Instrumental Changes: The Role of Finance in Climate Change

INSTRUMENTAL CHANGES:

The Role of Finance in Climate Change

The market for green bonds in the Middle East is growing quickly as retail and institutional, sovereign wealth funds, banks and portfolio managers are utilising ESG considerations to build and manage their portfolios

The oil-rich Gulf Arab countries made a seismic shift by unveiling a raft of measures to eliminate planet-warming emissions within their borders last year despite regional economies’ heavy reliance on oil and gas—which accounts for 70% of the six-nation bloc’s total goods exports and government revenues. The initiatives, which were unveiled ahead of COP26 last October, are part of the GCC states’ broader strategies to diversify and open their economies with a strong focus on sustainability.

While reacting to the Intergovernmental Panel on Climate Change (IPCC) report on climate change in August 2021, the UN Secretary-General António Guterres cautioned that global warming is dangerously close to spiraling out of control, saying it is “Code Red for Humanity”. Over the past two years, as the ongoing global health crisis morphed into an economic one, J.P Morgan said that investors are calling the COVID19 pandemic the 21st century’s first ‘sustainability’ crisis, one that is a wakeup call for decision-makers to prioritize a more sustainable investment approach.

Meanwhile, “green” or ethical investing is attracting increasing attention from both investors and lawmakers alike across the region owing to the strategy’s promise of utilising a range of nonfinancial information to better align finance with long-term value and societal values. Sustainability, which incorporates environmental, social and governance (ESG) concerns, is increasingly topping the agendas of most financial institutions in the region.

The pandemic is also expected to put the Islamic finance industry back on ESG investors’ radar. Fitch Ratings said that sustainable Islamic bond volumes soared 17.2% y-o-y to $15 billion, with the theme likely to remain prominent in 2022. However, S&P Global said that though the pandemic offered the possibility of more broad-based and transformative growth, Islamic finance has not yet fully increased its share of sustainable finance activity.

ESGs are increasingly becoming an integral part of how the global financial services sector operates. “Investors representing more than $45 trillion in assets under management have already agreed to drive climate change action across their portfolios,” Karin Oertli, the COO, Personal and Corporate Banking and Switzerland, UBS said in a report published by the World Bank.

Industry experts believe that sustainable financing together with technological innovation and digitalisation in the financial services industry is

instrumental to sustainable innovation and growth and the transition to a less carbon-intensive economy.

Fostering sustainability

The market for green bonds in the Middle East has grown tremendously over the last decade as retail or institutional, sovereign wealth funds, banks and portfolio managers are utilising ESG considerations to build and manage their portfolios. Several corporate and sovereign borrowers in the region have also increased the issuance of fixed-term securities to raise funds for projects with environmental benefits such as renewable energy projects.

Following the issuance of its $587 million debut green bonds in March 2017, UAE’s First Abu Dhabi Bank (FAB) is spearheading the financing of projects that has key environmental impact including climate change, renewable energy and energy efficiency. The Abu Dhabi-based lender issued $23 million yuan-denominated green bonds (the first private placement in the Middle East and North Africa) in June 2021. FAB also issued around $219 million in green bonds last November, the lender’s second Swiss Franc-denominated bonds in 2021 after it had raised $226 million in January, bringing its total issuance to $1.36 billion.

FAB is also the first bank in the Middle East region to join the UN Net-Zero Banking Alliance, an initiative comprising global banks that commit to reducing emissions by 2050 through responsible lending and investments.

Qatar National Bank (QNB), the Middle East region’s biggest bank, is also increasing its lending to businesses that contribute towards sustainable development goals in a bid to help customers manage their environmental and social risks. The Qatari bank issued a $600 million green bond in September 2020 signalling a growing investor appetite for the instruments in the Gulf region.

Abu Dhabi-based Sweihan PV Power Company issued a $700.8 million amortising green bonds at 3.625% in investors in the Middle East with an opportunity to adopt more sustainable, responsible investment strategies while tapping into the potential value of conscious investing.

