Green bonds are all the rage. The global green bond market topped US$35 billion in the first half of 2016 and countries from China to India to Australia are putting their money where their mouths are and taking concrete steps to issue — with governments and development banks playing a leading role. But what has happened to the Islamic finance industry — last year hailed as the golden child of SRI expectations? Why have we, LAUREN MCAUGHTRY asks, not yet seen a surge of green Sukuk — and why all the early enthusiasm appears to have evaporated?
A massive market
Climate bonds have long been a buzzword for the finance industry, but it looks as if they are finally catching on — and the market is gaining some serious momentum. The conventional sector has exploded in recent years — interest from both the public and private sectors has driven a ten-fold rise in green bond sales from US$3 billion in 2002 to US$36.6 billion in 2014, according to the UN. Over the last two years, growth has accelerated yet further, to reach a total issuance of US$41.8 billion in 2015 — and the pace is picking up.
“With strong issuance already observable in the first two weeks or so of July… the global green bond market is poised to reach US$75 billion in total volume for the year and set a new record for the fifth consecutive year,” predicted Moody’s in a recent report. That’s already more than some estimates of total expected Sukuk issuance, and the growth is ongoing, with expectations exceeding even the latest estimates. The market is increasing quarter by quarter — with the first half of the year raising almost 90% more capital than the same period in 2015.
“US$75 billion is a dramatic underestimate,” Sean Kidney, CEO of the Climate Bonds Initiative, told IFN. “We already have US$45 billion green bonds issued globally, and it will be closer to US$100 billion by the end of the year.”
So where is the Sukuk market in all of this? Last year we saw a surge of enthusiasm, with green Sukuk capturing the headlines at the World Islamic Economic Forum in November, announcements from the IDB about potential issuance, commitments from the UAE claiming they could be the first to offer a green energy Sukuk — and of course, the first tranche of the groundbreaking SRI Sukuk from Malaysia’s Khazanah, which won the IFN Deal of the Year in 2015.
Yet after this initial flurry of enthusiasm, all seems to have gone quiet. Despite Malaysia announcing tax incentives for ‘ethical’ bonds and Sukuk in its latest Budget 2016, there has been no further issuance — and despite the ambitious renewable energy commitments from the GCC governments (the UAE alone has committed to producing 7% of its electricity from renewable sources by 2020), concrete projects to achieve this have been thin on the ground. The US$22 billion Masdar City, the flagship renewable project from the UAE claiming to be the world’s first carbon-neutral city, was originally scheduled for completion this year but that date has vanished into the distance. “The target end date is 2030 based on the level of investment,” Anthony Mallows, the director of planning and delivery at Masdar City, told Construction Week in July.
Could this be a question of overall commitment rather than Islamic industry reticence, however? “There’s been very little conventional green issuance from geographies in which there is a concentration of Sukuk,” pointed out Andy Cairns, the managing director and global head of debt origination and distribution for the National Bank of Abu Dhabi (NBAD), speaking to IFN. “So perhaps it is less about green Sukuk gaining traction, and more about countries that are strong on Sukuk being less environmentally attuned than other countries.”
An urgent need
Yet energy needs are only increasing. According to a recent study from Frost & Sullivan, for example, Saudi Arabia will have to spend over US$100 billion in renewable energy projects over the next 25 years, as energy demand rises by 45% due to a growing population and increased industrial activity. “By 2020, Saudi projects alone will account for 70% of the total value of the GCC’s renewable energy projects,” said the report. With the cost of funding soaring, bank deposits shrinking and lending rates tightening due to the recent oil price pressure, where is this money going to come from?
The obvious answer is Sukuk — but governments appear reluctant to tap that route so far, with the major fundraising activity this year choosing a conventional route to obtain quick and easy funding. Qatar raised US$9 billion through the conventional markets in May, while Saudi issued its first sovereign bonds in a decade last month. The current state of the economy and the continued pressures — especially on oil-producing nations — have made speed and simplicity the most attractive elements of capital-raising, while innovation and evolution appear to have fallen by the wayside.
A long way to go
The trouble is, it takes effort to develop something new — and that focus has simply not been put into the Islamic market for green bonds, because everyone has had other things to think about. “The green bond market is catching on, but it takes a lot of work — and that work and those resources have not been invested into the Sukuk market yet,” agreed Kidney. “It’s frustrating that we have not seen the SRI Sukuk growth we expected. What I’m realizing is that markets really do need a lot of nurturing. We’ve been doing a lot of work around green bonds, but Sukuk need a lot more effort.”
