Launch Partners

Thursday, July 18, 2024

Launch Partners

The dynamics, challenges and potential for Islamic green finance and Sukuk

Oussama Kaissi, CEO of the Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC), writes that the shift toward increasing investment and financing to support a sustainable and inclusive development agenda has progressed steadily over the last two decades. These are in line with achieving the targets set by the 2015 Paris Climate Agreement of Net Zero Carbon Emissions by 2050 and the 17 UN SDGs by 2030.

During this time, a body of converging financing initiatives, sometimes termed blended finance, continues to gain traction in global markets to support transformation toward a green economy. They include ethical, green, sustainability and ESG finance, green, social, sustainable, and sustainability-linked (GSSS) bonds, socially responsible investments (SRI), and, of course, faith-based alternative financial intermediation, of which Islamic finance is the pre-eminent example in terms of market size, depth, and range of instruments, including Sukuk.

The broad scope of these initiatives involves financing investments that generate just benefits to the environment, society, equality, and diversity with the aim of achieving inclusive, resilient, and sustainable development. These initiatives have essentially become a core new component of economic, financial, and social inclusion.

Against a global background of a stalled recovery or ‘normalization’ from the ongoing COVID-19 pandemic, and even before events in Ukraine unfolded, the global economy had already shown signs of large-scale shocks, including rising fuel and food prices and inflation, subdued GDP growth, a cost-of-living crisis, burgeoning unemployment, and sovereign debt levels which have seen six countries default thus far in 2022, rising levels of inequality and food and energy insecurity and poverty – all of which have intensified underlying vulnerabilities in emerging markets and developing economies, many of which are member states of the IsDB Group.

Not surprisingly, dealing with the above impacts is a global policy priority, especially in the transition to clean and just energy, in resilience in climate adaptation, in promoting food security and in better health systems.

Regulators all over are rushing to adopt sustainable and green finance taxonomies and are rewriting the playbook for political and market demands that companies report their environmental and social impact. The EU introduced Phase I of its Sustainable Finance Disclosure Regulations (SFDR), requiring asset managers and financial advisors to reveal ESG information to encourage more private funds into green investing and to pre-empt green and sustainability washing.

Judging by the rhetoric of aspiration tempered with desperation emergent from the final hours of COP27 [the 27th UN Climate Change conference] negotiations in Sharm El Sheikh, that holy grail toward meeting the Paris and SDG targets remains elusive. Even the proposed new funding arrangement on loss and damage – a pooled fund for countries most affected by climate change – has failed to see even a single dollar of commitment and comes with too many unknowns.

What was bereft in the COP27 text was no progress nor follow-up on phasing out fossil fuels, especially coal and crude oil, and no mention of emissions peaking before 2025, as the science tells us is necessary. Instead, there is a sharp U-turn in the language around fossil fuels, which now refers to “low emission and renewable energy” that could allow for the development of further gas resources, as gas produces less emissions than coal.

Even climate activists are divided – some believe that the goal of achieving 1.5C is on ‘life support’, while others optimistically stress that “the spirit of 1.5C is strong, even if the COP27 final text is weak”.

The figures on gaps in SDG financing, climate financing, related infrastructure, food security, rebuilding health systems, and social safety nets are piling up into trillions of dollars over the next five decades. Public investment through national budget allocations can only meet some of the rising costs. Much will have to come from private investment, blended finance, public-private partnerships (PPPs), philanthropy, and innovative new structures with requisite risk mitigation and credit enhancement wraps provided by export credit agencies and credit and investment insurers.

Business case for green finance
As a signatory to the Principles for Responsible Insurance (PRI) and the ICIEC being the only Shariah compliant multilateral insurer, sustainable investment is firmly embedded in our due diligence process through linking all new business and other queries with SDG, food and energy security, and climate action indicators.

Insurers are regarded as green economy enablers because they are also risk absorbers. According to Fitch Ratings: “A long-term investment focus means insurers are well placed to channel investment into infrastructure projects, notably in renewable energy. Insurance solutions can reduce risks inherent in infrastructure projects and increase their attraction to investors. The ability to help channel investment into sustainable projects is a sizeable growth opportunity for the sector.”

