Green SukukRoundtable Discussion

Lead Sponsor Organised by:

AfricaAfrica

1NOVEMBER/DECEMBER 2019

Roundtable Participants

Aamir Rehman, Senior Advisor – Islamic

Finance, UNDP

Doug Bitcon, Head of Credit

Strategies, Rasmala

Nor Masliza Sulaiman,Senior Managing Director & Head

Capital Markets, Group Treasury & Markets,

CIMB Investment Bank

Andrew Lim, Head, Regional DCM

(ex-Malaysia), Maybank Investment

Bank

Mohd Daud Bakar, Founder,

Amanie Advisors

Promod Das,CEO, RAM Sustainability

& Deputy Group CEO, RAM Holdings

Beroz Mirdin, Chief Executive

Officer, Telekosang Hydro

John Arentz, Head of Treasury, Majid Al Futtaim

Sayed Al-Gohary, Investor Relations

Head Saudi Electricity

Company

Dino Kronfol,Chief Investment Officer, Global Sukuk and MENA

Fixed Income, Franklin Templeton

Investments

Zainal Izlan Zainal Abidin,

Deputy Chief Executive, Securities Commission

Malaysia

33OCTOBER 2020

Broadening sustainable finance structures to be more inclusive, a key driver behind the Securities Commission Malaysia’s (SC) embrace of Sustainable and Responsible Investment and the development of a thriving local sustainable Islamic finance market, could hold the key to plugging a yawning global sustainable funding gap – estimated to be in the trillions of dollars annually – and bring new pockets of liquidity and borrowers to the table, according to experts who participated in an exclusive roundtable discussion hosted by GFC Media Group and Capital Markets Malaysia.

Driving the Sustainable Finance Market Forward with SukukWhen it comes to sustainable finance, green bonds – whose proceeds are directed towards enhancing environmental sustainability – have historically captured the lion’s share of the industry’s focus; the asset class has grown from a relatively unheard of, exotic instrument sold by supranational agencies and banks less than a decade ago into more than USD 250 billion in annual issuance in 2019.

But as broader sustainability ambitions began rising to the fore – perhaps best exemplif ied by the UN Sustainable Development Goals, which include 17 broadly interlinked goals and objectives – a far wider range of funding instruments, all with their own unique structures or sustainability characteristics, have flourished: sustainability bonds, social bonds, gender equity bonds, water bonds (or blue bonds), and more.

Those evolutions have started to run their course in the burgeoning Islamic finance segment, where majority Muslim countries in ASEAN and the Middle East are supporting their transitions

towards a more sustainable economy with complementary funding structures.

Malaysia has quietly risen up as a regional leader in those efforts, with the SC undertaking a number of initiatives since 2014 to support the development of the sustainable finance market, including in that year, the launch of the world’s f irst sustainable and responsible investment (SRI) sukuk framework, to provide guidance to aspiring issuers and catalyse the development of a robust local ecosystem around sustainable investing. It also introduced a grant for issuers, to help offset the cost of getting SRI transactions certified by second-party opinion providers – increasingly a staple requirement for investors looking to buy green or sustainability-linked assets – and reduce barriers to entry.

Those efforts began to pay off in earnest. In July 2017, Tadau Energy Sdn Bhd issued the world’s first green sukuk (an Islamic bond), raising MYR 250 million (approx. USD 59 million) to finance a 50MW solar photovoltaic

Broadening the Reach of Sustainable Finance: Can Malaysia Internationalise the Sustainable Sukuk Market?Sustainable finance has taken on a profoundly more pronounced role in international funding and investment in recent years, a trend that has clearly accelerated in a post-COVID environment characterised by rising social inequality and environmental risks.

power plant in Sabah, Malaysia. The sukuk was issued under Malaysia’s SRI sukuk framework, endorsed by the Shari’ah Advisory Council, and received the highest rating by the Center for International Climate and Environmental Research Oslo (CICERO). More than a dozen issuers placing green, sustainable, or social impact sukuk have followed since.

Zainal Izlan Zainal Abidin, Deputy Chief Executive of the Securities Commission Malaysia and Chairman of Capital Markets Malaysia believes that growth, driven largely by the need for more sustainable infrastructure and the requirement to achieve nationally agreed sustainable development objectives, will need to accelerate at exponential pace, and is an outcome that can only be achieved through the integrated efforts of policymakers, funding stakeholders, and society.

