Islamic finance for green initiatives: An unfulfilled potential

Photo: wavebreakmedia / Shutterstock.com

Analysts see a clear affinity between Shariah-compliant financing and saving the planet for future generations but this has translated into precious few on-ground programmes.

Islamic financing solutions for sustainability have largely focused on sukuk issuance and the future, say analysts, lies in growth economies in the Islamic world adopting green financing for infrastructure development.

“We have seen the most activity in terms of discussion, debate and policy papers around the concept of green sukuk, and within these discussions a realisation that Islamic finance must play a part in developing green and climate-based finance and investment solutions to help meet Nationally Determined Contribution (NDC) goals and country-based climate and environmental objectives,” Sean Kidney, CEO of the UK-based non-profit Climate Bonds, told Salaam Gateway.

“There has been a lot of discussion in the Middle East and Southeast Asia around the potential for green sukuk – which is simply an ordinary sukuk except that the assets involved are green. We have seen one issued in Malaysia, and we know the Indonesian government is keen to do the same and we believe that further issuances will occur in 2018,” added Kidney.

The green sukuk from Malaysia was the country’s first ever, and issued in July this year under the nation’s Sustainable and Responsible Investment (SRI) Sukuk framework that was introduced in 2014. The 250 million Malaysian Ringgit ($58.56 million) issue was from Tadau Energy to fund a 50MW solar energy project. 

In the Middle East, Climate Bonds established the Green Sukuk Working Party (GSWP) in 2011 with Clean Energy Business Council (MENA), the Climate Bonds Initiative, and the Gulf Bond and Sukuk Association (GBSA), to promote and develop guidelines for Shariah-compliant financial products to invest in climate change solutions, with the aim of seeing “real capital move to climate finance”.

The GSWP has been trying to reach its aims via industry education, developing an enabling framework for green sukuk and facilitating deal flow. However, its target is nowhere close to being met, in that no green sukuk has been issued in the Middle East despite the theoretical resonance that Islamic finance finds with such initiatives.

The situation is different in Malaysia where the government has been building an ecosystem for green Islamic financing. Initiatives include tax deduction until year of assessment 2020 on issuance costs of SRI sukuk; tax incentives for green technology activities in energy, transportation, building, waste management and supporting services activities; and financing incentives under the Green Technology Financing Scheme (GTFS) with total funds allocation of 5 billion ringgit until 2022. Malaysia’s Securities Commission is also in the process of finalising its SRI framework for investment funds that it says will be launched by the end of this year.

In the GCC where the focus is to reduce dependence on oil, Kidney says that green sukuk “will become a great part of financing renewables in the Gulf”. But until the first green sukuk from the region is issued, green Islamic financing has come from other means.

One example of Islamic finance being used is a scheme developed in 2013 by Etihad Energy Service Company (ESCO) for renovating 30,000 buildings in Dubai by making them energy-efficient. The financing for the initiative is in line with Islamic finance, according to ESCO CEO Stephane Le Gentil in a report from the UN Environment Programme (UNEP) Finance Initiative’s 14^th Global Roundtable held in Dubai in October 2016. As part of ESCO’s scheme, in 2015 UAE’s National Bonds Corporation invested in the rehabilitation of 157 buildings in the Jebel Ali Free Zone using a Shariah-compliant structure. The overall cost of the project was 64 million Emirati dirhams.

GREEN PLANS

While there have been only a few on-ground examples of Islamic financing for green projects there are several multilateral and global plans and initiatives addressing related issues.

“The affinity between Islamic finance and green investing is very strong. I believe that greater convergence is a large-scale opportunity, both for Islamic finance and for the green investing industry,” Aamir A. Rehman, Senior Advisor, United Nations Development Program (UNDP), told Salaam Gateway.

Programmes and plans launched around COP 21 2015 United Nations Climate Change Conference include the Islamic Reporting Initiative (IRI), a global reporting standard for sustainability and corporate social responsibility based on Islamic values, which held its inaugural roundtable discussion at the COP22 in Marrakech, hosted by Morocco’s Minister of Environment, also a member of the IRI advisory council.

“In the months leading up to the Paris meeting, Islamic leaders from around the world came together to generate a unified Islamic voice against ‘the corruption (fasad) that humans have caused on the Earth due to our relentless pursuit of economic growth and consumption’,” Drs. Daan Elffers, the founder of IRI, told Salaam Gateway.

