Fitch Ratings expects ESG Sukuk to persist as a key issuance theme in core Islamic jurisdictions with the share of ESG Sukuk forecasted to reach 15% of all Fitch-rated outstanding Sukuk over the medium term. Outstanding ESG Sukuk grew by 11.2% quarter-on-quarter in the second quarter of 2022, reaching US$19.3 billion. The expected persistence of the issuance theme is driven by government initiatives promoting sustainability and economic diversification, along with rising investor demand and awareness.
About US$4.3 billion-worth of ESG Sukuk were issued in the first quarter of the year. The long-term growth potential of ESG Sukuk remains high, as it currently makes up only 2.6% of the total Sukuk market.
The rating agency identified the benefits of issuing ESG Sukuk including widening investor pools, Sukuk demand generally outweighing supply and branding effects. While demand dynamics was highlighted, it is noteworthy that it is uncertain if green or sustainable labeling gives Sukuk a significant demand boost.
“In some cases, green-labeled Sukuk achieve a lower yield at issuance than similar non-ESG instruments. However, the difference has been quite small in most cases,” Fitch said.
While the ESG Sukuk space is expected to continue its growth trajectory, key challenges include regulatory constraints, a shortage of ESG-focused investors and issuers and a lack of standardization. Additionally, major oil-exporting countries, including countries in the GCC and Malaysia, may face greater reputation and legal risks due to higher scrutiny of potential ‘greenwashing’ from investors.
The growth of ESG Sukuk may be stifled by regulatory constraints compared with its ESG bonds counterpart. Issuing Sukuk is at a disadvantage in general due to its added Shariah complexities with non-compliance likely to affect Sukuk demand. Many recently issued Sukuk require a tangibility ratio of at least 50% in order to comply with AAOIFI Standard 59, with the tangibility ratio falling below 33% likely to trigger a put option by investors. While the amount of ESG Sukuk that can be raised could be capped by the amount of tangible assets the obligor holds, ESG bonds face no such constraint.