Tuesday, 6 December 2016

Green sukuk herald new era of environmentally responsible investment

The Paris Agreement on climate change with its tougher rules on reducing the emission of greenhouse gases is seen by many analysts as a driver for the advancement of so-called green bonds, and with them green sukuk, a new variety of Islamic bonds for investments in environmental-friendly and clean energy projects. 

The new climate agreement prompted a number of Islamic banks to consider an expansion of their product ranges in socially responsible investments towards “green finance” in order to catch up with their conventional peers, many of which are already placing green bonds for years quite successfully. And, notably, two of the six signatory Gulf Cooperation Council (GCC) nations, Saudi Arabia and UAE, which are also the region’s largest sukuk issuers, surprisingly quickly ratified the Paris accord, enforced it on November 4 and December 3, respectively, and are supposed to take respective “green action’ in a variety of fields, including financing.

In a nutshell, green bonds evolved in the conventional finance world as a specific sub-set of bonds used for clean energy projects, mainly issued by renewable energy companies or by corporations for the construction and operation of green assets. They were introduced by the World Bank as early as in 2008 to give investors an innovative method to support clean energy and other low-carbon projects. Since then, conventional financial instruments supporting green projects have been on an impressive upward growth trajectory, with financial heavyweights such as Goldman Sachs, Blackrock, Norway’s sovereign wealth fund and many other large conventional asset managers jumping upon the bandwagon.

In the Islamic finance world, the development was a bit slower. Reasons are that, namely in the oil-rich Gulf States, the perception of environmental problems has not been particularly distinct in the past, and initiatives against climate change long had no priority in government policies or in civil society. But with the slump in oil and gas prices, the need for economic diversification and the growing advantage of the West, particularly Europe, in environmental technologies, the Gulf States noticed a need for action. Some of the Gulf banks are now embracing the green bond concept by starting to include green sukuk, realising in the process that ethical requirements of green projects fit in well with Shariah-compliance.

The Bahrain-based General Council for Islamic Banks and Financial Institutions found in a survey released last month that Islamic banks indeed want to increase green financing options. The survey, based on responses from 86 Islamic finance institutions across 29 countries mainly from the Middle East and Southeast Asia, as well as Africa, said close to one-third of small Islamic banks cited a “moderate exposure” to the green and renewable energy sectors, compared to 15.5% for large Islamic banks which means there is still considerable potential for Shariah-compliant green financing across the industry.
Technically, a green sukuk is not a complicated Islamic finance product.

“The structuring of a green sukuk wouldn’t be much different from that of a normal sukuk. The sukuk’s structure would largely depend on the available green assets to support the sukuk or the environmentally friendly project to be financed,“ says Hari Rai, Dubai-based partner of international law firm Latham & Watkins. “Given the size of the global sukuk market, it is almost surprising that Islamic banks and sovereigns have so far not really tapped into the potential of a green sukuk,“ he adds.

There have been some recent examples, though. In Malaysia, the largest sukuk issuer globally, a local lender has introduced green mortgages to facilitate installation of solar systems, while an Islamic bank in Jordan is developing alternatives to medium-term loans to fund energy efficient and renewable energy projects. There have also been new initiatives to promote green sukuk, namely the Green Sukuk and Working Party (GSWP), jointly established by Masdar City’s Clean Energy Business Council, the Mena branch of the Climate Bonds Initiative and the Gulf Bond and Sukuk Association. It aims to promote and develop Shariah-compliant financial products to invest in solutions that seek to prevent climate change. 

The scope of green sukuk can be quite substantial. They can not only be used to finance construction of green developments or infrastructure, but also to refinance construction or project debt or to finance the payment of a government-granted green subsidy. Eligible assets for green sukuk as per the international Climate Bond Standards include solar parks, bioenergy plants, wind energy, clean water, hydropower and agricultural irrigation projects, energy efficiency applications and low-carbon buildings, low-carbon land use, electric vehicles and infrastructure, geothermal energy and marine-related environmental projects.

However, who is eager to contribute to a cleaner environment by investing into a green sukuk should also take into account the challenges as with any other investment, for that matter. While demand for green sukuk will certainly grow in the future and Gulf governments are likely to promote them more intensely, they entail a higher risk profile than conventional sukuk while the secondary market for them is still small and performance measurement standards for the segment aren’t developed yet.

SOURCE: Gulf Times/6 Dec 2016

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