According to S&P Global, funds raised from green Sukuk typically support investments in renewable energy or other environmental assets such as solar parks, biogas plants, wind energy projects as well as renewable transmission and infrastructure projects.

The pandemic crisis is projected to boost the appetite for sustainable instruments in the GCC region as governments and corporates look to revive their economic diversification efforts while driving the growth of sustainable projects.

Islamic finance social instruments can help core Islamic countries, banks, companies and individuals economically affected by the pandemic to navigate these choppy waters, with market participants eyeing Qard Hassan, Zakat, Waqf and Social Sukuk, said S&P Global.

As GCC sovereigns and corporates are tapping debt markets to finance projects that may have been shelved following the outbreak of the coronavirus and plug their ballooning deficits, analysts expect Shari’ah-compliant social instruments to widen the appeal of Islamic bonds beyond traditional markets in the Middle East and South Asia to include ethical investors in West.

Sustainable debt covers a variety of instruments, from the well-established green bonds to the fast-emerging category of sustainability-linked loans. Despite Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards implementation challenges, the economic impact of the pandemic and a rebound in crude oil prices, global Sukuk issuance surged by 36.1% in 2021 to reach $252.3 billion, said Fitch Ratings.

Islamic banks in the GCC region are witnessing a growing frenzy for green bonds although the appetite is still in its infancy as more investors are committing to responsible investment. Nasdaq Dubai set a record $23.1 billion debt listing last

January 2022 as the solar energy joint venture, which is 60% owned by TAQA with Japan’s Marubeni and China’s JinkoSolar holding a 20% stake each, seeks to save 9 million metric tons of carbon dioxide from being emitted between 2020 and 2030. The Arab Petroleum Investments Corporation (APICORP) also sold $750 million debut green bonds with a five-year maturity in September last year after drawing as much as $2.1 billion in demand for the climate-friendly debt.

The oil-rich Gulf region has seen a surge of interest in ESG-related initiatives and deals as large public institutional investors are gradually incorporating the strategy into their investment mix. Saudi Arabia’s Public Investment Fund (PIF) reportedly hired five international banks as members of an ESG panel for its medium-term capital-raising strategy in September 2021. PIF’s ESG framework will allow the Saudi wealth fund to expand its funding base by attracting sustainable-focused investors.

Meanwhile, Abu Dhabi Investment Authority (ADIA), the UAE’s biggest sovereign wealth fund, said last September it would increase its exposure to technology and climate changeoriented investments as part of its post-pandemic strategy. Mubadala also joined forces with Abu Dhabi National Oil Company and ADQ last year to produce hydrogen from renewable energy amid a regional shift to developing hydrogen as fuel as several buyers are moving towards less-polluting alternatives to crude oil.

Though the outbreak of the pandemic slowed down the implementation of ESGs, it is evident that banks and institutional investors in the Middle East continue to embrace the strategy as new banking products and models are being developed, tested and commercialized.

Islamic finance

Though not mutually exclusive, Shari’ahcompliant financial instruments offer a framework that embodies the social and ethical values of ESG investing, providing

year and $11.9 billion of the total listings were Islamic bonds.

Meanwhile, Standard Chartered Bank’s Islamic banking services ‘Saadiq’, partnered with the Malaysian Halal Development Corporation in November 2021 to launch a $100 million Islamic finance programme aimed at funding SMEs and corporates in key halal markets including the UAE, Saudi Arabia and Bahrain.

Sukuk issuance

On the Sukuk front, S&P Global projected that total issuances would range between $140 billion and $155 billion this year compared with a plunge in issuance to $139.8 billion in 2020 from $167.3 billion in 2019. The Saudi National Bank, the Gulf state’s largest bank that is 50.4% indirectly owned by the government, raised 750 million in debut ‘sustainable’ Sukuk last month after demand topped $3.2 billion.

