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Energy Procedia 104 (2016) 311 – 316

CUE2016-Applied Energy Symposium and Forum 2016: Low carbon cities & urban
energy systems

The role of green finance in environmental protection:

Two aspects of market mechanism and policies
Yao Wang a, Qiang Zhia *
School of Government, Central University of Finance and Economics,Beijing,100081

Abstract

Green finance is a new financial pattern to integrate environmental protection with economic profits,
emphasizing “green” and “finance”, two of which are controversial issues. This paper probes into the
status quo of green finance in the field of renewable energy and finds out some inadequacies. We devote
attention to development of market mechanism and formulation of policies. By revealing the internal
contradictions between green finance and environmental protection, we propose solutions intrinsically for
better achievement of ecological balance.
© 2016 The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license
© 2016 The Authors. Published by Elsevier Ltd.
(http://creativecommons.org/licenses/by-nc-nd/4.0/).
Selection
Peer-reviewand/or peer-review of
under responsibility under responsibility
the scientific of CUE
committee of the Applied Energy Symposium and Forum, CUE2016: Low carbon
cities and urban energy systems.
Keywords: green finance; renewable energy; market mechanism; policies

1. Introduction

Green finance is a phenomenon that combines the world of finance and business with environmentally
friendly behavior. It is an arena for many participants, including individual and business consumers,
producers, investors, and financial lenders. Green finance can be expressed differently depending on the
participant, and it may be led by financial incentives, a desire to preserve the planet, or a combination of
both. Contrary to the traditional financial activities, green finance emphasizes more on the ecological
environment benefit and pays more attention to environmental protection industry.
The study of green finance in academics currently is more concerned with simple concept and lacks
detailed studies of green finance regarding to mechanism exploration, market research and so on. Based

* Corresponding author: Zhi Qiang E-mail address: zhiqiangthu@qq.com

1876-6102 © 2016 The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license
(http://creativecommons.org/licenses/by-nc-nd/4.0/).
Peer-review under responsibility of the scientific committee of the Applied Energy Symposium and Forum, CUE2016: Low carbon cities
and urban energy systems.
doi:10.1016/j.egypro.2016.12.053
312 Yao Wang and Qiang Zhi / Energy Procedia 104 (2016) 311 – 316

on the review of previous research, this paper highlights the development of green finance, and raises
problems and contradictions existing in the application of green finance. From the aspects of market and
policy, we explore and reveal how green finance helps us to achieve ecological balance.

2. The status quo of green finance in the field of renewable energy

Presently the researches on energy concerning with green finance are more theoretical in interpretation,
basically from the aspect of single energy in the energy industry, such as natural gas, oil, wind power,
solar energy and so on. It is worth for us to explore how to reduce the risk and cost of financing through
the means of green finance, perfect the financing mechanism and support the development of renewable
energy industry.
For years, an ignored factor restricting the development of solar energy is the lack of appropriate
financing system. The financing system should consider renewable energy processors and demand of
users in order to better promote the extensive use of renewable energy.
The electricity cost of Renewable Energy Technologies is closely related to the cost of financing.
Continued competitive electricity market will change the electricity power in the future and cause
potential impact on renewable energy structure. It is believed that fierce competition can reduce the
burden of the financing of renewable energy projects, thus achieving the goals already set for renewable
energy.
The financial sector's support for wind energy can be discussed from the following several aspects:
from the standpoint of bank, financing needs rational utilization of funds within a certain amount of time;
financial instruments must be matched with the development of science and technology progress and
financing needs of renewable energy; energy security law and energy fund accord with political objective
in order to better promote the development of energy industry.
However, there is no research on the linked development of energy industry and financial industry and
no specific analysis of the internal mechanism regarding to connection, mutual penetration and mutual
influence between the two industries.

3. The market mechanism of green finance

Green finance market includes market-oriented mechanism and financial products that can control
pollution emission, realize the ecosystem and avoid enterprises from unexpected nature change; the
former is represented by emissions trading and the latter has various types, such as environmental funds,
weather derivatives, nature-linked securities and ecological options, etc.

