- The current state of the green bond market.
- The moral and ethical imperative driving issuer and investor interest
- What’s in it for the issuers and investors?
- SRI sukuk in Malaysia: Will the GCC adopt or chart its own path
The values of Islamic finance are deep rooted upon the ethical, environmental and socially responsible principles. Given this strong underpinning of Islamic finance upon socially responsible investment (SRI), green financing is likely to make headway within the Islamic finance industry in the coming years.
Carbon finance, which falls within the SRI realm, explores the financial implications of living in a carbon- constrained world, in which emissions of carbon dioxide and other green house gases carry a price. Amongst many other factors, the focus to promote low carbon future led to the development of Green bonds. Green bonds are now increasingly being used to fund projects involving clean energy, mass transit, and other low-carbon projects that can help countries adapt to and mitigate climate change, while giving investors fixed-income investment opportunities that have a positive impact.
The World Bank Treasury developed the green bond in 2008 to raise funds from fixed-income investors to support its lending for eligible projects that target lower carbon emissions and advance climate-resilient growth. The market for green bonds is a budding one- there has been a three-fold increase in the market for green bonds from $13 billion in 2013 to $37 billion in 2014. Several recent issuances of international green bonds have been oversubscribed including a € 1 billion bond from TenneT which was two times oversubscribed and a € 500 million green bond from real estate firm Unibail-Rodamco which was 6 times oversubscribed suggesting strong demand for such bonds.
Green bonds – a win-win solution for both the issuer and investor
The prerequisite for a green bond is that it must fund ‘green projects’, which typically include those relating to renewable energy, emission reduction and this has attracted a large investor base. Both types of investors- those who have a greater interest and focus on environmental, social and governance (ESG) issues, and those who are less focused on green concerns but want to ensure that their bond portfolio meets investment objectives by fully diversifying its holdings to meet its managers’ and trustees’ fiduciary requirements- have demonstrated staggering growth in their demand for green bonds .
Over time, increased demand is likely to drive increasingly favorable terms and a better price for the issuer, compared to a regular bond from the same issuer. For example, the US State of Massachusetts issued both a regular municipal bond and a green bond in 2013. Both issues were priced identically, yet the green bond was 30 percent oversubscribed while the regular bond was undersubscribed. Another selling point of green bond is that it carries a lower risk than other (project-based) bonds. This is because proceeds raised for a specific green project is tied to the issuer and not to the success of the project. Thus the project risk stays with the issuer rather than the investor.
Connecting green bonds with SRI sukuk
There are several commonalties shared between Islamic finance and SRI. First, both are focused on investing money in a manner that conforms to their morals and beliefs. In addition to maximizing risk-adjusted returns, promotion of social welfare activities along with ethical investments is the main objective of both Islamic finance and SRI investors. Secondly, SRI and IF both are demand-driven; driven by investor beliefs and need to invest in sociable responsible projects in compliance to their beliefs. Another common point is that the cumulative wealth of both types of investor has historically focused on equity investments rather than fixed income. In the light of the above points, Islamic finance investors can be viewed as a unique sub-set of the SRI community. As both the sukuk and the green bond segments develop, it is just a matter of time before sukuk market investors and conventional SRI investors are drawn to investing in ‘Green sukuk’.
Realizing the importance and ability to attract a new category of investor through green bonds, Malaysia and countries in the MENA region have taken different initiatives to spur the growth of this asset class. The figure below shows the potential growth of green sukuk as an asset class.
The Climate Bonds Initiative, the Clean Energy Business Council (CEBC) of the MENA, and the Gulf Bond and Sukuk Association, established a Green Sukuk Working Group in 2012. This working group had been mandated to identify green energy projects that fall under Shariah-compliant categories for potential investors. A ‘green sukuk’ is the Shariah-compliant version of a green bond and represents Shariah-compliant investments in renewable energy and other environmental assets.
Green sukuk notably address the Shariah concerns for protecting the environment. The growth of such sukuk has not occurred yet in the GCC but the first issuance could be imminent. The inaugural Sustainability Report 2013 issued by the Dubai Electricity and Water Authority, notes that the 1,000-megawatt H.H. Sheikh Mohammed bin Rashid Al Maktoum Solar Park will provide ‘global financial investment opportunities in green finance’.
Similarly, Abu Dhabi announced a target of generating 7% of its energy capacity from renewable sources by 2020. In January 2015, the Masdar Institute of Science and Technology released a UAE Wind Atlas, similar to its previous Solar Atlas, to support investment in renewable projects. The road seems greener for the UAE, in general as well as it expected that the newly established Dubai Islamic Economy Development Center (DIEDC) will provide support for the growth of sukuk in the UAE, which will likely include green sukuk in the future.
Going forward, issuers seem likely to fill the green bond train to capacity!
With the dire need to finance enormous renewable energy projects and do so with low-cost alternatives to traditional bank financing, capital market options such as green bonds and green sukuk provide a very plausible investment solution. Moreover, as sukuk is the preferred choice of investment amongst GCC sovereigns, sovereign-related entities and corporates, green sukuk can be used as a preferred investment vehicle to finance the region’s ambitious renewable energy and infrastructure projects and the rising number of clean energy initiatives throughout the GCC and in the broader MENA region.