Sukuk issuers stand to benefit from increased fixed income investor engagement if they know how to respond
- ESG engagement has become a key element of responsible investment for equity investors, but has developed much slower among fixed income investors
- Efforts to boost engagement by fixed income investors could affect where inflows of investors direct their funding in Islamic capital markets
- Sukuk issuers receptivity to fixed income investor engagement could help differentiate sukuk from sector and regional peer issuers who only raise funding with conventional bonds
Sukuk markets have grown in their diversity to include green, social, transition, sustainability- and SDG-linked sukuk. Within the market, sustainability sukuk have grown faster than green sukuk in recent years which is in part due to limited availability of green assets in Islamic markets. Engagement has become a key part of how climate and ESG considerations are used by equity investors, and could become more widely adopted across fixed income markets.
- IFR reported that investors are considering joining together to create a ‘collaborative fixed-income engagement’ approach particularly focused on banks’ and asset managers’ collective Net Zero commitments. Similarly to equities, investors will have largely three ways to affect their emissions profile:increase their holdings of green and sustainability issuance
- sell higher emissions exposures (divest), or
- engage with issuers to improve their emissions footprint (engage).
Among sukuk, the total issuance of labeled (green or sustainability) sukuk has reached $15.6 billion since 2017. This compares to a total of $630 billion — about 2.5% — of outstanding sukuk as of the end of 2021 according to the State of the Global Islamic Economy Report. This limits the degree to which Islamic investors can affect their ESG or climate-focused objectives by increasing their holding of green and sustainability sukuk.
That doesn’t mean that all sukuk investors have the same constraints. A significant share of the sukuk issued is purchased by investors who don’t have a specific Shari’ah compliant mandate. If these investors shift their purchases towards more green and sustainability fixed income issuance, it could lead to weaker demand for sukuk.
On the divestment side, there is likely to be only limited market pressure driven by Islamic investors selling their sukuk holdings of higher emissions issuers. Divestment by conventional issuers could have a similar impact on the market, but many conventional investors buy sukuk either because of their inclusion in benchmark indices or because they provide exposure to an issuer or market sector with limited options.
That means engagement will be an important influence on the sukuk market development. For investors, increased engagement with sukuk issuers can focus on identifying ways to mitigate their emissions-related risks. For issuers, it can show where investors’ appetite is focused relating to new investments in green and sustainable projects to expand their access to green & sustainable capital markets.
Beyond the general reasons for why sukuk will be affected by greater investor engagement on ESG and climate issues, there are push factors from within markets where large volumes of sukuk are issued, such as GCC countries and Southeast Asia. National pledges to reduce GHG emissions or towards long-term Net Zero targets will require substantial investors which are likely to be met both through conventional bond and sukuk issuance.
For sukuk issuers, one factor in the market development that has been viewed as a constraint in the past has been the more complex documentation process reflecting the real economy linkages built into sukuk structures. In a world where investors are looking for both financial returns and real economy outcomes, this process could be used to provide better fit with investors.
For example, during the structuring period when between the issuer identifies the purpose of the financing raised and selects the underlying assets (if they are different than where the proceeds raised will be invested), the can take stock of where their investor engagement, or investor engagement in their sector or countries have been focused, whether on climate or ESG to align their issuance better with investor expectations.
Issuers solely relying on conventional bonds will be able to take some of this information into consideration during the bond issuance process, but by virtue of the relative simplicity of issuance, they will see a narrower and more compressed perspective of market expectations that is focused around issuance timing and how fixed income market conditions influence financial costs for the issuer.
For many issuers, especially those that don’t have standing sukuk issuance programs, the time it takes to develop a sukuk program and issue sukuk is seen as a barrier to be overcome in order to achieve a strategic objective such as diversifying funding sources that sukuk can offer. If issuers are able to use this process to better understand investor preferences — and if investors are able to direct engagement efforts beyond road-show one-on-one conversations — it could provide an in-built strategic advantage for sukuk. It would also be one that only regularly advantages sukuk because of the structural connection required to underlying economic activity or tangible assets that they are built on.
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