3.1 Emissions trading market mechanism

Establishing emissions trading market should meet three premises: first, the total amount of emissions
trading in the region; second, the initial allocation of tradable permits amount; third, sufficient market
information shared among emissions trading parties. In addition, the establishment of an emissions
trading market includes the transaction subject, transaction procedure and how to manage and regulate the
market, etc.
One of the famous cases that environmental regulators use financial market mechanism to solve the
problem of air pollution, water pollution and the problem of biodiversity is that Slovak government and
Japan's Sumitomo corporation signed the deal of emissions trading of 200000 tons in 2002; the deal is
regarded as the start of global emissions trading market.
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3.2 Types of green financial products

Environmental Environmental funds and biodiversity funds offer financial support directly to the projects of
Funds and conserving biodiversity or indirectly to business activities of protecting the area of biodiversity.
Biodiversity Funds According to the practice activities, the environmental funds and biodiversity funds promote the
organic agriculture, ecological tourism and sustainable development of forest and fishery.
Debt-for- Creditor country and less developed country reach an agreement that the debt of less developed
environment country can be exempted on the premise that less developed country should provide sources of funds to
Swaps environmental fund that is often important to protect biodiversity. At present, the United States,
Sweden and Germany are the most active countries to develop debt-for-environment swaps projects,
benefiting more than 30 countries; one of the most influential debt-for-environment swaps project is
the one between the government of the United States and Poland that achieved the value of about $370
million.
Forestry The enterprises of forestry exploitation which set up securities transfer all of the business profits to a
Securitizations new legal subjects which then will obtain funds from the investors by issuing securities in the capital
market and will loan the revenues to the enterprises of forestry exploitation, for instance, the system of
mitigation banking of wetland and endangered species in the United States and the system of tradable
native vegetation obligations in Brazil.
Weather This new financial products can handle the negative financial losses caused by changes in climate
Derivatives condition. If the level of climate change exceeds the prescribed standard, the enterprise signing
weather derivative contract may require a certain amount of compensation. Weather derivatives
derived from energy sector in the middle of 1990s, according to date from CME, the transactions of
weather derivatives since 2002 have been up to billions of dollars.
Nature-linked Nature-linked Securities can transfer the risk of natural disasters and climate change to investors in
Securities global capital market. The sponsors of the natural disaster securities generally set up a special purpose
vehicle (SPV) and then issue debt securities. SPV and the sponsors follow that SPV agrees to pay
compensation to sponsors in the event of natural disasters on condition that the sponsors must pay a
certain amount of insurance fee to SPV regularly.
Green investment Investment companies and trust funds invest in accordance with the "environmentally friendly",
funds "moral", "green", "social responsibility" or "sustainable" standards, for instance, many investment
companies decline investment in securities of companies which produce pollution. Equator principles
of green finance promoted more and more fund managers to use environmentally friendly investment
strategies.

3.3 A summary of green finance market mechanism

A lot of studies are concerned with green finance market’s effect and influence on environment. First
of all, green finance market is credit intermediary of environmental protection’s capital movement; it
adopts the way of serving to gather and allocate funds, and mandates the capital shortage of businesses
and residents. In addition, green finance market can improve productivity. Through financial institutions
handling monetary funds, currency funds movement promotes commodities trading according to the
market demands, bonds various factors of production rapidly and forms new productivity. Finally, green
finance market is one of the most important levers regarding to macroeconomic regulation and control.
Capital supply can adjust social total demand. Through the financial leverage effect, green finance market
can adjust the size, speed and structure of economic development.
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4. Discussion of policies in green finance

4.1 The role of policies in green finance

The development of environmental protection industry needs a lot of up-front investment capital and
has a long payback period of investment, so the environmental protection industry must have its own
unique financing path. The relevant polices of green finance can ease the financing bottleneck that
government faces to some degree combined with reform and innovative financial tools. The policies
include two aspects: first, the reform and innovation of existing financial tools, an exploration of the type
of fiscal policy and the feasible way to raise money for green finance development; second, the reform of
existing fiscal revenue management and distribution policy, namely the efficiency and direction in the use
of fiscal funds.

