Towards a Holistic Shariah-compliant Taxonomy for Climate Action, Mitigation, Adaptation and Finance 

As the world moves towards the UN Conferences of the Parties (COP) 27 in Sharm El Sheikh in Egypt in November 2022, the global narrative including for the finance and insurance industry is understandably concentrating on climate action, mitigation and adaptation.

This despite the lingering effects of the COVID-19 pandemic; the supply chain disruptions caused by the Ukraine conflict and its resultant impact on rising food and fuel prices; the global economic shocks of high inflation, subdued GDP growth and a global cost-of-living crisis.

The Islamic finance industry is no exception in this respect given that many of the OIC member countries are either primary commodity producers including oil, gas and palm oil, or the victims of climate change through rising sea levels, floods, hurricanes, poor air quality and other extreme weather conditions.

Governments and institutions are scrambling to adopt climate action strategies and policies, but the stark reality is that all governments irrespective of economic status cannot afford to finance pre-emptive and mitigation initiatives out of national budgets alone and will rely heavily on contributions from multilaterals and in particular private investment, which is seen to be the major driver of climate action.

COP27 Host, Egypt for instance, one of the largest emitters in Africa, has embarked on a comprehensive “National Strategy for Climate Change” and is preparing the “National Strategy for Hydrogen” to promote the use of blue and green hydrogen as a low to zero emission energy source.

“To deliver the SDGs,” explained Dr Hala El-Said, Minister of Planning and Economic Development of Egypt, “the UN estimates that between US$5 trillion to US$7 trillion per annum needs to be mobilised by 2030. Developing countries face an annual funding gap of US$2.5 trillion to achieve the UN SDGs. Low-income countries will require the largest increases in public expenditure relative to GDP to fill this gap. To increase the share of resources available for development purposes and to ensure that these resources reach those most in need, Islamic finance provides a novel option.”

Egypt has a strong relationship with the Islamic Development Bank (IsDB Group). Going forward, the priorities for the Egyptian-IsDB Group cooperation are in the following sectors: green and clean energy sectors, especially renewable energy, as well as digitalization, and trade finance. Furthermore, there is ongoing cooperation in the field of capacity-building and training provided by ITFC and the various member institutions of the IsDB Group. Capacity-building is of paramount importance to Egypt and is also one of the cross-cutting pillars of the various areas of development plans and programs of the Egyptian state, both in the field of trade, industry and other economic and development fields.

Islamic finance is increasingly adopting sustainability criteria, so it is well positioned to maximise social impact and address the SDGs. To Dr Hala, it provides an emerging opportunity that could be harnessed by investors and development partners, such as multilateral development organisations. “The SDGs require unprecedented mobilization of funds to support their implementation. Islamic finance, with its focus on the real economy, offers an effective non-traditional means of financing for sustainable development activities and projects in developing countries. Many countries have started to reap the benefits offered by Islamic financing options which lowers their debt-to-equity ratios for capital intensive projects. Over the next few years, Islamic finance will be considered as one of the primary financing strategies, especially for Egypt,” she confirmed.

The IsDB Group is a major player in contributing to the international climate finance ecosystem. ICIEC, the Group’s export credit agency, has proposed the establishment of a Climate Action Finance Trust Fund with institutional partners, peer multilaterals and ECAs in Member States and beyond, which would offer a discount to the insurance premiums needed for the financing of Climate Action projects in Member States that are not investment grade.

ICIEC actively targets real impact and change in all its financing, insurance policies it underwrites and projects it supports, and acts as a catalyst for private sector capital mobilization towards achieving the SDGs.

Cumulatively, over 28 years, ICIEC has insured US$106.34 billion in trade and investment, which include US$85.64 billion in supporting exports and imports, and US$20.7 billion in support of FDI. Its activities were directed to specific sectors including US$27.33 billion to clean energy. The IsDB Group’s current renewable energy financing totals about US$3.4 billion and ICIEC, as the Group’s ECA, has provided US$470 million in insurance for renewable energy projects in member states.

Malaysia, which is well into developing its own Green and Climate Taxonomy both under its own National Strategy and under the ASEAN Initiative, is strongly promoting climate action reporting by the financial services industry.

The Joint Committee on Climate Change (JC3) of Bank Negara Malaysia (BNM) and The Securities Commission Malaysia (SC), for instance held its eighth meeting in August 2022 to review the progress financial institutions are making in strengthening their response to climate risk. The two regulators have launched the Climate Change and Principle-based Taxonomy (CCPT) under which financial institutions are required to transition to the Taxonomy and to report their progress towards achieving this.

The JC3 reports increased demand from Malaysian-authorised and based financial institutions for practical tools and urgency to address key gaps needed to support transition. Jessica Chew, Deputy Governor, BNM and Co-Chair of JC3, is encouraged by the increasing focus and concrete actions being taken by financial institutions to manage climate-related risks. “Further progress,” she observes, “will however critically depend on key enablers, including accessibility to data and better disclosures being in place.”

According to the Committee, financial institutions have submitted the first report on the application of the CCPT to BNM. “While financial institutions have demonstrated capability to assess new financing and investments based on the CCPT, the Committee through the CCPT Implementation Group (CCPT IG), is working with the industry and partners to further improve the consistency and quality of classifications under the CCPT for existing outstanding financing and investments. Information gaps for existing exposures continue to pose the biggest challenge,” added BNM.

CCPT IG, for instance, has developed a due-diligence questionnaire together with the World Wide Fund (WWF) Malaysia on selected CCPT guiding principles “to help financial institutions capture important information from their customers and counterparties in a more consistent manner. This will serve to promote robust classifications of climate supporting and transitioning activities and reduce additional burdens for customers and counterparties of banks to provide such information to multiple financial institutions.”

The Joint Committee is also cooperating with Capital Markets Malaysia, an affiliate of the SC, to develop an ESG Disclosure Guide tailored to Malaysian Small and Medium Enterprises (SMEs). The Guide aims to improve the quality of and access to information on business resilience to ESG-related risks to ensure practical adoption by SMEs and larger businesses and alignment with global disclosure frameworks, including that being developed by the International Sustainability Standards Board (ISSB), to promote comparability and minimise compliance costs for businesses and financial institutions going forward.

 

Other initiatives under the JC3 carbon action footprint include:

  1. The issuance of the Sustainable and Responsible Investment-linked (SRI-linked) Sukuk Framework by the SC in June 2022 to facilitate companies to issue SRI-linked Sukuk to support their transition towards low-carbon activities.
  2. The exploring of suitable pilot programmes to test new green finance solutions and instruments such as blended finance to support the development of climate-friendly projects, and
  3. The Data Catalogue developed by JC3 remains on track for publication by end-2022. This will be accompanied by a brief report on the data availability, gaps and specific recommendations to bridge data gaps. The data catalogue is a key challenge and deliverable of JC3 to address the data needs of the financial sector by pointing users to credible sources of critical climate data needed to support identified use cases, albeit material gaps still exist within existing data sources due to legal impediments to data sharing.

Cooperation with stakeholders is vital. As Datuk Zainal Izlan Zainal Abidin, Deputy Chief Executive, SC and Co-Chair of JC3, stresses: “In progressing climate action in Malaysia, it is important for the JC3 to have close engagement and collaboration with relevant stakeholders. Towards this end, the JC3 has conducted a series of engagements, including a meeting with four key ministries in July to forge closer collaboration with the government. Such engagements have brought greater clarity on the national plans and initiatives that both the financial sector and Government can pursue and collaborate. Both parties can align their climate actions in developing an ecosystem that is conducive for sustainable finance to flourish.”

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