Recently at the Second International Conference on Climate Finance, 2019, the idea of a climate finance mechanism that aligns with Shariah law was discussed. The topic approaches addressing both adaptation and mitigation funding through an Islamic lens.
What is Green Sukuk?
The idea of a ‘Green Sukuk’ is comprised of a bond, more specifically a Shariah-compliant bond. This is a means by which 100 percent of the proceeds exclusively go to finance or refinance green projects, that contribute to mitigating and adapting to climate change as well as preserving bio-diversity. A Sukuk is similar to a bond, but it complies with Shari'ah law. The assets financed by Sukuk exclude investments in gambling, weapons, pork, and alcohol.
What is a Bond?
A bond is a loan which pays interest over a fixed term or a given a period. When the bond reaches maturity at the end of the term, the principal amount or amount of investment is repaid to the lender or owner of the bond.
Why Green Sukuk instead of Green Bonds?
A bond is based on debts and uses interest rates, which therefore makes the idea Haram in accordance with Islamic principles. That is why the ‘Sukuk’ has been developed. The word ‘Sukuk’ is derived from ‘Sakk’ which means certificate. A sakk represents proportionate beneficial ownership in an underlying pool of assets. Sukuk were developed to replace conventional bonds which are often used in non-Shariah compliant activities.
Basic differences between Sukuk and Bonds
| Sukuk | Bond |
|---|---|
Sukuk are, and must be, backed by assets, projects and/or economic activities | Conventional bonds are based on debt. |
Proportionate ownership (share) in the underlying assets/project/ activity. | Bonds are just debt obligations on the issuer towards bondholders (share in debt). |
The fair value of sukuk is mainly based on the market value of the underlying assets/ project/ activity. | The fair value of bonds is usually based on the issuer's creditworthiness and the interest rate implicit in the transaction. |
In sukuk, the holder receives a share of profit/ rental generated by the underlying assets/project/ activity. The face value of sukuk is not guaranteed | Bondholders receive regular interest payments (fixed or floating) over the life of the bond, and the principal is guaranteed. |
In sukuk, the losses and costs related to the underlying affect sukuk holders. | In bonds, the performance of the underlying does not affect bondholders. |
Target market
The ‘Green Sukuk’ in Indonesia and Malaysia is an excellent example of the pioneering role of governments in leveraging private finance for green and sustainable development. The instrument has the potential to significantly boost and secure public and private investment in adaptation and in building resilience, while also reducing carbon emissions. Typically, Sukuk returns are linked to returns and cash flows generated by the assets purchased or created through the proceeds of the Sukuk.
Most Sukuk to date have been asset-backed (eg infrastructure projects), where the credit of the originator has been the decisive factor for ratings and investor analysis, in accordance with Shariah principles attracting private capital into low-carbon and climate-resilient infrastructure investments. Tadau Energy issued the world’s first green Sukuk in July 2017 for MYR 250m ($59.6m) in order to finance a solar power plant in Malaysia. A key demonstration of the success of this project was that another issuer -- Quantum Solar -- followed quickly with a larger (MYR1 billion) issuance. Indonesia issued the first green sovereign Sukuk for $1.2bn soon after.
Sukuk to combat climate change
The ‘Green Sukuk’ in Indonesia and Malaysia is an excellent example of the pioneering role of governments in leveraging private finance for green and sustainable development. The instrument has the potential to significantly boost and secure public and private investment in adaptation and in building resilience, while also reducing carbon emissions.
Typically, Sukuk returns are linked to returns and cash flows generated by the assets purchased or created through the proceeds of the Sukuk. Most Sukuk to date have been asset-backed (eg infrastructure projects), where the credit of the originator has been the decisive factor for ratings and investor analysis, in accordance with Shariah principles attracting private capital into low-carbon and climate-resilient infrastructure investments. Tadau Energy issued the world’s first green Sukuk in July 2017 for MYR 250m ($59.6m) in order to finance a solar power plant in Malaysia. A key demonstration of the success of this project was that another issue -- Quantum Solar -- followed quickly with a larger (MYR1 billion) issuance. Indonesia issued the first green sovereign Sukuk for $1.2bn soon after.
Green Sukuk are similar to other debt instruments and offer attractive returns, but they also come with the added promise of using the proceeds to finance the world’s transition to a low-carbon economy. As such, Green Sukuk can help to combat climate change by paving the way for climate-smart investments in environmentally friendly projects that are based on sustainable resources.
Tasfiq Mahmood is currently working at the International Centre for Climate Change and Development (ICCCAD) as a Senior Project Associate. He is also looking after the policy support programme of ICCCAD. He completed his Bachelor's in Environmental Management and Masters on Natural Resources Management from IUB.