Given the current climate, this could be a long-term game, despite the lip service paid by enthusiastic supporters of the cause. “We need to build confidence back in the economy first,” warned Stuart Hutton, CFO of wealth management firm Simply Ethical. “Short-term we won’t see a spate of issuances, it’s a market for the long-term. Over the next decade working in this field, we should start to see some good quality institutions, as governments and corporates make some issuances on this basis. Once they’ve realized they can get some good investors in, the sector will grow.”
A solid example
The conventional market has this year unequivocally demonstrated how emerging markets can benefit from the green bond revolution, with the world and his wife jumping on board. Although the US still dominates green bond issuance with 23% of the market as of June 2016, followed by the major development agencies including the World Bank (17%), emerging markets are realizing the benefits and making their presence felt. Last month, the Bank of China broke records with a US$3.03 billion green bond issuance in three currencies (euro, US dollar and renminbi), the largest international issuance of its kind so far. Also in July, the BRICS New Development Bank, a multilateral development bank founded by Brazil, Russia, India, China and South Africa, issued US$449 million in five-year renminbi-denominated bonds to support sustainable infrastructure and clean energy in member countries — and plans to issue a further US$1.5 billion over the next six months.
India is another leader in the green bonds rush — with a US$200 billion state-spending drive to boost renewable energy supporting a surge of activity. The current administration has committed to sourcing 40% of its energy needs from sustainable sources by 2030, leading to a spate of issuance including the announcement last week from state-run Energy Efficiency Services of a plan to issue up to US$100 million in offshore green bonds. Kenya too has jumped on board, with the Nairobi Securities Exchange announcing the imminent launch of green bonds and carbon credits as it seeks to attract investors keen on sustainable development. Even Australia is on the bandwagon, with US$300 million-worth of green bonds issued by the Victoria state government last month to finance renewable energy.
But it is not just governments leading the charge. The conventional market has developed to a point where corporates are already seeing the benefits. In Europe, leading UK supermarket Sainsbury’s has taken a GBP200 million (US$264.3 million) ‘green loan’ to invest in carbon reduction while HSBC previously pledged US$1 billion for a portfolio of green and SRI bonds and Toyota has issued US$1.6 billion to invest in a cleaner range of cars. French renewables firm Akuo Energy in July raised EUR44 million (US$49.15 million) in green bonds to finance renewable energy plants — its second issuance after a debut in June 2015. India’s largest power producer, NTPC, has already appointed bankers for its first green bond issue while banks including Axis and Yes Bank are also joining the trend. In fact, S&P estimates that up to US$28 billion in green bonds this year could be issued by corporates.
Driven by demand
So where is the appeal? Surely the challenge of green bonds lies in their higher price and increased complexity — just like the Sukuk market, it takes time to attract investors to a concept they are unfamiliar with. Not so, says Kidney. “We had investors at the UN Climate Summit [in December 2014] accounting for US$60 trillion, who signed statements to the assembled world leaders about the critical importance of climate change and confirming that they stood ready to invest, subject to opportunities that met their regulatory requirements,” he told to IFN. “This is a market that has been driven so far by investors, not issuers. Issuers will eventually join the party when they realize that.”
Much of this demand is being driven by institutional investors who are keen to diversify their risk and meet their long-term strategic goals. “This is not a bunch of hippy investors sitting in Brighton,” explained Kidney. “These are the mainstream investors, the big insurance funds, who are developing organization-wide strategies to try to address their long-term climate change obligations and meet their risk and yield requirements.” This includes central banks and sovereign wealth funds that already recognize the importance of the sector. Mark Carney, the governor of the Bank of England, confirmed in a speech earlier this year that climate-friendly bonds and infrastructure projects would be a priority for September’s G20 meeting in China.
“These instruments can unite relatively short-term portfolio management strategies with long-term risk issues. And it will be no different with Sukuk,” said Kidney. “This is something that most bankers are not even aware of yet. They still think that there is a possibility that no one will buy it. But on the contrary — all the green bond markets, in every market, have been driven without preferential pricing. Everywhere I go, I meet investment banks who all say we won’t get investment pricing. And every time, the issuance is way oversubscribed and they are always surprised, because they don’t understand it. They don’t understand that investors are aware of the material risk to their long-term portfolios, and they are seeking instruments to help them hedge that risk. There is a real market out there. Yes, it is still a flat price market but it will get bigger. You get access to capital, then costs go down, and you get deeper levels of engagement and clients who bought early will stay loyal and buy again and again.”
