There has been steady growth in issuance of green, sustainable, sustainably-linked and transition bonds in both the conventional fixed income and the Sukuk markets in recent years.
These bonds provide investors a direct way to invest in, and benefit from, environmental and social investment projects carried out by issuing entities, where the use of proceeds can be immediately linked to specific projects.
From an impact perspective this is no doubt powerful.
Interestingly, Sukuk bonds provide an extra layer of oversight and protection where the borrowed funds are often tied to specific assets.
This provides extra security in the event of default but could also provide a nuanced way of ensuring that the borrowed funds are strictly used for projects that are not just Shariah compliant, but also clearly linked to identifiable sustainable projects with potential recourse to the assets associated with them.
This helps reduce uncertainty (Gharar) and guard against a mismatch of borrowing against assets which may contradict the ultimate sustainable objectives of the borrowing.
Indeed, there is the opportunity for Shariah advisors to play an additional role to ensure that when the Sukuk structure is designed, the borrowing is used for distinct environmental or social projects and also that any assets chosen to provide investor protection are of sufficient relevance given the importance of environmental and social preservation and harmony within a Quranic context.
In that respect, at the corporate level, Islamic finance has the potential to provide an extra layer of oversight for investors that want to invest in sustainable ‘use of proceeds’ products by employing heightened scrutiny and detailed investor protection in the event of misuse of funds which may reduce the risk of fraud, in turn leading to improved credit worthiness.
At the sovereign level, SDG-linked Sukuk bonds could assist in providing a platform for sovereigns that are looking to align issuance with the specific infrastructure and welfare needs of a country.
This would be particularly important for emerging market countries where private/public participation could be encouraged by having a multi-lateral development bank either guarantee the assets that are borrowed against, or multi-lateral banks could invest directly in SDG-linked Sukuk bonds alongside private investors.
In its latest review, the International Capital Market Association together with the IsDB and the London Stock Exchange Group provided issuers and key market participants with information on how Sukuk bonds may be labelled as green, social or sustainability aligned and outline a four-stage process including:
- Use of proceeds,
- Process for project evaluation and selection,
- Management of proceeds, and
- Allocation and impact reporting.
With important supranational, regulator and private sector collaboration of this sort providing clear standards for Sukuk issuance to obtain such labels, this should pave the way for a further acceleration in issuance enabling some of the most prominent government, quasi-government and corporate entities to pursue a sustainable agenda such as Dubai Ports World, which in 2023 issued US$1.5 billion Sukuk bonds to help fund its sustainable agenda including clean transportation, green buildings, energy efficiency and renewable energy projects.
Issuance sizes are likely to grow with sustainable investment ambitions over the coming years.
- Sefian Kasem is the global head of ETF and indexing investment specialists at HSBC Asset Management
