Rethinking China – a leader in trade and climate action

RE2017-FreeTrade_AdPages.jpg

Sometimes, the most powerful forms of leadership come from the least expected places. As the US takes a more protectionist line, pulling away from its leadership position in trade and climate change, an unlikely new leader is taking its place.

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.

China accounts for 29% of global carbon emissions, making it the largest contributor by a sizeable margin.

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.

China’s climate leadership is having a powerful effect. Its rapidly changing energy mix is the main reason why the trajectory for global CO2 emissions reversed for the first time in 2015.

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.

lombard_dragon_04.jpg

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.

As the global population grows, we will need to find alternative, more sustainable ways to feed a growing number of mouths, particularly given the simultaneous shift in demand towards highly nutritious, high-protein food stuffs.

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.

lombard_china_grow_02.jpg
China is gradually internationalising its markets and economy 

Benefiting from China’s climate leadership is also becoming easier for international investors as the country begins to open up to cross-border trade and investment.

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.

China’s leadership here is important given the changing dynamics in emerging market economies in the region.

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
 

IMPORTANT INFORMATION – GENERAL MARKETING
This is a marketing communication issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter "Lombard Odier"). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This marketing communication is provided for information purposes only. It does not constitute an offer or a recommendation to subscribe, to purchase, sell or hold any security or financial instrument. It contains the opinions of Lombard Odier, as at the date of issue. These opinions and the information herein contained do not take into account an individual’s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes a personal recommendation to any investor. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Lombard Odier does not provide tax advice. Therefore you must verify the above and all other information provided in the marketing communication or otherwise review it with your external tax advisors.
Some investment products and services, including custody may be subject to legal restrictions or may not be available worldwide on an unrestricted basis.
Investments are subject to a variety of risks. Before entering into any transaction, an investor should consult his/her investment advisor and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. The information and analysis contained herein are based on sources considered to be reliable. However, Lombard Odier does not guarantee the timeliness, accuracy, or completeness of the information contained in this document, nor does it accept any liability for any loss or damage resulting from its use. All information and opinions as well as the prices, market valuations and calculations indicated herein may change without notice.
Past performance is no guarantee of current or future returns, and the investor may receive back less than he invested. The value of any investment in a currency other than the base currency of a portfolio is subject to foreign exchange rate risk. These rates may fluctuate and adversely affect the value of the investment when it is realized and converted back into the investor’s base currency. The liquidity of an investment is subject to supply and demand. Some products may not have a well-established secondary market or in extreme market conditions may be difficult to value, resulting in price volatility and making it difficult to obtain a price to dispose of the asset.
European Union Members: This marketing communication has been approved for issue by Lombard Odier (Europe) S.A., a credit institution authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg and by each of its branches operating in the following territories: France: Lombard Odier (Europe) S.A.• Succursale en France, a credit institution and regulated in France by the Autorité de contrôle prudentiel et de résolution (ACPR) and by the Autorité des marchés financiers (AMF) in respect of its investment services activities. United Kingdom: Lombard Odier (Europe) S.A. • UK Branch, a credit institution regulated in the UK by the Prudential Regulation Authority (PRA) and subject to limited regulation by the Financial Conduct Authority (‘FCA’) and the Prudential Regulation Authority (‘PRA’). Details of the extent of our authorisation and regulation by the PRA and regulation by the FCA are available from us on request. UK regulation for the protection of retail clients in the UK and the compensation available under the UK Financial Services Compensation Scheme does not apply in respect of any investment or services provided by an overseas person.
Switzerland: This marketing communication has been approved for issue by Bank Lombard Odier & Co Ltd, a bank and securities dealer authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).
United States: Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
This marketing communication may not be reproduced (in whole or in part), transmitted, modified, or used for any public or commercial purpose without the prior written permission of Lombard Odier.
© 2016 Bank Lombard Odier & Co Ltd – all rights reserved