The focus in 2021 on sustainable finance within the Islamic finance framework, in particular within the energy sector, continued into 2022. 2023 is expected to be another year of increased activity in this space; however the speed of growth in the sector is considered still too slow by many when compared against the issues it seeks to tackle.
A lot has changed in recent years, not least because of COVID-19, but it is against this backdrop that there has been a renewed emphasis on sustainable finance and a change in the way ESG and climate risks are being perceived globally despite the economy not yet having completely shaken off the effects of the pandemic. Islamic financing has huge potential to finance new and renewable energy.
Review of 2022
Islamic finance and sustainable finance are complementary, both covering values such as fairness, equality and morality, both impacting social good and both focusing on being ethical.
One of the key developments globally in 2022 in the Islamic finance sector was the increased focus on ESG lending, in particular in the energy sector (notably solar and wind projects, clean fuels and sustainability), most likely as a result of the commitments to secure net-zero emissions following the 2021 United Nations Climate Change Conference (COP26).
In the Islamic capital markets, Sukuk structures continued to embrace more socially-aware investments, and there was a measured proliferation of ESG funds, Waqf-featured funds and leveraging of Islamic philanthropic instruments such as Zakat, Sadaqah and Waqf to develop the Islamic social finance sector.
Historically, perception has been that ESG and Shariah-based equity products underperform compared with conventional products due to their exclusionary nature; however, we are now seeing Shariah and ESG products outperforming conventional asset classes in the energy sector.
Approximately US$4.3 billion-worth of ESG-linked Sukuk were issued in the first half of 2022 according to Fitch Ratings, with outstanding ESG-linked Sukuk growing by 11.2% in the second quarter, reaching US$19.3 billion.
Among notable Islamic sustainable transactions that took place were Bahraini state-owned Oil and Gas Holding Company’s US$1.6 billion sustainability-linked Murabahah refinancing, GFH Financial Group’s US$900 million Sukuk (closed by its sustainability arm Infracorp), sustainable infrastructure company ACCIONA’s US$480 million green financing, Saudi National Bank’s US$750 million sustainability-linked Sukuk, Riyad Bank’s Tier 1 capital sustainable US$750 million Sukuk facility (the first Sukuk to be listed on the London Stock Exchange’s Sustainable Bond Market), Dubai Islamic Bank’s US$750 million Sukuk facility listed on Euronext Dublin and NASDAQ Dubai, Malaysia Building Society’s US$1.19 billion sustainability Sukuk Wakalah program and SME Bank’s US$120 million sustainability Sukuk issuance.
We have also seen banks launching new Islamic ESG products and issuing ESG frameworks, with the focus on allowing the issuance of green and sustainability-linked Sukuk and loans to fund projects in renewable energy, clean transport, green buildings and wastewater management.
Qatar’s Masraf Al Rayan launched a Shariah compliant green deposit scheme following the launch of its Sustainable Financing Framework, and HSBC Amanah Malaysia partnered with Bursa Malaysia to develop sustainability-linked Islamic financial products and ESG solutions aligned with the FTSE4Good ratings model and datasets for public listed companies.
CIMB Islamic and Standard Chartered Saadiq introduced the market’s first ESG Islamic repurchase agreement, and Abu Dhabi Islamic Bank and Bank Islam were among other Islamic banks issuing ESG frameworks in the second half of 2022.
Preview of 2023
According to S&P Global Ratings, the global Islamic finance industry is expected to see a 10% expansion in 2022–23 thanks to higher commodity prices and the relative resilience of many core Islamic finance countries to the macroeconomic shocks resulting from the Russia–Ukraine conflict.
As part of this growth, we expect to see the increased focus on ESG financings witnessed globally in 2022 in the energy sector to continue in 2023. We expect there to be several new projects in sustainable energy generation and to see similar projects that were conventionally financed being refinanced in a sustainable way, and predict a higher volume of green and sustainable, and more socially-aware, Sukuk.
The expected trend could have major implications in 2023 and beyond for Gulf states seeking to invest heavily in the renewable energy sector. Saudi Arabia aims to power half the country with renewable sources by 2030 under a green initiative.
Similarly, and following the launch of the UAE Sustainable Finance Framework 2021–31 and the government’s announcement of its ambitious energy targets under the UAE Energy Strategy 2050, Abu Dhabi is planning to reduce its oil dependency and achieve a 65% contribution to GDP from non-oil sectors, and Dubai is aiming for clean energy to become 75% of its total generation mix by 2050.
Conclusion
The space should be a landscape where Islamic finance can thrive and distinguish itself due to its strong connection to an underlying ethical purpose — the Shariah principles uphold the earth’s sustainability, and so Islamic financing has great potential to finance new and renewable energy. There is, however, still a long way to go before the convergences become mainstream and transpire to the wider world, not only at the policy level but in respect of shifting the mindset of those involved from one of maximizing profits to one of ‘profit with purpose’ — value-based language is therefore important for capturing the attention of the global population who may not follow Islamic principles.
Similarly, there is perhaps a need to rethink how products are labeled — it is likely that we will see a lot of new products develop in the coming years and, while we can state that certain products and/or structures are Shariah compliant, the best approach may be to focus on the ethical nature to attract the widest possible cohort.
Although it will require significant effort to manage the climate and nature-related issues, now is the time for Islamic finance to shine within sustainable and responsible finance and the energy sector in particular. We expect to see heightened activity in this space globally in the coming years and believe that with more success stories and market players, a much greater impact can be made.
Shariah–ESG finance is now an obligation and no longer just a requirement, and conventional financiers cannot continuously allow the complexity and expense of Shariah finance to be excuses to delay.
Shibeer Ahmed is a partner and Luke Robinson is the associate at Squire Patton Boggs. They can be contacted at [email protected] and [email protected] respectively.