City skyline with mountains at sunset

Green bonds could be used to mobilize private capital for resilient, nature-based projects.

China's sponge city program presents a promising approach to alleviating the country's urban drainage and flood management challenges. But financing the types of nature-based infrastructure involved is far from straightforward, and the government's recent push to rein in abuses of the public-private partnership model could constrain one possible approach to funding sponge city projects. At the same time, green finance may offer new opportunities.

Unlike traditional cities, where impermeable roadways, buildings and sidewalks interfere with the natural water cycle, sponge cities mimic and support the natural water cycle. They use nature-based solutions - such as rain gardens, green roofs, constructed wetlands and permeable pavement - to naturally capture, slow down and filter stormwater.

That water, in turn, can then replenish groundwater aquifers or be stored for future use. Nature-based (or "green") infrastructure options perform many of the same functions as their traditional (or "gray") infrastructure alternatives, and in many cases, they are more cost-effective. This is because gray infrastructure - which includes drains, concrete channels, piped drainage systems, pumps and treatment plants - tends to be single-purpose, whereas green infrastructure provides a variety of environmental, social and economic co-benefits.

At the December 2013 Central Government Working Conference on Urbanization, President Xi Jinping spoke about the need to develop spongelike cities that naturally accumulate, filter and purify rainwater. The government subsequently issued guidelines dictating that by 2020, 20 percent of urban areas should locally store and reuse 70 percent of all rainwater. By 2030, 80 percent of urban areas should meet that target.

Achieving these goals will mean retrofitting existing urban areas and designing new development to incorporate sponge city features. Under the program, pilot cities will receive generous annual subsidies of 400 million yuan ($58 million; 51 million euros; ￡46 million) to 600 million yuan from Beijing for three years. The 30 pilot cities selected by the finance, water and housing ministries include Beijing, Shenzhen, Chongqing, Fuzhou, Dalian and Shanghai. These cities have begun developing plans, securing financing and implementing sponge city projects.

China's central government is providing a significant amount of funding for the pilot cities, but the subsidies are far from enough to fully fund sponge city construction. Estimates vary but suggest that sponge city construction could require investments of 100 million to 150 million yuan per square kilometer. The total area under construction in just the first 16 pilot cities is more than 450 square kilometers.

Local governments will have to find ways to fill the funding gap. Some might be able to publicly fund sponge city projects, but most will need to attract private investment to support their efforts. However, securing private investment for nature-based infrastructure may be difficult. Many sponge city projects do not generate well-defined, fixed assets or obvious streams of revenue, and many of the benefits they provide are not easily monetizable. Nevertheless, leveraging private sector financing is crucial for the success of the sponge city program, so local governments will need to identify innovative financing tools to operationalize their sponge city plans.

One possibility is to develop public-private partnerships to finance or operate sponge city projects. And, in fact, the Ministry of Finance offered additional subsidies to pilot cities that do so. However, the government has since significantly increased scrutiny of public-private partnerships out of concern that they are being used in ways that allow local governments to skirt limits on government borrowing. Though the government's effort to weed out unqualified PPP projects is not specific to the sponge city program, it could have significant implications for its success if added constraints on public-private partnerships deter private investment in sponge city projects.

While heightened scrutiny of PPP projects may impede one potential avenue for funding of sponge city projects, the recent growth of green finance in China may present new opportunities for the sponge city program.

Green bonds could be used to mobilize private capital for resilient investments like sponge city projects. The green bond market has grown rapidly in recent years, with issuance surpassing $100 billion in 2017 and expected to reach $250 billion this year, and China is among the largest green bond issuers globally. To date, only a small share of proceeds from green bonds have supported resilience or climate change adaptation projects, and an even smaller share has supported nature-based assets infrastructure. But early examples could serve as promising models. For instance, in 2016, Washington, DC, issued a $25 million environmental impact bond to finance the construction of green infrastructure to manage stormwater runoff and improve the District of Columbia's water quality. In September last year, China Development Bank issued a 5 billion yuan bond to finance water resource protection along the Yangtze river economic zone.

Alternatively, local governments could pay private investors for the ecosystem services that sponge city projects provide. Sponge city projects that restore ecosystems and mimic the natural water cycle can generate a range of benefits for downstream communities, including flood control, sediment control and water purification, all of which can help reduce water treatment and equipment maintenance costs. Payment for environmental service programs recognizes these benefits and provide incentives for upstream communities to implement such projects. Such ecological compensation programs have been used in China - for reforestation and watershed management projects, for instance - and these earlier experiences could guide the use of eco-compensation in the context of the sponge city program.