Confronted by toxic debt packages, stock market volatility and an impending global recession, it is no wonder that Chinese companies are beginning to shift their focus away from the threat posed by global warming. Nevertheless, the past year has seen very interesting developments in China that suggest there is both a will and a way to leverage finance in order to support more sustainable development.

Chinese domestic and international investments in pulp mills, hydro and thermal power, mines and infrastructure have been blamed for a range of environmental and social impacts that have been widely reported in the global media. Most of this literature, to some extent, demonises China’s companies and financial institutions. What is not as well known are the efforts made by the Chinese government to support and enable more sustainable development, and in particular, its efforts to address pollution, water-use and impacts on natural habitats in a domestic context.

The overarching commitments to sustainable development were described in the most recent Five Year Plan. This legislation is now being promulgated and implemented via planning, pollution control and industry-sector guidance. Within this context, the financial sector is seen as an important lever for change.

China’s financial sector exhibits two key features: first, the use of banks by the government to support specific policy objectives by increasing or decreasing the costs and availability of credit to encourage low-carbon technology. Second, the explicit use of commercial banks and capital to restrict access to finance for companies which fail to comply with China’s domestic pollution-control laws -- the so-called “green credit” regulations. Both of these tactics are being used to encourage improvements in the environmental performance of domestic companies.

More broadly, it is clear that China’s commercial banks increasingly are subject to the same market pressures and reputational risks associated with high-profile and environmentally sensitive transactions as other international banks.

In September 2008, the People’s Bank of China (PBoC) and WWF jointly prepared a report, Towards Sustainable Development – Reform and the Future of China’s Banking Industry, which provides the first analysis of the state of sustainable banking in China. The report paints a picture of significant reform addressing a range of systemic and large-scale issues, including issues of capital adequacy, better credit and risk management and non-performing loans. It is within this context that the sustainability agenda is beginning to find a foothold.

The report suggests that most Chinese banks are at an early stage in the implementation of sustainable banking practices and that many have yet to take concrete action. Nevertheless, there are signs of rapid change and considerable interest from a wide range of banks. China already has commercial institutions such as the Industrial and Commercial Bank of China, China Construction Bank and the Industrial Bank, as well as policy banks like China EXIM, which are developing investment and lending policies that incorporate sustainability expectations. These policies also reflect the best practices currently employed in international finance, such as the Equator Principles. Indeed, the Industrial Bank appears likely to be the first Chinese financial institution to formally adopt the Equator Principles.

It seems that this unique and powerful combination of state policy and market models can be used to encourage better and more consistent risk management.

Importantly, as the global financial sector picks itself up from the fallout of the credit crisis, there will be a chance to look at the role of credit risk and make adjustments so that the presence of risks and opportunities are more adequately recognised. In this process, environmental and social issues will be factors that are likely to receive more attention making the recent efforts of China’s financial sector bode well for the future.

The report notes that the timing and emphasis that the Peoples Bank of China, China Banking Regulatory Commission and Ministry of Environmental protection are putting into environmental requirements, specifically the green credit and security regulations, are a significant precursor to the rapid scale-up and adoption of more sustainable banking practices. The challenge will be to ensure:

* swift, consistent and cost-effective integration of these requirements across a broad range of financial institutions;

 * that there are appropriate tools and guidance for banks and other financial institutions to implement more sustainable investment practices;

 * the development of a national capability to service the needs of sustainable banking -- particularly the growth of financial training institutions, consultancies and engineering and legal firms.

The report also concludes that international best practice, such as the Equator Principles, needs support from the international community -- particularly through the International Finance Corporation. The experiences of banks such as HSBC and Citigroup provide valuable “lessons learnt” for the Chinese financial sector. These lessons include the need to:

 * focus on key risks and issues such as climate change, the sustainable use of natural resources including water and forests and the interaction of social and environmental issues;

 * develop capability and tools within the financial sector and individual institutions so that more sustainable investment practices can be delivered in a cost effective, efficient and timely manner;

 * demonstrate the impact of investment decisions and to develop credible and meaningful mechanisms for disclosing information to a range of interested stakeholders.

State agencies and financial institutions have made impressive commitments to the task of ensuring sustainable banking. Their ambition and approach is unparalleled in my experience. The challenge will be to implement the necessary risk-management controls, and to develop the capacity to identify and capitalise on emerging opportunities for environmental investments, at a scale and consistency that reflects the size and complexity of China’s financial architecture.

Despite the wider workings of the global financial sector, the emerging evidence from China suggests a sincere and significant commitment to hardwiring more sustainable and responsible investment practices into its financial sector.

Mark Eckstein is the managing director of international finance at WWF US.

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