Green Sukuk

Accounting and Business magazine
www.accaglobal.com/ab

Certain Gulf countries, such as the Emirate of Abu Dhabi (pictured), are investing in solar power.

A recent initiative from Malaysia — one of the main Islamic finance hubs — could help turn Islamic bonds into the financing option of choice for environmentally friendly investments.

The ethical traits of sharia-compliant financing, such as not permitting interest or investments in gambling and tobacco, have made sustainable and socially responsible investment (SRI) and green funds an obvious extension for the sector. But Islamic finance is a niche market already, and its SRI initiatives have struggled. Indeed, some initiatives have not got beyond the press release stage and few have been successfully funded. However, SRI and green project funding has been revitalised by the launch of SRI sukuk (Islamic bonds) guidance this August by Malaysia, one of the main Islamic finance hubs.
The internet is awash with articles about a handful of green Islamic finance projects launched in recent years, such as an Islamic green fund issued by Malaysia's AmanahRaya Investment Bank and Asian Finance Bank (AFB), and the Green Sukuk Working Group (GSWG) set up in Dubai in 2012 to promote sukuk for renewable energy projects. But the GSWG is still a work in progress — no sukuk have been issued — and the Malaysian initiative did not take shape as expected, highlighting some of the issues faced by Islamic finance. 'Unfortunately the infrastructure was not there, nor the working capital,' says AFB CEO Mohamed Azahari Kamil.
More recently, London-based financial advisory service Simply Sharia set itself the target of raising £3m (US$4.9m) by June 2014 to build a solar energy plant through a sharia-compliant  funding structure, taking advantage of the UK government's Enterprise Investment Scheme (EIS). However, investors did not come on board in time, and legislative changes disallowed tax exemptions through the EIS as well as government subsidies, affecting the project's viability. A primary factor, however, was the performance differential between Islamic finance structures and conventional financing for the project.
'The non-sharia version had 50%-plus debt to equity whereas ours was a pre-equity play, so the debt cost 5% a year, which leveraged up the returns for equity players,' explains Faizal Karbani, CEO of Simply Sharia.
He adds: 'A key lesson for future investments is to have parity of returns for sharia and non-sharia, so returns are comparable or equal to any non-sharia investment out there. A lot of businesses that want to raise sharia finance are basically struggling as most financing is dominated by interest-bearing loans.'

Double bubble

Such experiences underline the issues that both Islamic finance and green energy have faced over the past decade — being overhyped in terms of potential and investor interest. As with Islamic finance, many green financing projects have been announced but not come to fruition, in part hampered by capital issues following the global financial crisis.
United Nations figures from January 2014 show that global clean-energy investment dropped by 12% in 2013, while Bloomberg New Energy Finance numbers show investments of US$254bn last year, significantly below the US$1 trillion a year the International Energy Agency estimates is needed to curb climate change.

'Our market soundings have shown returns on green bonds still need to be there, yet they may garner more attention by having those credentials,' says Michael Grifferty, president of the Gulf Bond and Sukuk Association (GBSA) in Dubai.

As for Islamic finance, the sector was valued at US$1.7 trillion in 2013, according to EY, dwarfed by the conventional capital markets, valued at US$64 trillion in 2012 by PwC.

'One issue with the green Islamic space is that it is a niche of a niche, so to really make that work you need to get distribution channels in place and sufficient momentum to pull away and gain maturity, which needs a push at the government level,' says Fergus McDonald, co-founder of VTA, a banking advisory firm in London.

Malaysia's August announcement is a welcome move, with its SRI sukuk framework requiring information on use of proceeds, choice of eligible projects, disclosure and reporting of various elements, and rules on appointing independent parties for deals.

Siew Suet Ming, senior general manager for structured finance at RAM Ratings in Kuala Lumpur, says: 'In green Islamic finance there has not been a lot of transparency and consistency in the numbers quoted, while green sukuk  have been fairly loosely bandied about with regard to green projects as they lack formal certification. As far as developing governing frameworks, it is quite nascent and I believe the first formal guidelines are from Malaysia.'

Malaysia is promoting Islamic finance and green projects to develop a more sustainable economy, having launched a national action plan on the subject in 2009, and in 2010 a green technology financing scheme with an initial budget of RM1.5bn (US$465m), which was subsequently expanded to RM3.5bn (US$1bn). So far, RM1.95bn (US$604m) has been distributed, almost 40% of which is in participation with Islamic financial institutions, according to Suet.

Government involvement

'Larger-scale financing has been quite limited for green sukuk to come in, and that's why the government has been involved in the framework,' adds Suet. Investment is expected to focus on green technology rather than farmland, as has been the case elsewhere in green finance worldwide, but there are challenges ahead. 

AFB's Kamil says: 'A lot of capital investment is involved, so the development of the sukuk market will play a critical role for long-term investment structures. Challenges are registration, infrastructure and capital, and more importantly the human capital expertise in this sector, especially sharia scholars with IFE [Islamic finance expert] accreditation.'

Over in the Persian Gulf, Dubai is trying to position itself as an Islamic finance hub by supporting green sukuk, while the national plans for 2030 of fellow UAE emirate Abu Dhabi and nearby Qatar both feature environmental sustainability and different kinds of capital markets.

'Green Islamic finance connects the two, and we are trying to connect them, not just on paper but in reality, to get the best choices for project selection,' says Grifferty of the GBSA, which is involved with the GSWG. To move forward, green Islamic finance will need to develop further, along with the sukuk market itself. 'Both sukuk and green bonds are getting more attention and will definitely draw in more issuers and arrangers that can bring the [green project financing] successes of Europe and elsewhere to Dubai, so it's worth keeping an eye on this space,' adds Grifferty.

 Indeed, Simply Sharia has learned from its recent experience, and is not daunted by the challenges ahead, having successfully worked on a sharia-compliant farmland project in Argentina, and currently working on a 10-year, £lbn (US$1.2bn) project on electric cars in Europe with the potential for a sukuk. 

'I think the sector is going in the right direction and while a huge amount has been said about the sector's potential,  it is time for action by marrying Islamic finance and SRI,' says Karbani. 'Our vision is that Islamic finance needs to be positioned very much as an ethical alternative for people to invest in, which is the future of Islamic finance.'