The business case for increased green finance is clear. According to the UN and IMF, the world needs some US$90 trillion worth of infrastructure investment by 2030 and US$5-7 trillion annually to meet the SDG targets by 2030 – but there is a persistent financing gap of US$2.5 trillion each year. As such, the issuance of green, social and sustainable debt instruments have proliferated. In 2021, a record US$1 trillion of green, social, and sustainable bonds were issued globally. This figure, according to the EU, has already surpassed US$2 trillion by October 2022.

A lagging Islamic green finance and Sukuk footprint
In contrast, total green and sustainable Sukuk, according to Fitch Ratings, reached US$15 billion in 2021, led by sovereign and corporate issuers in Indonesia, Malaysia, and the GCC states. Core Islamic finance markets, however, have failed to capitalize given that Sukuk remains the preferred format for ESG-linked debt in these markets. According to the IMF, climate Islamic finance (in the form of green Sukuk issuance) stood at US$2.56 billion in 2020. It fell to US$869 million in 2021, even as global green Bond issuance rose to US$517 billion in 2021 from US$297 billion in 2020.

In a recent paper on mobilizing private climate finance, the IMF maintains that “despite the constraints and risks, there are several opportunities for private sector finance to play a bigger role in climate finance, including through employing new innovative financial instruments. Several financial tools have already been used in climate financing in recent years, including commercial bank lending with climate considerations, green bonds and green loans, sustainability-linked bonds and sustainability-linked loans, social bonds, green asset-backed securities, private equity and venture-based investments in climate-related companies, and others. Green Sukuk that were first launched by Malaysia in 2017 and were used to exclusively finance green projects, have seen issuances in a few countries over the past few years, including Indonesia and the UAE.”

Similarly, the global Islamic finance industry, according to S&P Global, is projected to have assets under management (AUM) in excess of US$3.6 trillion by 2025. And yet, the industry’s green, ESG and sustainable finance footprint lag significantly compared with the conventional finance industry.

Paul Horrocks, the head of the private finance for sustainable development unit for the OECD, and Alissa Kruger, a policy analyst in the same unit, in a recent article on how GSSS bonds can be important blended finance instruments that can effectively support the SDGs through scale and impact, noted that: “Global Islamic finance with a total market value of US$2.2 trillion, is considerable and supports the financing needs of approximately a quarter of the world’s population. The Middle East, Africa, and South Asia (MEASA) region plays a key role in driving its expansion.

“The industry-wide growth means that the global value of Sukuk issuances is expected to have reached US$155 billion in 2021, up from US$149 billion in 2020, as both corporates and governments tap into Islamic finance. S&P highlighted in its recent report the likelihood of more frequent issuance of dedicated social Islamic finance instruments and green Sukuk as the financial actors in the region further align with ESG values to be significant. This is also in keeping with the agenda of many countries that use Islamic finance towards an energy transition pathway.”

Across the Islamic finance industry region, there have been some green Sukuk transactions, including in countries such as Indonesia. However, they maintain that “for a long-term market to be established and for greenium levels to develop in regard to pricing a number of factors will need to be put in place such as the right regulatory framework, a flow of transactions by both sovereign and corporate issuers and awareness and interest by private sector investors in GSSS bonds.” Greenium, or green premium, here means the saving an issuer can enjoy on its cost of borrowing, because it is issuing a green bond – or other green instruments such as Sukuk – rather than a conventional instrument.

The consensus is that the potential for Sukuk in funding sustainable investment and infrastructure development is huge. The questions remain: why are the issuance volumes, its regularity, product diversity, market depth, and reach muted, given that the rhetoric of aspirations is so loud and clear? How can the issuance of green Sukuk be impactfully upscaled through facilitating government and institutional policy commitment, political will, best practice enabling regulatory frameworks for issuance, product innovation, market education, risk mitigation solutions, disclosure standards, inadequate independent data flows, poor messaging, and fragmented communications?

Islamic finance and sustainable investment have connectivity steeped in our faith principles. To gain traction in green finance and Sukuk, we need to reset the industry’s role to achieve greater policy coordination, the structure of processes, standardization of taxonomies, and regulatory, reporting and disclosure standards. The OIC, the IsDB, and the Islamic finance industry are in urgent need of a unified Islamic green and sustainable finance and investment vision 2050, of which a holistic Shariah compliant taxonomy and roadmap for sustainable and green finance must be a central plank.

