By: Bashar Zeitoon

Plans to establish green Islamic bond markets are being promoted in the Middle East and North Africa (MENA) region, several news reports suggest. The use of Islamic debt instruments, known as sukuk, to raise capital for sustainable development projects in the MENA region would set a new precedent. It is hoped that the green sukuk would become key to financing low carbon economies in a region bent on diversifying away from fossil fuel to renewable sources of energy. Green ventures in need of capital may include projects to build renewable energy generation or to implement large-scale energy efficiency measures in cities and industries.
The effort to spur Islamic climate bonds is being spearheaded by the Climate Bonds Initiative, a global civil society network created to promote the rapid development of climate bonds in global markets.
Climate bonds are long-term, debt securities that are specifically issued to finance climate mitigation and adaptation projects, while creating stable returns for long-term investors. The issuer guarantees repayment of the debt plus a rate of return after a certain period of time, called maturity. Bonds are ideal instruments to mobilize private financing for long-term projects. The Abu Dhabi English-language publication, the National, reports that “green sukuk and bonds could provide as much as $300 billion for projects to combat climate change.”

Promoting climate sukuk is designed to attract Islamic funds under management to investments in low carbon transitions in the MENA region. Such funds are becoming attractive at a time when alternative financing scenarios have so far not materialized sufficiently to provide the kind of sustained funding needed to invest in carbon emission reduction or climate adaptation at a pace and at a scale large enough to make a strong impact in combating climate change.

Private banks are increasingly reluctant to offer loans for climate solutions due to financial market uncertainties and the shifting priorities in the European Union to address the debt crisis. More and more, governments do not have the capacity or the appetite to provide funding for a transition to a low-carbon economy, with other priorities pressing on their public budgets. Furthermore, the failure to conclude an international climate agreement now means that funding from carbon trading and other carbon pricing schemes will take years to materialize. Another potential source of funding is the Green Climate Fund, which is supposed to channel $100 billion a year by 2030 for carbon emission reduction projects in developing countries. However, mechanisms for governance and distribution for the Green Climate Fund are yet to be formally developed. And finally, the value of United Nations-backed carbon credits has declined in 2011 due to oversupply and weak demand.

These dynamics have provided the impetus to consider green or climate sukuk as a source of financing that could provide long-term liquidity in the bonds market while offering stable returns to long-term institutional as well as retail investors. Many believe that the next few years up to 2015 will be critically pivotal in mobilizing capital for climate solutions. The Climate Bonds Initiative has stated that “the small window available to grow the critical low-carbon industries is closing and avoiding two-degree warming will require simultaneous and rapid industry growth across all mitigation opportunities.” In fact, regardless of the shape and form of any future binding international agreement on climate change, financing schemes, or emission targets, the Initiative believes that “rapid progress on low-carbon industries within the next five years will be critical to allowing any long-term measures a chance of success.”

Climate sukuk may just provide the kind of jolt needed for governments and corporate entities in the MENA region to raise capital for a low carbon economy. In general, making a transition to a diversified energy sector in the MENA region frees oil-producing countries to export more of their crude oil, while allowing them to rely on renewable energy sources, such as solar and wind, to meet local electricity demand. Green sukuk would provide the necessary financing for investments in renewable energy generation and higher efficiency buildings and factories. Even climate change adaptation measures may qualify for funding through a green sukuk if a compelling business case for stable, long-term returns can be made.

According to Bloomberg, anywhere between $10 and $15 billion can be raised by a green sukuk today to fund some of the green climate projects that have been announced in the MENA region. For example, Dubai is considering plans to issue a green sukuk to finance a $30 million 10MW solar park, biogas plants, and energy efficiency in buildings, according to the Dubai Carbon Center of Excellence.

As the new phrase implies, green sukuk involves certifying the environmental credential of the bond as well as the compliance of the debt security with Islamic Shariah law. To ensure climate and Shariah compliance, the Climate Bonds Initiative, in partnership with the Clean Energy Business Council, an Abu Dhabi-based trade group, is setting up a panel to develop a standard for a climate sukuk. The standard will be used to provide assurances to issuing entities and investors that the bond is certified to contribute to low carbon emissions. By working together, the Climate Bonds Initiative and the Clean Energy Business Council hope to engage governments, industry, and investors to develop the regulatory and policy framework for a green sukuk in the MENA region. The Clean Energy Business Council is a not for profit company representing the private sector involved in clean energy sector across the MENA region. It is registered in Masdar City, Abu Dhabi.

The Climate Bonds Initiative has already launched an internationally recognized Climate Bond Standard as a screening tool to ensure that investments seeking funding through climate bonds are specifically tied to climate change mitigation and adaptation. The Climate Bonds Initiative is a special project of the Carbon Disclosure Project (CDP) and the Network for Sustainable Financial Markets (NSFM). NSFM is an international network of finance sector professionals, academics, and others dedicated to ensuring financial market integrity and efficiency.

Other financial institutions are also lobbying for the promotion of climate bonds for financing low carbon investments. A group of large insurance companies, such as Allianz and Swiss Re, with assets of more than $3 trillion have called on policy makers at the COP 17 climate negotiations to encourage governments to issue green sovereign bonds.

Looking forward, the challenges facing those advocating climate bonds include labeling and certification, standardization of ratings, aggregating individual low carbon projects, and the pooling of climate bonds into a new asset class.

Bashar Zeitoon is program manager at the Arab Forum for Environment and Development (AFED)