Islamic banks stripping away 'sustaina-babble' to fund science-backed green projects

A panel discussion during Cop28 in Dubai explored the potential of Islamic finance instruments to help fund climate change initiatives in emerging economies. Photo: Abu Dhabi Islamic Bank

The Islamic finance industry has a “big role” to play in providing capital to emerging economies to fight climate change, as its Sharia-based principles support the goals of environmental protection, experts said at a panel at the Cop28 conference in Dubai.

The higher intent of Shariah – which advocates social and economic justice as well as community welfare – means that there is an alignment between Islamic finance and sustainable finance, said Mohamed Damak, managing director and global head of Islamic finance in the Middle East and Africa at S&P Global Ratings.

This year to the end of September, $8 billion of sustainable Islamic bonds were issued, doubling from $4 billion last year, and that growth is expected to continue, he said.

About 70 per cent of Islamic finance assets are concentrated in the Middle East, according to S&P.

“This part of the world is subject to an energy transition and many GCC countries have come up with strategies in order to enhance the sustainability of their economies and the implementation of these strategies will translate into significant financing needs and Islamic finance could contribute from that perspective,” Mr Damak said.

There is appetite for Islamic financing, particularly into emerging economies, with countries such as the UAE and others in the region that are seeking to deploy capital into green projects, said James Cameron, a climate change adviser, advocate and social entrepreneur.

“We want long-term investment, we want relationship-based investment, we want investment that has a long-term purpose where the outcome matters, money for the real world, not just spinning around the financial system, but for infrastructure, for building livelihoods and making sure homes are properly insulated,” he said.

“And stuff like this should be a good fit for Islamic finance.”

However, bankers called for a focus on a science-based approach when deciding on which sectors to work with to help them achieve their environmental targets and assess climate risks.

“What really troubles me is that when I look at all these ESG [environmental, social and governance] reports and analyses, there's a lot of sustaina-babble, meaning they're not really focusing on the issue,” said Rafe Haneef, group chief executive of Malaysia Building Society.

The Middle East is confronted with more extreme heat with every degree of global temperature rise. Operating in a region that is vulnerable to the physical impact of climate change means financial institutions have major investment opportunities in the transition to a low-carbon economy, the panelists said.

The region is particularly well-poised to deploy Islamic funding into green projects as oil-producing economies prepare for the transition to clean energies, they said.

“Without Islamic financing, we can't achieve climate transition … it's critical to address this in the Islamic finance space,” said Christian Kunz, chief of strategy, innovation and ventures officer at the Dubai International Financial Centre.

“This region is playing an enormous role in making that happen.”

Nasdaq Dubai's sustainable finance market grew to $28.8 billion over the past five years, of which sukuk make up $16.1 billion, Mr Kunz said.

In the past five years, the sustainable bonds and sukuk market was about $15 billion, with listings this year alone of $11.7 billion.

“We're seeing enormous growth both in the green sustainable bonds and the sukuk, we have four green sukuk listings worth $4 billion, which is half of the global market share,” Mr Kunz said.

“Sustainable finance and sukuks are taking the lead in a higher percentage of new listings, following green and sustainable frameworks, and I want to emphasise the opportunity.”

The Islamic finance industry should continue to embrace innovation and the “next big thing” for the sector could be an Islamic security token, said Sohail Zubairi, an Islamic finance specialist.

“The tokenisation of the asset could be significant because a huge amount of liquidity is trapped into the assets – real estate assets, movable and immovable assets – so if we could bring in Islamic tokenisation effectively … we could generate huge amounts of liquidity from the grassroots level because the issue with sukuk is the barrier to entry now is very high,” he said.

Asset tokenisation is the process of transforming an underlying asset into another unit of a digitised or physical asset called tokens, according to PwC.

Tokenisation helps to convert an asset into a digital unit that can be managed without a central intermediary through blockchain technology.

Panelists also called for the convergence of standards for Islamic financing products and unified rulings that ensure Islamic banks' instruments meet the requirements of Sharia across geographies.

“How do you make the $8 billion [of sustainable Islamic bonds], that have doubled compared to last year, into $80 billion or $800 billion? The answer is simple … you need standards when it comes to Sharia, when it comes to the sukuk themselves, you need to make the product easier for issuers and for the investors,” Mr Damak said.

“There is an ongoing debate in the industry on how can we move the industry from what is permissible, or halal, to what is permissible and adds value.”

The Islamic finance industry needs to go a step beyond considering the permissible sectors they can invest in and consider the climate impact of these industries, panelists said.

“We want to bridge the gap between Sharia and science, so whilst we continue financing in the permitted sectors, we need to now start measuring the impact of permitted sectors in relation to climate risks,” Mr Haneef said.

“Today that is happening and we are seeing Islamic banks coming up with sustainability and ESG reports.”

However, the “elephant in the room” is the lenders' Scope 3 emissions, he said. Banks' Scope 3 emissions, or financed emissions, are lending-related emissions and are the biggest contributor to financial sector's carbon footprint.

Islamic banks are examining the impact on the environment from their financing of permitted sectors, he said.

Abu Dhabi Islamic Bank is calculating its Scope 3 emissions and accordingly will set a “clear target” on how to reach its goal of net-zero emissions by 2050, said Lamia Hariz, head of ESG, at ADIB.

“For Islamic finance to succeed, first it has to become mainstream, and we are becoming mainstream, but when we combine green principles with the Sharia principles and set common standards, this for me is a perfect world,” Ms Hariz said.