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Tuesday 22, May 2018 by Jessica Combes

Green Sukuk: driving issuance in the GCC


Michael Wilkins, Head of Sustainable Finance at S&P Global Ratings, considers the opportunities for Green Islamic finance in the region for the year ahead

The GCC faces high spending requirements on two fronts. Infrastructure projects require approximately $120-150 billion between now and 2019; while refinancing corporate capital market debt also demands $23.6 billion, due before 2019. Yet, alongside rising infrastructure and financing needs, there are a number of positive offshoots emerging that can bolster market growth.

Of these new developments, green Sukuk—the Shari’ah-compliant alternative to green bonds—have perhaps the most potential to increase total issuance in 2018. When two green Sukuk were issued last year, totalling the equivalent of $321 million, the wider marketplace took note. Now Indonesia has issued the first sovereign green Sukuk, raising $1.25 billion.

The green finance space has grown exponentially over the last decade— predominantly led by labelled green bonds. Where the green bond market totalled $11 billion outstanding in 2013, last year saw close to $160 billion of green-labelled issuance alone, according to the Climate Bonds Initiative (CBI). Trends this year could break records once again: S&P Global Ratings estimates the labelled green bond market to grow by 30 per cent, reaching a total of $200 billion in 2018. Yet green bonds aren’t the only green financing tool available.

As the market seizes new business opportunities within the green space, S&P Global Ratings has observed the development of new sustainable financing instruments. For example, green lending and green securitisation have been rising over the past two years—reaching close to $36 billion in 2017.

Green loans include those that finance projects involving some form of environmental benefits; whereas green structured products have green underlying collateral or assets or reinvest their proceeds in green technologies. America is taking the lead in the green securitisation market, supported by existing state and government programmes as well as positive momentum in collateralized loan obligations and mortgage-backed securities (MBS) issuance.

Notably, the rise of green structured products in 2017 was driven by the US issuer Fannie Mae’s $25 billion MBS programme, which aims to improve the energy and water performance of US properties. Despite the current geographic concentration in the structured green products market, there is potential for green lending across a broader range of geographies and types of financings. In the GCC, demand could be met by the nascent green Sukuk marketplace.

The CBI defines green Sukuk as Shari’ah-compliant investments in renewable energy and other environmental assets. These financings address Shari’ah concern for protecting the environment. Proceeds are used to finance construction, to refinance construction debt, or to finance the payment of a government-granted green subsidy.

The first green Sukuk in the infrastructure market was issued in July of 2017. Tadau Energy, a unit of China-owned Edra Power Holdings, issued a Sukuk for Malaysian ringgit (MYR) 250 million (c.$63 million). Proceeds from the issuance— known as Green SRI (socially/sustainably responsible investment) Sukuk Tadau— will finance a large-scale solar project of 50 megawatts (MW) in, Sabah, Malaysia.

Perhaps indicative of a coming trend, Green SRI Sukuk Tadau was followed late last year by a second green Sukuk issuance. Quantum Solar Park (another Malaysian entity) raised MYR 1 billion for solar PV power plants with a combined expected capacity of 50MW. Together, these issues contributed to the total of $51 billion committed to renewable energy projects last year (CBI).

As renewable energy projects continue to proliferate in 2018, there is potential scope for further green issuance in the GCC region.

However, there is no natural GCC investor market for green finance. S&P Global Ratings thereby expects GCC issuers to combine green and Sukuk features as they attempt to tap liquidity pools available in both green and Sukuk markets. A number of local utilities might consider green issuance, but in order to proceed they’re likely to expect to obtain pricing at least equivalent to conventional bonds. In fact, there is a growing anecdotal evidence of tighter spreads for green bonds in the primary market, when compared to their conventional (non-green) counterparts.

This can be attributed to strong demand and opportunistic pricing. For example— from data collected in the CBI’s sample— the spread benefit for USD corporate green bonds was on average 12.1 basis points (bps) vs Initial Price Talk (IPT). On the other hand, vanilla bonds saw a benefit of 10.2bps on average during same period. Whether green Sukuk could enjoy the same kind of pricing premium is unclear. But there is no doubt that green financings typically attract a more diversified investor base, which may in turn lower the cost of funding.

Sukuk issuance has generally been low in the GCC. This is because the landscape remains small and undifferentiated; only a few corporate and infrastructure entities currently issue Sukuk in the region. 2017 saw the majority of Sukuk issuance represented by Saudi Aramco, Emaar, and Ezdan, with most of the issuance occurring in the second quarter.

Given the limited pool of main issuers, any additional Sukuk issuers that tap into the capital markets could significantly increase overall volumes. Mid-sized issues—between $20 million and $100 million, for example—may offer the most likely path for growth of the market. These financings, executed over several tranches, could fund projects such as rooftop solar. Over time, this sort of financing may be done on a portfolio basis, or as capital market bundling financing. For smaller-scale financings in the green market to develop, containing transaction costs will be crucial.

Therefore, regulatory frameworks that have been tried previously and have supported the European market, such as the feed-in tariff—as well as standardisation of power purchase agreements (PPAs)—could aid growth in the GCC. With the first green Sukuk ever issued last year, and a handful since then, there is likely to be more in 2018. And given that Sukuk issuance is a relatively nascent asset class in its own right, increased green Sukuk could lead to the development of Sukuk issuance overall in the GCC—helping the region to realise its infrastructure needs.