The prospects for green bonds and green sukuk in the Middle East, Part One

Following the region's inaugural green bond this year, what is the potential for further green-labelled bonds or sukuk from the region? This round table, sponsored by Latham & Watkins, London Stock Exchange Group, and S&P Global and hosted by the Gulf Bond & Sukuk Association, canvassed the opinion of market players.

Peter Cripps: We have had more than $200 billion of green bonds but only one from the Middle East, from NBAD in March. Is there potential for more green bonds or green sukuk from the region?

Michael Grifferty: Yes, no doubt about it. Just look at the debt capital market at this time. Last year was a breakout year, in a sense, where issuance more than doubled and this year is going to be very strong again. Having said that, the region is just arriving, it is still early days, but we are poised to become a consistent, significant issuer in conventional and Islamic debt.

It has also been instructive that, in the past 18 months, issuers have been looking at debt capital markets at the expense, for the first time, of syndicated lending, which is a game changer. We have the combination of the general market in the process of exploding, and huge infrastructure need, much of which is green, broadly speaking, whether it is water, transport or energy, all of which are potentially huge.

We are starting from a low point and the only way is up.

"We have the combination of the general debt capital markets in the process of exploding, and huge infrastructure need, much of which is green" – Michael Grifferty, Gulf Bond and Sukuk Association

Peter Cripps: This region is probably best known for oil. We have had the Paris Agreement on climate change; how is the Middle East fitting into this?

Gus Schellekens: There is some action in the area of climate change. It is worth noting that the whole GCC region was an active participant in the lead up to the Paris discussions and also hosted the Abu Dhabi Ascent in May that year. What is encouraging is that ambitious targets have also been announced by most GCC governments, and in some cases these have already been revised upwards, particularly in terms of renewable energy.

The other thing that has helped move renewable energy up the government agenda is the drop in costs, particularly for PV. With some of the headline‑grabbing costs that have been achieved here in Dubai, and most recently in Abu Dhabi, it is a game changer. For once, the economics mean that it is suddenly cheaper than gas, it is cheaper than oil, it is cheaper than a lot of conventional infrastructure options.

Peter Cripps: What we need, if this region is to become a substantial issuer of green bonds or green sukuk, is substantial capex on green projects. Is it happening?

Rohit Sinha: Yes. As a region, GCC was slow on the uptake and there were a few reasons for that, one of them being the price of oil. Once you factor in that the cost of solar panels and the technology itself has come down … the underlying fact is that it is really cheap now.

Dubai has shown the way; in Abu Dhabi, there are mega projects that are reaching financial close; and Saudi has announced certain transactions. Within the broader MENA region, Jordan is looking at renewables quite seriously; and Morocco is a market leader in a lot of ways.

We think that this is a trend that will keep gathering momentum and more capacity will come.

Peter Cripps: Hani, you are an arranger, is this something that comes up in conversation when you are talking to companies or organisations that have some kind of green capex or green projects?

"The green market is quickly getting to a place where issuers listing green bonds will be able to achieve a pricing differential" – Darko Hajdukovic, London Stock Exchange

Hani Ibrahim: Not as such. It is not that they are doing it because it is green, they are doing it because it will make them a profit and it happens to be green and it serves a further agenda that goes with that.

Gus Schellekens: It is important that we recognise that this market may not develop as quickly or as fully as we would like it to by itself.

The pipeline is not huge. It is not as though we are overcome by so many opportunities that all need to be financed. We are still hunting. NBAD is still looking for projects where it can apply the proceeds of its bond. There are not enough projects of the right shape, size, etc that they feel happy to finance.

Peter Cripps: Do SSAs need to get involved to set a trend going?

Sam Mirza: I think you are exactly right. You need a sovereign to step in first and show the way for everyone.

Right now, every time we talk to the issuers the fundamental question we have to answer is, 'What is the key benefit for us?'

If it is a clear pricing advantage, like a sukuk for example, or we cannot confirm that this is going to generate the right marketing value, issuers will not have the same kind of traction with issuers.

