Unsustainable economic activities have led to the destruction of nearly 70% of Earth’s biodiversity since 1970 (NPR, 2022), diminishing the capacity of these ecosystems to provide climate change mitigation and adaptation benefits. Neglecting nature and biodiversity conservation amidst worsening climate change could result in a detrimental cycle of escalating effects, considering the interconnectedness of biodiversity loss and climate change (IFC, 2022). However, conservation efforts cannot be accomplished without adequate funding from all sources.

In support of global discussions aimed at addressing the funding gap of $598-824 billion per year (NC and others, 2020) and recognizing the sustainable development opportunities in Islamic finance products, this article will explore the use and flexibility of Green Sukuk as a finance tool to expand and diversify funding sources for nature and biodiversity.

Financial institutions currently view nature and biodiversity loss as a calculable material risk in terms of physical flows, corporate reputation, or other broader impacts (Richard and Nowella, 2022). However, with financiers treating nature as ‘natural capital’, the value of biodiversity remains embedded in its accounting prices (Dagpusta, 2021).

The unprofitable nature of ecosystem conservation practices is an issue to be addressed to mitigate their unattractiveness to financiers.  Therefore, global discussions emphasize attaching commercial value to nature and biodiversity preservation to attract private sector investment, as public sector funding alone cannot bridge the funding gap (NC and others, 2020). Placing a monetary value on nature and biodiversity is essential for long-term sustainable development, as it not only attracts investors and innovative sustainable financial products, but it also encourages systemic change across value chains where businesses would be compelled to account for nature and biodiversity in their products and processes to attract funding. This is particularly crucial for economies that have been built on unsustainable practices due to various geographical and political factors, such as fossil-fuel dependent countries. It is also important when considering a shift away from interest-dominant green financial products (Edana, 2019) to expand the green finance pool and include Islamic finance products.

In a comprehensive catalogue of finance solutions to address nature and biodiversity loss, BIOFIN has identified Green Sukuk as one of the financing solutions for sustainable development (BIOFIN, 2022). It is estimated that $30-$50 billion of capital dedicated to the UN’s Social Development Goals (SDGs) could be raised through green and sustainable Sukuk by 2025 (UKIFC, 2022). Green Sukuk presents a unique opportunity to attract investors mandated to comply with Shari’ah principles and offers an alternative fixed-income investment channel for ESG-focused investors, helping address the funding gap. Notably, reported subscription data indicates that green and sustainable Sukuk were oversubscribed 4.4 times compared to 3.3 times for traditional Sukuk  (Refinitiv, 2022). This demand is driven by both non-Shari’ah-related ESG-centric investment mandates (42%) and Shari’ah compliance-focused investors (38%), signifying growing interest in Green Sukuk beyond its religious significance.

Shari’ah rules governing Green Sukuk are capable of addressing some of the limitations of the current green bond regime, offering more rigorous governance and accountability. Shari’ah principles require funds raised through Sukuk to be specifically allocated to an identifiable asset, typically through a special purpose vehicle established and owned by the issuer seeking to finance the asset. This differs from green bonds, which are generally issued directly from a company’s balance sheet. Consequently, a Sukuk structured to fund a designated green project is less likely to be diverted for non-green purposes, thereby enhancing legal accountability (Hussain et al., 2017).

Furthermore, there is potential for stronger governance regarding the environmental aspect under Islamic principles. The Shari’ah board, a committee of Islamic scholars within an Islamic bank responsible for determining the compliance (halal) and theological purity (tayyib) of transactions, has authority to establish the specific Islamic principles that a Green Sukuk must adhere to. This means that the environmental and sustainability principles would be integrated into the underlying asset itself, rather than merely being reflected in the structure of the Sukuk. Such characteristics demonstrate an effective mitigation tool against greenwashing risks commonly present in traditional green bonds.

Existing Green Sukuk issuances and supporting frameworks in the GCC, Indonesia, and Malaysia (who dominate the Green Sukuk market) have been focused on renewable energy, energy efficiency, sustainable transportation, sustainable water and wastewater management, and carbon neutrality (UKIFC, 2022). Although the market is at a nascent stage, a lack of innovative development in biodiversity-related Islamic finance products risks an interest-dominated market of biodiversity investment instruments (World Bank, 2020) inaccessible to Shariah-compliant investors.

The development of innovative and Shari’ah-compliant investment instruments focused on nature and biodiversity would reflect and internalize the Islamic concepts of Maṣlaha (public good), Qawa’īd (ethics) and the Maqāsīd al-Sharī’ah (the broader goals of Islamic law) into contemporary Islamic finance practices. This would not only address the existing gap but also underline the fundamental compatibility between Islamic finance and sustainable investment in nature and biodiversity.