Currently, the Islamic green finance and Sukuk ecosystem is too piecemeal, fragmented, and ad hoc, underpinned by unreliable, dated, non-independent, and, in many instances, incomplete and unverifiable data, which makes investment decisions even more difficult.

Green shoots of hope
The ethos of Islamic finance, especially the principles of Fiqh Al Muamalat (Islamic principles relating to financial transactions), in general, is consistent with the objectives of the SDG agenda, climate action, ESG, poverty alleviation, gender empowerment and equality, and food security to promote the wellbeing of citizens.

Green finance has essentially become a core component of economic, financial, and social development and inclusion. Regulators and corporates all over are rushing to adopt green finance taxonomies and frameworks and are rewriting the playbook for political, market, and societal demands that companies report their environmental and social impact. Islamic green finance has the same aspirations. The stark reality is that all governments, irrespective of economic status, cannot afford to finance pre-emptive and mitigation initiatives out of national budgets alone and will rely heavily on contributions from multilaterals and, in particular private investment, which is seen to be the major driver of sustainable development action.

Islamic finance is increasingly adopting sustainability criteria, so it is well-positioned to maximize social impact and address the SDGs. “The SDGs require unprecedented mobilization of funds to support their implementation. Islamic finance, with its focus on the real economy, offers an effective non-traditional means of financing sustainable development activities and projects in developing countries. Many countries have started to reap the benefits offered by Islamic financing options, which lowers their debt-to-equity ratios for capital-intensive projects. Over the next few years, Islamic finance will be considered as one of the primary financing strategies, especially for Egypt,” stressed Dr Hala El Said, the Egyptian minister for planning and economic development.

The pandemic also focused attention on SDG, ESG, SRI, Sustainability, and ethical finance, and the agenda was also promoted by Islamic finance markets. Moody’s Investors Service, in a recent survey of GCC fund managers, forecast strong growth over the next year, supported by growing demand for Islamic products and ESG investment.

Green Sukuk issuance will accelerate as governments promote sustainable policy agendas and as demand for sustainable investments encourages new issuers to consider green Sukuk as an alternative financing tool. According to Fitch Ratings, the volume of green and sustainable Sukuk outstanding increased by 31.7% in the first quarter of 2021 to reach US$11 billion, representing 9% of the total Sukuk portfolio. There has also been a measured proliferation of ESG funds, Waqf-featured funds, and leveraging Islamic philanthropic instruments such as Zakat, Sadaqah, and Waqf for the development of the Islamic social finance sector.

The IsDB Group is a major player in contributing to the sustainable finance ecosystem. The ICIEC, the group’s insurance arm, has proposed the establishment of a Climate Action Finance Trust Fund with institutional partners, peer multilaterals, and export credit agencies in the member states and beyond, which would offer a discount to the insurance premiums needed for the financing of climate action projects in the member states that are not investment grade.

ICIEC actively targets real impact and change in all its financing, insurance policies it underwrites, and projects it supports, and acts as a catalyst for private sector capital mobilization toward achieving the SDGs. Cumulatively, over 28 years, the ICIEC has insured more than US$92.4 billion in trade and investment and US$1.3 billion in support of foreign direct investment at the end of October 2022. Its activities were directed to specific sectors – US$37.2 billion to energy, US$26.1 billion to manufacturing, US$6.3 billion to infrastructure, US$2.3 billion to healthcare, and US$1.5 billion to agriculture. The IsDB Group’s current renewable energy financing totals about US$3.4 billion, and the ICIEC, as the group’s insurance arm, has provided US$470 million in insurance for renewable energy projects in member states.

Moody’s, in its 2022 Islamic finance cross-sector outlook, maintains that it expects the Sukuk market to remain on a positive growth trajectory in the long term, mainly driven by the entrance of new participants to the market, combined with and supported by rising demand for green and sustainable Sukuk.

“We expect green Sukuk issuance will also accelerate as governments promote sustainable policy agendas and demand for sustainable investments encourages new issuers to consider green Islamic instruments as a financing alternative. In addition, Sukuk instruments already fill some of the ESG requirements and make them even more compatible with sustainable investment. Increasing appetite for such instruments is underpinned by the strong growth of green and sustainable Sukuk in the last five years, with issuances nearing US$8 billion in 2021 compared with less than US$1 billion in 2017.”