Saudi-based Islamic Development Bank, a regular issuer in the capital markets, raised $1.7 billion in five-year Islamic bonds last October after the Sukuk drew more than $2.4 billion in demand. IsDB raised $2.5 billion in March 2021 with sustainability Sukuk finance projects including renewable energy. The multilateral lender also sold $1.5 billion in Sukuk in June 2020 to support its member states to mitigate the fallout from the pandemic.

Though overall Sukuk issuance is gathering steam in some of the world’s largest financial hubs such as London, the market for green Islamic bonds remains small compared to the conventional Sukuk market. Last March, the UK issued a $686 million (GBP 500 million) sovereign Sukuk in its second foray into the Islamic finance market, doubling the amount it raised from its debut Sukuk in 2014.

Leading from the front

Saudi Arabia, the world’s top oil exporter, announced last October that it would aim to reach net-zero carbon emissions by 2060 by investing more than $186 billion (SAR 700 billion) into a green economy, in a way that’s compatible with the Gulf state’s development plans and advances its economic diversification strategy. Crown Prince Mohammed bin Salman said that the kingdom’s green initiative includes cutting carbon emissions by over 270 million tons per year.

The Gulf state’s majority-owned energy giant, Saudi Aramco, also set a target to achieve net-zero emissions from its operations by 2050, a decade sooner than a government timetable for the kingdom. The pledge puts Aramco at par with European energy majors such as Royal Dutch Shell and BP and ahead of US oil companies Chevron and Exxon Mobil.

Saudi Arabia is not the first Gulf petrostate to pledge to eliminate planetwarming emissions. The UAE, earlier in October last year said that it would invest $163 billion (AED 600 billion) in renewable energy as part of its strategy to achieve net-zero emissions by 2050. Meanwhile, the country is extensively investing in nuclear energy, solar plants and sustainable transport.

Bahrain’s cabinet also made the same net zero commitment in October 2021, saying the Gulf country aims to reach net-zero carbon emissions in 2060 to help tackle climate change and protect the environment. Last May, the International Energy Agency (IEA) in a report said that the energy sector accounts for around three-quarters of greenhouse gas emissions and “holds the key to averting the worst effects of climate change.”

The Sultanate of Oman updated its climate action plan in July 2021 to include a 7% reduction in emissions by 2030 while Qatar aims to reduce greenhouse gas emissions by 25% by 2030. The net-zero commitments are the latest in a series of green initiatives by the Arabian Gulf petrostates, but Oman’s target is far short of the 50% reduction scientists say is needed to stem runaway climate change.

As Gulf countries continue to fight the threats associated with environmental and climate risks, and in light of the ongoing coronavirus pandemic crisis, sustainable finance is expected to serve as a deal enabler or implementor for sustainable projects while acting as a solution to curb and manage future threats.

Global perspective

McKinsey said that banks are under rising regulatory and commercial pressure to protect themselves from the impact of climate change and to align with the global sustainability agenda. As the world continues to battle the pandemic, regulators, oversight authorities and policymakers are expected to take the lead in calling for the need for greater adoption of ESG.

Investors are also ramping up pressure on banks to some extent due to the increasing recognition that conscious investing, in particular issues to do with climate change, represents material risks that must be managed. This has seen several global lenders refusing to renew loans on existing fossil-related projects such as coal mining to improve their carbon disclosures.

JPMorgan Chase & Co. in May 2021 unveiled its carbon reduction goals for clients in line with the Paris financing commitments as the investment bank is facing mounting pressure from shareholder activists to align its funding activities with their climate change commitments. The Wall Street lender also unveiled a $2.5 trillion funding package to lend, invest and provide other financial services over the next decade to advance long-term solution projects that address climate change and social inequality.

In October 2021 Standard Chartered Bank set new targets for reducing its funding to carbon-intensive sectors by 2030, including plans to mobilise $300 billion in green and transition finance as part of the bank’s broader goal to reach netzero emissions for itself and its clients by 2050. Globally, almost all sectors including the fashion industry are focusing more on environmentally friendly and sustainable investments amid pressure from clients, consumers, shareholders and regulators to align with ESG.