To draw the attention of innovative Islamic finance products to direct investment in nature and biodiversity, the following section will highlight how existing and potential (Green) Sukuk contracts can be used for the purpose of directing private finance to ecosystem conservation efforts.

The structuring of a Green Sukuk is similar to a traditional Sukuk with the only difference being greener assets used to support the Sukuk or an environmentally friendly project (Norhayati and Masri, 2020).

Existing contractual arrangements for Green Sukuk have been structured around the following Shari’ah arrangements (Edana, 2021):

• Commodity Murabaha (sales agreement): most common and was used for the UAE’s MAF Green Sukuk- which was an international issuance, and the Malaysian Sarawak Green Hydro Sukuk
• Ijarah (leasing), Istisna (manufacturing sale): used for SRI Green Sukuk Tadau (Solar photovoltaic construction)
• Wakalah (agency- share of expertise and management for a fee): used for the BEWG (M) Sdn. Bhd. (Solar photovoltaic) Green Sukuk

Reflecting on IFC’s biodiversity finance reference guide (IFC, 2022), these contractual arrangements can prove effective and straight forward in one of the biodiversity finance streams: the investment into business operations and production practices that seek to address the key drivers of nature/biodiversity loss. However, it can prove challenging for the other IFC-identified streams: the investments in nature-based solutions to conserve, enhance, and restore ecosystems and biodiversity; and the direct financing of conservation and restoration of terrestrial and marine ecosystems.

The returns provided to investors under the listed contracts depend on profit from sale or lease, fees for managerial and know-how sharing benefits, or a combination. Such returns under the 1^st stream of biodiversity finance can be enabled through investment projects themed around productive agriculture and land use; replacement of biodiversity-adverse infrastructure, processes, and equipment; ecotourism services; freshwater/marine sustainable production; waste and plastic management for pollution control; transport and logistics innovation to avoid the transport of invasive species, etc.

However, the non-revenue nature of conservation projects and nature-based solutions risks them being excluded from the biodiversity Islamic finance agenda considering these non-revenue projects are traditionally addressed through interest payments. While it is certainly possible to engineer the existing Green Sukuk contractual arrangements to target nature-based and conservation solutions, through an Ijarah and Wakalah hybrid, for example, it is important to expand the contractual offerings through product innovation to maximize ecosystem investment and risk-sharing opportunities for Shari’ah-mandated investors.

While they have not been replicated, the 2 series SRI Malaysian Sukuk Ihsan by Khazanah Nasional Bhd, which involved Wakalah, commodity Murabaha and Istithmar (Islamic investment agency) arrangements, were innovative in addressing the unprofitable nature of community investments as it linked returns to specific performance targets (Edana, 2019). Such structuring can be effective in a nature and biodiversity context as it complies with Shari’ah mandates and also fosters a performance-centric approach.

An additional innovative Islamic finance model worth considering is the Cash Waqf-linked Sukuk (CWLS). In this model, assets from Waqf, which are Islamic charitable donations or endowments, serve as the underlying support for issuing Sukuk (Rozaq, 2021). The CWLS model, initiated by the Ministry of Finance of the Republic of Indonesia, is a pioneering effort that utilizes non-profit instruments overseen by the government to finance to finance social projects on a large scale (Eko, 2022). This approach, available to public and private sectors, promotes the integration of Islamic social and commercial finance and enriches the diversity of the Islamic capital markets. The success of this model is evident in the recent issuance of the 2023 “Sukuk Al-Salam” by the Central Bank of Bahrain, which was oversubscribed by 197% and its recent award of the Islamic Development Bank Prize for Impactful Achievement in Islamic Economics (1444H, 2023) (Zawya, 2023)

To further strengthen and broaden the impact of CWLS, the incorporation of “Green Waqf Frameworks” is being explored (UNDP and BWI, 2022). By integrating green development initiatives, Cash Waqf-linked Sukuk has the potential to create a more robust, extensive, and sustainable influence on the environment and society.

As discussions on climate change and the role of nature continue, Green Sukuk emerges as a promising finance tool for nature and biodiversity, particularly considering the crossover between Shari’ah mandates and ESG. However, while it was noted that existing Green Sukuk contracts offer flexibility, they may fall short in addressing nature-based and conservation solutions. It is crucial for issuers to develop innovative products that effectively tackle the challenges of nature and biodiversity preservation.

The Malaysian Sukuk Ihsan issuance serves as a notable example of innovation in this field, highlighting the potential for linking returns to specific performance targets. Additionally, exploring the use of Cash Waqf-linked Sukuk, which utilizes Islamic charitable donations or endowments, can further enhance the integration of social and commercial finance for impactful projects on a larger scale. Continuously expanding the range of inventive Islamic financial products is vital to maximize investment opportunities, promote risk-sharing, and ultimately create substantial positive environmental and societal impacts.