F&C's Alexis Krajeski says China needs to create a greener environment while maintaining economic growth.
During 2009, China approved a ground breaking $586bn stimulus package with the intention of helping the country weather the global economic recession.
In a clear sign of its avowed commitment to build a ‘harmonious society’ that balances the need to maintain economic growth while protecting the environment and society, the National Development Reform Commission earmarked $200bn to support development of ‘green’ industries including energy efficiency, low emission vehicles, rail transport, and updates to the electricity grid.
Growth in these industries will be critical if China is to meet its target to reduce the carbon intensity of its economy by 40%-45% by 2020, a commitment it reasserted at the global climate change negotiations in Copenhagen in December 2009.
While such a clear commitment to green growth was laudable, sceptics began to wonder if such stimulus plans would actually be effective in protecting the economy from the global meltdown in addition to altering the profile of China’s energy-intensive growth model. In order for the plan to be effective, China’s Treasury needed to provide clear guidance on which sectors and companies would qualify for stimulus funds and create a distribution platform to deploy stimulus monies quickly. It also needed to ensure stimulus funding targeted viable growing businesses rather than those unlikely to recover or contribute to the country’s growth needs.
While many developed-country governments struggled to deploy stimulus funding in 2009, China’s government-controlled economy proved it was highly efficient in doing so. By August 2009, the government had deployed $55bn in stimulus funds, the highest of any country with a stimulus plan, primarily through its control over the country’s five largest banks. The challenge for the banks is to play this role while maintaining their own strong financial performance; they are required to combine their customers’ environmental footprint with their business prospects to determine creditworthiness.
Given the Chinese Government’s control over its banks, investors understandably were concerned by the potential impacts of such a strategy. The Government might prioritise environmental goals over business objectives and encourage the banks to deploy capital to companies with poor credit quality or business prospects.
Conversely, commercially viable companies with strong business prospects might struggle to access capital under any robust green credit policies introduced by leading Chinese banks. Combined, these two trends could lead to a significant rise in non-performing loans and risk another credit crunch which would ultimately drag down returns.
In November 2009, a group of institutional investors met with China’s Banking Regulatory Commission, who reassured them China’s banks were well capitalised and were maintaining credit quality. In fact, during 2009 China’s banks were amongst the world’s best performing banks, greatly outstripping the returns of global behemoths such as Citibank and Royal Bank of Scotland.
Quality of life
As one of the leading Chinese banks driving the country’s green growth plan, Bank of China indicated it believes the Bank has a core responsibility to support and stimulate economic growth while improving the quality of life in China. In a year when many banks in developed markets faced serious operating challenges, Bank of China posted its lowest-ever non-performing loan ratio. The company also began embedding its Green Credit Policy, approved in 2008, into its lending application process. By working with the State Environmental Protection Administration (SEPA), it identified the high emitting industries most likely to breach the policy and established a blacklist of companies with the worst environmental track records who could not be approved for loans.
Going forward, the Bank also plans to expand its support for projects that will reduce carbon emissions in China and generate carbon credits from the Clean Development Mechanism (CDM). Bank of China Chairman Xiao Gang recently commented the Bank “will adhere to its green credit policy and offer more diversified financial services to support the development of domestic environmental protection companies”. In 2009, it launched its CDM carbon service and transaction platform which should help Chinese companies monetise carbon savings by facilitating carbon trading.
Similarly, China’s largest bank, Industrial & Commercial Bank of China (ICBC) also is deploying government stimulus monies while implementing its own green credit policy and maintaining credit quality. ICBC was the first Chinese bank to deploy stimulus monies using a green credit index developed by SEPA and the International Finance Corporation (IFC). The index is based on a range of corporate environmental indicators including energy consumption and pollution, resource use and overcapacity of a sector. As of November 2009, the company states 98.6% of its corporate customers met its green credit requirements. When pressed on which sectors were most impacted, ICBC explained basic materials companies including cement, steel and aluminium production had been targeted for a reduction in lending, while railways, telecoms, and new energy were identified as sectors in need of active lending. The company claims it was able to do this because all corporate loan officers had been trained on implementing the green credit policy, and the bank has developed a database of sector and company environmental data against which companies can be assessed.
There is substantial evidence of progress in “greening” China’s economy through its banking sector, while maintaining credit quality and investment returns. Nevertheless, reports that over 98% of customers are meeting the banks’ green credit policy may call into question just how rigorous these standards can be. As long-term investors in China, F&C will be monitoring the impact of the banks’ green credit policies on credit quality and companies’ ability to access capital. Furthermore, given the Government’s carbon intensity target and concerns over the economic impacts of climate change, we expect – and indeed will encourage – high emitting companies in China to take active steps to ‘green’ their own operations and curb emissions.
Alexis Krajeski, associate director of F&C’s governance and sustainable investment team
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