How ESG & Green Sukuk are driving sustainability investments in the Middle East
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How ESG & Green Sukuk are Driving Sustainability Investments in the Middle East
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By Dr. Issam Altawari, Founder and Managing Partner of Newbury Economic Consulting and Saniya Fatima, Analyst at Botho Emerging Markets Group
April 25, 2023
The Middle East is increasingly turning to environmental, social, and governance (ESG) and Green Sukuk to finance their green transitions, as these sustainable financing solutions gain momentum worldwide. In 2022, ESG and Green Sukuk achieved a remarkable growth rate of 35 percent, reaching a global value of total funding deployed of $8.1 billion. However, the GCC region continues to dominate this financial sector, with the Kingdom of Saudi Arabia (KSA) outperforming other countries in both total issuance and average issuance size, as seven out of the top 10 issuances in 2022 were from KSA.
Similarly, other Gulf countries, such as the United Arab Emirates (UAE), are seeing an uptick in private and public sector Sukuk issuances, too. By addressing the challenges in the Islamic finance sector and increasing ESG and Green Sukuk issuances, the Gulf countries are unlocking new avenues of finance to double down on their climate change strategy and increase their sustainable investments.
What is Green Sukuk and why is it gaining traction?
ESG Sukuk and Green Sukuk are two Islamic financing vehicles that allow investors to support projects that meet ESG criteria and finance climate change projects while adhering to Islamic finance principles, respectively. Compared to traditional bond financing mechanisms for conventional ESG and Green projects, ESG and Green Sukuk rely on a risk-reward sharing mechanism based on shared ownership. Investors share in the risks and rewards of the underlying assets of the Sukuk bond, receiving a share of profits and sharing in losses, with potential additional guarantees or collateral from the issuer. This mechanism offers advantages for both the investor and the issuer.
For issuers, ESG and Green Sukuk offer longer-term financing options, unlike traditional bonds, providing greater flexibility for those who require patient funds for capital-intensive projects or who wish to match their financing with the lifecycle of their assets.
Meanwhile, for investors, unlike traditional Green bonds, Sukuk’s value increases in relation to the assets backing the Sukuk certificate, with the risks often hedged by the issuer through guarantees and collaterals. With climate change requiring governments to adopt newer and often riskier technologies, like green hydrogen, finding risk-reward-sharing financing mechanisms has become imperative. This has allowed Sukuk to bridge a gap for issuers in the Gulf while also adhering to the needs of investors looking for Islamically-compliant options, ushering a new wave of Green and ESG Sukuk issuances in the Gulf.
Growing Green Sukuk and Islamic ESG Financing in the Middle East
A large number of Green and ESG Sukuk issuances in the region are being used to finance energy transitions in the Gulf region and beyond. For instance, the public sector firm, Dubai Electricity and Water Authority (DEWA) issued a $1 billion Green Sukuk in 2017, which was listed on Nasdaq Dubai. The proceeds were used for the construction of the Mohammed bin Rashid Al Maktoum Solar Park in Dubai, which is one of the largest solar energy projects in the world.
At a multilateral level, the region’s biggest Islamic financing institution, the Islamic Development Bank (IsDB), issued a $1.25 billion Green Sukuk in 2018, which was also listed on Nasdaq Dubai. The proceeds from the Sukuk were used to finance renewable energy and energy efficiency projects in member countries of the IsDB.
Apart from governments, Green Sukuk is also gaining traction amongst the Gulf private sectors. For example, Majid Al Futtaim, a Dubai-based retail and property development company, issued a $600 million Green Sukuk in 2019. It was used to finance environmentally sustainable projects in the company's properties, including energy-efficient lighting and water-saving systems. Furthermore, two other private sector Sukuks were raised in the Gulf in 2022. These deals across the business spectrum indicate the potential of Green Sukuk in the region, especially as COP28 comes to the UAE in 2023.
Gulf countries are taking steps to address the challenges
However, Green and ESG Sukuk financing are not without their challenges. One of the main hurdles is the lack of standardization in the Green Sukuk market, which makes it difficult for investors to compare different issuances. Another challenge is the limited supply of ESG and green projects that meet the requirements of Shariah-compliant financing. Additionally, the complexity of shariah-compliant financing structures also poses a challenge for issuers and investors alike, making it harder to attract new participants to the market. That said, the Gulf governments are moving fast to bridge these gaps and accelerate the Sukuk and larger Islamic finance ecosystem.
To address the lack of standardization that impedes the industry, governments in the region have been making significant policy efforts. For instance, the UAE, through its sustainable finance framework, the Sustainable Finance Working Group (SFWG), and the KSA, through its leadership at the IsDB, have been working on developing policy and standardizing Green Sukuk at a High-Level Working Group (HLWG) chaired by the London Stock Exchange, first convened after COP 26 in 2021. Secondly, Gulf countries have embarked on sustainable finance frameworks that provide a roadmap for the future and also facilitate the growth of sustainable financing and green projects, in particular. The UAE, Qatar, and Saudi Arabia have all established sustainable finance frameworks to enhance the development of the local sustainable finance market. Finally, Gulf countries have galvanized government support initiatives to address some of the challenges facing Green Sukuk in the region, fueled by a commitment to sustainability.
How ESG and Green Sukuk might enable Gulf countries to deepen their green investments in Africa
In alignment with the Net Zero target of 2050, Gulf Cooperation Council (GCC) governments are prioritizing social and environmental financing across borders. Consequently, ESG and Green Sukuk could enable Gulf countries to deepen their green investments in Africa through mobilizing private sector co-financing, instrumentalizing Green Sukuk, and bridging the green financing gap on the continent. Furthermore, investing in or issuing ESG and Green Sukuk to finance green projects in Africa will enable Gulf countries to hedge climate and financial risks as they look to invest in projects in the continent, especially in newer technologies in the green energy sector. In particular, Green Sukuk and ESG instrumentalization will allow Gulf countries to share the risk and rewards with either private sector co-developers or African governments, thus boosting the Gulf’s investor confidence.
The deployment of Green and ESG Sukuk will only grow as the regulatory and capacity gaps are bridged, opening new opportunities for the Gulf region to pursue alternative financing mechanisms to deepen their investments globally.
Dr. Issam Altawari is the Founder and Managing Partner of Newbury Economic Consulting and a Senior Advisor at Botho Emerging Markets Group. Saniya Fatima is an Analyst at Botho Emerging Markets Group.