New issuers seeking to diversify their funding sources are also joining the market as Sukuk becomes widely accepted. The low penetration rate of Islamic products in several Muslim-majority countries also offers additional growth opportunities for Sukuk. This potential, says Moody’s, has been identified by several governments across the MENA and Southeast Asian regions, who have accordingly implemented favorable regulations and issued sovereign Sukuk to support market growth.

This is particularly true in the case of Turkiye, where the authorities have played a prominent role in the creation of Islamic banks and taken on issuing Sukuk on a regular basis. It is also the case in Saudi Arabia, where the government used its debt refinancing in the 2022 financial year as an opportunity to further increase the share of Sukuk in its debt mix, although the Kingdom has yet to issue a sustainability or green Sukuk.

“It is important to note that most Muslim-majority countries benefit from strong demographic and economic growth potential that will provide Islamic debt markets with a growing economic base to continue to expand in the coming years. The global Muslim population is projected to rise from 25% of the world’s population currently to 30% in 2050,” observed Moody’s.

Green Sukuk market activity in 2022
Sukuk issuances linked to sustainability, ESG, SRI, and green finance continue to gain momentum in the global Islamic capital market, albeit the pace, size, and diversity of Sukuk structures need to be far more urgent given the huge challenges OIC states are faced with in terms of climate adaptation costs and finance and transition to just clean energy.

Sukuk, according to the G20, has a huge potential to finance climate-related projects, especially in key sectors, including infrastructure, renewable energy, primary healthcare, and agriculture.

The green Sukuk market is nascent and despite its alignment with the principles of Islamic financial intermediation, it has been slow to take off on any meaningful growth trajectory.

There is much aspirational rhetoric about green Sukuk and its faith-based ethos and suitability to SDG and sustainable finance, but unfortunately, it is not matched by market activity in the 57 member states of the IsDB. Not surprisingly, projections of its growth trajectory are equally optimistic. The Islamic Finance Council UK (UKIFC), for instance, estimates “an additional US$30-50 billion of capital towards the SDGs can be raised by 2025 through green and sustainability Sukuk. This will require focused efforts and targeted initiatives by institutions such as United Nations Development Programme, PRI and the IsDB along with multiple governments”.

The reasons for this green Sukuk inertia are manifold – Sukuk policy deficit from governments, absence or dearth of green Sukuk issuance frameworks and enabling legislation, lack of secondary trading of Sukuk certificates due to limited listings in stock exchanges, lack of awareness in general of the green debt market, risk averseness of issuers, lack of market makers – both sovereign and corporate, the need for third party certification of the green asset pool, lack of suitable assets to securitize and political and ideological reluctance to allocate state-owned assets to Sukuk asset pools, the unfamiliarity of large swathes of sovereign and corporate issuers with Sukuk structures albeit this is steadily receding through market education and technical workshops, lack of credit enhancement and third party guarantees especially for developing countries’ issuers which are not investment grade rated, a limited investor base and failure to democratize Sukuk issuances by also making them accessible to ultra-retail investors.

Green Sukuk have been issued for a few years now, pioneered by Indonesia, the most proactive sovereign issuer of green Sukuk. Similarly, Malaysia, Turkiye, Pakistan and a host of multilaterals such as the IsDB, banks, corporates, government-linked companies have issued green, ESG, SRI, and sustainability Sukuk in the last few years.

Jakarta’s latest offering in June 2022, a two-tranche US$3.25 billion Sukuk Wakalah, according to the Directorate of Islamic Financing at the Directorate General of Budget Financing and Risk Management, Indonesian Ministry of Finance, is the largest single global green Sukuk transaction ever issued by the Republic. The issuance comprised a US$1.75 billion five-year tranche maturing in June 2027 and a US$1.5 billion 10-year year (Green) Reg S/144A Trust Certificate tranche due in June 2032. The proceeds from the green Sukuk, according to the Directorate General, “will be used to finance or refinance expenditure directly related to ‘eligible green projects’ as defined in Indonesia’s Green Bond & Green Sukuk Framework”.

We have also seen small green Sukuk issuances in Türkiye, Malaysia, and South Africa in the agricultural, construction, and renewable energy sectors.