4.2 The impact of green bonds on environmental protection

Financial instruments are crucial means for applying green finance in real life. The global green bonds
experienced an explosive growth. Green bonds combine both "bonds" and "green" features. First and
foremost, green bonds own basic function and characteristics of ordinary bonds. For issuers, capital cost
of issuing bond is low and interest is pre-tax charge; bond investment risk is relatively low and investors’
demand for yield is low thus reducing the cost of capital. Also, the bonds can raise a larger scale of funds
whose terms are relatively long, so bonds are very suitable for those investment projects of large-scale
infrastructure construction which demands huge capital and returns investment for a longer period. In
addition, the financing subjects are diversified, including government, financial institutions and
enterprises, etc. For investors, compared with bank deposits, bonds tend to provide higher profitability,
liquidity and stability meeting the diversification of investors. At the same time, the bonds markets make
investors easier to enter and exit, adjust the investment portfolio, thus having higher flexibility in liquidity
management.
Compared to the regular bonds, green bonds put forward requirements to "green". The raised funds
must be spent on renewable energy and sustainable green projects. Green bonds can hedge investment
risk brought by environment and climate change. Some green bonds raise money to the project with
national or local government subsidies and the government in the future may also launch preferential
policies related to green bonds, such as lower investment threshold, more favourable tax, etc. In addition,
green bonds have stricter disclosure requirements than regular bonds, so that investors can invest with a
low risk, both meeting the social sense of responsibility and can obtaining benefits.
In June 2007, the European Investment Bank (EIB) issued the first global Climate Awareness Bond for
financing its renewable energy and energy efficiency improvement projects. Since then, the international
green bonds market has experienced the initial development stage (2007~2012), and in 2013, the green
bond market entered the stage of rapid development. Among the key characters that the green bonds
market performs are scale increase and the issuer varieties. Distribution scope is expanding from Europe
to all over the world especially developing countries.

4.3 How the policies ease the contradictions between the green finance and environmental protection

The policies to support the development of green finance need to deal with the contradiction between
ecological environment protection and green finance. The initial contradiction is the liquidity of funds
that green finance raises for environmental protection. Liquidity refers to the ability of an asset to
liquidate at a reasonable market price. There are two measure standards of liquidity: one is the cost of the
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assets to liquidate, the lower the cost of assets to liquidate, the stronger the liquidity of the assets; the
second is the speed rate of assets to liquidate, the faster assets to liquidate, the better liquidity of assets. In
general, when traded at active platform or market with plenty of the buyers and the sellers, the assets’
ability to liquidate is stronger. However, ecological protection is a long-term process. Whether it is
directly invested for eco-friendly projects, or invested by equity in related industries, it needs relatively
long investment cycle. In particular, some projects of large infrastructure construction often do not have
money in the early stages of the investment, the recycling condition, therefore, also limits the relevant
projects’ ability of absorbing funds.
Hence, to deal effectively the contradictions between green finance and ecological protection, first of
all, the policies need to find funds that match with the term structure of projects; secondly, the relevant
subjects can issue financial derivatives, such as asset securitization products, to change the term structure
of the project; finally, the policies should improve green finance market activity through developing
ecological finance, constructing climate derivatives market and other secondary financial markets related
to ecological protection, thereby directly improving the liquidity of related investment.

5. Discussion and Conclusion

Green finance is an innovative financial pattern aimed at the environmental protection and the
accomplishment of sustainable utilization of resources. If the market mechanism of green finance is
rational, green finance can guide the flow of funds and achieve effective management of environmental
risk and optimal allocation of environmental resources and social resources. The effective regulation of
policies will avoid the information asymmetry phenomenon and solve the moral hazard.
The construction of environmental protection should consider setting up the mechanism of efficient
green finance system coordinating the relationship between the ecology and finance. We can promote the
use of renewable energy to achieve environmental protection through active financial tools.

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