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China Report: The Risks and Opportunities of Stranded Assets

The rise and fall of different technologies, products and businesses are central to rising productivity in healthy, well-functioning markets. This process can result in “stranded assets”—assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities. Stranded assets are therefore a regular and necessary feature of dynamic economic systems, a phenomenon inherent in the “creative destruction” of economic growth, transformation and innovation.

China’s strategic decision to move away from a high-pollution and high-resource-intensive economy and build an “eco-civilization” will clearly have implications both for existing assets and the trajectory of future capital investment. This will be problematic for some firms and sectors, but need not hinder China’s economic development; it could actually work to support China’s multiple interlocking objectives of addressing inequality, ensuring sustainable growth, increasing domestic consumption and improving social infrastructure. One opportunity is to secure an optimal rate of asset stranding given China’s level of economic development, targeted rate of economic growth and sustainability concerns. Too little asset turnover could leave China with insufficiently productive assets far from technological frontiers, while too much could result in unmanageable losses for companies and financial institutions, as well as challenging social issues due to job losses and displaced industries. However, allowing polluting, inefficient assets to continue to operate will undermine sustainability and long-term growth.

To encourage financial institutions to take a precautionary approach, stress tests required by regulators could be extended to environment-related risks driving stranded assets. For example, a carbon stress test could involve assessing the impact on portfolios of the rapid introduction of effective carbon pricing. Additionally, given that environment-related risks are likely to affect underlying asset bases of financial institutions (to the degree that they lend to clients in vulnerable/high-risk industries), there could be merit in higher capital requirements for assets with greater levels of exposure to such risks.

[NB: This report is one chapter in the book Greening China’s Financial System]