Over the next five to 10 years, China's high-carbon sectors, including energy, transport, construction and manufacturing, will develop clear and more ambitious carbon-reduction strategies.

As an important participant in green climate financing, the financial sector should also grasp and study such trends and lay out the target for "net-zero carbon" as early as possible.

Financial institutions need to enhance their understanding about climate change from a strategic perspective, actively embrace carbon neutrality, grasp the great opportunities in carbon neutrality and promote the development of green industries.

The goal of carbon neutrality will bring three types of challenges to China's financial sector. The financial risks associated with climate change come from two main sources: direct risks associated with climate shocks and the possible risks during transition to a net zero carbon economy.

First, households, companies and countries exposed to direct climate shocks will increase their risk exposure in the form of increasing risk of loan defaults, asset depreciation or sovereign risk. Severe losses from extreme weather events directly affect borrowers' ability to repay their loans, and both the probability of default and the loss from default will increase.

Climate-sensitive enterprises are directly exposed to the risk of revenue reduction and business disruption. For several years in a row, extreme weather events, inadequate mitigation and response to climate change and natural disasters ranked among the top three of 29 global risks in the World Economic Forum's Global Risks Report.

Second, risks in asset allocation associated with climate change are rising. The rapid transition to a net zero carbon economy means that deep decarbonization of high-carbon industries like energy, power, industry, transportation and construction will become the key task for China's low-carbon transition.

Third, policy actions, technological changes and changes in consumer and investor behavior, like carbon pricing, higher energy efficiency standards, tighter environmental laws and public awareness of green consumption, will increase the operating costs of high-emission enterprises in these sectors and reduce their profitability and solvency, which may increase credit risk for financial lenders.

The shift to carbon-intensive industries will also have an impact on energy and commodity prices, corporate bonds, equities and some derivatives contracts.

While the risk of a sudden and significant systemic adjustment may not arise immediately, future financial risks will rise more quickly if financial institutions' portfolios do not align with a carbon-neutral path over the next few years.

Meanwhile, there are a number of potential opportunities for financial institutions to transition to a net zero carbon economy. China's move toward carbon neutrality will inevitably bring about profound changes in the country's energy structure and industrial structure, and will create huge new investment markets in many fields.

These include renewable resource use, energy efficiency, clean power generation, energy storage, hydrogen energy, carbon capture and absorption, and digitization. In this process, financial institutions can unearth and harness great opportunities for development.

The transition to a net zero carbon economy will bring new industry-related investment opportunities, and financial institutions with a focus on certain areas may face major adjustments.

To achieve carbon neutrality, the power sector is bound to shift from thermal power to clean power. Most of China's coal-fired power plants will be phased out by 2045.

In this process, natural gas will play the role of "transitional energy", while clean energy, as alternative energy, will keep growing rapidly. Carbon neutrality in industrial sectors is expected to focus on tapping energy-saving potential and improving the efficiency of resource recycling, while the transport sector is expected to move toward electric, smart or automated vehicles powered by cleaner fuels.

The new energy vehicle industry development plan (2021-35), released in November 2020, has already taken effect. By 2025, new energy vehicle sales will account for 20 percent of total vehicle sales, and by 2035, the public vehicles will be fully electric.

All-electric cars will become mainstream. As a key means of achieving carbon neutrality, the process of innovation and application of low-carbon technologies is accelerating and is expected to lead to the formation of new industry chains and profit pools. All these provide direction for the adjustment of credit structure of financial institutions.

Financial innovation will give birth to new business forms and investment and financing models. In terms of the growth rate and scale of green credit, securitization has great potential. China's green bond issues have been the first in the world, and launched the exploration of climate bonds, blue bonds and so forth.

In the capital market, innovation and trading around key low-carbon technologies are very active, creating conditions for financial institutions to carry out equity investment in accordance with related laws and regulations.

The climate investment and financing guidance also calls for exploring the trading and innovation of carbon financial derivatives represented by carbon futures and the timely entry of investment institutions and individuals into coverage of the main trading body of the carbon market. The carbon finance market space will also be gradually opened up.

Given the special nature of climate-related financial risks and China's determination and strength to transition to a net zero carbon economy, financial institutions need to plan and arrange for an orderly transition to carbon neutrality well in advance, enhancing strategic adaptation to national climate policy and minimizing financial risks associated with climate.

Efforts are needed in understanding the potential risk to core financial risk and strengthen strategic planning and top-level design. Financial institutions should take the lead in combating climate change, set out clear climate objectives, and establish sound management systems to strengthen the supervision, assessment and evaluation of their climate work.

Capacity-building for climate change risk assessment and information disclosure-related work are also important. High-quality forecasts, detailed industry investment and financing policies and reducing the risk of climate change-related asset allocation will all be conducive steps in this regard.

Innovation capacity is needed in improving the multidimensional climate financial products. The pilot area of green finance can be taken as the window to accumulate the experience of financial innovation and window guidance.

Efforts shall also be incentivized to strengthen environmental and social risk management for overseas investment and actively participate in green Belt and Road construction.

(This article was published in China Daily on July 19, 2021. The original title is "Pursuit of carbon neutrality brings many financial opportunities, challenges".)