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Islamic Finance

Explainer: How is the ESG sukuk market faring?

We speak with Bashar Al-Natoor, global head of Islamic finance at Fitch Ratings on sustainable issuances and its growth trajectory.

Sustainable or green issuances through sukuk across Gulf countries are higher compared to bonds. What is the primary reason for that?
Commonalities exist between Islamic finance and ESG principles due to built-in Shari’a filters.

In the GCC region, 40% of hard-currency ESG debt mix is in sukuk format, with the rest in bonds. The key reason why the sukuk format is prevalent in the regional ESG debt mix is to attract the larger Islamic investor base, mainly Islamic banks, that have a robust appetite for sukuk and can only invest in Sharia-compliant securities, along with tapping the international investor appetite for ESG products.

A significant portion of ESG sukuk globally is denominated in hard currency. What is the key reason for this?
Almost two-thirds (66.2%; $23.9 billion) of all outstanding ESG sukuk was in hard currency in 2023, mostly in US dollars.

ESG sukuk issuers seek to tap the international investors’ appetite, including from ESG sensitive investors. The sukuk format is often deployed to tap the local and regional investor appetite, many of which comes from Islamic banks. In general, the local-currency debt capital market in the GCC is not as deep compared to some of the other emerging market economies.

In the GCC region, there has not been a sovereign ESG-sukuk issuance to date, with most ESG debt led by financial institutions and corporates.

What are the three biggest challenges in the issuance of sustainable sukuk globally?
The outstanding ESG sukuk market has experienced notable yearly growth of 56.8% and reached $36.1 billion in 2023.

However, it still faces headwinds.

These include scarcity of sustainable projects or green assets which obstruct some sovereigns, banks, andBashar Al-Natoor, global head of Islamic finance at Fitch Ratings corporates from issuing ESG sukuk, and instead they may issue non-ESG sukuk or bonds.

The local ESG frameworks and taxonomy in many OIC countries are still underdeveloped.

There also remains a shortage of domestic ESG-focused investors and issuers in Muslim-majority countries.

Uncertainty also remains over any pricing advantage for issuers compared to non-ESG debt. The ESG debt market is vastly more developed in regions such as the US, Europe, and China.

How can these challenges be addressed? 
The ignition of ESG sukuk growth requires government initiatives, supportive regulations, increased awareness and adequate market infrastructure. In recent years, we have seen more initiatives to help boost ESG debt issuance.

In the UAE, the Higher Sharia Authority directed Islamic banks and windows to create separate sustainable businesses and activities within existing business lines that include sustainable sukuk issuances and financing.

In addition, the Dubai Financial Services Authority waived regulatory fees on ESG listings on Nasdaq Dubai for 2024.

A sustainable finance framework was unveiled in Oman, with plans to issue green, social and sustainable sukuk and bonds. The proceeds will be used to fund and refinance renewable energy projects, aiming to reduce dependency on fossil fuels and to attract ESG investors.

In Malaysia, the tax deduction given on the issuance cost of Sustainable and Responsible Investments sukuk has been extended to 2027.

Which five countries hold the highest share of ESG sukuk issuances? 
In 2023, ESG sukuk issuance totaled $10.5 billion (down 4.6% year-on-year), with issuance from the UAE most common at 41%, followed by Malaysia (28%), Saudi Arabia (21%), and Indonesia (10%).

Sukuk, rather than conventional bonds, are the preferred format for ESG-debt in many core Islamic finance markets.

During 2023, the five countries with the highest share of ESG sukuk, as a proportion of total outstanding ESG bonds and sukuk in hard currency, were Bahrain (100%), Indonesia (56%), Malaysia (52%), UAE (41%) and Saudi Arabia (37%).