There is no doubt there are major challenges facing the future of the planet. Climate change, sustainability, energy transition and protecting biodiversity are themes which varyingly appear in almost every investment publication in any language almost daily. The investment themes which underpin these globally systemic issues are the subject of lots of discussion in Islamic finance including specific initiatives by the Islamic Finance Council UK and many government issuances including Bangladesh, Indonesia, Malaysia and even Sudan.
The European regulatory pressures to ensure fair treatment to investors and also carpetbaggers (or greenwashers) do not yet exist in the US (interestingly enough) but neither have they been systematized by AAOIFI or the International Islamic Financial Market, for example.
Every conference I have attended in the past 12 months has had environmental, social and governance/green Sukuk on the agenda; it is time for standardization to protect investors’ interest and ensure market efficiency. In the meantime, be warned, the demand to ‘greenify’ Sukuk issuance is not necessarily good news for investors.
I would be surprised to see any company which is doing fundraising (in any form) not to align themselves with at least four or five of the UN Sustainable Development Goals (SDGs). After all, the SDGs are catchy, colorful and full of emotive messages for a better future. Much easier for a new Sukuk issuer to identify with the SDGs (which seem to be the main Islamic finance industry guidance from advisors as there is little else to create some order out of the current slightly chaotic answer to the question: “What makes a green Sukuk?”).
Lots of targets to shoot for and almost impossible to miss
But what about investments which not only are supposed to deliver sustainability but also positive performance? Preserving the future and making money are not mutually exclusive; the best sustainable business is one that is profitable. If it is not, how can it survive to make an impact in the future?
Equity markets have slumped this year; the NASDAQ Green Economy Index is down 15% year-to-date and global green bonds (Bloomberg Global Green Bond Index) have underperformed investment grade debt by 40%.
There is not yet a global green Sukuk index but surely this product (or a fund which seeks to establish a benchmark for actively managed green Sukuk) should be in the offing. This is not a good trend.
To explain underperformance in a conventional context, the problem is that the largest asset managers are having to sell off their non-green assets (particularly in Europe with the Sustainable Finance Disclosure Regulation looming) which drives the prices down to buy ‘greener’ assets (particularly bonds which meet the Article 9 requirements) which further drives the yields down as prices rise.
To make matters worse, green issuers (‘dark green’ if they meet the new rules) are issuing long-term debt at very low rates. Why not? Institutional investors need to buy benchmark-sized green debt to meet the new rules; issuers are having a laugh as they can get very cheap long-term funding.
This is a hazard which needs to be minded if any of the Islamic finance standard-setting bodies try to take a parallel course of action. Dislocating the market in favor of green Sukuk to align with conventional standards (as has been done with the London Inter-Bank Offered Rate and the International Swaps and Derivatives Association for example) has a downside for investors.
With inflation on the horizon, the investments are only going one way — down. How is this good for investors when the regulators are forcing people to invest in green products? Suitable investments? Certainly not for the largest asset managers. The solution for Islamic finance investors looking to buck the trend of conventional investors?
Look further afield and for new issuers who do not have the legacy portfolio problem, they can pick up smaller issuances which are at a premium. Large benchmark deals are fought over. Smaller issuers (US$100–500 million) can only get attention by offering higher returns.
‘Greenium’ — the risk is not higher but the market is less efficient in offering a source of value. The risk profile is often lower (given that the issuers need to attract funding by offering more in terms of asset cover, covenants or more robust purchase undertakings, for example) but also impact. Impact happens before these companies or projects reach a benchmark size; job creation, innovation and growth are fostered by supporting such mid-tier issuances.
Islamic finance has a natural alignment to conventional issuance and the opportunity to raise capital from the wider investment community is a limited-time window of opportunity for Sukuk issuers. Investors are looking for sustainable, long-term strategies and Sukuk issuers have to join the wider conversation. For investors, real impact and value can be found; just do not fall so easily for the green trap.
Dr Scott Levy is CEO of Bedford Row Capital. He can be contacted at [email protected]