Everyone is talking about the Islamic/ethical crossover and the potential for sustainable financing, clean energy and green Sukuk — but so far no concrete issuance has been forthcoming, and very little has actually happened in the market. What are the actual parameters of the ‘green’ movement and where is the material benefit for the Islamic finance industry? Is it really a commercially viable opportunity for Islamic practitioners — or just a convenient promotional tool to publicize corporate social responsibility? LAUREN MCAUGHTRY asks the hard questions.High demandGreen bonds are big business. Since 2007, the overall green bond market has seen compound annual growth of 50%, 2015 saw around US$42 billion in conventional green bonds come to market according to Moody’s Investor Services which has predicted another record year with over US$50 billion in expected issuance for 2016 and growth expected to continue well into next year. In January alone, total global green issuance reached US$6.7 billion (according to Renewables website SeeNews); on the 25th February, Luxembourg celebrated the listing of its 100th green bond; and so far this year players as diverse as the European Investment Bank, the UK’s Swindon Borough Council, New York’s Metropolitan Transportation Authority, technology giant Apple and China Industrial Bank have all tapped the green bond market — with deal sizes topping US$1.5 billion.This all sounds great — so is the Islamic finance industry getting on board to make sure it doesn’t miss out? In theory — absolutely. Last year we saw headlines galore, and optimistic announcements from all over the world. GCC governments have set ambitious clean energy targets that should be perfect for building up the green Sukuk market: the Climate Bonds Initiative (CBI) claimed to expect at least two green Sukuk issuances by April last year, while at the UN global warming conference in November last year the IDB also confirmed it would look at green Sukuk — and players from across the Islamic markets have paid lip service to the concept.But in practice on the other hand ... very little has actually happened. “We know that issuers are certainly looking at it,” Lee Irvine, a counsel with Latham & Watkins in Dubai, told IFN. “[But] one of the big challenges for the issuance of a green Sukuk [facility] is that the market for such green instruments is still yet to mature.”Public promotionSo what needs to be done? In February 2016, the CBI and the World Business Council for Sustainable Development announced a new partnership designed to drive the development of the green bond market and address global sustainability challenges through a combination of credit enhancements, government guarantees, tax incentives, pension fund mandates and regulatory steps such as preferential risk weighting for green bonds in bank capital requirements. Surely this would be an obvious move for governments not only to build their Islamic finance capabilities but meet their clean energy requirements, garner positive publicity and diversify away from hydrocarbons amid the ongoing oil price volatility.“It makes sense that a GCC sovereign or quasi-sovereign would be one of the first issuers of a green Sukuk [facility], and that would be great for the green Sukuk market — it would help open up the market and help set the price for these instruments,” said Irvine. “We are missing that benchmark in the green Sukuk space right now, and that is what we need, to establish it as a viable and acknowledged financing instrument and develop it as an asset class in its own right, rather than just a branding exercise.”Thus far however, only Malaysia has stepped up with any kind of socially responsible Sukuk issuance, with Khazanah’s inaugural sustainable and responsible investment (SRI) Sukuk in May 2015 — and that raised money for education, not renewable energy or ‘green’ causes per se, nor has it been followed by any further issuance, despite the much publicized SRI investment platform and ‘ethical’ Sukuk guidelines issued in 2014.So in the dearth of state support, could the private sector take the lead? The Gulf recently saw one of its biggest commitments to date in the form of the 10-year commitment to sustainable financing from the National Bank of Abu Dhabi (NBAD). “The bank has developed a US$10 billion target to lend, invest and facilitate in sustainable businesses: which is both a statement of strategic intent and a direction of travel,” explained Nathan Weatherstone, the head of renewable energy and sustainable business at NBAD, speaking to IFN.The definition of the projects is wide. NBAD last September became the first UAE bank to sign up to the UN Equator Principles, and the new financing strategy will adopt a similar definition to the International Capital Market Association (ICMA)’s green bond principles and will include renewables, clean transportation, energy, water efficient real estate, sustainable water and waste management systems, energy efficiency, decarbonizing technologies and climate change adaptation.Islamic opportunityBut how much of this activity will be Islamic? “That’s an interesting question,” said Weatherstone. “Is there any reason why they shouldn’t be structured in a Shariah compliant manner? No. We believe that a lot, if not all, of the activities we are looking at are capable of being structured to use Islamic finance.”So what might prevent NBAD, or anyone else, from going down the Shariah compliant route? Realistically, it becomes a question of competitiveness — both in terms of pricing, depth and liquidity, expertise in the market and — crucially — tenor. “A lot of these projects are infrastructure-based by nature. Traditionally, tenors in Islamic finance have not been so competitive with conventional finance,” pointed out Weatherstone. However, he stresses the business aspect. “We do see this sector being driven by commercial realism — 20% of our corporate clients are already active in the sustainable sector, and with the trend toward the removal of