The marketing benefit of the transaction is helpful, but a key decision maker too will be when issuers ask, 'Well, I have not seen many issuers do a green bond, is the market tried and tested and should I not see a significant cost saving for venturing into this market?'

When you look at the sukuk market in Hong Kong, for example, the Sovereign's debut Sukuk worked to open up the Islamic instrument for the north‑east Asian market, so having a big brother step in to show how it is done and popularise the approach is ideal.

Pricing considerations

Darko Hajdukovic: Issuers will only consider green bonds if it is clear to them that the green certification is beneficial. The green market is quickly getting to a place where issuers listing green bonds will be able to achieve a pricing differential.

There are other considerations which will have an effect on pricing. For example, issuers who list green bonds are perceived generally to have better corporate governance and to be more forward-thinking companies. This, along with the investor diversification achieved through a green issuance, will eventually impact the price.

"I am an investor and I will accept having less coupon – I would say between five and 10 bps – from a green sukuk issuer if it trades like a regular sukuk in the market" - Mohammad Awad Al Duwailah, Kuwait Finance House

Mohammad Awad Al-Duwailah: From the investment point of view, I am an investor and I will accept having less coupon – I would say between five and 10 bps – from a green sukuk issuer if it trades like a regular sukuk in the market. It shows me that this guy is succeeding, the management is socially responsible, and this is a good sign generally. The management of this corporation is thinking about the long term, they are thinking about the environment, they are thinking about the health of my family. This is my point of view.

There are striking similarities between green bonds and sukuk, because both of them are asset based, so there should be a project. From a concept point of view, Islamic finance supports the development of land and society and this is totally in line with something like a green project.

It is like the chicken and the egg; which comes first? If we showed our money first, the project would come. The market for sure will support a green sukuk.

Peter Cripps: Does your organisation have some kind of ESG or SRI commitment, are you a signatory to the Principles for Responsible Investment?

Mohammad Awad Al-Duwailah: No. The problem in the GCC is that it is not like in Europe, where the pressure came from individuals, from the bottom up, until they brought in laws and regulations. Here, the government is trying to impose it and, individually, there is no environmental culture in our countries.

This can be a good point from a PR perspective. For example, I do not want Kuwait Finance House not to be in the first green sukuk, because we are a pioneer and that could be used by our competitors against us. We want to be the pioneer, because we will use it as PR. It is a PR move, in fact.

Gus Schellekens: There is a perception, as you were saying, that companies that embrace this tend to perhaps have better governance, take a longer-term view on returns, invest responsibly, and look after society as well as business. They are not just about profit maximisation, they are about longevity and sustainability of the business itself, as well as the community within which they are investing. Research has increasingly shown that this gives a much better payback in the long term.  

Karim Nassif: Coming to the issue of transparency and governance, these are central pillars in this Green Evaluation Tool that we have just launched. Indeed, transparency and governance are two important categories and then we look at either mitigation and/or adaptation. You have a total weighted aggregate score for all of those things, assessed on a scale of E1 to E4 or R1 to R4 for adaptation projects.

"We would be more than happy to do a green bond. If there are investors, if it is priced at least the same as conventional bonds, then we will look at it quite seriously" – Rohit Sinha, ACWA Power

Lee Irvine: Are you expecting better pricing perhaps if you are E1 as opposed to E4 or are you expecting some of the big investors in green bonds to have limits and say, 'I can only invest in an E1 or E2', which obviously then would have an impact on pricing anyway?

Karim Nassif: It is purely an evaluation and one that, ultimately, investors can use to form their own opinions about whether they want to invest in this particular corporate or project issuance.  We have only just performed our first assessment, on a US project financing, followed more recently by another on a Swedish municipality. Certainly there is a lot of money in the world that wants to be dedicated towards responsible investment.

Building the market

Hani Ibrahim: Being the first (NBAD) is great, but there needs to be a way of creating a market that is not just the first, but there is also a second, a third, a twentieth and a hundredth. If you look at the sukuk market, one of the reasons it took off is that it was comparable as a borrowing instrument, potentially even slightly cheaper for the borrower, at one point in time and it still is, depending on the issuers, etc.

