Making net-zero happen: How China can finance its transition

Since 2006, China has been the world’s largest emitter of carbon dioxide (CO2). The 11 billion metric tons of carbon dioxide it released in 2020 accounted for about 30% of global emissions that year.

China is also an active participant in the global discussions on how to curb climate change. The country’s latest five-year plan, covering 2021-2025, placed decarbonization and the “construction of a green development engine” at the center of policymaking.

To achieve its ambitious carbon peak and carbon neutrality goals, China needs to close an annual funding gap of about RMB1.1 trillion ($170 billion). It can only do so if it manages to develop far more sophisticated green financing schemes.

In China, bank lending is the backbone of corporate finance. Due to their risk-averse nature, banks tend to target large state-owned and private enterprises, meaning SMEs (small, medium enterprises) miss out on the funding — despite accounting for 65% of the country’s CO2 emissions. Public funding must play a more significant role in China to close the substantial gap in net-zero financing.

To generate the funding required for such a seismic transition away from fossil fuels, industry leaders and policymakers must address four major challenges:

1. Data granularity and quality.

Tracking and reporting emissions is fundamental to China’s net-zero transition. China has established national-level Carbon Emission Accounts and Datasets (CEADs). However, further efforts are required to be able to collect and make available all the granular, standardized data that is necessary. For example, regarding emission measurements, further clarity is needed if China’s data is to match the requirements of international standards such as the Partnership for Carbon Accounting Financials and the Paris Agreement Capital Transition Assessment.

2. Funding mismatches.

Funding support for net-zero transition efforts has thus far been primarily offered through bank loans, characterized by shorter tenors, rigid collateral requirements and pricing mechanisms. To support net-zero targets, the market needs to respond with longer-dated, blended equity and debt structures. Providing adequate financial support for the net-zero transition of SMEs will also be key, given their significant emissions and role in the economy.

3. Lack of clear policy support.

Systemic coordination will be needed from government and across industries to develop standards that are aligned across regions, business types and sizes. For example, production limits for blast furnace steels vary widely, with large-scale state-owned enterprises in East China tending to have more flexibility than SMEs in the country’s northeast. Currently, many steelmakers are reluctant to invest in mini-mills because of concerns about possible future caps on production.

4. Lack of cross supply chain collaboration.

The indirect emissions in a company’s value chain, known as Scope 3 emissions, can be significant in certain industries. Reducing these emissions requires collaboration along a company’s value chain. Scope 2 emissions arising from the purchase of electricity, heat and steam will also need to be addressed through partnerships with power generators. Most companies surveyed, however, are focusing mainly on cutting their Scope 1 emissions, those directly generated in the production process.

Due to the scale of change needed, China’s major carbon-emitting sectors won't be able to complete their transition journeys themselves successfully. They need support from the government and financing providers. They also need active collaboration from firms in their value chain.

Policy support for net-zero

Top-down support led by the Chinese government is crucial given its outsized role vis-a-vis Western economic models. The support can be both financial and non-financial: tax incentives are particularly powerful tools for accelerating the transition similar to carbon taxes in Europe.

Underpinning these efforts should be an ongoing effort to develop and enforce consistent and unified rules and regulations across regions and sizes of companies.

Financing innovation

Financial institutions need to introduce innovative new products and services tailored to the needs of Chinese corporates. Innovation will require new term structures, collateral requirements, instrument archetypes and portfolio strategies to ease the shortage of equity green financing and long-term green loans in China.

Ecosystem collaboration

Industry players need to connect with their value chain to establish holistic emissions goals, especially when it comes to Scope 3 emissions. This will require anchors setting standards and enforcing them throughout their supply chains. Beyond standard setting, there is also a need for more tailored incentives and verification mechanics.

While the road ahead is long, if China gets this right, it could position itself to drive the next green revolution globally, using the country’s scale and its position in the global economy and supply chains to its advantage. This will require a more innovative approach to financing, policy support and industry collaboration.

The Forum continues to play a critical role in providing a platform for public-private partnership through its Financing the net-zero transition initiative. The project engages a multistakeholder community of financiers, industry stakeholders, philanthropists and public institutions to identify policy interventions necessary to mobilize private capital needed to achieve the net-zero targets.

During the 2022 New Champions Dialogue, technology and innovation were identified as major building blocks in achieving the deep cuts in China’s carbon emissions required. The financial services community plays a crucial role in bringing these technologies to life and the participation of committed industry and public sector leaders means this dialogue could be pivotal, as industries and the world at large confront climate change.