KUALA LUMPUR: Environmental, social and governance (ESG)-linked sukuk will remain a key issuance theme in core Islamic finance jurisdictions, said Fitch Ratings.
The rating agency said this was supported by government initiatives that promote sustainability and economic diversification, as well as rising investor demand and awareness.
Fitch global head of Islamic finance Bashar Al Natoor said commonalities existed between Islamic finance and ESG principles due to built-in sharia filters, but they still had differences.
Bashar said Islamic finance did not relate only to the use of proceeds but Islamic products also had to be structured in a way that complied with shariah.
"Global ESG sukuk market has grown rapidly in recent years, and we expect growth to continue in the medium term," he said in a report.
Fitch said ESG sukuk made up 2.6 per cent of global outstanding sukuk, and the firm expects this share to increase to around 5.0 per cent over the coming five years.
"The share of ESG sukuk is also forecasted to reach 15 per cent of all Fitch-rated outstanding sukuk over the medium term," it said.
According to Fitch, outstanding ESG-linked sukuk expanded by 11.2 per cent quarter-on-quarter at the end of June, reaching 19.3 billion.
About US$4.3 billion of ESG-linked sukuk was issued in the first half of the year,l.
Meanwhile, Fitch said key challenges in core Islamic finance markets included a complex issuance process and regulatory constraints, as well as a shortage of domestic ESG-focused investors and issuers.
This is unlike regions such as the US, Europe, and China, where the segment is more developed.
"Barriers also remain in the conventional ESG debt markets, including a lack of commonly accepted green and sustainability standards and definitions, issues in ESG data comparability across issuers, and scepticism over "greenwashing" – that is, an entity giving a misleading impression about its green performance.
"Sukuk on its own also has an additional layer of the need to comply with sharia (Islamic rulings), with sukuk not having a standard structure," it said.
In addition, Fitch said the ESG sukuk segment, including green, sustainable, sustainability-linked and transition sukuk, was emerging as a sizable segment of the global sukuk market.
This was despite volatilities caused by the Russia-Ukraine war, and by the increasing interest rates, rising oil prices and inflation.
"ESG sukuk growth was faster than that of the total sukuk market, which topped 11.6 per cent quarter on quarter (qoq).
"The largest Fitch-rated outstanding ESG sukuk were by entities in Saudi Arabia– including the Islamic Development Bank, and followed by those in Indonesia, UAE and Turkey.
"About 97.4 per cent of Fitch-rated ESG sukuk were investment-grade," it added.