Developing markets will need some USD 3.3 trillion to USD 4.4 trillion annually for infrastructure alone, a burden the public sector will not be able to

Roundtable Participants

Global Green Bond Issuance: 2014 – 2019

Source: Climate Bonds Initiative

300

250

200

150

100

50 37 45

85

159 168

258

2014 2015 2016 2017 2018 20190

OCTOBER 2020

4

Breakdown of Local Market SRI Sukuk Issuance in Malaysia

Source: Securities Commission Malaysia

RM 535 mil(2 issuances)

RM 2,524 mil(7 issuances)

RM 2,245 mil(6 issuances)

SRI sukuk only ASEAN standards only Dually recognised under SRI sukuk and ASEAN standards

shoulder without substantial private sector involvement. In Malaysia alone, the sustainable infrastructure needed to achieve the country ’s ambitious renewable energy targets cost some MYR 40 billion along (approx. USD 9.6 billion).

“The scale of investment required is significant, but what we do have is a thriving ecosystem, with the right framework and government incentives in place to help grow sustainable and responsible investment and enhance the value proposition that Islamic finance already offers,” Izlan explains.

Malaysia has already cemented itself as a hub for Islamic finance, in the region and the world more broadly, having developed a thriving local market for sukuk, deep institutional investment appetite, and strong structuring and execution expertise – with the country’s largest lenders, CIMB and Maybank, taking leading roles on capital markets transactions both within and outside her shores, and bolstering their bilateral lending in sustainable formats.

The transition from Islamic finance hub to sustainable finance hub could be made easier by the natural complementary characteristics between sustainable finance, and Islamic finance, which usually emphasises social and other non-financial considerations. Both also share unique features in terms of how they trade in markets: in many cases, pricing tends to be less volatile, owed to the fact that a great many holders of both sukuk and green or sustainable bonds tend to buy-and-hold; in some cases, partly as a result of the latter, they trade tight to the conventional curve, making them potentially attractive to issuers and investors from an all-in cost and arbitrage point of view, respectively.

“Total green bond issuance year to date globally is around USD158.5 billion, and global sukuk issuance last year totalled USD 157.8 billion. If we could channel just 10% of global green bond volumes into the sukuk market, that could make a huge impact – allowing a wider range of regional and global investors and issuers to take part in the transition to a more sustainable economy,” Izlan adds.

The size of the shariah-compliant assets under management – assets that could only be invested in Islamic securities like sukuk – is growing quickly. According to a report by the Malaysia Islamic International Financial Center, total global Islamic assets under management (AUM) were USD 70.8 billion at the end of the first quarter of 2017. But when factoring in funds, banking assets, and takaful (Islamic insurance), that opportunity swells to nearly USD 2.3 trillion, according to S&P.

“Malaysia has hit the sweet spot in terms of the overlap between sustainable finance through the capital markets and Islamic finance. The country has the ecosystem and expertise, and crucially, the domestic bond-sukuk market, which at USD169.32 billion ( June 2020 ) is the second largest corporate bond market (as a proportion of GDP) in the region after South Korea,” says Promod Dass, Chief Executive Officer of RAM Sustainability, a leading provider of sustainability services and ESG analytics in Malaysia.

Structuring to Soak Up Green InvestmentThe lack of a large domestic capital market is seen to be an inhibitor to sustainable finance in other parts of the world where sukuk play a key role in the funding landscape, notably the GCC, where the prevalence of currency pegs (to the USD) has slowed the development of local markets.

But it takes more than a thriving local market to get sustainable f inance

growing year-on-year. Assets need to be investable for international investors, many of whom have size or currency constraints that prohibit their meaningful involvement in local markets, and incentives need to give issuers confidence to take the first step.

“The GCC doesn’t have a very developed local [capital] market, and sukuk has actually decreased its share of the total issuance out of the region in recent years. And when you compare the GCC to other regions like Europe or countries like Malaysia, you don’t see the same incentives and grants for sustainable issuers. More can be done to promote sukuk in general and green sukuk specifically – but it needs to be holistic in the sense that policymakers, the financing stakeholders, and issuers all need to play their part,” says Mohieddine Kronfol, Chief Investment Officer of Global Sukuk and MENA Fixed Income at Franklin Templeton Investments.

“In ASEAN and the GCC, where up to 80% of issuance typically comes from banks and sovereign institutions, it seems even clearer that policy will have to play a very important role to keep these markets going.”

Nor Masliza Sulaiman, Senior Managing Director & Head Capital Markets, Group Treasury & Markets, at CIMB Investment Bank, who worked on the world’s first sovereign green sukuk – the Republic of Indonesia’s flagship green sukuk programme – agrees that while structure and size are clearly important for soaking up demand from global

OCTOBER 2020

5OCTOBER 2020

investors increasingly under pressure to buy sustainable assets, more can be done to structure transactions so that they are more accessible. She used the example of Quantum Solar Park Malaysia, which in October 2017 had issued what was then the world’s largest SRI sukuk, a MYR 1 billion (approx. USD 236 million) transaction under one structure to finance three large-scale solar projects.

