China: leading the march against climate change? 
Five years ago few people would have thought that China, the world’s largest polluter, would become a leading force in the fight against climate change. However, as so often in investment markets, the biggest opportunities are not always the most obvious ones.

The US, with 14%, comes second followed by the European union (10%)¹. Historically, China has proven resistant to international encouragement to address its high emissions. It was China, for example, that scuppered the 2011 climate change talks in Durban as it rejected proposals for a new treaty.

Fast forward to 2016 and the political rhetoric on both sides of the Pacific has almost reversed. In its 2018 Budget, President Trump’s new government has proposed a 31% cut to the Environmental Protection Agency’s budget, eliminating its climate change programs and cutting back initiatives designed to protect air and water quality. Meanwhile, Beijing’s attitude has changed dramatically as the health impacts of pollution have become a high-profile concern. China was one of the strongest voices urging Donald Trump to reconsider his plans to back away from the Paris climate agreement, which China has already ratified. China is also leading the field when it comes to investing in a low-carbon economy. The country has more solar power capacity than any other country in the world, for example, after doubling its photovoltaic capacity to 77.42 gigawatts during 2016. In fact, China’s spending on clean energy has surpassed that of the European Union (EU), the former market leader, for the last four years².

Although China’s emissions decreased only 0.7% that year – their first year of negative growth – the savings are equivalent to the total emissions of Greece, for example. By contrast, EU emissions increased 1.3% in 2015.

With plans to invest RMB2.5 trillion ($364 billion) in renewables by 2020, China’s leadership in the fight against climate change is likely to become well entrenched, especially given their more compelling political mind-set than the current US administration. A change in leadership on this scale, and the progress it is likely to drive, will create significant opportunities for investors.

China dominates green bond issuance
Consider climate bonds, for example, which raise assets that are ring-fenced for spending on climate-friendly projects. China has already established itself as a dominant force in the market. There were 56 Chinese renminbi issues in 2016 raising $36.2 billion in total, around 36% of the $80 billion global issuance and a seachange in a country where issuance had previously been almost zero. The proceeds from selling these bonds have predominantly been focussed on renewable energy and energy efficiency projects both in and out of China. Geely Auto’s $400 million issuance, for example, will fund development of an electric taxi for London.

Climate bonds can also be used to help China secure its food supply as its population continues to grow. China has the largest population on the planet, which the United Nations expects will grow to 1.4 billion in 2028. This will put pressure on the country’s agriculture industry, which is also highly carbon intensive.

Redefining agriculture
Climate bonds can be used to finance improvements in irrigation, integrated pest control and non-polluting farming systems, for example, to promote food security in districts were extreme events and temporal shifts in rain are already threatening crops.

This problem is not unique to China – far from it. India is expected to overtake China as the largest population by 2022 while more than half of the world’s population growth is expected to come from Africa. Agriculture is already the biggest contributor to carbon emissions and deforestation globally.

Adapting the agriculture industry to cope will take massive investment and innovation, and, once again, opportunities could spring up in unexpected places. Producing a kilogram of protein from beef, for example, requires 258m2 of land and creates 170kg of CO2 emissions. Producing the same amount of protein from insects, however, requires only 18m2 and emits only 14kg of CO2. Insects are already a standard part of the diet for around a third of the world’s population, especially in regions where population growth is likely to be strongest – including Africa and Asia. However, with demand for meat expected to grow by 44% between 2014 and 2050 and more and more countries ratifying the COP21 agreements in an effort to limit global warming to less than 2°C, the West in particular may have to rethink how they define meat and livestock. Intensive invertebrate farming is likely to become a key part of the solution to creating a more sustainable agriculture industry – whether through human consumption or as an animal-feed alternative – that can meet the dual demands of a growing population hungry for a higher-protein diet.

China is gradually internationalising its markets and economy 

Once again, Beijing is looking to fill a leadership void left by the US. How many people would have predicted five years ago that, as the US pulls out of key trade deals, China’s President Xi Jinping would be the country’s first premier to address the World Economic Forum and that his message would be “say no to protectionism”?

China is expected to become the world’s largest single market by 2050 and is on its way to becoming one of the world’s biggest cross-border investors as their offshore assets rise to nearly $20 trillion, according to research from Rhodium Group and the Mercator Institute for China Studies.

The inclusion of the yuan in the International Monetary Fund’s basket of reserve currencies for the first time in October 2016 is also a significant milestone for a country trying to establish its global leadership position.

As the importance of China’s currency and economic might continue to grow, investment markets will have to adapt accordingly. Benchmark indices, for example, will have to lower their exposure to the dollar in favour of the yuan, pushing more money into Chinese government bonds. This is unlikely to be limited to currency markets. Over time, as China moves towards a more open financial market system that allows capital to flow more easily in and out of the country, it could also spread to equity indexes. Although MSCI has been delaying the inclusion of Chinese A Shares in its international stock indexes for several years, for example, citing investor concern about lack of accessibility, in 2016 the index provider laid out a roadmap for inclusion as China has made meaningful progress towards reaching international standards.

A new pan-Asian leader
To be clear, we think that President Trump’s priorities threaten trade stagnation rather than outright trade reversal: we expect his administration to deploy a sector-specific approach to protectionism rather than pursuing an overarching confrontation, as that would succeed in addressing the jobs concerns of his core voters in “swing states” while lessening the risk of an asymmetric response from China that spirals beyond trade into an all-out capital war. Nonetheless, it is difficult to deny that Trump’s decision to pull the US out of the Trans-Pacific Partnership (TPP) has left a leadership chasm in the region, and China has been quick to respond.

The traditional view of Asia as highly-export and dollar reliant is increasingly outdated as their economies, particularly China, move to a new stage in their economic development, in which domestic demand and intra-regional trade play a much more central role. The US retreat on global trade is therefore unlikely to impact the Asian region as it once might have, particularly in light of China’s emerging leadership.

This trend is still young, but China’s growing influence in areas such as trade, investment and the fight on climate change will likely be transformative, not just at home, but also across the global landscape. As China continues to open its economy and financial markets, and moves closer to international standards, investors willing to rethink their traditional view on China will see an increasing opportunity to benefit from the emergence of an unlikely leader.

¹Trends in Global CO2 Emissions 2016 Report, European Commission Joint Research Centre, PBL Netherlands Environmental Assessment Agency
²The world’s biggest polluter is now the global leader in renewable-energy spending, Quartz
³China Green Bond Market 2016, The Climate Bond Initiative, January 2017
⁴China Green Bond Market 2016, Climate Bonds Initiative
⁵World agriculture towards 2030/2050, The 2012 Revision, Food and Agriculture Organisation of the United Nations
 

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