Islamic finance's answer to SDGs and climate change

July 3, 2019


On his recent visit to the Pacific nation of Tuvalu, UN Secretary-General António Guterres described climate change as ‘the battle of his life’. From rising sea levels to prolonged dry season, much has been discussed about the adverse effects of climate change and the global crisis we are facing. Yet there is a shortfall of climate change funding; new sources of financing must be found.

This is where Islamic finance can play a critical role.

First, let’s crunch the numbers.

According to the High-level Advisory Group on Climate Change Financing, Sustainable Development Goal (SDG) 13 on climate action aims to mobilize US$100 billion annually by 2020. This is needed to overcome the hundreds of billions of dollars in losses every year  from climate-related disasters. Yet between US$3 trillion and US$4.5 trillion is needed annually to achieve the SDGs, while current investment is around US$1.4 trillion, creating a financing shortfall of about US$2.5 trillion.  At the same time, the Islamic finance industry is expanding rapidly, at about 12 percent annually. In 2015 it reached an estimated value of around US$2 trillion. By 2020 that’s expected to rise to  US$3 trillion.

Islamic financial instruments are an important key to unlocking  the SDGs. They promote socially responsible development and link economic growth and social welfare. In the context of climate change and the green economy, green sukuk offers the best solution. It’s a sharia-compliant bond, where 100 percent of the proceeds are used to finance or re-finance green projects that contribute to mitigation and adaptation of climate change, and preserving biodiversity. Unlike a conventional bond, which is an instrument of indebtedness, the sukuk must have underlying assets to be compliant with sharia.

In 2018 and 2019 the Sovereign Green Sukuk was issued by the Government of Indonesia. It raised US$2 billion in private investments and financed 23 public green and sustainable projects. These fell into five of the nine eligible green sectors: sustainable transport, renewable energy, waste to energy and waste management, energy efficiency and resilience to climate change.

This instrument can be used by developing countries to support a country’s Nationally Determined Contributions (NDCs) which embody efforts by each signatory to the Paris Agreement to reduce national greenhouse gas emissions. UNDP can play a key role in supporting governments and the private sector with similar initiatives.

Responding to the threat of climate change have become both a both national priority and a global responsibility. To date 183 countries have submitted their first NDCs to the United Nations Framework Convention on Climate Change, outlining plans to reduce greenhouse gasses and build resilience to climate change.

In Indonesia UNDP supports the government to monitor and track climate-related expenditure with a Climate Budget Tagging system. This has enabled the government to better map its financing needs, as well as identify and track projects for green financing. UNDP provided support to the government before the bond was issued, through framework development and project selection, and in the post-issuance stage through technical assistance, advocacy and impact reporting. Indonesia’s Green Sukuk yielded important lessons for UNDP’s future support to governments and investors.  UNDP’s partnership with the World Bank in particular, delivered invaluable insights and peer review of the impact reporting.

Transparency is a cornerstone of Islamic finance. The first Green Sukuk Report was published in January 2019, providing investors with a high degree of certainty that the proceeds were used for their intended purpose. The environmental impact is monitored through the national system and validated with key stakeholders. The primary indicator for the mitigation projects is reducing greenhouse gases.

Indonesia is one of the few countries that regularly issues sukuk in the domestic market. It can capture both sharia and conventional consumers. In the Indonesia Green Sukuk issuances more than 30 percent of the investors were from United States and the European Union. Sukuk can also leverage private finance for investment in infrastructure.

While different rules govern the use of different forms of Islamic finance, examples in Indonesia have shown a great degree of complementarity when viewed holistically. Zakat, Islamic microfinance and waqf, a charitable endowment, can all be used to lift people out of poverty and help them thrive, while sukuk can unlock investment to promote inclusive sustainable economic growth.

Islamic finance encourages investors to create positive non-financial value alongside financial returns to support a socially conscious, environmentally friendly system. It also shares a broader understanding of the relationship between business and society, centered on advancing society's wellbeing.  Islamic finance instruments will be vital to better protect the planet while ensuring shared economic prosperity.