Abstract

Construction activities and property operations account for a large share of energy consumption in China. With ongoing urbanization and higher living standards, the energy consumption in building sector is likely to grow, accounting for 40 percent of the overall end use at its peak. Meanwhile, among the three major energy consumption sectors of industry, construction and transportation, the construction sector has the greatest potential for emission reduction. Therefore, it is essential to promote the green development of building sector for the low-carbon transition of China’s economy and society, as well as achieving its goals of carbon peaking by 2023 and carbon neutrality by 2060.

1. Introduction

In June 2018, the Opinions of the CPC Central Committee and the State Council on Comprehensively Enhancing Ecological and Environmental Protection and Resolutely Winning the Tough Battle for Prevention and Control of Pollution stated that "to build a beautiful China, new buildings should be encouraged to use green materials, vigorously develop prefabricated buildings, and increase the proportion of newly constructed green buildings." In 2013, the Notice of the General Office of the State Council on Forwarding the Action Plan for Green Buildings by the National Development and Reform Commission (NDRC) and the Ministry of Housing and Urban-Rural Development also pointed out the a combination of economic measures such as pricing, taxation, and finance to leverage the fundamental role of market on the allocation of resources, creates a market environment favorable to green buildings, and stimulate the intrinsic motivation of market entities to design, construct, and use green buildings. However, the development of green buildings in China has long relied on administrative efforts and fiscal funds, so a market-oriented mechanism has not yet been formed. Since the 13th Five-Year Plan (FYP), fiscal funds have gradually become insufficient to meet the needs of the green development in the construction sector. During the 14th FYP, the traditional efforts to promote green development in the construction sector need to be combined with green finance to form an integrated support system involving land, pricing, taxation, and finance.

In recent years, multiple ministries and industry associations have encouraged the use of green financial instruments to support green buildings, which have already been included into China's green finance framework.

• In the "Green Credit Statistics System" issued by the China Banking Regulatory Commission in 2013, "Building Energy Efficiency and Green Buildings" were included in the statistics of green credit under the "Statistical Form of Loans to Energy-saving and Environmental-protection Projects and Their Services".

• On December 22, 2015, the Green Finance Committee (GFC) of the China Society for Finance and Banking released the " Green Bond Endorsed Projects Catalogue (2015 Edition)", which included "New Green Buildings" and "Energy Conservation Renovation of Existing Buildings" under the "Sustainable Buildings" subcategory of the "Energy Conservation" category.

•  In 2019, the NDRC and six other ministries issued the " Green Industry Guidance Catalogue (2019 Edition)", which classified " Energy Saving Buildings and Green Buildings" under the "Sustainable Upgrade of Infrastructure" category, further divided into subcategories such as "Construction of Ultra-Low Energy Consumption Buildings", "Green Buildings", "Application of Renewable Energy in Buildings", and "Prefabricated Buildings."

Under the guidance of policies, financial institutions have begun to explore financial products and instruments to support green buildings, including green loans, green bonds, green Commercial Mortgage-Backed Securities (CMBS), quasi-REITs, green building pilot insurance products, and green building themed funds. Green loans and green bonds are providing primary support to green buildings in terms of size, but their volume still falls far short of the industry's needs.

In terms of green loans, the balance of green loans in both domestic and foreign currencies was 11.55 trillion RMB at the end of September 2020, according to People's Bank of China. In terms of industries, the balance of green loans in the transportation, inventory, and postal services sector was 3.52 trillion RMB, accounting for 30.48% of the total, and the balance in the production and supply of electricity, heat, gas, and water was 3.33 trillion RMB, accounting for 28.83% [3]. The proportion of green loans related to green buildings was too small to be disclosed.

In terms of green bonds, according to the "Climate Bond Taxonomy", the funding structure of green bonds in mainland China is similar to that of green loans. The sectors that received the most funds were low-carbon transportation and clean energy, accounting for 33% and 28% of the total issuance amount in 2018, and 37% and 28% in 2019, respectively. However, the proportion allocated to green buildings during these two years was only 9% and 6% [4]. Globally, building (30%) is the second-largest sector for green bond funding, after energy (32%) [5]. In the North American market, Fannie Mae (Federal National Mortgage Association) became the world's largest green bond issuer for three consecutive years (2017-2019) through the issuance of large-scale Green MBS (Mortgage-Backed Securities). By comparing with the overseas green bond market, it can be seen that the scale of funds supporting the “greening” of the building sector through green bonds in mainland China is very small.

