ESG Sukuk are likely to continue being a key issuance theme in the second half of the year and beyond, says Fitch Ratings (Fitch). The rating agency expects the ESG Sukuk space, which currently makes up 3.8% of global outstanding Sukuk, to increase its share to around 7.5% over a five-year time horizon.
In its estimations last year, Fitch projected the global outstanding ESG Sukuk sector to grow to roughly 5% of total outstanding Sukuk over a five-year period.
While Fitch-rated hard-currency ESG Sukuk accounted for 12.5% of its hard currency-rated Sukuk at the end of the last quarter, the rating agency opines that the sustainability Sukuk space still faces considerable challenges.
With ESG instruments primarily driven by agnostic investors, the shortage of domestic ESG-focused investors and issuers continues to limit the growth potential of the asset class, Bashar Al Natoor, the managing director and global head of Islamic finance at Fitch, told ISFI.
“Islamic finance needs to go the extra mile to achieve the targeted ESG impact. This is because unlike bonds, ESG Sukuk need to be structured in a Shariah compliant manner as well as in a manner that meets green or sustainability mandates,” Bashar remarked.
In addition to the complex issuing process, the rating agency highlighted regulatory constraints as one of several challenges looming over OIC countries, curtailing the issuance of ESG Sukuk.
While a lack of regulatory drive may play a role in stunting the issuance of ESG Sukuk in some OIC countries, the four regions from with ESG Sukuk issuances are concentrated, which are Saudi Arabia, Indonesia, Malaysia and the UAE; all have a significant number of legislation and top-down directives to promote the sustainable finance space.
Although various constraints may be capping the growth of the asset class, the current space has outperformed its non-ESG peers in terms of ratings.
With sovereigns and supranationals contributing to 50% of Fitch-rated ESG Sukuk, over 98% of the ESG Sukuk it rated in the second quarter of this year were investment grade. This notably represents a higher percentage of investment grade instruments than the overall average Fitch-rated outstanding Sukuk, which stand at 79%.