Green bonds have become rapidly popular throughout the world. And now Islamic finance is one of the latest sectors to explore green bonds in order to promote and develop Sharia-compliant financial products to invest in climate change solutions.
Green Sukuk are Sharia-compliant investments in renewable energy and other environmental assets. They address Sharia concern for protecting the environment. The Sukuk market has great potential to channel the growing global pool of Sharia-compliant capital to fund renewable energy and climate change projects.
A growing market
Over $30bn worth of green bonds were issued in the second quarter of 2017. Additionally, issuance from emerging markets has jumped from $2.3bn to $9.2bn year-on-year (about half the total from developed markets) versus 16 percent a year ago. Countries such as Malaysia and the UAE are most active on this front out of the top ten key Islamic finance markets.
In Malaysia in 2014, the Security Commission revised its Sukuk guideline by incorporating the new requirements for the issuance of socially responsible investing (SRI) Sukuk. The new Sukuk guidelines set out that the proceeds of SRI Sukuk can be used to preserve the environment and natural resources, conserve the use of energy, promote renewable technologies and reduce greenhouse gas emissions.
A recent entrant to SRI, Malaysia remains a leader in Asia in SRI asset under management with an estimated 30 percent of market share predominantly attributed to Malaysian Islamic funds. Malaysia has the opportunity and ambition to be a leader in this space on the premise that primarily, Malaysia is already a leader in Islamic finance.
There is also a strong push for SRI in the UAE which we have seen through the UAE Green Agenda’s Green Finance and Investment Support Scheme’s endeavor to promote financial growth through investing in green projects, products and services. Among the financial vehicles being considered is green Sukuk.
Why go green?
Green Sukuk is a good model to finance sustainable infrastructure as well as help bridge the gap between conventional and Islamic financial worlds. Both sustainable investors and Sukuk investors aim to use their money in manners that comply with certain values.
Green Sukuk funding and environmentally sustainable infrastructure projects, such as the construction of renewable or clean energy projects, could appeal to both Sukuk investors and conventional environment-focused investors, as Sukuk by design are structured based on a specific pool of assets.
A closer look reveals that there is a need for infrastructure globally that could require up to hundreds of billions of dollars a year in additional financing. This represents a real opportunity for green Sukuk where we find key and potential Islamic finance markets are primarily young and growing populations. However, this opportunity has not yet been tapped in to; 2016 was no different to previous years where we saw limited activity in the Islamic finance regions’ infrastructure bond financing, let alone Islamic finance and Sukuk.
Challenges for green Sukuk
Perhaps the most important challenge for Sukuk is gaining acceptance by international investors due to lack of standardisation and legal enforceability risk. The industry is struggling to keep pace with the rapidly changing regulatory environment and achieve at least a local standardisation. In addition, the time spent drafting green Sukuk structures that are acceptable to governments, investors and the Sukuk’s Sharia boards, can mean a much longer time-frame of Islamic finance implementation leading to higher costs (at least until a standardised framework is established).
Market norms and standards for green bonds are still evolving, reflecting the market’s nascent status. It is essentially a self-regulated market although various voluntary guidelines exist, most notably the International Capital Market Association’s Green Bond Principles which were established in 2014 by a group of banks and focus on use of proceeds, process for project evaluation and selections, management of proceeds, and reporting.
The Climate Bond Initiative also provides guidance, focusing on specific sectors. Other challenges of green Sukuk include investor’s awareness, demand for energy supply, government support and demand for energy financing.
While still relatively new, Islamic finance seems a logical fit for green bonds, or in this case green Sukuk, where demand could proliferate. Sukuk is already confined to a pool of assets by nature which makes it easy to be green. However, reaching this goal comes with significant challenges and achieving a sustainable, established green Sukuk market could be a long road ahead.