Therefore, although there are various financial instruments supporting the green building sector, the level of support is still inadequate. Green finance have also failed to push the “greening” of the construction industry, such as pressing developers to achieve full-process “greening” due to disclosure requirements after issuing green bonds, which was desired by policy intention.

Overall, although China's green building market has great potential and can provide new impetus for its green finance market, the synergy between green buildings and green finance has not been fully realized. The following sections will analyze the main obstacles faced by green finance in supporting green building market, and propose policy recommendations.

In a broader sense, "greening” of the building sector includes both the construction of new green buildings and the energy conservation renovation of existing buildings. These two have significant differences in project processes, stakeholders, and processes and characteristics of financing. This article only focuses on the analysis of new green buildings, and the term "Green Buildings" specifically refers to newly-constructed buildings that meet national green building standards.

2. Main Obstacles Faced by Green Finance in Supporting the Green Building Market

Currently, green finance faces several obstacles in supporting the development of the green buildings. These obstacles include, but are not limited to, the following:

2.1 Lack of Differentiated Treatment for Green Buildings in Macro Controls on the Property Market

Since 2019, China’s central government has made it clear that "real estate should not be used as a short-term stimulus for the economy," indicating a firm stance on real estate regulation. Relevant authorities also believe that the real estate industry consumes a significant amount of financial resources and have made specific requirements for containing real estate credit and non-bank financing. Although green buildings are encouraged by the government as a green industry, they have not been distinguished from general real estate in the macro controls over property market. Consequently, financial institutions find that their support for green buildings can be easily interpreted as support for real estate development, which goes against the regulatory policies. As a result, many commercial banks and non-banking financial institutions are hesitant, unable, or unwilling to support green building development projects.

2.2 Absence of Management Methods and Evaluation Mechanisms for Green Building Label

Ensuring the continuous "greenness" of green buildings is a major challenge faced by regulators in promoting green buildings. In the 2019 "new national standard" (Assessment Standard for Green Building, GB/T 50378-2019), the previous "Green Design Label" was replaced with a pre-assessment (which does not grant label) after the completion of the building's construction design. However, based on this pre-assessment, green financing can be obtained from financial institutions and the market. However, both management methods for green building operational label after project completion, and post construction evaluation mechanisms are absent. The information disclosure mechanism for green buildings has not been established either. Therefore, regulators, financial institutions, and consumers cannot promptly understand whether the operational performance of green buildings meets green standards.

For example, the energy consumption data of most buildings' energy management systems and the operational results of various energy-saving facilities are not disclosed. Consequently, regulatory authorities are unable to track, evaluate, and monitor the performance of green buildings in use; financial institutions cannot access this data to assess the “greenness” of these buildings; and owners/consumers cannot determine the credibility of their green benefits.

On one hand, this situation hinders the assurance of "green" benefits during the operation stage of green buildings. On the other hand, it lowers the motivation of financial institutions to support green buildings and the interest of owners/consumers in purchasing or renting green buildings.

2.3 Gap between immediate costs and long-term returns of green buildings

Compared to traditional buildings, green buildings require higher initial costs, including the incremental costs associated with green technologies, equipment, and materials, costs related to project design, simulation, and validation, and additional costs for obtaining green building label. According to China Academy of Building Research Shanghai Branch, the current incremental costs associated with green buildings range from 2.7% to 9.3% of the total construction cost [6]. Green buildings can lower operating costs such as water and electricity bills in the future, and provide better living environments compared to traditional buildings. Therefore, developers or investors should be able to compensate for these incremental costs by increasing property prices or rents, reducing the gap between incremental costs (immediate occurrence) and incremental returns (long-term benefit).

However, this mismatch may not be easily resolved due to the following reasons:

• Firstly, many home-buyers and tenants in China have limited understandings of green buildings and their benefits, like the reduction on utility bills, as well as the environmental and health impacts. Usually, they are not willing to pay more for green buildings as they do not calculate present values of future savings in utility bills.

• Secondly, under the undifferentiated financial regulation policies over real estate, many financial institutions have not fully considered the long-term benefits of green buildings when issuing development loans and mortgage loans. They do not offer preferential loan interest rates and higher credit lines for green buildings.

