To those unfamiliar with Islam, environmentalism may not be what immediately jumps to mind when one thinks of it. But in fact, it is a significant part of the religion. According to the Quran, humans are meant to be stewards of the earth, and environmental protection is a religious duty as much as a moral one. In keeping with this doctrine, there are several cases of Islamic investors, institutions and individuals funding environmental protection efforts, like leopard conservation and coral restoration.
Moreover, the Islamic world also has great potential to help save the planet on an even bigger scale than this, specifically because of the value of Islamic finance.
What is Islamic Finance?
Established in the 1970s, Islamic finance refers to the provision of financial services in accordance with the Quran, which forbids the receipt and payment of interest, speculative income and the financing of activities that could be harmful for society.
Because of this, Islamic finance trades in interest-free bonds known as sukuk, proceeds from which are used to purchase assets that all participating bondholders have partial direct ownership of, which are jointly managed to generate profits to repay them with. Because assets and income from sukuk can’t be speculative, issuers must be fully transparent about the nature of assets and proceeds from sukuk must be used for their intended purpose, giving investors a higher degree of certainty than conventional bonds.
Green Potential
Despite its relative youth, Islamic finance has become an increasingly significant player in global financial markets, being valued at US$ 3.95 trillion in 2021 and projected to be worth $US 5.9 trillion by 2026. Of this, sukuk –which take up an increasing share of the global fixed-income market– were worth over US$ 775.7 billion in 2021. Given that annual funding for the UN Sustainable Development Goals (SDGs) falls short by around US$ 2.5 trillion each year, this makes Islamic finance well-positioned to help close this funding gap.
Indeed, there has already been a shift towards this through the creation of green sukuk, in which 100% of proceeds are spent on eligible green assets (primarily renewable energy projects and government green subsidies). Since the first green sukuk issuance in 2017, its market value has grown dramatically, going from US$ 500 million to US$ 3.5 billion in 2019 to US$ 8.1 billion in 2022, with the three biggest issuers being Indonesia, Malaysia and Saudi Arabia. This trajectory is likely to continue due to both the emergence of new sukuk markets in regions like Africa, and a growing interest in transparent ethical and environmental investments among international investors, who are already oversubscribing to existing green sukuk. There is therefore great potential for green sukuk as a source of environmental funding, with the Islamic Finance Council UK estimating that it could raise US$ 30-50 billion for the SDGs by 2025.
The Green Sukuk Receipts
Green sukuk are so far relatively few in number, with only 17 being issued globally as of July 2020 according the World Bank. Nevertheless, there are already cases of it generating tangible environmental benefits through attracting large investments to green projects, with perhaps the most exemplary being the Sovereign Green Sukuk issued by the Indonesian government.
Issued in 2018 in partnership with the United Nations Development Programme (UNDP), this five-year sukuk raised US$ 1.25 billion to finance or re-finance 23 green projects focusing on climate change resilience, energy efficiency, renewable energy, waste management and sustainable transportation. These include the development of 121 renewable energy units (replacing fossil fuel powered ones), flood mitigation in areas facing excess rainfall, and a double-track railway system in Java to encourage greater use of low carbon public transport. In total, the Sovereign Green Sukuk is projected to reduce 8.9 –10.3 million tonnes of carbon emissions, and UNDP is now using it as a model for similar exercises in other countries, including Uzbekistan and Pakistan.
Corporate-issued green sukuk are also showing signs of promise. In 2017, Malaysian renewable energy group Tadau Energy, raised US$ 59 million from the very first green sukuk to finance a solar power plant. More recently in the United Arab Emirates (UAE), clean energy company Masdar, recently raised US$ 750 million through green sukuk to fund the development of new renewable energy projects, both domestic and international.
Limitations
Despite the achievements and growth of green Islamic finance, there are still several limitations that are keeping it from meeting its full potential.
One of the biggest is that green sukuk issuance has not kept up with demand, with investors frequently reporting a lack of availability for green investing opportunities. Indeed, green sukuk currently represent just 2.6% of all sukuk issued globally despite growing interest in it. The limited number of green sukuk limits its market liquidity, making it harder to attract further investors and leaving less sukuk capital available for environmental projects.
Another issue is the lack of a standard definition of green sukuk, which in turn leads to differing regional standards of practice for it, such as what percentage of sukuk proceeds should go to green projects, or even what counts as ‘green’. This leaves Islamic finance vulnerable to greenwashing, as companies can exploit the loose definitions to classify projects as eligible for green sukuk proceeds even if their practices have only marginal environmental benefits. Additionally, compliance with green standards post-issuance is largely self-governed, and monitoring of compliance is limited to annual reporting on the use of proceeds, creating difficulties in objectively determining a project’s overall ‘greenness’.
Moreover, most project-based green sukuk issuances are only for renewable energy and green real estate projects, with relatively little for other environmental causes. For instance, Indonesia’s Sovereign Green Sukuk has a lower budget for biodiversity than for climate change mitigation, and financed very few sustainable resource management and biodiversity conservation projects.
Make Green Islamic Finance Greener
With the climate and ecological crisis rapidly intensifying, it is crucial that we utilise every possible source of funding to combat it, including Islamic finance. Thus, the problems that have limited green Islamic finance must be resolved, and here the Sovereign Green Sukuk of Indonesia can offer some insights.
One reason for the success of the Sovereign Green Sukuk is because of the strength of its Climate Budget Tagging System, and the underlying green sukuk framework that lays out well-defined criteria for the types of projects eligible for receiving green sukuk. The Climate Budget Tagging System identifies projects that deliver on climate change benefits in accordance with national priorities. The appropriate government agencies then assess the projects’ climate benefits and shortlist them based how well they align with sustainability goals and the criteria of the green sukuk framework, before they are finally endorsed (or not) by the Ministry of Finance for green sukuk reception. Such a framework ensures that green sukuk is directed towards projects with meaningful environmental benefits.
To ensure that projects comply with green standards after green sukuk issuance, annual impact reporting should be conducted alongside an independent audit to objectively verify a project’s environmental benefits. Again, the Sovereign Green Sukuk provides a model for this, as it was the first sukuk impact report to also incorporate SDG indicators to help measure the success of projects.
There is also a need to diversify into financing other types of environmental causes, for instance, the creation of blue sukuk to fund marine conservation. This will require finding revenue-generating projects that promote those causes, developing criteria for project selection, and educating the Islamic finance industry on the benefits of investing in them.
Likewise, increasing the use of green Islamic finance in general will require greater awareness of its benefits, as Islamic finance investors have traditionally shunned environmental projects over a perceived lack of profitability. The creation of green sukuk has done much to improve this situation , but the limited number of issuances so far shows that more progress is needed. Standardising the definition of green sukuk could be one means of doing that, as the current varying standards may make it hard for investors to determine the true impact of projects and potentially discourage them from investing.
Ultimately, Islamic finance has great potential to be a force for good in the fight against climate change, which aligns well with its faith-based principles of not supporting societal harm. Given that addressing climate change could potentially save at least a million lives per year, if the issues with green Islamic finance can be resolved, then perhaps it may one day be hailed as one of the great driving forces in the salvation of our planet.
Author: Thomas Gomersall, Seneca Impact Advisors
For more information, please contact info@senecaimpact.earth