However, it is adding an additional amount of liquidity to any borrower's ability to borrow. That happened as Islamic bank balance sheets grew and so there was capital there needing a home. Once there is capital in the green funds space and investors being able to invest in green bonds, we will naturally see that grow. In this region, as far as I know, we do not have any green portfolios or green funds or SRI funds that look for assessments or ratings of environmental compliance.

Karim Nassif: Rohit, on the issuances that you guys have been doing, especially the long‑term issuance, you are seeing a lot of investment from outside the region, so a large share of the invested portfolio resides in places like the US, Europe, Asia?

Rohit Sinha: The $800 million issuance that we did had a lot of demand from the US, Europe and the UK because of its specific nature, long tenor and the kind of structure we had.

What I understand is that regional issuances typically, if they are 5‑10 years, will get a lot of regional demand, but otherwise it is not something that the investors are able to look at.

Going back to Michael's point that 18 months back the focus was still on syndicated lending, for us, as well, it has been true, because we have about $22 billion of project financing sitting in our assets and it is all syndicated lending. Syndicated lending makes sense because it has been cheaper, it has been competitive, and it is available.

The reason we went for the specific issuance that we did is because that kind of syndicated lending was not available, and a second very important reason was that we wanted to diversify our investor sources.

We would be more than happy to do a green bond. If there are investors, if it is priced at least the same as conventional bonds, then we will look at it quite seriously.

But, if it is expensive or more problematic or we do not find the investors, we would not force-fit it into our capital structure.

Investment demand

Hani Ibrahim: The Middle East will pick up the trend [for issuing green] and, when it does, it will pick it up very quickly – we have seen GCC sovereigns such as Dubai, Abu Dhabi, Qatar and more recently the Kingdom of Saudi Arabia embrace both the bond and sukuk markets.

In a similar way, as the investment community in Europe and the US etc, is shifting towards an SRI/green agenda, I hope that a similar trend is picked up by the investor community in this part of the world.

However, as was mentioned earlier, the limitation is that the trend for green was pushed up in the developed world from people, here it is pushed down from government initiatives. That investor trend may also need to be pushed up, and the catalyst may need to be pension funds and sovereign wealth funds saying: 'We will allocate 10%, 20%, 50% of our portfolio as green' for it then to be taken on by the wider community. That is probably one big catalyst that is needed, but I do not know how likely or feasible it is.

Michael Grifferty: Yes, that is a key point. When we talk of pension funds here, we are talking about a very small and inactive pension community, with some exceptions, but one that is totally un‑mobilised as far as SRI and so on. However, that is growing: we hosted a regional pension reform event earlier in the year and there is a growing consensus that the eventual unsustainability of public pension funds in the region has to be addressed, as well as the provision of alternatives for private retirement savings. The green and SRI agenda will inevitably be built into that process.

We also need to draw the sovereign wealth funds a little bit more into this discussion.

Mohammad Awad Al-Duwailah: Green sukuk and green bonds are similar to normal sukuk or bonds, it is just we add another factor, which is the rating from E1 to E4, to show that this money is invested in green projects. That is all.

For sukuk, it will open a new market for me, in Sweden for example, and I am sure those investors will be interested. In this kind of market, I will not open it with a normal refinery sukuk or something, I will go with a green sukuk.

The sustainability agenda

Gus Schellekens: Part of the reluctance to engage with 'sustainability' may be a psychological one. I have been in the region since 2010 talking about sustainability and the opportunities that it offers. For many people, as soon as they hear the term 'sustainability', they turn away and look at their phone – 'Sorry, I have a call I need to take…'.

"The Middle East will pick up the [green] trend and, when it does, it will pick it up very quickly" – Hani Ibrahim, QInvest

What I started doing from an early point onwards is not to use the word sustainability. What may be holding the market back in this area is the 'green' label, which is not taken seriously, and also because different people understand 'green' in different ways.

People should build Sustainability into their decisions as part of business as usual, and every now and then it will impart additional benefits.

Read part two of this round table here.