• Thirdly, in terms of industrial policies, the government has not provided better incentives (such as lifted price ceiling and plot ratio) for green buildings. Therefore, it is difficult to offset the mismatch between short-term costs and long-term benefits.

2.4 Financing difficulties faced by small and micro-enterprises in the green building industry chain

The green building industry has a long industrial chain and involves various entities. In addition to large developers, there are numerous small and micro private enterprises, including green building material companies and energy service companies (ESCOs). They have certain capacities for green technology innovation, but most of them are asset-light enterprises, and could hardly provide collateral acceptable to financial institutions.

On one hand, financial institutions, including guarantee institutions, find it difficult to determine the value of the green technologies of these small and micro-enterprises, due to the lack of "green benefits" assessment and information disclosure mechanisms for green buildings. On the other hand, the imperfect credit-rating system makes it difficult for financial institutions to accurately assess the credit risks of those companies and to provide financing or guarantees. The financing difficulties faced by small and micro-enterprises hinder the long-term development of the entire green building industry.

2.5 The demand for green buildings needs stimulation

Firstly, consumers have not been fully aware of green buildings and are price-sensitive. Green buildings started late in China, and most consumers have a limited understanding of the concept of green buildings and their benefits such as energy conservation, environmental improvements, and health impacts. Additionally, Chinese consumers are highly sensitive to housing prices, unwilling to pay relatively higher prices for green buildings. Therefore, their organic demand for green buildings is still significantly insufficient, causing uncertainty for real estate developers’ green building investment.

Secondly, consumers have difficulties in directly understanding the financial benefits of energy and water savings in green buildings. Even if developers promote the advantages of green buildings, consumers cannot directly see utility bill savings of green buildings due to the lack of monitoring and information disclosure mechanisms during the operation and maintenance phase.

Due to the reasons above, the consumption of green buildings in China is not activated, and green buildings cannot demonstrate the clear-cut cost advantages. Therefore, real estate developers shy away from green buildings investment and the demand for green buildings related financial products is insufficient.

2.6 The need for improved and innovative financial products and services 

In addition to policy and consumer-level issues, the lack of innovation capacity in financial institutions means that current green finance products are not well aligned with the needs of the green building market in China. For example:

1) Except for a few financial institutions, most banks in China lack research on the default rates of green development loans and green mortgage loans. They have not realized that banks should be able to lower the interest rates (the credit risk premium portion of the interest rate) of green loans because of their lower credit risks. Without interest rate incentives, it is difficult to stimulate more demand for green building financing. Currently, many financial institutions in the UK and Europe have recognized this fact through research [7][8][9][10].

2) Few financial institutions in China have attempted to securitize green development loans, green mortgages, and other green assets related to buildings (such as rooftop solar assets). As a result, institutional investors (such as insurance companies and fund management companies) have limited channels to invest in green building-related assets.

3) Most insurance companies in China have not yet developed green building insurance products. In fact, green building insurance, which guarantees the claimed energy-saving and water-saving benefits of buildings, can greatly alleviate the insufficient demand caused by the difficulty in judging the “greenness” of buildings through financial innovation.

4) Carbon emission reductions from buildings should be traded in the carbon market as Chinese Certified Emission Reductions (CCER). However, the current carbon trading market in China is not yet capable of accommodating such products.

3. Suggestions for Leveraging Green Finance to Support the Development of Green Buildings

Based on the analysis of the challenges faced by green finance to support the development of green buildings, this section proposes several preliminary ideas from the perspectives of macro-control, industry supervision, credit system, consumer market, and financial innovation to facilitate green buildings through green finance.

3.1 Issuing Differentiated Policies for Green Buildings in Macro-Control on Real Estate

A series of measures have been issued to restrict the financing of real estate companies, and the main purpose of real estate regulation policies is to prevent financial risks caused by high-leverage financing and to restrain the extensive growth of the real estate industry. Therefore, while ensuring the implementation of total control targets, such as capping the loan growth rate and overall leverage ratio of the entire real estate industry, it is recommended to restrict "non-green" real estate companies and projects, and provide relatively relaxed financing conditions for qualified green developers and projects, that is, "adjusting the structure" under the requirement of "controlling the total volume."

