Recent statistics published by Dow Jones Venture One and Ernst & Young indicate that venture capital investment in the Chinese cleantech sector increased 159 percent in 2006, making the country the world's second-largest destination for cleantech investment after the US.

The research found that venture capital funds invested $221.8 million (€168.2 million) in Chinese cleantech in 2006, or 17.3 percent of the global total. Europe, the third-largest destination for cleantech funding, lagged behind China on $157 million, or 12.2 percent of the total.

Investors in Chinese cleantech have been attracted by the market's considerable growth potential. Don Ye, president of Beijing-based Tsing Capital, says: “Investor interest in the sector has been phenomenal – it is a young market with huge growth potential, and that makes it an extremely interesting place to be right now.”

One investor that has recognised this potential is Michigan-based Cleantech Venture Network. Together with Tsing Capital (formerly Tsinghua Venture Capital Management), the firm recently launched Cleantech China, an enterprise that aims to introduce Chinese cleantech innovation to sources of capital.

Investment in the sector from domestic firms has so far been minimal. Tsing Capital is China's first and only dedicated cleantech venture capital firm. Founded in 2001 by the fund management business of Beijing's Tsinghua University, it makes environmentally sustainable and socially responsible investments through two China Environment Funds

International venture investment in the sector has, on the other hand, been prolific. US firms are active investors, with the likes of DFJ Element, Kleiner, Perkins, Caufield & Byers, and @Ventures all having invested substantial amounts in Chinese cleantech companies last year.

So what are the drivers of the market? One of the biggest is (recent and future) government support. The Chinese government aims to invest RMB1400 billion ($180 billion) in cleantech projects by way of a five-year plan. Such active political support for the sector is a necessary response to the serious environmental challenges that China faces. A 2004 study by the World Bank found that 16 of the world's 20 most polluted cities are in China. Comments Tsing Capital's Ye: “The government has realised that pollution has become a bottleneck for future economic growth. Its investment in cleantech projects reflects its increasing concern with this fact.” Li Zhe, partner at Cleantech China, says: “China has the most serious environmental problem in the world and the government's response to this problem is an important driver for the cleantech sector.”

However, venture investors would do well not to be too seduced by prospects: there are still significant challenges. One of these is the fact that cleantech is not yet a properly defined sector in China. Says Ye: “Cleantech is not yet a publicly accepted idea in our country. The government and investors in the sector have been actively promoting the concept but it takes time for something like this to permeate public consciousness.” Consequently, one could argue that Chinese consumers are not yet inclined to prioritise environmentally friendly options when making buying decisions.

Another important challenge that investors in the sector face is the cultural divide. Says Cleantech China's Zhe: “Chinese entrepreneurs can have a different speed and rhythm – everything is different because of the cultural background.” Chinese cleantech companies are not hugely accessible therefore to US and European investors and it takes a sophisticated approach to get a foot in the door.