Going green can come with costs, warns Islamic finance adviser and others

Those attracted to “green” investing may also be interested in Shariah finance. A firm operating in such spaces agrees, but also warned that pricing conventional green debt means it may struggle to meet return expectations.

Issuers of Shariah-compliant financial Sukuk should be careful to avoid the potential pitfall of foregoing “green” investment returns – as appears to have happened with some conventional issuances, according to one industry figure.

Sharia financial structures called Sukuk are certificates representing individual participations in a portfolio of existing or eligible future assets. Sukuk are more like equity than debt, as charging interest is prohibited by Islamic law. Their pricing and structure take into account risks, including default, in order to mimic in some respects the cash flows of conventional debt.

And with Shariah finance, areas such as gambling, pornography and alcohol are prohibited, and there is a general aversion in Shariah to waste and wasteful consumption – which matches quite closely what many green investments claim to be.

These points were made recently in this post by Scott Levy, managing director of Bedford Row Capital. The London-based firm describes itself as a “non-bank originator” that exists to serve businesses unable to access the services of banks, who wish to raise funds in the debt capital markets. It has partnered with Sukuk’s broadcasting platform, Al Waseelah. Potential companies receive an exclusive ESG assessment that asks questions about their core business and operations. Al Waseelah is one of the few Islamic financial companies to follow the UN Principles for Responsible Investment, Levy said.

Levy, a figure not afraid to pull his punches, says there’s a problem with conventional green bonds – some of them could struggle to meet investors’ return expectations as the inflation is reaching multi-decade highs. These bonds attracted a green premium when they were introduced, such was the enthusiasm for all things environmental – but the calculations have become less attractive as inflation rises. Green bonds were cheap ways for issuers to get funding, but they didn’t offer much inflation protection, which wasn’t helpful in the current environment.

According to some estimates, more than $1 trillion in green bonds have been issued since their inception. One wonders how many of them will return all of their investors’ capital.

“We are riding this total wave of interest and issuers are able to push for low costs because everyone wants to go green. There are no inflation-linked green bonds,” he said. Heritage BriefingOn appeal. “There is a lot of regulatory pressure for Westerners to hold green bonds; there will be performance issues and investors’ patience could run out. This is going to be a headache for regulators,” he said.

In a March article, Beware of the green trap: warningsLevy wrote that issuers of Sukuk and other Shariah financing should be aware of the problems faced by conventional issuers of “green” bonds.

“The biggest asset managers must sell their non-green assets (especially in Europe with SFDR
[sustainability related disclosure] looming) that depresses prices to buy ‘greener’ assets (especially bonds that meet Article 9 requirements), further depressing yields as prices rise,” a- he writes. “To make matters worse, green issuers (“dark green” if they meet the new rules) are issuing long-term debt at very low rates. Why not? Institutional investors must buy benchmark size green debt to comply with the new rules; issuers laugh because they can get very cheap long-term funding.

In his March note, Levy said, “Stock markets have crashed this year; the NASDAQ Green Economy Index (QGREEN) is down 15% year-to-date and global green bonds (Bloomberg Global Green Bond Index) have underperformed investment grade debt by 40%. »

The S&P Green Bond Index shows that total returns, in dollar terms, have struggled since the index was launched on July 31, 2014; they increased in 2020 and 2021 but fell sharply this year. The value of the index at launch was 139 and, on May 2, 128.16. The S&P International Corporate Bond Index broadly followed the same trend.

Inflation continued to rise and central banks such as the Federal Reserve and the Bank of England raised rates. Green bonds, issued when price pressures were low and rates were zero or even negative, may not perform as well in a changed environment.

Levy argues that Shariah finance, because it can tick some of the same boxes as those seeking green finance, deserves more attention. Bedford Row works with organizations such as International Islamic Financial Market. He said even non-Islamic investors can benefit if they consider Sharia-compliant zones something to hold in their portfolios.

The lack of Sharia-compliant products in the West is a problem, he said. There are a few cases: Quilter Cheviot has a discretionary portfolio for sharia-compliant investors; HSBC offers certain services.

One problem is that the UK’s FCA does not yet have expertise in this area, Levy said.