3.2 Establishing a Green Credit System for the Green Building Market

First, it is important to establish a sound management system for green building labels, including assessment, supervision, and punishment during the operational phase, ensuring that buildings with “Green Building Label” remain "always green" throughout their life-cycle. Second, improve the information disclosure mechanism for green buildings, allowing regulatory authorities, consumers, financial institutions, property management companies, and other stakeholders to promptly access "green information" about the entire life cycle of green buildings, eliminating information asymmetry. Third, establish a database for green building companies and their projects, as well as a green credit evaluation system, which can reduce the cost and investment risk for financial institutions in finding green building investment targets, as well as lower financing costs and barriers for business.

3.3 Activating the Consumer Market for Green Buildings

On the one hand, industry regulators should increase promotional campaigns and publicity for green buildings. On the other hand, consumers’ green benefits should be protected through measures such as information disclosure and penalties for non-compliance. Financial institutions can provide customers with convenient tools such as "energy-saving and water-saving calculators" apps which can calculate the energy and water savings from green buildings, making the concept of "more money on green buildings, even more savings on utility bills” more concrete and visual.

3.4 Meeting the Financing Needs of the Green Building Supply Chain through Innovation of Financial Products and Services

Financial institutions should customize financial products based on the characteristics of the green building industry. For example, banks should analyze the default rates of green development loans and green mortgages, compared to "non-green" loans, by setting differentiated prices. Various non-bank financial institutions should develop financial products such as green development loans, green mortgages, security-based products for photovoltaic assets on buildings, green building insurance products, as well as transaction mechanisms of green building decarbonization.

Furthermore, based on the green credit system in the green building industry, supply chain finance can provide customized financial services for green MSMEs (Micro, Small and Medium-sized Enterprise) in specific segments of or the entire building supply chain, with large real estate companies serving as risk control entities. This can alleviate financing difficulties for MSMEs in the value chain, improve the efficiency of funds for financial institutions, and transform the uncontrollable risks of individual business into controllable risks for the supply chain as a whole.

4. Conclusion

Green buildings have significant potential for carbon emissions reduction and market growth, and should be a key industry in China's green economy. However, the “greening” of the construction sector has mainly relied on administrative measures and fiscal support, rather than a market-driven mechanism with incentives. To better leverage the limited available fiscal funds and attract social capital into the green building sector, it is necessary to make full use of the policy and financial instruments within China's green finance to promote the sustainable development.

Although there have been some attempts in green finance to support green buildings, it is still at early stages and far from sufficient. Green finance faces various challenges at the macro, industry, and micro levels in supporting green buildings, including:

• the lack of differentiated policies for green buildings in macro-control over real estate industry

• incomplete regulatory policies and supporting measures for the green building industry

• time mismatch between incremental costs and benefits of green buildings

• financing difficulties for small and micro enterprises in the industry chain

• inactive consumer demand for green buildings

• and the absence of financial products and tools serving the green buildings.

In order to tackle the challenges, collaboration and coordination among the central and local governments, housing and construction regulators, financial institutions, and other stakeholders are required to design and implement measures regarding macro-control policies of real estate, the establishment of a green credit system for green buildings, activation of the consumer demand, policy incentives for green finance, and innovation of financial products. Together, they can promote the synergistic development of green building and the green finance market.

References:

[1] First Green Building CMBS Issued Successfully, Valued at 820 Million RMB

https://www.sohu.com/a/204982075_803365

 [2] PICC P&C Beijing Branch Issues China's First Green Building Performance Liability Insurance

http://www.epicc.com.cn/renbao/zixunzhongxin/xinwen/201904/t20190408_14008.html

[3] People’s Bank of China, “Statistical Report on Credit Structure of Financial Institutions (Q3 2020)”

[4] Climate Bonds Initiative, China Central Depository & Clearing Research Centre (CCDC Research), “China Green Bond Market Report 2019”

[5] Climate Bonds Initiative, “World Green Bond Market Report 2019”

[6] Sun Daming, Shao Wenxi. “Statistic and Study on Incremental Cost of Green Building in China”, Eco-city and Green Building 2010(04): P43-P49

[7] Home Energy Efficiency and Mortgage Risks, Institute for Market Transformation (IMT), 2013.

[8] Impact of energy use and price variations on default risk in commercial mortgages: Case studies, Mathew et al. 2017.

[9] Insulated from risk? The relationship between energy efficiency of properties and mortgage defaults, Guin and Korhonen, 2018.

[10] Transition in Thinking: The impact of climate change on the UK banking sector, case study 1: Tightening energy efficiency standards and the UK buy-to-let market, Bank of England, 2018.