There has been significant growth in the market for Shariah compliant project financing, especially in the MENA region, over recent years. It is clear that the Islamic finance industry is increasingly shifting focus to sustainable investing with an emphasis on areas like renewable energy and ESG financing. This is due to Islamic financing being a dichotomy that can exist under capitalism, without the oft-perceived exploitative nature that has become intrinsic with the western capitalist paradigm, making it a viable financing solution for sustainability projects.
Review of 2022
An increase in emphasis on the climate emergency and infrastructure efficiency has led to the introduction of renewable energy strategies which have set clear targets for GCC states. As an indirect result of this, we have seen an increase in Islamic finance being used to fund renewable energy and infrastructure projects.
One example of this is the DEWA solar projects, where Abu Dhabi Islamic Bank funded US$103.5 million into the project. It is expected to power 270,000 homes and offset carbon emissions amounting to 1.18 million tons per year in Dubai.
The Kingdom of Saudi Arabia (KSA) has led the adoption of ESG Sukuk globally by issuing ESG Sukuk totaling US$1.5 billion during the first two months of 2022 and there has been a push from fund managers within the industry to launch ESG and Waqf funds to meet increasing investor demand following the COP26 summit in Glasgow.
It is not just GCC countries which are using Islamic financing for infrastructure and sustainability projects. There is an emergence of African nations, such as Tanzania, using Sukuk and Musharakah financing in the form of public–private partnerships (PPPs) to fund their sustainable infrastructure projects. This is because Sukuk are a viable and flexible tool for investment funds, mitigating project risks to infrastructure PPPs.
There are still some key challenges in the Islamic finance market, including a complex issuance process and the need for Sukuk to comply with Shariah laws. Despite these challenges, and according to Fitch Ratings, outstanding ESG financing/Sukuk expanded by 11.2% in the second quarter of 2022, reaching US$19.3 billion. We anticipate seeing this kind of growth in sustainability financing in the year ahead.
Preview of 2023
According to the International Energy Agency, the growth of renewable capacity is forecast to increase by over 60% by 2026, with 65.5 GW of growth forecast for the MENA region. Accordingly, the energy sector remains a huge opportunity for investment with great prospects for the Islamic financing industry to step up as an alternative financing model for these capital-intensive projects across Africa and the MENA region.
Africa has lagged behind many other regions of the world when it comes to investment in basic infrastructure sectors, such as energy. According to the African Development Bank Group, the Program for Infrastructure Development in Africa (PIDA) has estimated that US$360 billion of investment is required to bridge Africa’s infrastructure deficit by 2040, with as much as 60% accounted for by shortfalls in energy investment.
PIDA estimates that addressing these issues through provision of renewable energy supplies could facilitate Africa’s much-needed economic growth with minimal damage to the environment. It is estimated that the Islamic finance industry in parts of Africa will continue on a moderate growth trajectory in 2022–23 with a particular focus on sustainable development, which was discussed as part of the 9th African Islamic Banking and Takaful Summit held in July of this year in Dar es Salam.
The KSA will continue to lead the way in terms of commissioning Islamic finance. NEOM Company is endorsing the use of Islamic finance across its various infrastructure projects. Many of the projects being implemented in an attempt to build the city of NEOM are initially being financed by Sukuk with a focus on sustainability and it is expected to continue until the current completion deadline of 2030.
Overall, the global Islamic finance industry is set to grow by 10% by 2023 according to a new report by S&P Global Ratings. The Fintech Times reported that this is partially due to the MENA and African regions’ resilience to the macroeconomic uncertainty of the Russia–Ukraine conflict and a higher volume of green and sustainability Sukuk as issuers look to broaden their investor base over the next year. In addition to this, Islamic financing has proven to be more resilient than western finance in the face of the COVID-19 pandemic.
According to a report by the IsDB, Shariah compliant equities performed considerably better than their conventional counterparts. This is largely due to the risk-sharing principles of Islamic finance, which will help the industry to provide a strong safety net against any induced economic cycles that lie ahead. Invariably, the resilience of this investor base will have a knock-on effect in relation to finding infrastructure projects across sectors such as transport, health and education.
Conclusion
As predicted, the Islamic finance industry continued to develop over the course of 2022 with projects focusing more particularly in the utilities and infrastructure sectors, despite some challenges facing the Islamic finance industry. The global focus on the climate emergency and the greater-than-before need for renewable energy sources are likely to result in a significant increase in Shariah compliant investment and ESG financing more generally across Africa and the MENA region, perhaps particularly in the KSA.
Imran Mufti is a partner at Gowling WLG. He can be contacted at Imran.mufti@gowlingwlg.com.