One potential means of attracting capital markets investment in infrastructure finance is to combine the two other trends described above – the expanding markets for both environmentally sustainable investing and sukuk. To date, these two markets have been geographically distinct. Environment-focused investors are mainly found in Northern Europe, North America and Japan, and sukuk investors are concentrated primarily in the Persian Gulf and Malaysia. However, the two markets do share a strong commonality. Both environmentally sustainable investors and sukuk investors aim to use their money in a manner that conforms to their values and beliefs. Whereas traditionally, finance has been solely driven by the effort to maximise risk-adjusted returns, these types of investors have added an additional qualitative objective for financial market activity—compatibility with the investor’s ethics.
A sukuk in which the proceeds are used to fund a specific environmentally sustainable infrastructure project, such as the construction of renewable energy generation facility, could appeal to both sukuk investors and conventional environment-focused investors. Combining these two distinct investor bases would be a novel development for the capital markets. While some conventional investors, mainly bank treasuries and hedge funds, purchase sukuk, the vast majority of conventional investors (including virtually all environmentally sustainable investors) have no experience at all with these instruments.
However, there is nothing intrinsic to sukuk that make them inappropriate for conventional investors. Although the structures and terminology will be unfamiliar at first, sukuk should be attractive to conventional investors if they offer reasonable risk-adjusted returns and are properly marketed. A sukuk that meets those criteria and provides funding for an environmentally sustainable project could be particularly attractive to environment-focused investors for two principal reasons. First, sukuk provide investors with a high degree of certainty that their money will be used for a specific purpose. In order to comply with the underlying Shari’ah principles, the funds raised through the issue of a sukuk must be applied to investment in identifiable assets or ventures. Therefore, if a sukuk is structured to provide funds for a specified infrastructure project, such as a renewable energy project, there is little chance the investors’ money will be diverted and used for another purpose.
Second, many more environment-focused investment products exist on the equity side of the capital markets than on the fixed income side. The reason for this lack of supply is that the majority of corporate and sovereign bonds are general, unsecured obligations of the issuer, meaning the use of the proceeds of the bonds is not restricted to a particular purpose. Since most environmentally sustainable investors want to know precisely how their money will be used, bonds that are general obligations of an issuer have limited appeal unless all of the activities of the issuer meet the investor’s environmental standards. Sukuk, which are most similar to a conventional fixed income security, could help fill the fixed income supply gap for environmental investors to the extent the proceeds of a sukuk are earmarked for a particular environmentally beneficial purpose.
In the conventional capital markets, environment-focused bonds have begun to appear in recent years. The World Bank, for example, has issued since 2008 a type of bond called "World Bank green bonds". Rather than funding all of the activities of the World Bank, the proceeds of World Bank green bonds only go to support certain projects that meet pre-determined criteria for low carbon development. These bonds have been very well-received by environmentally sustainable investors, and the structure has become a model for other supra-national, corporate and sub-sovereign issuers. “Green” sukuk to finance sustainable infrastructure have the potential to further broaden this market as well as to help to bridge the gap between the conventional and Islamic financial worlds.
source: World Bank