Here, Marzunisham Omar, Assistant Governor of Bank Negara Malaysia, sheds light onto the role of Islamic finance in green investments including its potential as well as the solution it offers and the way forward for Islamic finance. This article was first published in the second issue of WIEF In Focus magazine.
The Role of Islamic Finance in Green Investments
Islamic finance is grounded in the principles of maqasid al-shariah or goals of shariah which, among others, call for the preservation of life and property. As such, environmental protection and sustainable growth are objectives that are already embedded within Islamic finance.
This therefore, strongly positions Islamic finance to advance green investments, primarily in two key ways:
First, the structure of Islamic financing instruments, such as bank financing or sukuk, is subject to stricter requirements with respect to the purpose of financing. A key tenet of Islamic finance is that finance must have underlying economic activities. This places Islamic finance in a strong position to structure financing for green investments that are clearly
in line with the intended outcome of Islamic finance. Sukuk is a good example of financing instrument for green investments and 2017 saw the introduction of the world’s first green sukuk in Malaysia.
Second, there’s a strong pool of Islamic finance investors. It’s significant in size – total global Islamic financial system valued at USD1.9 trillion and Islamic funds holding USD56.1 billion of assets under management as at end of 2016, according to IFSB Islamic Financial Services Industry Report 2017. It’s also self-selective, given the nature of Islamic finance described earlier, participants naturally predisposed towards advancing the sustainability agenda.
The Islamic finance industry is therefore poised to take a leading role in meeting the climate and energy challenges of the near future.
Importantly, there is a growing demand for such needs. According to the International Energy Agency in the World Energy Investment Outlook 2014, annual investments in low carbon technology and energy efficiency will need to increase six times to USD2.3 trillion by 2035 from the USD330 billion in 2013 in order to meet the goals of the Paris Agreement. These are astounding numbers but the costs and risks of inaction are far greater.
The Economist Intelligence Unit (EIU) estimates that up to USD43 trillion or 43 per cent of the total global stock of assets is at risk of losses due to climate change in the 21st century. Put another way, this is also a USD43 trillion opportunity for Islamic finance to tap into while promoting the sustainable industries of tomorrow.
Islamic Finance Efforts in Advancing Green Finance
Malaysia has been working to advance the green finance agenda for a number of years.
Our early focus had been to generate interest among financial institutions in financing viable and innovative green technology projects through educational efforts and economic incentives. A key initiative is the establishment of the Green Technology Financing Scheme in 2009, which involved the sharing of financial risk between financial institutions and the government in financing sustainability-related projects. This scheme is important to initiate a nascent industry. To date, the scheme has benefitted over 272 projects with an allocation of nearly RM3 billion. Of this, according to Malaysia Green Technology Corporation, almost half of the financing offered is shariah compliant.
Since then, efforts have turned towards developing more industry-driven and market-based solutions.
In 2014, the Securities Commission Malaysia issued the Sustainable and Responsible Investment (SRI) sukuk framework that promotes innovation in the SRI space, including green sukuk. A recent highlight was the issuance of a RM250 million sukuk to finance a 50-megawatt solar farm in July 2017, thus introducing the world’s first green sukuk.
Going forward, we expect to see a deepened integration of the green agenda within Islamic finance. In July 2017, Bank Negara Malaysia and the financial industry jointly launched ‘value-based intermediation’. It’s an approach that aims to deliver the intended outcomes of shariah of making a positive impact on the economy, community and environment. This is an ambitious vision, but will be built on concrete, practical improvements in the day-to-day running of Islamic financial institutions. One example is the incorporation of environmental and sustainability factors in the business strategy and risk management of banks.
Next Steps for Islamic Finance in Greening the Global Economy
Islamic finance can play three key roles going forward:
First, as a Specialist. Islamic financial institutions should establish a niche in strategic and risk assessments for sustainable businesses. This is an area that, at present, remains relatively novel or esoteric. With the growing demand for more sustainable businesses, entrepreneurship in this area is poised to evolve and expand. Upskilling the talent pipeline will be crucial in ensuring that Islamic finance can meet the industry’s needs, be it in terms of financing
or advisory. With this manner of specialisation, Islamic finance will secure its position as the primary choice for companies and consumers in our future economic landscape.
Second, as an Educator. To an insider, the potential of Islamic finance in the sustainability agenda may be obvious. However, awareness remains relatively low among companies and individuals that are likely to need it most. Islamic financial institutions can do more to bridge that gap. This may include intensifying efforts to identify relevant clients and educate them on the suitability of Islamic finance as a partner for their SRI and ESG objectives. Islamic financial institutions can also lead the way in elevating public awareness about the readily available avenues through which individuals can invest in green solutions.
Third, as an Advisor. Around the world, the Paris Agreement goals are being translated into ambitious national targets and strategies. These will entail significant capital outlays. Islamic financial institutions can play a fundamental role in driving engagements with the relevant government agencies and businesses. This includes understanding their unique financing requirements, the financial risks involved, and developing tailored solutions. This is a role that Islamic banks are beginning to spearhead today here in Malaysia. Through a process of continuous learning and improvement over the years, we are confident that efforts to advance Islamic finance in Malaysia can evolve into a global solution to the sustainability challenge.
Photo by Bud Helisson on Unsplash