Sparks

How Islamic finance is funding renewables

 By Criselda Diala-McBride

Islamic finance has been one of the fastest growing segments of the global financial industry. With assets estimated to be worth $1 trillion in 2015 – and year-on-year growth at 16% – it holds huge potential for funding green and sustainable projects, including renewable energy…

Islamic finance represents a tiny fraction (about 1 percent) of the global financial industry, yet its growth over the past years has been phenomenal. EY (formerly Ernst & Young) reported that Islamic banking assets crossed the $1-trillion mark globally in 2015 and by 2020, the industry’s profit pool is expected to reach over $30 billion, with annual growth rate projected at double digits. Other estimates point to the industry being valued at an impressive $4 trillion by 2020.

Often described as “ethical capitalism,” Islamic finance is a type of financial system that adheres to Islamic laws or Shariah. It revolves around the Islamic principle of cooperation, therefore all risks and profits associated with an investment are shared among investors. Interests are also prohibited under Shariah, which prevents the exploitation of investment. In addition, Islamic finance does not engage in industries that are considered “haram” or forbidden under the law. These industries include alcohol, tobacco, pork meat products, pornography and gambling, according to The Guardian.

In recent years, demand for Shariah-compliant financial products such as mortgages, loans, bonds and insurance has seen an uptick, as the Muslim population worldwide has expanded and as countries representing them become economically stronger. However, the ethical standards behind Islamic finance has also attracted non-Muslims, with countries like the United Kingdom, France, the United States and Japan dipping their toes into the issuance of sukuk, or Islamic bonds.

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Outlook for Islamic finance has been generally upbeat, but the industry has yet to realize its potential in raising much-needed capital to fund renewable energy programs worldwide.

Ashar Nazim, partner, Global Islamic Banking Center at EY, said that: “There is a strong natural fit for Islamic finance [to invest in] the renewable energy asset class, especially given the [industry’s] ethical and social angle. However, the challenge will be the availability of talent and structuring capabilities in this space.”

Bank Negara Malaysia agrees that the focus on environmental protection and sustainability suits the Islamic finance agenda, which underscores the enhancement of society’s general welfare. Despite this, “Islamic finance has largely remained absent from the green financing sector in the global markets,” the company reports.

Quoting United Nations Environment Program (UNEP) figures, Salam Awawdeh, partner and Energy and Resources leader at Deloitte Middle East, said that green energy investments worldwide surged by a solid 17% to $270 billion in 2014.

“A key feature of this report highlights the rapid expansion of renewables into new markets in developing countries, which stood at $131.3 billion, and was largely featured by the BRICS [Brazil, Russia, India, China and South Africa] countries,” he continued. “Noticeably, solar and wind predominantly accounts for over 90% of the overall investment in renewable power and fuels.”

Awawdeh said there is no reported evidence of Islamic finance contributing significantly in emerging green energy investment, although Islamic finance – mainly through sukuk – has had an increasing role in investing in broader energy projects.

He cited Saudi Aramco, which financed a refinery plant with over $6 billion worth of Islamic bonds; UAE’s Dolphin Energy Limited partly funded its pipeline projects with around $1 billion of sukuk; and Petronas of Malaysia also announced that it strategically aims to raise 30 percent of its new capital requirements in sukuk.

 

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“Similarly, SABIC of Saudi Arabia has been a key sukuk issuer for a number of years and attracted strong base of regional and international institutional investors in its sukuk debut,” Awawdeh pointed out. “Moreover, other energy-related projects in Bahrain, UAE, and Turkey have all tapped into Shariah-compliant finance. This trend is believed to be on the surge given the current constrains in conventional global capital markets, in search of alternative financing instruments.”

Dr. Hatim El Tahir, director of the Deloitte Islamic Finance Knowledge Center in the Middle East, added that across the Middle East and North Africa region, around $900 billion of investments are required in the energy sector, with renewable energy projects at the forefront of governments’ efforts to meet rising power demand.

“Financing [energy] projects have become more challenging in the face of current geopolitical risks and global economic downturn,” he said. “Last year, [we] examined the potential of corporate sukuk [in serving as] an alternative financing mode for infrastructure, including green energy.”

El Tahir and his team at Deloitte Middle East believe that corporate sukuk presents a practical option to bridge the gap in conventional capital investment. Corporate sukuk is “largely seen by investors and practitioners as a socially responsible investment asset class [because] it offers a different risk-and-return profile for investors and issuers alike,” he says.

While Islamic finance’s contribution to renewable energy funding may currently be negligible, pockets of opportunities have started to appear in countries like Malaysia and the UAE, where the concept of “green sukuk” is being developed by using Shariah-compliant bonds to finance green energy projects.

about the author
Criselda Diala-McBride
Dubai-based journalist with 20 years of experience writing and editing finance, aviation, tourism, retail, technology, property and oil and gas articles for a range of print and online publications.