Islamic Green Markets (Green Sukuk)
Green sukuk is a form of Islamic green finance that helps in mobilisation of funds for green projects. Like conventional sukuk, green sukuk is an asset-based security based on sharia laws and is used mostly in Muslim majority countries to mobilise finances for infrastructure and large-scale developments (Sekuriti, 2019). It is a low-risk, guaranteed return for the investor. These programs provide solutions in areas where financial inclusion is low, as they minimise risk. For instance, they help governments and local authorities to implement sustainable projects or projects aimed at combating climate change such as renewable energy and waste management projects. The use of Sukuk also reduces debt levels by promoting economic security and equality. According to Ng (2015), Sukuk can be restructured to help in the attainment of sustainable development goals by integrating contemporary innovations in financial technology. Consistent with this argument, the OECD (2020) proposed the introduction of the incentive-compatible Sukuk masharakah model (figure 1) in the development of green bonds.
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Fig. 1: Green Sukuk framework from Malaysia
Source: OECD, 2020
Figure 1 illustrates different objectives of SRI sukuk in Malaysia. Malaysia’s SRI Sukuk framework identifies specific sustainability projects where Sukuk could be issued, including renewable energy, environmental protection, and energy conservation, among others. However, there is a particular process that Green Sukuk should follow to achieve their objectives. For instance, figure 1 identifies issuance process to include utilisation of the proceeds, eligibility of SRI projects, assessment and reporting. While the Malaysia’s Green Sukuk framework is relatively simple, it bears some similarities with the Indonesia’s framework in terms of the issuance process (Suroso et al., 2020). However, there are multiple stakeholders who are involved in the issuance of sukuk in Indonesia. Figure 2 illustrates various stakeholders and issuance processes of the Green Sukuk in Indonesia.
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Fig. 2: Green Sukuk framework from Indonesia
Source: Suroso et al. 2020
Also, the Sukuk models for sustainability projects link the issuer’s shares of the profit to the performance and include convertibility clauses. The model measures the firm’s performance based on the benchmarks, which use the industry’s return on equity and the firm beta. The risks associated with Sukuk musharakah are similar to those of shareholders in ordinary firms. In this regard, when the firm’s return on capital is higher than the established benchmark, then Sukuk holders could have lower returns compared to shareholders (Islamic Relief Academy, 2015). While this model is relatively new, it offers greater diversification opportunities, higher returns, and better tradability.
Social Impact Bonds (SIB) concept complements the Sukuk idea within the Islamic finance sector. SIBs are designed to source finance for new and existing projects to address or mitigate a particular social issue or attain positive social outcomes (Masrifah et al., 2019). Like Sukuk, SIBs share the losses among the investors and users of the investment. Broadly, Sukuk and SIBs will push the government to deliver on the social objective and improve social welfare due to reputational risks or trust issues associated with failure. Since SIBs finance worthy social causes with attainable objectives, it is consistent with Islamic financial risk-sharing and social justice principles. In line with this argument, Ng (2015) suggested that social impact Sukuk will be appropriate for funding programs with worthy public approval, such as buying mosquito nets or combating climate change. Sukuk issuance proceeds could buy the mosquito nets, which are then leased to the government to distribute. The lease payments from the government will be dependent on the distribution success or overall reduction in malaria cases attributed to the mosquitoes. Since investments in malaria prevention result in considerable savings on health expenditures and greater workforce productivity, Sukuk promotes intergenerational risk-sharing and ensures that the next generation does not inherit a greater health burden (Marwan & Ali, 2016).
The Islamic finance sector in the United Kingdom grew at a compound annual growth rate (CAGR) of 17% between 2009 and 2015 (Sidlo, 2017). The progressive growth of the UK Islamic finance industry could be attributed to many factors (Masrifah et al., 2019). Significantly, Islamic finance has become integral to funding green projects around the world. Sukuk programs are still at an infantry stage. The development of successful green Sukuk programs will need investors, issuers, policymakers, and industry players to commit to its success. The OECD (2020) suggested a green bond framework focusing on the use and management of proceeds, external party reviews, and reporting processes. In addition, regulations on bond issuances should consider market needs. In the case of investors, the framework suggests disclosures regarding insurance and takaful companies, their management, and public and private pensions, among other stakeholders (Smolo, 2019). These considerations would result in green and Sustainable and Responsible Investment (SRI).
Masrifah et al. (2019) added that Sukuk green bond framework accounts for various principles of sustainable finance, such as financial stability, environmental preservation, and financial and social inclusion. Consequently, green Sukuk are structured in a similar manner to normal Sukuk, as shown in this example in Figure 3 from Malaysia (Islamic Markets, 2016). The first step is for the bond issuer to engage a principal advisor tasked with facilitating the overall transactions, such as appointing financing parties, terms agreement, and Sukuk conditions. The principal adviser plays a leading role in ensuring due diligence compliance, green Sukuk certification, and the issuance of Sukuk (Islamic Relief Academy, 2015). Sharia compliance is necessary for the green Sukuk issuance process as it must obey sharia contracts stipulating financial obligations and relationships.