20 February 2024

Islamic and sustainable finance: potential synergies

S&P Global Ratings sees foundations developing in the Middle East and beyond for a robust sustainable bond market that caters to local needs.

Islamic finance can contribute funding for climate transition strategies and sustainable development in the Middle East and Asia.

Mohamed DamakHeightened exposure to climate change, as well as government initiatives and company pledges, could fuel sustainable, mostly green, bond and sukuk issuances in the Middle East. Such issuance should continue to increase in the coming years, supported primarily by government initiatives.

The United Arab Emirates (UAE) and Saudi Arabia will likely remain the leaders of the region's sustainable bond and sukuk market. This is particularly the case through green bonds and sukuk, which S&P Global Ratings believes are likely to continue driving regional issuance over the next three to five years.

Meanwhile, across the core countries of Islamic finance, including those of the Gulf Cooperation Council (GCC), Malaysia, Indonesia, and Turkey, efforts are underway to create the foundations for a more vibrant sustainable Islamic finance industry.

Global harmonisation of Islamic finance principles could smooth the process for issuing sustainable sukuk to fund climate change mitigation measures in core Islamic finance markets. S&P Global Ratings considers the principles behind Islamic finance to overlap with many of the objectives of sustainable finance and therefore more of a boon than an impediment to sustainable issuance.


We consider sustainable finance to be related to the issuance of green, social, sustainability, and sustainability-linked bonds (GSSSB).

Rawan OueidatIslamic finance is finance that complies with Sharia principles. These principles include bans on interest, uncertainty, speculation, and financing certain economic sectors such as gambling. In addition, there is a profit-and-loss sharing principle where risks and rewards associated with the transaction are shared among participants. Furthermore, under the asset-backing principle, transactions must refer to a tangible, identifiable underlying asset.

Islamic finance and sustainable finance share common features. There are parallels between the objectives of sustainable finance and some of the underlying principles of Sharia, particularly with respect to climate transition and sustainable development. The core principles of Islamic finance call for the creation of a sustainable, stakeholder-focused, and socially responsible financial system.

In many respects, these principles overlap with sustainable finance's focus on the integration of sustainability objectives into investment decision-making. There are also parallels between the social focus and the principle of profit-and-loss sharing. Ultimately, both Islamic and sustainable finance aim to adopt a stakeholder view and increase social cohesion.

Both types of finance also include principles to review the allocation of proceeds from issuance. The tracking of the allocation of proceeds to eligible projects is a principle of sustainable bonds and loans, and, specifically, use-of-proceeds assessments. Sharia, meanwhile, requires that tangible and identifiable assets back Islamic finance transactions.

Taxonomies are aligning with sustainable principles

Some regulators across the core Islamic finance countries, including those of the GCC, Malaysia, Indonesia, and Turkey, have released local sustainability standards and taxonomies with the aim of providing additional clarity for potential issuers and investors. Their efforts aim to bring more harmonisation to the interpretation of standards related to instruments such as sustainable sukuk.

S&P Global Ratings finds current principles for sustainable Islamic finance to be largely consistent with sustainable principles and frameworks available elsewhere in the world. For instance, they all list examples of eligible projects for the use of proceeds, alongside recommended disclosures. The latter include criteria used by issuers to select projects financed, reports on the environmental and social impacts of projects, and how proceeds are allocated among projects.

Central banks and regulators in Indonesia, Malaysia, Qatar, the UAE, Bangladesh, and other countries, have published taxonomies and principles for what constitutes a sustainable finance activity. Some recommend using International Capital Market Association (ICMA) or Climate Bonds Initiative (CBI) principles (see table). Still, approaches differ. Malaysia's Sustainable and Responsible Investment taxonomy is principles-based and includes green and social principles; it is not a list of economic activities like the EU's green taxonomy.

Sustainable finance taxonomies and principles in Islamic countries

 Local taxonomy Local principles  Sukuk features
Bangladesh   Yes  No - recommends ICMA  
 Indonesia  Yes  No  
 Kuwait  No No - recommends ICMA or CBI   
 Malaysia  Yes  Yes  Grant scheme
 Qatar  No  Yes, ICMA-based Recommends sustainable fixed-income assets
 Saudi Arabia  No  No  
 Türkiye Expected  No  
 UAE No   Yes, ICMA-based  
ICMA – International Capital Market Assn. CBI - Climate Bonds Initiative. UAE - United Arab Emirates. Source: S&P Global Ratings.

Sustainable sukuk issuance continues to increase

Source: S&P Global Ratings. Copyright 2024 by Standard & Poor’s Financial Services LLC. All rights reserved.

The nations of the GCC are also developing green taxonomies. In March 2023, the Arab Monetary Fund released guidance for sustainable sovereign instruments, including sukuk. The guidance recommends issuers follow ICMA principles and that a regional environmental, social, and governance taxonomy should be developed.

We have also seen developments in sustainable sukuk. These Islamic finance instruments allow issuers to raise funds in a disintermediated way, similar to bonds. They can be based on existing or new assets. With this in mind, Qatar, for example, suggested that, for sukuk to be seen as sustainable, the underlying asset should be sustainable or at least have no net negative environmental impact.

