Why you should care
The Islamic green bond is emerging as the next big tool in financing the fight against climate change.
With mystic peaks, coral reefs, jungles and over 4,000 hours of annual sunlight, Malaysia’s Sabah state is an ideal candidate for clean energy initiatives. But what makes its 50-megawatt solar project, launched in April 2018, special isn’t just its potential to provide electricity to this northern Borneo region. The project is the outcome of funds raised from the world’s first Islamic green bond, with a value of $60 million, unveiled by Malaysia’s Securities Commission in July 2017.
Modern Islamic financial tools, such as bonds that adhere to Islamic law and collect no interest, first emerged in the 1970s. The clean energy projects have grown in demand globally over the past two decades as concerns over climate change have mounted. Now, more and more countries and organizations are beginning to marry the two, opening up the possibility of investing billions in a sector that’s only expected to grow, while also offering the clean energy industry access to money it desperately needs to ramp up society’s transition away from fossil fuels.
Since the first Islamic green bond, Malaysia has released six similar issuances, known as sukuks, with a cumulative value of $1.42 billion, specifically for the green or sustainable and responsible investing (SRI) sector. It’s an approach the IMF and World Bank support. In fact, the World Bank is actively working with Malaysia on these bonds, and the fever is spreading.
In February 2018, Indonesia launched its first green sukuk — the term is derived from the Arabic word sakk, meaning “check” or “IOU” — worth $1.25 billion. In April, fintech company Blossom Finance created the world’s first SmartSukuk platform to raise money from the retail market through blockchain technology so that ordinary people could build social projects. In 2017, the United Arab Emirates’ National Bank of Abu Dhabi launched the Gulf’s first green bond, raising $587 million. Saudi Arabia, with its massive $28.07 billion sukuk kitty, is expected to join this growing rush toward Islamic green financing soon, say experts. Europe is the next frontier.
Infrastructure is really an area where there can be great use of Islamic finance, because most of it doesn’t fall under what is disallowed by Shariah.
Sharifah Bakar Ali, founder, Bespoke Globiz
Malaysian consultancy firm Bespoke Globiz in November 2018 organized an event at the London law firm CMS, titled Beyond Profit: Global Purification Fund and SRI/Green Sukuk for a Sustainable Future, that looked at how Islamic green bonds could represent a win-win scenario for countries looking for funds to support infrastructure and other projects and for Islamic financial institutions searching for safe investments.
Islamic finance is defined by its compliance with Shariah law — interest can’t be charged, you can’t speculate, uncertain investments are looked down upon and areas like alcohol, gambling, pornography and arms dealing are strictly off-limits. Financial products instead make money through agreed-upon profit-sharing deals with investees or higher markups at the point of sale. The customer knows up front exactly how much the product will cost, or the fraction of profits he or she will need to share.
For their part, developing nations have a collective need of about $1.7 trillion annually for infrastructure development but are able to invest only about half of that, says Sharifah Bakar Ali, founder and director of Bespoke Globiz. This makes the match between the two perfect, she suggests. The World Bank estimates Islamic financing will have a value of $3 trillion by 2020.
“Infrastructure is really an area where there can be great use of Islamic finance because most of it doesn’t fall under what is disallowed by Shariah,” says Ali, citing roads, hospitals and schools as examples of projects that are Shariah-compliant.
It isn’t surprising that the first Islamic green bond took place in Malaysia. After Japan and South Korea, the country is Asia’s third-largest bond market as a fraction of GDP. It is also the world’s largest sukuk market. The launch of the Islamic green bonds since 2017 was facilitated by the country’s revision in sukuk guidelines in 2014 to incorporate the use of proceeds for environmentally friendly projects.
But the excitement and interest in the concept is spreading — all the way to the U.K., Malaysia’s former colonizer. Dr. Samir Alamad, head of Shariah compliance and product development at Al Rayan Bank, one of the U.K.’s largest Islamic banks, believes the convergence between Islamic financing and green energy projects makes perfect sense. To him, a truly Shariah-compliant financial institution must “contribute to the betterment of society.” Ensuring no link to social taboos is one part of that mandate, as is maintaining distance from crimes like child labor. But preventing environmental harm is something Islamic banks in Europe could well look at, he suggests.
“The key factor driving this market is government reaction to climate change and current pollution levels in the world,” says Alamad of the new interest in green sukuk. And that’s not limited to Muslim customers but includes a growing set of people globally who are seeking alternatives to traditional banks, as “consumers are now questioning what their bank does with their money,” he says. Top banks such as Wells Fargo, HSBC and Deutsche Bank have been hit by scandals in recent years.
Equally, the rapid expansion of clean energy markets in booming economies like China and India makes the sector attractive for investments. The size of the existing global Islamic finance portfolio interested in green sukuk could be between 15 and 17 percent, estimates Alamad. Islamic green bonds could also serve as a solution to the “dramatic shortfall of funding” for natural disasters that may be exacerbated by climate change, says Mohammed Kroessin, head of Islamic microfinance at Islamic Relief Worldwide, a U.K.-based international humanitarian organization.
“This could be a game-changer,” says Kroessin. “Sukuk could play an important role in front-loading humanitarian responses by building more resilient communities.” Proceeds could be used to pre-finance investments in climate-adaptation technology or humanitarian interventions such as shelters for those displaced by disasters. These disaster sukuks produce financial returns through future grant funding that humanitarian agencies receive. This is how the Gavi World Bank vaccination sukuk worked and how the Red Cross created an “impact bond” in 2017. That, Kroessin says, would benefit everyone — not just the Muslim world.
Green sukuks still face obstacles. When it comes to funding infrastructure, the time between conceptualizing a project and raising money to finance it is sometimes between five and 10 years, says Ali. By then, the funds may have been locked in elsewhere, never reaching the intended project. In the European market, Islamic finance models are still seen as more expensive because they require extra documentation. There’s also the question of perceptions. “The Western world still thinks that Islamic finance is related to terrorist activities,” Ali explains, so anti-money-laundering checks come into the mix.
Still, at a time when the world is grappling for strategies to meaningfully limit climate change, Ali is optimistic that more markets will embrace Islamic green bonds. China and even America are countries she hopes will see the issuance of such bonds. “These markets want to tap into the Islamic investors’ space or already have a sizable Muslim population,” she says. It makes sense for many countries. From Paris to Poland, developing nations have repeatedly highlighted at climate change conferences their need for financing to support clean energy projects. In the green sukuk, they might have an answer.