Global Sukuk market dynamics
Refinitiv projects a stable outlook for Sukuk supply despite global headwinds. “Following a five-year record streak,” stresses Refinitiv, “global Sukuk issuance is set to moderate in 2022. The Refinitiv Sukuk supply and demand model projects Sukuk issuance to settle at US$185bn by the end of the year. Sukuk supply, as defined by the total Sukuk outstanding, reached US$726.8bn in FH 2022 and is projected to increase to US$742.3bn by the end of the year. Refinitiv projects Sukuk issuance to grow at an estimated compounded annual growth rate of 6.8% over the next five years, reaching US$257bn in 2027. The size of the Sukuk market is expected to reach US$1.1 trillion in 2027, growing at a compounded 7.9% annual growth rate.

It maintains that new issuers seeking to diversify their funding sources are joining the market as Sukuk becomes widely accepted. It predicts that the issuance of Green Sukuk will also accelerate as governments promote sustainable policy agendas and demand for sustainable investments encourages new issuers to consider Green Sukuk as an alternative financing tool.

Sukuk regulatory resilience
The main regulatory development governing SRI and sustainability Sukuk in 2021 thus far has been the SRI-linked Sukuk Framework launched in June by the Securities Commission Malaysia (SC) to facilitate fundraising by companies in addressing sustainability concerns such as climate change or social agenda, with features that relate to the issuer’s sustainability performance commitments. With the accelerated shift toward developing a climate-resilient future, high-emitting industries are at a high risk of being phased out. The SRI-linked Sukuk will enable companies in these, as well as other industries, to transition into a low-carbon or net zero economy.

The new framework is an extension of the initiatives under the SRI Roadmap that was introduced in 2019 to broaden SRI product offerings. More significantly, this initiative reflects the SC’s commitment to expand the reach of the Islamic capital market (ICM) to the broader stakeholders of the economy and build an enabling ICM ecosystem for the sustainability agenda. According to SC Chairman Dr Awang Adek Hussin: “The SRI-linked Sukuk Framework will encourage the greater mobilization of the private sector and issuers’ financing toward sustainable development and meet the increasing global demand for sustainable financing. This is in line with the initiatives outlined in Capital Market Masterplan 3 to reinforce Malaysia’s value proposition as the regional center for Shariah compliant SRI.”

The SC recognizes that there are significant opportunities for the market to attract a more diverse issuer and investor base and undertake a wide range of sustainable projects. Malaysia is currently one of the top hubs for sustainable and responsible investment in the world, especially in the Shariah complaint space, in which social and financial inclusion values and goals are firmly embedded, in addition to the market and financial returns. Measures to grow the domestic SRI ecosystem focus on enhancing awareness and appreciation of sustainability and facilitating green and SRI product offerings. As such, the SC recently released a consultation paper on the principles-based SRI taxonomy for the Malaysian capital market.

Mortgage securitization – Sustainability and green Sukuk for housing
Affordable housing stock and concomitant mortgage finance is a major social and economic development deficit in all economies partly because of aberrant housing policies, which has seen the sector starved of investment, demographic changes, an over-concentration on a high-end luxury development, and the vagaries of the mortgage finance market in changing interest or profit rate environments. The flip side to the housing and mortgage market is mortgage securitization, of which Cagamas, the National Mortgage Corporation of Malaysia, is one of the most prolific issuers of Sukuk (and conventional bonds), including sustainability, SRI, and green Sukuk.

Proceeds from Cagamas’s Sukuk are used to fund purchases of eligible housing assets from the financial system by issuing bonds or Sukuk. Cagamas is by far the most experienced and prolific issuer and originator of Sukuk and continues to be an innovator in the mortgage finance and securitization market. In the last two years, the corporation has enhanced its green and sustainability Sukuk issuance credentials. In early November 2022, Cagamas issued a RM500 million (US$108.7 million) ASEAN social SRI Sukuk through a private placement.

“The social SRI Sukuk demonstrates our continued efforts to facilitate an emerging sustainable asset class and to promote the growth of a sustainable market ecosystem,” explained Chung Chee Leong, the president and CEO of Cagamas.

Sukuk guarantees and credit enhancement
Credit enhancement and third-party guarantees are virtually bereft from the Sukuk landscape, at least in terms of potential demand. A major development, however, is the imminent role of ICIEC’s Sukuk Insurance Policy (SIP) for a project in Sharjah. SIP is a credit enhancement and third-party guarantee instrument aimed initially at promoting sovereign domestic issuances by member states that are rated below investment grade. The SIP allows issuers to better attract capital for ‘green’ projects. The SIP is valuable for issuers in low-income and developing member states, which are below investment grade rated and consequently attract less private capital for sustainable development projects.

