ICMA sustainable sukuk guidance brings flexibility and risks for issuers with limited green assets

Blake Goud
5 min readMay 1, 2024

The International Capital Markets Association (ICMA), Islamic Development Bank (IsDB) and LSEG have released guidance on sustainable sukuk, reflecting the growing contribution of Islamic capital markets to the wider sustainable fixed-income market.

Through the first quarter of this year, sustainability-labelled sukuk have been dominated by core Islamic finance jurisdictions including Malaysia, Indonesia, the UAE, Saudi Arabia and the IsDB, but the new guidance has been purposely developed for issuers coming from either sukuk or green bond markets to issue green, social, sustainable, transition or blue sukuk.

This is generally supportive of market development because there has been particular growth of labelled sukuk rather than bonds within the GCC market to accommodate the widest investor base within the region’s financial markets. The guidance focuses on asset-based use-of proceeds bonds where “proceeds are intended to be allocated towards eligible green and/or social projects”.

One element of the market that isn’t directly addressed in the review process specifically is the sustainability characteristics of the underlying asset referenced in the sukuk transaction. The guidance clarifies that the asset-based structure involves transfer of beneficial ownership interest in the underlying portfolio “with no recourse to the assets and their credit quality”. In addition to no recourse, investors are not always provided detailed disclosure about the underlying assets.

The guidance notes that the contribution of Islamic finance to sustainable development provides “an additional layer of governance (Shariah) that helps in the allocation of issuance proceeds and directs them towards projects/companies that are aligned with both Shariah standards and ESG/sustainability criteria”. It is silent, however, on whether the underlying assets used to structure asset-based sukuk would be subject to similar consideration against ESG/sustainability criteria.

This is an important consideration because it affects the specific structural difference between use of proceeds sukuk and bonds. It could become particularly relevant in countries or for issuers with a need for finance who lack green assets but have a large domestic investor base that requires Shariah-compliant options.

Consider, for example, three types of projects: refinancing a coal-fired power plan as part of a transition plan for early retirement; financing a new solar power plant; and financing a program supporting the retraining of workers from fossil fuel production to renewable energy.

Within a conventional green, social or sustainable bond issuance, many financial institutions and investors are struggling to incorporate early-phase out financing into their sustainable finance frameworks despite the importance of credible transition finance for climate mitigation. Financing most renewable energy projects fits cleanly within definitions of green projects so long as they don’t produce significant harm such as population displacement or contravening the land rights of indigenous communities.

For conventional bonds, it would be relatively uncontroversial to train transitioning workers to use skills developed in fossil fuel-related industries to be able to adapt and apply these skills for renewable energy. For example, training drilling engineers for geothermal energy or offshore platform workers for offshore wind. However, similar financing through a social sukuk would face limits in the structuring process because it would require Shariah-compliant tangible assets owned by the originator to be included. The requirement to link the transaction to a tangible underlying asset may impede the efforts of some companies, or lead to situations constraining investors who may have strict and narrow limits for what they can finance (for example, excluding finance of any fossil fuel investments).

In some cases, these financing requirements may be combined in a way that makes it more difficult for Islamic finance compared to conventional finance. This is relevant as many OIC countries have substantial financial assets held by institutions that can only invest in Shariah-compliant structures into which conventional investors are also able to invest.

Consider a project that involves the early retirement of a coal-fired power plant, eventual replacement of all or part of the electricity supply with renewable capacity, and a Just Transition plan to maintain overall employment through retraining. A conventional transition bond could be issued to refinance the power plant while a social bond is issued for worker retraining, and over time successive green bonds could be issued to finance new renewable capacity as part of the transition plan for the originator.

In the conventional case, each dedicated investor base could have different financing structures to maximize the range of investors who participate. Financial institutions wishing to finance Just Transition but not able to finance or refinance fossil fuel assets could invest only in social or green bond issuance, while development banks actively supporting early phase-out of fossil fuel assets (such as through JETPs) and investors with fewer restrictions on financing the transition away from fossil fuel could provide support only to those elements that need some degree of concessional financing to pencil out.

That same series of transactions would be more complicated to issue as a sukuk with the same ability to meet the requirements of all investors, but it doesn’t appear to be ruled out under the new ICMA guidance. The difficulty of financing a worker retraining program on a standalone basis would be more challenging in the absence of a clear underlying asset owned by the obligor.

Financing through a sustainable sukuk along with a solar plant could be possible, but if the workers need to be trained before the new renewable capacity is installed, then it may not be able to be attached to that part of the financing. This either means the transaction cannot be done using sukuk for all elements, or the training component needs to be financed with the coal-fired power plant as the underlying asset, endangering the participation of green investors.

There may not be a way to fully replicate each element of the example above. However, the guidance wouldn’t clearly rule out the potential for an asset not directly involved in fossil fuel combustion (such as an office building at the coal-fired power plant) being used for structuring a social sukuk alongside a refinancing with transition finance of the remainder of the plant as part of an early retirement plan and later issuance of green solar sukuk to finance construction (or refinance bank financing) for the new renewable capacity.

This is just a hypothetical example. But it highlights both risks and opportunities connected with expanding the application of Islamic finance for sustainable finance purposes. The risks are clear where there is a division between underlying assets and use of proceeds where there is not ESG/sustainability evaluation screening of the underlying assets.

The opportunity may nonetheless be needed to allow for structuring flexibility in markets — such as many of the OIC countries — lacking in green assets and needing substantial and phased investment to support the transition where the supply of green assets may lag the requirement for finance. Notwithstanding that important need for flexibility, the lack of ESG/sustainability evaluation of underlying assets in the process of receiving a second-party opinion may introduce a risk that needs a response to mitigate. For example, a second party review could include additional disclosures about the ESG/sustainability characteristics of the underlying assets. This would avoid controversy in the future about the sustainability characteristics of underlying assets used by issuers of green, social and sustainable sukuk.



Blake Goud

Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.