Green Sukuk

A green sukuk is a sukuk, or Islamic investment certificate, whose proceeds are reserved for projects with environmental benefits, such as solar and wind power, energy efficiency, clean transport or climate adaptation. Investors receive returns from an underlying asset or business activity, as with any sukuk, and the issuer also commits to spending the money on eligible green projects and reporting on their impact.

Green sukuk sit at the meeting point of Islamic finance and the wider sustainable finance market. They are the Sharia-compliant counterpart of the green bond: they follow the same voluntary market standards on use of proceeds, but they must also avoid interest and be approved by Sharia scholars. They are distinct from social sukuk, which fund social outcomes, and from sustainability-linked instruments, whose returns depend on targets rather than on how proceeds are spent.

Imagine a community fund that pools savings to buy rooftop solar panels for a town. Savers do not lend money at interest. Instead, they jointly own the panels, and the town pays them a share of what it saves on electricity, a bit like rent. At the end of the agreed period the town buys the panels back, and the savers get their money returned.

A green sukuk works the same way on a much larger scale. The certificates give investors a stake in real assets, which keeps the arrangement within Islamic rules, and the money can only be used for projects that help the environment. A promise to publish reports on what was built, and how much pollution was avoided, lets investors check that the label is honest.

A green sukuk uses the same legal machinery as a conventional sukuk. A special purpose vehicle issues the certificates, holds the underlying assets or contracts on behalf of investors, and passes periodic payments through to them. Common structures include the ijara sukuk, based on leasing, and the wakalah, in which an agent invests the funds in a pool of Sharia-compliant assets.

The green element is added through a framework that most issuers align with the Green Bond Principles published by the International Capital Market Association (ICMA). Those principles have four core components:

• Use of proceeds. The money must fund clearly defined green projects, described in the offering documents.
• Project evaluation and selection. The issuer explains how projects are chosen and which environmental objectives they serve.
• Management of proceeds. Funds are tracked and kept separate, or otherwise accounted for, until they are spent.
• Reporting. The issuer publishes regular updates on how the money was allocated and, where possible, its environmental impact.

Many issuers also obtain an independent second-party opinion on their framework. On the Islamic side, a Sharia supervisory board or adviser approves the structure, so a green sukuk carries two separate assurances.

Malaysia laid the groundwork. Its Securities Commission introduced a Sustainable and Responsible Investment (SRI) Sukuk Framework in 2014, and in July 2017 Tadau Energy issued a green SRI sukuk of 250 million ringgit to finance a 50-megawatt solar power plant in Kudat, Sabah. It is widely described as the world's first green sukuk. Further Malaysian corporate issues followed, many of them for solar projects.

Indonesia made the first sovereign issue in early 2018, raising $1.25 billion through a five-year green sukuk with technical assistance from the World Bank. The government has returned to the market regularly since, and it later added retail green sukuk sold in rupiah to individual savers. Development banks, Gulf companies and other sovereigns have also issued green sukuk, and in April 2024 ICMA, the Islamic Development Bank and the London Stock Exchange Group jointly published guidance on green, social and sustainability sukuk.

• Wider investor base. A single issue can attract both Islamic investors and conventional funds with environmental mandates.
• Fit with Islamic principles. Supporters argue that protecting the environment matches the objectives of Islamic law described as maqasid al-Sharia, including the preservation of life and wealth.
• Asset link. Sukuk already require real assets or activities, which suits project finance for infrastructure such as power plants.
• Policy support. Governments in Malaysia and Indonesia have used green sukuk to fund national climate plans and to deepen local capital markets.

Pricing generally follows the issuer's credit quality, and studies disagree on whether the green label produces a meaningfully lower yield.

Green sukuk face the same concern as green bonds: greenwashing, where the label overstates the environmental benefit, because the market standards are voluntary and impact reporting varies in quality. Some projects funded under green labels, such as certain waste or hydropower schemes, are debated on environmental grounds.

They also carry the usual sukuk risks. Investors may hold only a beneficial interest in assets rather than enforceable ownership, a feature of asset-based sukuk, and documentation must satisfy both Sharia scholars and green verifiers, which adds cost and time. Standard-setters such as the IFSB and AAOIFI have worked to harmonise Islamic rules, but practice still differs between markets, a reminder of the Sharia non-compliance risk that runs through the asset class.

• ICMA Green Bond Principles
• Securities Commission Malaysia
• Islamic Development Bank