As the world steps up its efforts towards achieving net-zero, so has the demand for investment to fund environmentally friendly projects – and green sukuk, or Islamic bonds, is tipped to play a key role in this.

According to the World Bank, nearly US$27 trillion will be needed for renewable energy projects worldwide by 2023, and the market for green sukuk is expected to hit US$2.4 trillion by early next year.

“We are witnessing a large increase in demand for sukuk, (which) could play a key role in funding (renewable energy projects),” Isam Abu Suleiman, regional director for the Gulf countries at the World Bank, was cited by Dubai newswire Zawya last month as saying.

So, what exactly is green sukuk and how can one invest in it? We guide you through some key aspects.

1. What is green sukuk?

A green sukuk is an Islamic bond that complies with the principles of syariah law. Unlike conventional Islamic bonds, the proceeds can only be used to finance investments in renewable energy and other environmental projects.

While the instrument itself needs to be syariah-compliant, there are no restrictions on the religious beliefs of sukuk issuers and investors.

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2. How did it come about?

The increasing acceptance of Islamic investment has created opportunities for Islamic finance to expand into sustainable investments.

The first green sukuk was launched by Securities Commission Malaysia in 2017, under its Sustainable and Responsible Investment (SRI) Sukuk Framework. The framework was introduced in 2014, in partnership with the World Bank and in alignment with the International Capital Market Association’s Green Bond Principles.

The first green sukuk in Malaysia was issued by solar power firm Tadau Energy, and raised RM250 million (S$79 million) for the construction of large-scale solar photovoltaic power plants in Kudat, Sabah.

3. Why is there a need for it?

Green sukuk is an innovative way of addressing global funding gaps in green financing, given the growing demand in the Middle and Far East for syariah-compliant or Islamic bonds.

Banks are currently the main investors in Islamic bonds, with corporate investors accounting for some 10-20 per cent of the market, and hedge funds and asset managers making up 20-30 per cent.

4. What sort of projects does it fund?

The proceeds raised from green sukuk are used to finance the construction of or refinance the construction debts of eligible assets, or to finance the payment of government-granted green subsidies.

Eligible assets for green sukuk include solar parks, biogas plants, wind farms, and electric vehicles and their related infrastructure.

5. How big is the green sukuk market?

Green and sustainable sukuk volumes grew 17.2 per cent year-on-year in 2021, to US$15 billion, according to Fitch Ratings, amidst global outstanding sukuk volumes of US$711.3 billion in 2021. And Fitch expects the theme to remain prominent in 2022.

According to Moody’s, sukuk issuances are expected to reach up to US$170 billion in 2022, of which green sukuk will account for a significant portion. 

GFH Financial Group said it expects the decarbonisation strategies of the Gulf countries to drive the growth of sustainable Islamic bonds globally, especially after the upcoming United Nations Climate Change Conferences. The 27th session of the Conference of the Parties (COP27) will be taking place in Egypt in November, while COP28 will be held in the United Arab Emirates next year, with green sukuk expected to be a central theme at both.

6. How are returns calculated?

In an asset-backed sukuk, the profit return and return of capital are based on the assets.

Unlike a conventional bond, which represents the debt obligation of the issuer, an Islamic bond represents an interest in an underlying funding arrangement structured according to syariah law, entitling the holder to a proportionate share of the returns generated by such arrangement and, at a defined future date, the return of the capital.

7. Challenges?

• Eligible assets are restricted to renewable energy and green real-estate projects;

• There is a lack of pricing incentive for issuers: green sukuk requires a green reporting mechanism and input from practitioners with relevant expertise;

• There is a steep learning curve for new issuers and marginally higher costs from having to spend on review and reporting.