The rollout of SIP could expedite the issuance of sovereign and quasi-sovereign issuances, especially from the least developed ICIEC member states in Asia and Africa, which can then be extended to corporate offerings, bearing in mind the credit enhancement base is very low.

The only institution that has guaranteed Sukuk issuances in 2022 thus far is Danajamin Nasional, Malaysia’a first financial guarantee insurer. KAB has four guarantee products, including a Green Technology Financing Scheme, which is intended to encourage SRI that achieves green, social, and sustainable standards in Malaysia. To date, Danajamin’s financial guarantees have assisted 48 issuances, with a total guaranteed size of RM11.4 billion (US$2.58 billion). The total market impact of these deals, through risk-sharing collaboration with partner banks, stands at RM24.2 billion (US$5.48 billion).

Resilience tempered with the rhetoric of aspiration
The Islamic finance industry has shown remarkable resilience in the wake of global uncertainties over the last three years, especially in its response to the COVID-19 pandemic and in its growth trajectory. This trend is especially encouraging in the two largest Islamic finance markets by far – Malaysia and Saudi Arabia. The importance of the Islamic banking industry to the economy cannot be overstated. In Malaysia, for instance, the industry contribution to the national GDP in 2021 totaled 1.23%.

The growth dynamics suggest an upward trajectory over the next few years. S&P Global projects the industry to reach assets under management (AUM) of over US$3.6 trillion by 2025. Refinitiv, in its Islamic Finance Development Report 2021, reports a steady increase in total AUM from US$2.96 trillion in 2019 to US$3.37 trillion in 2020 to reach a projected US$4.94 trillion in 2025.

In Malaysia, according to Bank Negara Malaysia (BNM), Islamic financing in 2021 totaled US$198.88 billion – up from US$183.36 billion in 2020. This trajectory continued in the first four months of 2022 when Islamic banking assets of the total banking system assets reached 30.42% compared with 30.66% at the end of December 2021. Total Islamic banking AUM at the end of April 2022 reached US$219.56 billion – up from the US$214.48 billion at the end of 2021. In Saudi Arabia, Islamic banking AUM is well on its way to breaking the US$1 trillion barrier. According to the Saudi Central Bank, Islamic AUM reached over US$565 billion in the first quarter of 2021.

The green and climate taxonomy conundrum
While several OIC member states and corporates are starting to adopt green taxonomies and ESG and climate action frameworks and strategies, they remain ‘works in progress.’ Climate action – finance, mitigation, and adaptation, is hampered by a cornucopia of structural constraints, apart from the usual lack of resources, policy deficits, lack of technical expertise and the market vagaries of decarbonization, carbon pricing, capture, and storage.

A forum organized by OMFIF, the UK-based independent central banking think tank, identified several constraints, including “unnecessary bureaucracy”, excessive risk aversion, lack of harmonization of disclosure standards for sustainable finance, proliferation of worldwide fragmented green taxonomies for guiding sustainable investments, and the need to achieve an appropriate framework for public and private investors and financial institutions to channel private investments into the vast opportunities for sustainable and green finance.

Worldwide regulatory agencies need to harmonize disclosure standards for sustainable finance to reduce unnecessary bureaucracy and maximize capital flows into investments countering climate change. Currently, there are several different definitions of ESG, sustainable investments, and impact investment. Similarly, the proliferation of worldwide taxonomy schemes for guiding sustainable investments is causing confusion and inefficiency. What is required is a regulatory system that is diverse enough to handle the complexity of sustainable finance initiatives and the multiplicity of organizations promoting them yet sufficiently simple to improve transparency and enforceability.

The danger, according to the forum consensus, is that a failure to harmonize climate action regimes and green taxonomies may lead to competition between jurisdictions and some investors migrating to regions such as the US and Asia, where opportunities for scaled-up investment may deemed to be greater and perhaps even more lax.

