and then agreeing which standard should be adopted – the more universal the better.

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In five or ten years from now green bonds will not be the exception but the standard. The future of finance will be and has to be green.

These standardisations create clarity and certainty for the investor and will help push the market forward.

“Trends such as the TCFD (Task Force on Climate-related Financial Disclosures) in the banking sector are progressively pushing in the right direction. I think that the private sector still has a long way to go on climate and green initiatives. Corporates and banks could use the green bond market much more intensively, so I believe very much that we are just at the beginning of a tremendous phase of development. In five or ten years from now green bonds will not be the exception but the standard. The future of finance will be and has to be green.”