A responsible approach to financial decisions

By channelling funds into projects and businesses prioritising eco-friendly practices, sustainable finance has become a powerful tool for combating climate change

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The growing threat of climate change has prompted global markets to prioritise investments in climate-neutral economic activities.

This is reflected in Cop28 climate summit pledges, such as the UAE’s promise to mobilise AED1tn ($270bn) in sustainable finance by 2030.

Beyond the UAE, public and private organisations around the world have also declared substantial commitments to help shape a sustainable and responsible financial future (see Cop28 finance pledges).

“As the world approaches a turning point for global climate action, investments in renewable energy, energy-efficient technologies and environmentally conscious infrastructure have become significant for reducing carbon footprints,” said Ibrahim Al Mheiri, executive vice-president and head of Islamic banking at Mashreq, speaking at the Sustainable Asset Management forum hosted by Mashreq Al Islami and MEED in Dubai.

The greater focus on environmental, social and governance (ESG) factors has spurred companies, banks and governments to evaluate and enhance their practices, he noted – fostering sustainable business approaches, minimising carbon emissions and reinforcing accountability.

“The collective effort contributes significantly to the broader transition towards a net-zero economy,” he added during his keynote address at the one-day event.

Al Mheiri told attendees that global awareness of the need for sustainability has prompted companies to align themselves with this goal: “A case in point is the UAE’s pledge of $30bn made at Cop28 to a new fund for investing in climate-friendly projects across the globe.”

Al Mheiri’s remarks mirror the Cop28 presidency, led by Sultan Al Jaber, which highlighted the urgency of tackling the lack of accessible and affordable finance at the recent intergovernmental climate summit in Dubai.

Al Jaber emphasised that this financial gap jeopardises global climate goals and sustainable development, making it a top priority for the summit.

Shaping economies

Sustainable finance can be categorised into two main groups: sustainable products and sustainability- or ESG-linked markets.

“The dual categorisation of sustainable finance into sustainable products and sustainability-linked markets reflects the diverse strategies employed to promote environmental and social responsibility within the financial sector,” said Hussam Abdel Al, senior director of origination and head of sustainable finance, investment banking, Mashreq.

Sustainable products refer to financial instruments designed to support such initiatives. This category includes green bonds, which are fixed-income securities earmarked for projects with positive environmental impacts.

While these projects could be anything from building solar farms to improving water conservation and establishing sustainable infrastructure, there needs to be more clarity on what constitutes a green or social project.

“Typically, the criteria is outlined in a sustainable finance framework provided by the issuing company where qualifying projects can range from renewable energy to clean transportation and social inclusion. Therefore, it is important for issuers to establish a proper framework,” said Abdel Al.

Another facet of sustainable products is social bonds, aimed at financing projects that address social issues such as affordable housing, healthcare and education.

In contrast, sustainability-linked finance tie interest rates to the borrower’s performance in meeting predefined sustainability targets. At the same time, ESG-linked markets provide a platform for companies committed to responsible business practices, fostering transparency and accountability.

Abdel Al further explained that in such approaches, the funding provided for general corporate purposes or capital expenditures is tied to achieving predefined KPIs and targets.

“These KPIs should be relevant to the industry and set at ambitious levels, going beyond business-as-usual activities,” added Abdel Al.

Green savings

The rise of sustainable finance is not just a response to ethical considerations; it is driven by the realisation that long-term financial success is intertwined with environmental and social sustainability.

“Sustainable practices go hand-in-hand with operational efficiency,” said Abdel Al. “By identifying opportunities to optimise energy consumption, reduce waste and streamline processes, environmentally conscious firms can achieve significant cost savings in the long run.”

Addressing whether sustainable finance is more expensive than traditional funding, Abdel Al clarified, “Interestingly, there is no noticeable difference.”

He dispelled the notion that green finance should come with a substantial discount, explaining that banks do not receive direct benefits or incentives from central banks for offering green financing. “While competition for financing green assets may impact prices, the funds do not come from a separate pool.”

“Banks, as intermediaries between depositors and projects, prioritise ensuring the creditworthiness of the projects they support.”

Banks do not show more leniency on credit solely because a project is green, he noted.

“For early-stage sustainable projects, alternative liquidity sources might be more suitable, but as projects progress and scale up, banks are willing to support their growth, similar to their approach with any other corporate endeavour.”

Islamic alignment

Islamic finance has gained recognition for its ethical and equitable approach to financial transactions. It complements the goals of sustainable finance, as both aim to promote economic development while considering social and environmental factors.

Sharia-compliant finance aligns with the sustainability agenda by promoting investments in environment-friendly and socially responsible projects, and prohibiting investments in industries such as gambling, alcohol and tobacco.

“There is a strong connection between Islamic principles and sustainability as both aim to do good,” said Abdel Al.

“Despite differing product structures, the core principle of promoting positive actions for long-term success remains the same. Islamic finance encourages partnership, where both profit and risks are shared. This Islamic concept aligns well with sustainability goals.

“And therefore, the screening process in Islamic finance, known as sharia compliance, can serve as a model for sustainable finance, ensuring ethical considerations in investment decisions.” 

23 February, 2024 | .By Sarah Rizvi