Malaysia has added another feather in its green cap as a global leader in Islamic ESG financing with the introduction of a sustainable and responsible investment-linked sukuk framework that will spur more corporates to adopt sustainable agendas.
"I am delighted to see that Malaysia has achieved another key milestone with the issuance of the SRI-linked or sustainability-linked sukuk guidelines," said Shafiq Sheikh Mohamed, OCBC Bank Malaysia’s head of Islamic and structured finance. "This is a great profiling for Malaysia’s leadership not only in Islamic financing but also in the sustainable finance space."
Under the newly established framework for SRI-linked sukuk, which are akin to sustainability-linked bonds, companies with high levels of carbon emissions will have an avenue to fund a transition to a low-carbon or net zero status.
The SRI-linked sukuk is a natural progression from the sustainable journey that Malaysia has embarked on since 2014 when it established the world’s first sustainability or SRI sukuk guidelines. The global market saw its first green sukuk in July 2017 from Tadau Energy, which sold a M$250m (US$55.8m) green sukuk. That was also the country’s first green project paper for a greenfield solar power project, and there have been plenty of other precedent-setting transactions since then.
The Government of Malaysia scored a global first with a US dollar sovereign SRI sukuk in April 2021, in a US$1.3bn dual-tranche deal that included a US$800m sustainability 2.07% 10-year sukuk. This was built upon by Malaysian energy infrastructure company Yinson Holdings, which sold Malaysia’s first sustainability-linked sukuk at end-November 2021 with a M$1bn 5.55% five-year deal that comprised a step-up of up to 25bp if the issuer did not meet some or all of their key performance targets. This was the world’s first sustainability-linked sukuk with a coupon step-up feature.
“It has been very encouraging to see this evolution in Malaysia’s SRI financing development,” said Raja Amir Raja Azwa, HSBC Amanah’s chief executive officer.
The new SRI-linked sukuk guidelines will take Malaysia’s leadership in Islamic financing a step further.
“The SRI-linked sukuk framework will encourage greater mobilisation of private sector and issuers’ financing towards sustainable development and meet increasing global demand for sustainable financing,” said Awang Adek Hussin, Securities Commission Malaysia’s chairman, when the framework was announced on June 30.
A handful of Malaysian companies had already issued SRI-linked sukuk even prior to the release of the guidelines. These included Yinson’s sustainability-linked issuance, water treatment company Cenviro’s M$54.6m unrated sustainability-linked sukuk in March 2022 and Sunway REIT’s private placement of M$10m 2.93% two-year unrated sustainability-linked sukuk in December 2021. These SLBs had standards that were aligned with sustainable financing principles from the International Capital Market Association and the ASEAN Capital Markets Forum.
The new SRI framework was guided by ICMA’s SLB guidelines but the Malaysian version has more stringent rules, such as requirements for a second-party opinion as well as annual reporting on the performance against KPIs.
Bankers said companies are exploring SRI-linked sukuk to fund their climate transitions, but a major challenge is for the issuers to accept the structure in the form of a step-up in coupons if KPIs are not achieved by pre-defined deadlines. Issuers argue they should be paid an incentive in a form of step-downs if they achieve targets.
“Technically speaking, it is fairer to see more symmetrical coupon adjustments but for now, the SLB market is geared towards one end, that is a step-up if KPIs are not met,” said Gan Luying, HSBC’s head of sustainable bonds.
The bulk of sustainability-linked bonds issued globally feature only the coupon step-up. In Malaysia, Sunway REIT and Hap Seng Management however incorporated both step-up and step-down features, making their unrated sustainability-linked bonds a rare breed globally. Both deals were placed privately via sole lead manager OCBC Bank Malaysia.
“Sukuk or bonds are essentially a fixed income product that can be priced on a marked-to-market basis – a key element for tradability," said Shafiq. "The reason why we have not seen many rated sustainability-linked sukuk or bond issued globally with a profit or coupon step-down feature is mainly due to the price uncertainties which could affect the tradability of such bonds and this is something that investors would want to avoid."
Shafiq said they expect this investor approach to change at some point given the increasing trend in the issuance of sustainability-linked sukuk or bond by companies as part of their sustainability transition journey.
More companies may also be incentivised to sell sustainability-linked sukuk on the possibility of a government grant or tax benefits to help costs. The SC had in the past introduced tax incentives and grants to encourage issuers to adopt ESG financing.
Fitch acknowledged Malaysia’s leading role in global ESG sukuk markets in a report this month on the global ESG sukuk market, noting that the country’s Islamic ESG ecosystem “is amongst the most developed amongst Muslim-majority countries”.
Malaysia has the largest number of ESG sukuk globally with 175 out of 192 outstanding ESG sukuk instruments as of end-June, with the bulk of its sukuk in local currency, said Fitch.
According to HSBC Amanah's Raja Amir, a total of M$8.3bn of SRI sukuk has been issued in Malaysia since the framework was set up in 2014. Of this, some M$6bn was recognised under both the SRI sukuk framework and the ASEAN green bond standards and ASEAN sustainability bond standards.
“There is a synergy between Islamic finance and ESG as Islamic finance is essentially ESG in nature since it excludes a lot of controversial industries such military and alcohol ,” said Raja Amir.
Malaysia has become even more aggressive in its push to achieve carbon neutral status by 2050 after Prime Minister Ismail Sabri Yaakob announced a pledge in 2021 to stop building coal-fired power plants and to transition existing ones to run on gas. The government has estimated it will need some M$350bn–$450bn of investments to hit net zero GHG emissions by mid-century.
Regulatory agencies such as Bursa Malaysia have introduced several initiatives to ensure the country meets the net zero objective, including stringent requirements for listed companies on sustainability compliance reporting. The exchange also announced on August 15 it will launch a voluntary carbon market exchange later this year, which will allow companies to buy voluntary carbon credits from climate-friendly projects and solutions.
Major funds are also getting into the act, with government-owned Retirement Fund Inc stating its willingness to dispose of any investments if the companies failed to show improving ESG practices. Some 34 SRI funds have been launched since the SC introduced guidelines on ESG Funds, said the SC in response to IFR queries.