Finance

Islamic finance is (almost) close to sustainable finance

For Scott Levy of Bedford Row Capital, ESG jargon is the main obstacle to the financing of sustainable projects by Islamic investors.

How to get Islamic finance investors to invest in energy transition projects? How to get Western investors to fund ESG projects in Shariah countries? Both issues are familiar to Bedford Row Capital, a London boutique dedicated to structuring Sharia-compliant debt products. The answer involves simplifying the language to improve understanding between these two worlds. The stakes are high: not only because Islamic investors are at the head of immense liquidity but also because many SME holders of sustainable projects cannot find financing. Explanations with Scott Levy CEO of Bedford Row Capital.

“Islamic countries are promoting projects at the forefront of the energy transition.”

Many projects, environmental ones in particular, could be financed in both Islamic and Western countries if investors in Islamic finance and traditional finance spoke the same language. What’s at stake?

There is indeed a whole range of projects which require 100 to 200 million dollars of financing and do not find an answer with the large investment banks. Why? Because the latter, due to regulatory constraints relating to their balance sheet, no longer come into play below 500 million dollars. Not to mention that they only look at files that concern classic, “plain vanilla” projects. Today, there are few players who offer real alternatives to commercial paper and other old-school approaches to financing sustainable projects. Bedford Row Capital is one of them, because we are convinced that both Islamic finance and conventional finance have a lot of cash that they want to invest in the most sustainable way possible in an inflationary context. There are many projects waiting for investors, both on the side of Islamic and Western economies.

What types of projects are we talking about?

The projects that I can talk about because we help to implement and finance them concern all areas of sustainable finance. Environmental first and foremost. Islamic countries are promoting cutting-edge energy transition projects. We have thus supported a project in Jordan aimed at securing the extraction of copper and other essential metals for the manufacture of batteries used in the context of the energy transition. We have also helped Islamic investors finance crucial Mexican copper companies in this industry. In other words, it works both ways. The social field also holds the attention of sovereign funds of Islamic finance: Malaysia, the largest issuer in number and volume of green bonds, and Indonesia, generously finance infrastructure and social housing in London. Even the Gulf countries (GCC), which are reluctant to lend money to regional players, come out of their reserve when it comes to financing sustainable infrastructure in London, Paris or Zurich.

What hinders today the commitment of Islamic finance in sustainable projects in the West and that of traditional finance in sustainable projects in Islamic lands? Sharia?

Islamic finance is by ethical principle, it cannot exist without moral foundations. A dimension that the ESG criteria do not include as such, but which creates commonalities, particularly on governance and social aspects. Justice and simplicity are pillars of Islamic finance which is inherently transparent – ​​in particular, detailed reporting is mandatory. The E is not to be outdone, and occupies an essential place in Islamic societies where waste is prohibited, water and trees are particularly protected. Their sensitivity to environmental issues is natural, much more than one might imagine. Finally, Islamic finance is based on sustainable values.

“The problem is not with Sharia but with the language.”

According to Sharia, a leverage of 30% is possible. The main limitation is in the design of the debt: Islamic finance prescribes that a half-finished project be sold so that the profits are shared, which temporarily brings the project to an end. Traditional finance authorizes the purchase of the project, therefore its continuation. This difference is important, but does not prevent arrangements that allow projects to be carried out. The problem is not Sharia but language.

How to solve this language problem? Is a common language possible, which would promote the conclusion of sustainable projects without coming up against ESG jargon?

The challenge today is essentially a problem of jargon: sustainable finance uses concepts that are not meaningful for Islamic finance even though what they refer to is part of its morality. This is very similar to the concepts of CLO (collateralized loan obligation) or MBS (Mortgage-backed securities) used in the financial industry to show its difference, which led to the rout that we experienced in 2008. Both sides will have to make an effort. A crucial effort to prevent investors from turning their heads, which is common these days. Western investors ignore projects involving solar installations because the investment vehicle is a sukuk, while Islamic investors simply ignore SFDR-compliant documents. It doesn’t seem like much, but creates a huge misunderstanding, even if perfectly superfluous.

Are you optimistic, do you think the barriers will come down?

Yes, because everyone wants the same thing, whether they are players in Islamic finance or those in traditional finance: to find sustainable investment projects. All investors face the same reality: they have a lot of cash that they want to invest in future projects. Little by little, Islamic investors will adapt their approach to integrate DGS while Western investors will accept a “delabelling” which will not mean downgrading. We have already entered a momentum, the best proof of this is the increase in GCC countries issuing sukuks in forms of traditional green bonds.

Would this trend be a good deal for both parties?

The big winners from this trend will be bond issuers from emerging Islamic countries: the yield should be 100 or even 200 basis points higher than traditional green bonds. This is because the green bond market in these countries is much smaller.

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