Malaysia, which is well into developing its own comprehensive green and climate taxonomy both under its own national strategy and under an ASEAN initiative, is strongly promoting climate action reporting by the financial services industry. The Joint Committee on Climate Change (JC3) of BNM and the SC, for instance, reviewed in August the progress of financial institutions, including the countries 14 or so Islamic banks, are making in strengthening their response to climate risk. The two regulators have launched the Climate Change and Principle-based Taxonomy (CCPT), under which financial institutions are required to transition to the taxonomy and to report their progress toward achieving this.

JC3 is also cooperating with Capital Markets Malaysia, an affiliate of the SC, to develop an ESG disclosure guide tailored to Malaysian SMEs. The SC also released a consultation paper on the principles-based SRI taxonomy for the Malaysian capital market. The SRI taxonomy aims to guide companies with transition finance needs, facilitate investment allocation and promote the growth of SRI assets. In terms of Islamic social finance, there was continued traction in Waqf-featured funds, thus providing investors with an instrument to achieve both financial and socially impactful outcomes.

Sustainability and climate action for OIC member states is a complex policy challenge. Most OIC member states face particular climate threats due to declining agricultural productivity, weather volatility, and receding water levels and quality. These threats are exacerbated in some countries by political instability, conflict, corruption, and low adaptation capacities due to technological and financial impediments.

Together they make member states most vulnerable because of their dependence on high climate-sensitive natural resources. Many OIC states are primary commodities producers and processors, including oil, gas, coal, palm oil, and other agri products. Transitioning to clean energy will be a difficult and lengthy process.

As such, the transition has to be well thought out and pragmatic, balancing the demands of climate change with those of economic development agendas and resource mobilization. The arbitrary divestment and decommissioning of the above sectors are not realistic because of the devastation it can potentially cause to the economy per se and its resultant impact on the lives and livelihoods of the
the general public may be bigger than the actual disruption caused by climate change itself.

It is not surprising that the Islamic finance industry, like the mainstream sector, is subject to the same unintended anomalies or dichotomies.

Sustainable commodity and retail finance
Commodity Murabahah and retail finance are the two largest directions of financing in the global Islamic finance sector. While there is no reliable aggregate independent, up-to-date data about the volumes directed towards that corpus of financing called Islamic ESG, SRI, green, ethical and sustainable finance, some ad hoc financings continue to flourish in the market.

In September, for instance, Saudi Arabia’s Al Rajhi Bank, successfully concluded a three-year dual-tranche US$1 billion sustainability commodity Murabaha facility, which will be directed toward sustainability financing for corporate clients and projects. This transaction is considered as the largest Shariah compliant syndication in the Middle East that complies with ESG standards and practices.

The fact that the Murabahah syndication was well received in the international and regional markets with the orderbook well oversubscribed, which prompted Al Rajhi Bank to upsize the value of the facility from the initially offered amount, suggests a strong latent investor appetite for ESG and climate related offerings. The transaction is the first ESG syndication in accordance with the bank’s sustainable financing framework, which was established to facilitate the financing in accordance with global ESG standards and principles.

In the retail sector, Affin Islamic Bank recently launched the AFFIN Solar Financing-i product, a first-of-a-kind Shariah compliant sustainable and personal financing plan for the banks’ retail customers to purchase and install solar photovoltaic System at residential and non-residential properties.

Philanthropy in the climate finance mix
Philanthropy is well entrenched in the ethos and playbook of Islamic finance. Waqf, Zakat, Sadaqah, Qard Hassan, Fidyah, and other instruments are well established, albeit their existence, structures, regulation, and oversight remain fragmented, sometimes politically abused, sometimes subject to mismanagement and even corruption – thus undermining their impact.

We are optimistically told that their aggregate AUM total billions of dollars. The reality is that despite various national, regional, and institutional attempts, there is still no reliable, independent central data repository to support the above claims.

Nevertheless, where Islamic philanthropy is active, it has managed in delivering impressive outcomes in primary healthcare, housing, MSMEs, education, gender empowerment and entrepreneurship, drug rehabilitation, financial literacy for children, and so on. The challenge is how these achievements can be upscaled into a coordinated regional and global initiative that capitalizes on resource mobilization, technical expertise, research and development, product innovation, governance, transparency, and so on.

Philanthropists globally are estimated to spend a total of US$730 billion each year on good causes, yet just 2% of this finds its way toward climate change mitigation. In the Islamic philanthropic finance space, the situation is no different. Philanthropic capital can contribute effectively toward climate change mitigation and adaptation, especially through PPP mechanisms and related projects.

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