Launch Partners

Tuesday, January 31, 2023

Launch Partners

Islamic sustainable finance in 2022: Walking the talk

For the best part of the last decade, Islamic sustainable finance, which mainly took the form of green Sukuk, was the talking point of the industry. But that was all it was – talk. Despite loud aspirations, Islamic ESG activities remained largely muted. But there have been signs in 2022 which perhaps indicated that we are at the cusp of a real, meaningful shift. The question is: have we turned the corner? VINEETA TAN explores.

Slow start
It took 10 years for the Islamic finance industry to produce its first green Sukuk after the conventional market made their debut. This is despite years of Islamic finance practitioners touting the natural synergy between Islamic finance and ESG principles. Some have chalked up this delay to weak political and industry will.

While perhaps there is some truth to that (then), a complex array of hurdles continues to stand in the way of Islamic sustainable finance. Conflicting climate action regimes and green taxonomies (or the lack thereof), the lack of technical expertise, bureaucracy and the absence of enabling regulations are just a handful of pain points.

Since the first ever green Sukuk offering was made in 2017, the industry has been playing catch-up. EU data values green, social and sustainable bonds at over US$2 trillion in October 2022, double the amount in 2021. On the Islamic side, green and sustainable Sukuk scratched US$15 billion last year.

It may be easy to pick apart how we are seemingly falling behind, even within the Islamic finance microcosm – after all, sustainable finance only accounts for less than 1% of total industry assets.

Diversity sprouting
But there is merit in appreciating how far we have come. Since the 2017 green Sukuk offering out of Malaysia, serious foundational groundwork has been laid out. This has paved the way for sovereigns in Southeast Asia to tap climate related and social Sukuk and even attracted the elusive issuances out of the Middle East.

More notably, that work has germinated into further promising progress seen this last year. Most significantly, in the diversity of Shariah compliant ESG-aligned instruments.

Make no mistake – Sukuk remain the industry’s showpiece. Some US$4.3 billion was raised through sustainability and green Sukuk in the first six months of 2022 (outstanding related Sukuk stood at US$19.3 billion). For the full year of 2021, that number was US$6.1 billion.

In fact, in the second half of 2022, several landmark offerings were made including Dubai Islamic Bank’s US$750 million sustainability debut (one of the largest international offerings out of the GCC this year), the Malaysian government’s first ringgit-denominated RM4.5 billion (US$968.5 million) sustainability Sukuk, as well as several smaller-scale but big-impact green and agricultural papers from the likes of Turkiye’s Emlak Katilim Bankasi and Tarfin, and South African firm Agrarius.

But other flavors of ESG have also emerged, if not gaining greater popularity.

As the Islamic debt capital market took a backseat this year, bank and syndicated financing took off in the Islamic finance realm, and this also seeped into the Shariah sustainability sphere. Banking giant Al Rajhi closed a US$1.16 billion commodity Murabahah facility which complied with the Loan Market Association’s Green Loan Principles – an industry first. Arab Petroleum Investments Corporation signed a US$75 million Murabahah agreement in favor of UK’s Hartree Partners Power & Gas Company to fund voluntary carbon offsets. Maybank Islamic executed a sustainability-linked Islamic profit rate swap with Axis REIT.

More banks such as CIMB Islamic and Standard Chartered are cashing in on the trend with Shariah compliant sustainable investment and deposit accounts. In fact, CIMB Islamic and Standard Chartered Saadiq Malaysia also entered a RM1 billion (US$224.74 million) sustainable collateralized commodity Murabahah deal, a mechanism about four years in the making. In the UK, Gatehouse Bank rolled out the country’s first Halal green home financing products.

Investment managers are also building on the momentum: HSBC Asset Management launched an Islamic ESG exchange-traded fund on the London Stock Exchange, with four others in the pipeline while Malaysia’s RHB Banking Group introduced its Islamic Structured Investment Linked to Index, which takes into consideration ESG parameters, targeting institutional investors.

Credit to carbon credits
Despite doubts, controversies and scandals, the largely unregulated carbon credits universe is making a splash in Islamic finance.

The carbon credit market is on a phenomenal run: it more than tripled in valued from US$310 million in 2020 to US$1 billion last year and it looks like its heading into another record year. McKinsey & Co estimated that the market could be worth US$50 billion by 2030. The Islamic finance industry wants a slice of that pie.

The Malaysian bourse unveiled the world’s first Shariah compliant voluntary carbon market exchange right before 2022 closed its curtain; the first carbon auction is set for early next year. Multilateral financier International Islamic Trade Finance Corporation (ITFC) and the Saudi-backed Regional Voluntary Carbon Market Co facilitated the issuance of the first-ever Fatwa for carbon credits.

This follows the ITFC’s participation in the world’s largest carbon credit sale by Saudi’s Public Investment Fund, which auctioned 1.4 million tons of carbon credits. The ITFC intends to launch carbon offset offerings in 2023.

Islamic markets are paying serious attention: Indonesia, Saudi Arabia and the UAE are among those looking at launching carbon exchanges, making Islamic carbon credits an asset class to watch out for in 2023.

Sustaining momentum
To the optimist, we are making good progress on our promise to channel finance for good, as required of Islam. To the skeptics, our sustainability journey is riddled with flaws and gaps and missed opportunities.

Take COP27 for example. The UN Climate Change Conference, which took place in Egypt this year, to some practitioners fell short this year. Some expected more Islamic finance initiatives and for the industry to have a bigger voice in this global narrative, especially considering the Muslim-majority host country, but that was largely absent. Some thought that the historic loss and damage fund could have had an Islamic component, but that boat has sailed.

However, the IsDB doubled down on its sustainability commitments: it intends to fully align its sovereign operations with the Paris Agreement by the end of 2023. Islamic finance giants Saudi Arabia and the UAE have committed billions toward energy transition. The industry expects a good portion will be Shariah compliant. And, of course, many are holding out hope that the UAE’s presidency of COP28 will translate into an impetus for Islamic finance to play a bigger role in the fight against climate change.

There is no denying that the needs are pressing: devastating floods, debilitating droughts and destructive wildfires demand meaningful actions from financial institutions. Beyond that, it is also a business decision: investors and stakeholders want their investments to do good. A Lombard Odier 2022 survey of high-net-worth individuals found that 91% are already investing in a Shariah compliant manner and 88% plan to increase their allocation to sustainable assets – the opportunity is immense.

The year 2022 witnessed the sector beginning to reap the earlier seeds sowed: the industry is mobilizing Islamic sustainable efforts at a level never seen before. Islamic financial institutions are equipping themselves with the right frameworks to support their sustainability ambitions. Regulators are putting together policies to prop the market. Market players are engineering new products.

The hope is, we will see this pace picking up next year, and diversity of products and structures ramping up.

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