Islamic finance turns to climate and energy

To meet sharia rules, Islamic financial institutions are increasingly looking to the energy transition and socially responsible investing, boosting decarbonisation efforts and bringing new business opportunities in the Muslim-majority world.

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​Dedicated green investment is at an early stage in Islamic finance, but it’s growing quickly, particularly in the UAE, Saudi Arabia, Malaysia and Indonesia, as these countries seek to transition from hydrocarbons, reach net zero targets and attract foreign investors with environmental and social priorities. Their financial regulators are developing principles and taxonomies to facilitate this process.
​Arguably, Islam, by its nature, is in tune with sustainable principles. Preserving life is one of the five pillars of sharia. While purchasing stocks and shares, or equities, is allowed within Islamic finance, investing in ‘sin stocks’ that potentially harm life, including arms, alcohol and tobacco, is classed as ‘haram’ and forbidden. 

Islamic finance forbids earning money from interest charged on loans or deposits. Bond investment falls foul of this prohibition. However, there is a sharia-compliant version of the bonds market known as sukuk, under which investors receive a share of the profit generated by assets.

Rise of sustainable Islamic finance
In 2017, Malaysia issued the world’s first ‘green sukuk’, raising $58m to finance a solar project. The S&P Global analysis explains that globally, green sukuk issuance was $11bn in 2023 compared to less than £400m in 2017 — an almost 30-fold increase.

Indonesia has issued a total of £7bn in green sukuk since 2018, to finance energy, transportation, waste management and climate resilience projects. The UK’s Islamic Finance Council estimates that, globally, green and sustainable sukuk could generate between $30bn and $50bn towards the 17 SDGs by 2025.

The core Islamic countries – excluding Iran – allow both Islamic and non-Islamic finance issuance and they are rapidly adopting sustainable finance instruments in both financial ecosystems, in local and foreign currencies. S&P Global reveals that the issuance of green, social, sustainability and sustainability-linked (GSSSB) bonds) in the Middle East more than quadrupled in the first nine months of 2023, to reach $19bn. Saudi Arabia and the UAE made up more than 80% of this total.

Green and sustainable sukuk is only part of this picture, but it has become emblematic of a re-orientation of Islamic financial systems.

Impact of COP28
Mohamed Damak, global head of Islamic finance at S&P Global Ratings said: "Market participants are coming to the conclusion that in the debate about climate and energy transition, Islamic finance can bring something to the table."

"Holding the COP in Dubai in 2023 undoubtedly had an impact on local issuance, a phenomenon we have observed in other COP host countries," Damak added. "While 63% of sustainable sukuk issuance in 2023 was green sukuk, we believe that 2024 could be the year that transition-labelled instruments go towards decarbonising hard to abate sectors in the Middle East."

Financial regulators are following this investment trend. The UAE, Qatar, Indonesia, Malaysia and Bangladesh have published taxonomies and principles for sustainable finance. In 2022, the ASEAN Capital Markets Forum released a sustainability-linked standard for bonds, which covers sukuk and, in 2023, the Arab Monetary Fund released guidance for sustainable sovereign instruments.

Meanwhile, the International Islamic Financial Market (IIFM), the Islamic Financial Services Board (IFSB) and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) are working towards regulatory consolidation for sustainable investment.

Charitable obligation of Islam
There is another globally significant Islamic contribution to sustainable development. It is a requirement of Islam, known as zakat, that qualifying individuals donate a proportion of their wealth to charitable causes. Globally the potential size of the zakat pool has been estimated at between $200bn and $1tn a year. 

The United Nations Development Programme notes that zakat, one of world’s largest forms of wealth transfer to the poor, aligns with numerous SDGs. It says: "Considering the estimated $2.5 trillion annual gap in SDG financing, as reported by the World Economic Forum, a funding source this large cannot be ignored."

The UNDP has collaborated with Indonesia’s zakat agency to install micro hydropower plants bringing electricity to more than 4,500 people. Future projects will use zakat funds to protect biodiversity.
Largely unappreciated by the rest of the world, it can be argued that Islamic finance is particularly in tune with a global energy transition and sustainable development.

The concept of risk sharing is central to Islamic banking and finance, which exist to further the socio-economic goals of communities. Green sukuk has proved a useful mechanism, particularly because its investment is linked to defined assets rather than generalised goals. 

​This rapidly growing asset class has helped to raise awareness internationally that Muslim countries care as much about climate change as non-Muslim ones, and that they are seeking to slow it down. It also provides a means for foreign investors to help oil-dependent states to decarbonise.