Within three years the Chinese green bond market could be the world's largest and have a significant impact on global financial markets, said Sean Kidney, CEO of the Climate Bonds Initiative.
"The growth of China's green bond market can help many Chinese green projects to reduce their cost of capital, and also the growth of this market in China can help to demonstrate to other emerging markets how to grow a successful green bond market," he said.
Climate Bonds Initiative is a not-for-profit organization based in London that campaigns for more investment in low-carbon projects.
This year the initiative issued a special report, which is supported by Britain's Foreign and Commonwealth Office, with recommendations for the Chinese government for growing the country's green bond market.
The report included examples of incentives the Chinese government could introduce in the market, one being a central fund to provide partial credit guarantees for green municipal revenue bonds and green public-private partnership project bonds.
Other suggestions included tax credits for interest earned on green enterprise bonds including making them more transparent, and new rules to make them more identifiable for investors across bond markets' information systems.
As well, the Chinese government could set up green investment quotas through the expansion of the Renminbi Qualified Foreign Institutional Investors program and the Qualified Foreign Institutional Investors program, which allow foreign investors to tap into China's onshore investment opportunities under the country's restricted capital market controls.
As the market develops, Kidney said, strong investor demand is expected to provide a slightly better price for green bonds. In the meantime, the green theme will be a useful marketing tool to appeal to the low-interest Western capital markets.
Many bonds are already issued in China relating to environmentally friendly projects, but these bonds are not yet labeled as green, meaning they are losing out on potential marketing advantages, he said.
These bonds relate to industries such as solar power, railways and low carbon transport, and clean water.
"To be labeled as a green bond, they will receive great marketing benefits, as we have seen many international investors are placing great demands on green bonds," Kidney said.
In the Chinese market there will also be great demand for green bonds because the Chinese government's 12th Five-Year Plan (2011-15) places great emphasis on growing green projects, and the gravity of environmental problems in China would persuade citizens to care about and want to invest in green bonds.
Kidney said that while there is very little money to be made in possessing green bonds, the strong demand for them in the international market may produce price benefits of a few basis points, although this remains to be proven.
But to grow this market properly, the Chinese government should focus on developing clear guidelines on what can be considered green bonds and create incentives for market participants to grow the green bond market.
The Chinese government should also help this market's growth, through policy incentives, by encouraging banks to issue green bonds for themselves or to provide liquidity for this market, Kidney said.
Also, incentives such as tax credits, discount loan structures and regulatory policies that are now applied to China's rural agricultural loan market can also be used to help grow the green bond market, he said.
Chinese issuers have great potential to attract capital both from China's domestic capital market and overseas capital markets, through the issuance of green offshore renminbi bonds, Kidney said.