MTNs issued by China General Nuclear Power Group are a first step for China's carbon trading market but significant structural barriers remain in place The launch of a carbon-linked financial product by China General Nuclear Power Group (CGN) marks the first attempt by Chinese enterprises to explore issuing carbon derivatives, however the advent of a robust carbon derivatives market remains a long way off, according to market experts. CGN Wind Energy, a subsidiary of China's central government-controlled nuclear power group CGN, launched a batch of medium-term debt notes with a total value of 1 billion yuan ($160 million) two weeks ago. The notes will be issued on the interbank bond market with a tenor of five years. "It is a fresh attempt by Chinese companies. The market can expect more carbon-linked financial products in the future," says Yu Zhenjia, analyst at Ping An Securities based in Beijing. The final value of the note will be decided by a combination of a fixed rate of 5.65%, and a floating rate, linked to the company's carbon emissions trading performance on the China Emissions Exchange. "It's a creative way for an enterprise to optimise its debt structure and maximise the benefit," says a source familiar with the launch at Shanghai Pudong Development Bank, the lead underwriter and bookrunner of the note. The source says the bank is paying close attention to potential demand for similar products from other enterprises. It is also monitoring developments in carbon futures, but the moves hinge on the market and regulatory progress. "The derivatives market must be based on a well-established spot market, so we are looking at how the sector develops," the source says. The carbon offsets to be traded by CGN come from its five wind power projects. If the China certified emission reduction (CCER) can be traded between 8 and 20 yuan per unit in the following five years, these carbon offsets can generate 1 million–3 million yuan for the company, according to the project's earnings appraisal. CCER is the Chinese version of certified emission reductions set out by the Kyoto Protocol, and were rolled out by China's National Development and Reform Commission (NDRC) in 2012 under a domestic greenhouse voluntary emission reduction scheme aimed at reducing the country's carbon emissions. Currently the price of CCER in Shenzhen is around 20 yuan per tonne, the highest in China, while it is traded in Beijing at around 16 yuan per tonne. Ping An Securities' Yu says the issuance of the carbon-linked note reflects growth in China's emissions trading market and that carbon offset trading will speed up in the coming years. This view is supported by Shen Yiyang, a low-carbon projects financing consultant at Asian Development Bank based in Beijing, who believes that the long-term development of a solid carbon emissions trading market in China, both spot and derivatives, is inevitable. "The international CDM [clean development mechanism] market has nearly dried up in recent years given the CER price collapse in Europe, but China's own carbon trading market is developing, though at a slow pace. China is at a critical point of restructuring its industries. Carbon emissions trading can be employed as a good market tool to help achieve its goal," he says. Though the market accepts that the launch of CGN's debt notes signals the heating up of China's carbon emissions trading market, China still lacks fundamental preconditions, Shen says. "Compared with other commodities transactions, emissions trading is much more driven by government policies. China hasn't set up a national mandatory cap on carbon emissions, so the market will hardly see any essential growth," says Shen. The barrier of setting up the mandatory emissions cap lies in the operational difficulty of developing a nationwide carbon data reporting and audit system. Effective regulatory enforcement measures need to be in place to ensure accuracy of data collected by the authorities, otherwise the market will end up being a non-transparent and inefficient market, according to Shen. "Some enterprises have been active in the market but the number is very limited. More enterprises are taking a wait-and-see approach until the regulatory outlook becomes clearer," he adds. In 2011 China rolled out an emissions trading pilot scheme in seven provinces and cities including Beijing, Shanghai, Tianjin, Chongqing, Shenzhen, Guangdong province and Hunan province. It is widely believed that the Chinese government will take a phased approach to develop the market: first, carry out the emissions trading within these regions; secondly, encourage the regions to conduct trading between each other; and last, extend the trading to cover the entire country. Given that the regions have different approaches to developing trading, the market may evolve in fragmented fashion, Shen says. It is also not clear who will lead the market and if the government will enact unified trading legislation across the country. Among the seven pilot regions, Guangdong uses a carbon offsets auction while the remaining regions give the emissions quota for free. Shenzhen brings in both retail and financial institutional investors into the market while other exchanges limit the participants within the industrial player base. The difference in trading mechanisms between the regions is also seen in the aspects of risk management, over-the-counter transactions and clearing....
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