“The International Islamic Climate Change Symposium took place in Istanbul and issued a unified affirmation to set in motion a fresh model of well-being that replaces the current financial model which depletes resources, degrades the environment and deepens inequality,” Elffers added.

The UNDP and the Islamic Development Bank (IDB) Group signed an MoU in 2016 to create an action plan to collaborate on crisis response and recovery, peace-building, poverty reduction, youth employment, innovation, disaster risk reduction, climate change, sustainable energy, capacity development, and knowledge sharing beyond the Arab states region to Africa, Central and South Asia, and Southeast Asia and the Pacific.

The two also published a joint report – I for Impact: Blending Islamic Finance and Impact Investing for the Global Goals – in May 2017 to explore the potential role of Islamic finance in serving the Sustainable Development Goals (SDGs).

Another joint project by UNDP and the IDB Group is the Global Islamic Finance and Impact Investing Network (GIFIP), a platform for multi-stakeholder collaboration to “serve as both a knowledge hub and a tool for matchmaking and the identification of investment opportunities”.

BARRIERS TO ACTION

Clearly, there is a plethora of information on how Islamic finance can play a large role in the sustainability sector – a promise not yet matched by implementation. Rehman said the hindrances to more on-ground implementation are “strategic and commercial in nature”.

“Many ESG and green investors are not yet investing in the emerging and frontier markets where Islamic finance is most active. At the same time, many in the Islamic finance industry are not yet familiar with environmental screening. On top of this, the high level of demand for Shariah-compliant assets – especially sukuk – has created market conditions by which sukuk issuances can be highly successful without being green,” he said.

At the UNEP Finance Initiative’s global roundtable hosted in Dubai by the UAE Ministry of Climate Change and Environment (MoCCAE) in 2016, one of the key questions addressed was how Islamic finance can contribute to the growth of the sustainability sector.

Timed with the roundtable, the first national survey on contributions of financial institutions to the green economy found that 46.8 percent consider that the rise of Islamic finance will provide more opportunities to develop green finance products and services or to invest in green projects. “An increasing number of institutions provide a range of Islamic finance products and services, while the views over the prospect for applying them to green finance are mixed,” the survey report said.

The most significant barriers (among all institutions surveyed, Islamic and conventional) include macroeconomic situations, conditions surrounding green finance, transactional issues and public support. “The highest number of institutions (29.1 percent) pointed out that the lack of adequate enforcement of policies and regulations has caused a difficulty in introducing green finance in the UAE,” the report said, adding that this implementation is critical to give clear incentives for industry to take greener actions and invest in greener solutions by penalising non-compliers.

Other factors include the high risk of green sectors (24.1 percent), long payback period and lack of long-term finance (21.5 percent), lack of profitability (20.3 percent), unclear benefits (17.7 percent), lack of data (17.7 percent) and the absence of standard methodology for measurement, reporting and verification (16.5 percent).

A GREEN FUTURE

Rehman suggests a three-step approach to encourage green Islamic finance, starting with a change in mindset. “Environmental protection is rooted in the spirit of protecting future generations – a key goal of Islamic ethics. Raising awareness of these values is an important step in embracing a more sustainable approach.”

Creating clearly measurable standards would come next. “Identifying specific metrics and screens is important. The ESG investment sector offers an abundance of relevant metrics that can be used and incorporated into an institution’s screening processes. Specificity is crucial in moving from the broad principle of sustainability to the concrete practice of influencing business decisions,” Rehman said.

The third step is to continue engaging with “the conventional sustainability community – like the World Green Economy Summit”. Rehman said: “The participation of conventional ESG investors in transactions can be the impetus for Islamic offerings to integrate environmental metrics – actual investments can be the best way to drive change.”

Climate Bonds’ Kidney remains optimistic about the future of Islamic finance initiatives for sustainable development. “We see Malaysia fulfilling its traditional role but we also see significant opportunities in Indonesia and the Middle East. Interestingly enough, we have quite a lot of interest in smaller markets such as Kenya and Nigeria,” he said.

Rehman added: “As both green investors become more comfortable with Islamic markets and Islamic finance adopts more concrete aspects of sustainability, I expect to see higher levels of convergence.”

© SalaamGateway.com 2017 All rights reserved