widespread state subsidies for things like electricity and the ever-increasing cost competitiveness of clean technologies, I have no doubt that other institutions may choose to follow our lead.”Size mattersAnd of course, there could be other opportunities for the Islamic market to benefit — although this may take time. “Bonds and Sukuk are great ways to refinance renewable energy projects, but it’s a difficult road to walk down on a first financing,” pointed out Jeremy Crane, CEO of Yellow Door Energy and board member of the Clean Energy Business Council MENA. “Green bonds in most cases are used for refinancing in markets that are large and relatively liquid. The Islamic world has relatively limited renewable energy penetration — relatively little has been built to date, so it requires projects to be built and then refinanced before we can go down the green Sukuk route.”Another problem is that the projects need to be big — and many of the smaller energy investment firms simply don’t have the scale or capacity. “Our portfolios just don’t really line up well for this,” agreed Crane. “We target smaller projects and you need to do at least US$100 million to make it worthwhile — that really means a major utility issuance.”Identity crisisThe major issue however, especially for the Islamic industry, is that of parameters. The ‘Islamic/ethical’ crossover is an idea that has gained significant traction recently — but the boundaries are blurred and while a good catchphrase or useful PR tool, the theory behind it doesn’t always hold up. Just because something is ‘ethical’ doesn’t mean it is Islamic — and just because an investment is Islamic does not make it ethical. The same holds true for green Sukuk and the sustainable financing trend. What constitutes a ‘green’ Sukuk and why? What parameters are there, what definitions exist that make an issuance ‘green’?There are multiple different agencies, such as the Climate Bonds Initiative, the ICMA Green Bond Principles and the UN Equator Principles — but these guidelines are all voluntary and the standards vary, which makes it harder for investors to evaluate their benefits and the impact.For the Sukuk market it is even more challenging, because you need tangible assets — and no one seems to have really explored yet how this might work. With green bonds, the underlying principle is simply that the proceeds must be invested for green purposes. But with Islamic transactions, there is also an underlying Shariah requirement for assets to structure the transaction — do these also have to be green? Surely a fossil fuel company backing a ‘green’ Sukuk issuance with a coal-fired power station is hardly environmentally friendly, for example?Conversely, what if the underlying assets are accepted as ‘green’ — for example, a solar power issuance using the solar panels as the underlying assets sold and leased back as part of an Ijarah structure with the rental going to pay the investors — but the proceeds are then used for non-green purposes? Would this still count as a green Sukuk? “That’s probably the biggest challenge,” agreed Irvine. “From a structuring perspective, we can structure a Sukuk [facility] utilizing the assets a company has available. But what is going to be interesting is how we are going to go about the verification process for a green Sukuk. This is something that we don’t believe the verification agencies have considered yet, simply because until now, there hasn’t really been a need to consider it.”Market driversThe problem is that as yet, there isn’t a clearly defined standard for certifying green Sukuk — and that is impeding progress. “Creating a standardized green Sukuk [issuance] would make it a lot easier for everyone to access the market. Standardization would be very useful — and it would certainly accelerate the market,” agreed Crane. “The thought has always been that investors are willing to accept a slightly lower coupon for green projects. All bonds around the world get different labels put on them — municipal bonds, treasury bonds and so on — we categorize them. Putting the green label on is a category that will bring with it certain attributes that hopefully will drive a lower yield threshold for the industry.”And there could be a number of advantages to issuing green Sukuk over green bonds, both from a public relations/corporate image perspective as well as a general commercial stance. “Why Islamic [issuance] over conventional? You open up to a wider pool of investors. From a pricing perspective, this wider pool of investors typically means you get better pricing,” pointed out Irvine. “The same analogy applies to green Sukuk: you open yourself up to a wider pool of investors, including those that have the stated aim of investing in sustainable projects.”Market demandThere is certainly demand — with a large pool of money already looking to invest in this sector. NBAD might be the first GCC bank to commit funds, but multiple other banks have already taken the same step. Barclays in November 2015 pledged to invest a further GBP1 billion (US$1.42 billion) in green bonds, after hitting a previous GBP1 billion target. HSBC has also announced plans to invest US$1 billion in green bonds to boost its investment in clean energy and transportation, while Zurich Insurance Group has already met a reported US$750 million of a US$2 billion mandate. These might be conventional institutions but, as Irvine points out: “Investors are interested — and while they are predominantly after yield, if they can invest in a green Sukuk [issuance] with a similar yield, why not choose that?”However: more standardization is needed, parameters must be defined, and goals must be identified in order to progress. Yes, there is demand and yes, there is potential. But it is not enough to simply jump on the green bandwagon in order to boost corporate image. For the sector to succeed, it is time for green Sukuk to be treated seriously as a commercial asset class — rather than pandered to as a promotional public relations exercise.