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Saturday, May 25, 2024

Launch Partners

Financing transition in Malaysia through the Islamic capital market

The importance of transition activities has particular significance in markets such as Malaysia, where economic development has been spurred by industries that are naturally reliant on resources such as energy and oil, and the plantation sector.

In September 2021, the Malaysian government announced its net-zero ambition: to become carbon-neutral as early as 2050, putting us ahead of many of our Southeast Asian neighbors.

The government has set a series of credible commitments toward attaining ESG goals. Among others, it has committed to cease building new coal-fired power plants by 2040 and has also tabled plans to introduce carbon pricing. The Malaysian government aims to deliver on renewable energy capacity of 31%, and 40% by 2035 and has committed to reduce 45% of its economy-wide carbon intensity against its GDP in the next eight years.

These are major shifts, as Malaysia has traditionally relied on coal for power generation. Many of its hard-to-abate sectors such as energy, transport, shipping and manufacturing must undertake significant transformation in order to reduce their emissions — a feat not only technically challenging but one that will require major financing and investment.

The country has begun to witness traction in this space. The first three sustainability-linked issuances were transacted in Malaysia within the last 10 months, with issuers coming to market with two sustainability-linked Sukuk and one sustainability-linked bond amounting to a combined total of US$1.45 billion.

Malaysia’s financial regulators as early as 2014 have embarked on efforts to develop sustainable finance standards and facilitative development policies to catalyze growth in sustainable finance. More recently, a greater focus has been placed on transition finance and sustainability-linked debt issuances.

In June 2022, the Securities Commission Malaysia (SC) introduced the SRI-linked Sukuk Framework aimed at facilitating companies, including those in hard-to-abate sectors, to tap into the capital market to meet their transition finance needs, thus enabling them to speed up their transition toward low-carbon emission activities. The framework provides clear expectations for Sukuk issuers to comply with as it is premised on financial as well as structural features, disclosure and reporting in accordance with international best practices.

Following the introduction of the framework, the SC expanded its SRI Sukuk and Bond Grant Scheme, which was established in 2018 to assist issuers in defraying up to 90% of the external review costs for SRI Sukuk, to include SRI-linked Sukuk issued under the SC’s SRI-linked Sukuk Framework. This means that issuers of sustainability-linked Sukuk will now be able to defray the cost of pre- and post-issuance independent reviews through the grant.

As the sustainable finance universe expands to include high-emitting activities at greater scale, avoiding greenwashing has naturally emerged as a key challenge, heralding the need for robust taxonomies that clearly identify those economic activities which are sustainable and outline reporting obligations on companies and financial market participants. To this end, Malaysia’s financial regulators have developed two taxonomies catered specifically to the country’s banking sector and the capital market respectively.

The Climate Change and Principle-Based Taxonomy was issued in April 2021 by Bank Negara Malaysia (BNM) to guide financial institutions in identifying and classifying economic activities that could contribute to climate change mitigation and adaptation. BNM has introduced a progressive system of transition categories (climate supporting, transitioning and watchlist) to acknowledge concrete transition efforts and commitments by businesses to adopt sustainable practices.

The SRI Taxonomy, which will be launched by the SC by the end of 2022, was developed to enable capital market participants to identify economic activities that are aligned with ESG objectives. This taxonomy also provides guiding principles in financing a credible transition to enable more companies to leverage market-based instruments in meeting their transition finance needs. Notably, given that emissions-intensive and hard-to-abate sectors are arguably where the social risks and potential impacts on workers and communities are the greatest, the SRI Taxonomy includes social objectives, which is particularly important in the context of ensuring a just transition.

With these various frameworks and policies in place, it is anticipated that more companies will avail of the transition financing opportunities made available through the Sukuk market, demonstrating how Islamic finance can play a role in facilitating transition and its effectiveness in meeting the SDGs.

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