“The Quantum Solar Park is a great example of how three distinct large-scale solar power plants, each with 50MW capacity was funded under a fundraising of one single RM1billion Green SRI sukuk to provide size, liquidity and an acceptable credit which was locally rated AA- by the Malaysian Rating Corporation Berhad at issuance, which are all important from the investor’s point of view.”

Structural enhancements could play a meaningful role in bringing new issuers to the table, even outside the energy space. Sustainability-linked bonds (SLB), an instrument for which the financial or structural characteristics can vary depending on whether the issuer achieves predefined Sustainability or ESG objectives, have started to gain traction ever since Italian utility Enel placed its pioneering SLB in the market last year – and could easily be adapted to sukuk.

“The benefit of sustainability-linked sukuk is that it provides an option for issuers that want to demonstrate ESG commitments but are less able to issue a “use of proceeds” bond. Further, sustainability-linked sukuk can be potentially structured with mechanisms like an interest-rate step-down as a natural incentive to pull in issuers that wouldn’t otherwise consider themselves as candidates for this kind of funding. It can help change the perception around sustainability, particularly among carbon-intensive industries, and provide these companies with a platform for transition” explains Andrew Lim, Regional Head of DCM (ex-Malaysia) at Maybank Investment Bank

But ‘greening’ sukuk will require more than just layering green or EGS criteria on top of established sukuk structures,

says Dr Mohd Daud Bakar of Amanie Advisory & Consultancy, a leading Shariah advisory.

“What is lacking is the securitisation of the asset itself, because most [sukuk] structures are asset based and not asset backed in the same way we understand asset-backed securities… the real issue from a green or sustainability perspective is that you need to ensure all of the assets involved in the transaction actually conform to the relevant standards. If you are using a Murabaha [sukuk] structure, which implies the use of commodities for example, you would also need to ensure they conform to the same standard.”

“One solution might be to create sukuk structures that more closely resemble project financing, where there is a closer link between the project and the investor, and to find a shariah-compliant way of deriving the profit rate from the project itself,” he adds.

Issuers See a Bright Future for ESGWhile more needs to be done to enable greater green sukuk issuance, it seems clear borrowers are finding barriers to entry are dropping.

"For us, the ecosystem in raising a green sukuk in Malaysia is mature. The incentives and regulatory framework is robust enough that going through the issuance process was essentially just a check-box exercise,” says Beroz Mirdin, Chief Executive Officer of Telekosang Hydro One Sdn Bhd, which last year placed a MYR 470 million (approx. USD 115 million) 18-year green sukuk to finance the construction of a of a 40 -MW run-of-river hydro plant.

“Because the project we were financing was already environmentally friendly in nature, green sukuk was a natural fit.

For John Arentz, Head of Treasury at Majid Al Futtaim, a Dubai-based lifestyle conglomerate with shopping malls, hotels and mixed use real estate and the first corporate from the region to issue a green sukuk in international markets, the ‘fit’ can extend well beyond power production.

“Awareness is growing, and the issuance process gets easier with each transaction. There are a range of industry-developed frameworks to leverage – including the ICMA green, social, and sustainability-linked bond principles – and significant expertise from second-party certification providers and banks who can help with structuring on the ESG aspects. Having a national agenda that prioritises the transition towards sustainability is also an important ingredient.”

“But issuers also need to take ESG seriously in a deeper sense. [Majid Al Futtaim] benefited from the fact that we’ve been focused on sustainability across our operations for more than a decade.”

“Robust assessment of SDG impact and ESG factors is increasingly important. Measuring impact can help issuers articulate and quantify the ways in which their issuances contribute to national and global SDG financing plans.” According to Aamir Rehman, Senior Advisor at the United Nations Development Programme (UNDP).

“By making grants available for issuers to pay for impact assessment, SC Malaysia has taken a remarkable step in encouraging SDG-aligned and socially responsible finance.”

Working together with regulators, Izlan believes Malaysia can continue to innovate and build on the thriving local ecosystem it has fostered. It launched an SRI roadmap for the capital markets last year, which broaden the categories of qualifiable projects eligible for green sukuk investment and continues to look at other policy instruments and partnerships to help bolster the market’s development. But regulation alone will not be able to mobilise the gargantuan volumes of funding required by the country to achieve its sustainable development goals.

“Regulations are extremely important, and if you look at the most successful countries and regions, including Malaysia, it plays a key role in the market development. But it takes an ecosystem to make the transition to a more sustainable economy, and that’s what we will continue to enhance.”

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