Under ICMA principles, meanwhile, the proceeds from sukuk should be used to purchase sustainable assets. This is similar to how a secured collateral green, social, and sustainability bond label would require the underlying collateral pool of assets to also be sustainable.

How have sustainable sukuk been seen by the market? The numbers suggest, positively. Issuance continued to increase in 2023, rising to about $11 billion from $9 billion in 2022 (see chart). However, sustainable sukuk constitutes 6.4% of overall sukuk issuance.

Sustainable sukuk issuance had three key characteristics in 2023:

  • Green sukuk accounted for the majority of sustainable sukuk issuance.
  • Corporates were the main issuers of sustainable sukuk, closely followed by banks.
  • UAE issuers accounted for 40% of total sustainable sukuk issuance.

UAE and Saudi Arabia make up most GSSSB issuance in the Middle East

9M – First nine months. Excludes structured finance issuance. Source: S&P Global Ratings, Environmental Finance Bond Database

Middle East and North Africa are more exposed to water stress and heatwaves. 2050 combined GDP at risk RCP4.5 scenario, physical stress and heatwaves

Note: Conutries’ income and regional classification is based on World Bank. Source: S&P Global Ratings, S&P Global Sustainable1 (2022).

Growth to continue

S&P Global Ratings expects the volume of sustainable bond issuance, both conventional and Islamic, to continue to increase over the next two years. This is likely to be driven by issuance in core Islamic finance countries.

Middle East economies' sustainable bond issuance has been increasing fast, despite a higher interest rate environment. However, it is expanding from a relatively low base. Still, such issuance represents a higher share of the region's bond issuance than the global average. Green, social, sustainability, and sustainability-linked bond issuance comprised about 30% of total US-dollar-denominated international bond issuance in the Middle East during the first nine months of 2023. Globally, it made up about 12% of total issuance last year.

What is likely to drive issuance in the region? Fundraising for projects related to the climate transition and adaptation and water projects, such as desalination, in our view. Saudi Arabia and the UAE will likely continue to capture the largest share of issuance. This is largely fueled by issuance from governments or government-related entities to meet national sustainability targets. In addition, the high reliance of regional economies on the hydrocarbons sector, in which emissions are difficult to reduce, and exposure to water scarcity are issues to tackle.

The majority of governments in the GCC region, with the exception of Qatar, have announced net-zero targets. Türkiye has made a similar announcement. Deploying renewable energy can help meet the climate commitments in their Nationally Determined Contributions. The UAE and Saudi Arabia – which produce the highest greenhouse gas emissions in the GCC – in absolute terms – have made the largest investments in renewables. Both have also committed to diversifying and enhancing the sustainability of their economies. This will likely create opportunities for tapping the sustainable bond and sukuk markets.

The fossil fuel question

Regionally, fossil fuel plays a big role in many economies. Hydrocarbons contribute about 70%-80% of central government revenue in the GCC economies, on average.

We believe there could be more sustainable issuance related to projects coming from corporates in sectors that struggle to reduce emissions. Large players that align their strategies with the national sustainability targets of their home countries may spur issuance. However, much will depend on the pace at which corporations in these sectors implement decarbonisation strategies.

There are impediments to momentum. With oil prices likely to remain above $80 per barrel for the next three years, according to S&P Global Ratings' base-case scenario, fiscal indicators at the sovereign level should improve. This trend may delay the actual implementation of decarbonisation strategies.

Looking ahead

Where do we go from here? In core Islamic finance countries, the funding of the investments needed to meet sustainability targets could support issuer and investor demand for sustainable issuance in the coming years. However, the pace of change in regulatory environments, and the overall macroeconomic environment, including oil price levels, could hinder growth.

For Islamic finance specifically, there are further challenges. A key factor holding back sukuk, and Islamic finance in general, is the increased complexity compared with conventional instruments. The sukuk issuance process is more time consuming than for bonds. And then there are differences in the interpretation of Sharia. Scholars and Sharia standard setters seem to be pushing for more profit-and-loss sharing in sukuk structures. This could change the nature of these instruments and the dynamics behind them, including investor appetite.

Efforts to create taxonomies and other methods for harmonising interpretation could make issuance of sustainable sukuk more straightforward. It could also make such issuance a potential financing option for investors less familiar with Islamic finance. Robust oversight of the final use of proceeds raised from sustainable sukuk may strengthen the integrity of this small but expanding market. And this could lead to further growth. 

Mohamed Damak is managing director, global head of Islamic finance and Rawan Oueidat is director, corporate ratings at S&P Global Ratings

For more information about these topics please read:

Middle East Sustainable Bonds May Expand Further | S&P Global Ratings (spglobal.com)

Islamic Finance's Role In The Climate Transition | S&P Global Ratings (spglobal.com)

Sukuk Outlook 2024: Cautiously Optimistic | S&P Global Ratings (spglobal.com)

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