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Abu Dhabi, UAEMonday 19 November 2018

Climate finance deficit could be plugged by green sukuk

Combating global warming is the critical challenge of this century

Tackling global warming is a critical challenge for the world. AFP
Tackling global warming is a critical challenge for the world. AFP

In 2015, 195 countries signed the historic Paris Agreement on tackling climate change, an ambitious attempt to build on the United Nations Framework Convention on Climate Change by binding all signatory countries to a common approach for creating and implementing a global response to the challenges posed by climate change, including through innovative financing initiatives.

However, since then, with the tightening of government budgets and more immediate policy priorities, green financing has not been at the forefront of the agenda as has been most notably evidenced by the withdrawal of the US from the Paris Agreement.

At a time when populations across the world are experiencing increased environmental disasters, food insecurity and rising temperatures, it is vital that we look to innovative tools and alternative methods, such as faith-based financing solutions, to help address climate change. New thinking is needed.

Islamic Finance

The Islamic finance industry was founded and developed on the adherence to Sharia. It has grown tremendously in the past two decades and the World Bank estimates that by 2020 the industry is expected to reach $3 trillion in assets. Furthermore, environmental stewardship is deeply enshrined in Sharia principles and Islamic teachings.

Given the importance that Islam places on the care of the environment, combined with the growth of the Islamic finance market and growing green financing needs, it is only logical that the Islamic finance industry should be encouraged to get involved in addressing climate change issues.

The creation of Islamic green finance, a confluence of Islamic and green finance, is one way that the Islamic finance industry has addressed the issue. It is a form of socially responsible investing, which seeks to consider not just the financial return but also the social good. The concept of socially responsible investing is aligned to the ideology of Maqasid Al Sharia, which outlines the objectives prescribed in Sharia to protect and preserve the interest of society.

Islamic green finance has been growing in popularity in the past couple of years with one of the latest developments being the creation of green sukuk. These are Sharia compliant capital market instruments similar to green bonds, whereby the proceeds raised are specifically allocated for use in funding environmentally friendly projects such as waste management and renewable energy.

Accordingly, in 2014, due to the rising trend for and increased popularity of green bonds and social investing, the Securities Commission of Malaysia launched a Sustainable and Responsible Investment (SRI) sukuk framework with the aim of incentivising the development of a domestic SRI market and paving the way for SRI sukuk issues.

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By tapping investment markets not open to conventional green bonds, green sukuk offerings have the opportunity and potential to help meet the world’s increasing appetite for green financing solutions and, as such, unlocking its potential could help finance the fight against climate change. For example, earlier this year, Indonesia issued the first ever sovereign green sukuk, raising a total of $3 billion through a dual-tranche deal.

Case Study: Malaysia

In Malaysia, green sukuk are proving to be an effective tool for funding environmentally-friendly projects and addressing the country’s growing green financing needs. The Malaysian government sees the importance in Islamic green finance and the benefit of stepping in to create a regulatory environment to encourage this.

To date, only a few green sukuk transactions have been issued utilising the Malaysian Securities Commission’s SRI sukuk framework and raising a combined 1,250bn Malayisan ringgit (Dh1.1bn) for the funding of renewable energy projects.

In July 2017, Tadau Energy, a Malaysian subsidiary of Chinese-owned Edra Power Holdings, became the first issuer of green SRI sukuk raising a total of 250 million ringgit to finance a 50MW solar power plant in the Malaysian state of Sabah. The offering was more than twice oversubscribed, indicative of market demand for such instruments.

Subsequently in October 2017, Malaysian corporate Quantum Solar Pak issued a green SRI sukuk raising a total of 1bn ringgit to finance the construction of solar photovoltaic power plants in three Malaysian states.

Galvanising Islamic green finance

As shown above, the governments of Indonesia and Malaysia have taken the lead in proactively leveraging the use of Islamic finance tools to fund renewable energy projects, thereby demonstrating how green sukuk can be a viable funding vehicle for both corporate and sovereign issuers alike in South East Asia.

In particular, it is to hoped that these early successes could encourage Gulf Cooperation Council countries to consider issuing green sukuk, given that green finance has also been steadily gaining traction in the Arabian Gulf region. For example, last year, First Abu Dhabi Bank, the largest bank in the UAE, issued the region’s first green bond raising a total of $587m. Unlocking the potential of green sukuk could help the region meet its growing renewable energy requirements, including aiding Saudi Arabia in addressing its ambitious 2030 agenda.

Also, it should be noted that, given the increasing demand for environmental social and governance (ESG) investing, green sukuk represents an instrument that appeals not only to Islamic investors but also more widely to institutional investors that are becoming increasingly ethically minded, thus widening the potential pool of investors for such offerings.

For this market to really take off, other jurisdictions need to take a leaf out of Malaysia’s book and develop regulatory environments that embrace Islamic green finance as a funding opportunity, creating frameworks that outline the eligibility of green projects and providing tax incentives for potential issuers as a step towards stimulating the industry.

Maram Ahmed is a Visiting Fellow at SOAS, University of London