The appeal is obvious. According to Moody’s, 97% of green bonds issued so far this year were investment grade, with 43% carrying an ‘AAA’ rating. And while slightly below global benchmarks, overall returns have been positive: with gains of 1.7% for the second quarter and 4.3% for the first half (compared with 2.5% and 5.7% for the Bank of America Merrill Lynch Global Bond Index). The rating agency also noted that the difference in total return was likely due to the shorter weighted life of the average green bond.
Existing issuers have already seen the benefits. “A year after our first green bond issue, we are very pleased to have confirmation that a growing number of investors have organized themselves to be able to participate in the financing of the green economy,” said Eric Scotto, the chairman of Akuo Energy.
And due to the scarcity of supply for green bonds, the large pool of liquidity that exists is making the area very attractive for potential issuers. India’s Yes Bank for example, plans to issue by December this year. “India has a growing need to finance its renewable energy projects and green bonds can play a vital role in providing funds,” said Jaideep Iyer, the group president at Yes Bank, to Bloomberg last month. “Pricing on these notes will improve going forward as there are large funds available globally whose mandate is to invest in energy-efficient projects.”
All talk, no action
So we’ve seen the attraction — and we have seen the advantages. Why then, has the Islamic finance industry not yet taken advantage of this booming market? Excluding the admirable Khazanah issuance, which focused on funding education, the industry has not yet seen a truly green bond issuance, despite the Islamic Declaration on Global Climate Change published in August 2015 and calling for action from governments, corporates, investors and all Muslims around the world. The IDB has not yet stepped up, despite its commitment at the UN conference in Paris in 2015 — although it has already invested around US$2 billion in clean energy to date. The World Bank has not followed its 2014 IFFIm vaccine Sukuk with a green issuance and no corporates have yet taken the lead.
“We had hoped the Malaysia government would step up, but there’s been nothing yet,” lamented Kidney. “We’ve [also] had a lot of conversations with the GCC and you would think that someone like ACWA would have done an issuance by now. But the truth is that capital is still very cheap, so the pressure to open up new markets is not high enough for anyone to make the first move. There is no sense of urgency.” But, he warns, this apathy could be detrimental. “It’s a missed opportunity for GCC market leaders — I think they are going to blow it. It will happen eventually, but right now people are taking the easy route.”
Having said that, momentum has not come to a complete halt. The G20 Green Bonds paper to be published in September reportedly contains a page authored by Bank Negara Malaysia on promoting green Sukuk. There is a deal currently being explored in Southeast Asia that could come out in the next few months and lay the foundations for further issuance; and there are rumors that the Dubai Electricity and Water Authority could be planning a green Sukuk for later this year. In January, we saw a US$10 billion commitment from the NBAD toward sustainable financing, and the bank has continued working toward driving this goal forward. “We’ve been pushing green Sukuk quite aggressively: we did the first ever SRI Sukuk for IIFIm, we’ve been speaking to the World Bank to explore potential issuers and we had a modicum of traction,” said Cairns. “I think we will see a green Sukuk [facility] but it is a matter of when. Hopefully, within the next year or so.”
At the moment, however, it is a story of opportunity, not delivery. “We have to get some pioneers into the race — and all markets start with government issuance,” urged Kidney. “We just need a few demonstration Sukuk — it’s as simple as that. As soon as you get a couple out in the market, everyone will want one. There are no regulatory issues, there’s no lack of deal flow — it just needs someone who wants to attract new investors enough to take the first step. We need to work with key potential issuers to tempt them over that threshold, which is what we expect to do over the next six months.”
“We are at the tipping point. We have governments, central banks, investors and they all want to move this forward, but no one is quite brave enough to take that step,” agreed Hutton. “It is a case of the first person across the line — people are scared of failure and they want other people to make the mistakes. There’s a waiting game going on.”
There’s certainly a market out there, but the problem remains size. Investors want a financial return as well as a social one, and while green bonds may have scaled up to the point where they are at parity, the Sukuk market remains limited, especially in the current economic environment. “There has to be a sizeable market and a scalability to make it efficient,” agreed Hutton. “Smaller markets mean the return is eroded. Governments will have to step in, and institutions will have to follow quickly.”
Missing a trick
There is no doubt that the market will eventually tip over the edge — with US$60 trillion in waiting investment, how could it not? The question is whether the Islamic finance industry will be ready to benefit. Right now, the enthusiasm is there - but the first step has been a long time coming. “I’m very confident that there is a long-term market here. It is taking a long time to get the competence, but we can see the necessity being generated,” thinks Hutton. “Over the next five-10 years, we will see significant development.”
But this development will take commitment — which has not yet materialized. “The Islamic finance industry is missing a trick,” warned Kidney. “Sukuk are now a global instrument — look at your investor base. The industry will be left behind if it does not rise to the occasion and ride this wave.”