Exploring Ethical Sukuk Market

The sukuk market, an essential segment of Islamic finance, provides a distinct form of investment that aligns with Shariah principles. As Islamic bonds, sukuk avoid interest (riba) and emphasize ethical financial practices, making them appealing to investors seeking sustainable and compliant opportunities. The ethical sukuk market has seen remarkable growth in recent years, driven by factors such as increasing demand for sustainable investments, efforts to standardize Shariah compliance, and evolving global financial conditions. In 2024, Sukuk are not only a financial instrument but also a vehicle for ethical and sustainable economic development.

Ethical Sukuk Market Trends

The sukuk market has expanded significantly, with global issuance expected to reach between $160 billion and $170 billion in 2024. This growth follows a slight decline in 2023 when issuance dropped to $168.4 billion due to challenging liquidity conditions. Despite this dip, the total outstanding sukuk market is projected to grow to around $875 billion by the end of 2024. The ongoing growth is fueled by higher financing needs in core Islamic finance markets such as Saudi Arabia, Malaysia, and Indonesia, and the emergence of new players like Egypt and the Philippines. These countries have entered the market with significant sukuk issuances aimed at addressing both budgetary needs and sustainable development goals.

Foreign currency-denominated sukuk, which rose by almost 24% in 2023, plays a role in the market’s expansion. This surge is partly driven by clarity around interest rate policies and central bank actions, which have attracted global investors looking for stable returns. For instance, Egypt’s debut sukuk in early 2023 raised substantial interest, being 4.9 times oversubscribed, reflecting a strong appetite for ethical investments amid uncertain economic conditions.

Aligning with ESG

The ethical sukuk market aligns naturally with the principles of Environmental, Social, and Governance (ESG) criteria. As Islamic finance forbids activities that harm society or the environment, sukuk inherently promotes promotesable economic practices. In 2023, sustainable sukuk saw an uptick, with green sukuk accounting for a significant portion of issuances. The shift towards sustainable finance has been supported by initiatives such as COP28, where Islamic finance was highlighted as a means to address climate change. Issuers in the UAE, in particular, have embraced sustainable sukuk, which made up 40% of the nation’s total sukuk market in 2023. These instruments not only help countries achieve their net-zero targets but also meet the growing demand from investors seeking socially responsible investments.

The sustainable sukuk market includes green, social, and Waqf sukuk, each serving distinct but complementary purposes. Green sukuk finance environmental projects, such as renewable energy or conservation initiatives. Social sukuk, on the other hand, funds projects aimed at improving social well-being, such as affordable housing, healthcare, and education. Waqf represents the philanthropic dimension in the market, where proceeds fund charitable initiatives or community development projects while generating returns for investors. The diversification within sustainable sukuk provides a broader range of investment opportunities and aligns with various ethical investment strategies.

Standardization Efforts

Efforts to standardize sukuk structures and Shariah compliance are pivotal for the market’s development. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) plays a significant role in setting global standards for Islamic finance. With over 119 standards covering Shariah, accounting, auditing, and governance, AAOIFI has helped create a framework that supports the sukuk market’s growth. The implementation of Standard 62, which mandates the transfer of ownership and risks associated with the underlying assets to sukuk holders, aims to increase market transparency. This regulation is expected to facilitate the development of asset-backed sukuk markets in countries adopting AAOIFI standards.

However, the adoption of Standard 62 also presents challenges. Sovereign entities and corporations may hesitate to issue sukuk if they must transfer control over key assets, potentially increasing financing costs. This reluctance could slow sukuk issuance growth in regions where asset ownership is a sensitive issue, such as in countries with significant state-owned assets. Despite these concerns, many jurisdictions, including Bahrain, Malaysia, and the UAE, have adopted AAOIFI standards, which could eventually lead to greater harmonization in the global sukuk market​.

Challenges in the Ethical Sukuk Market

The sukuk market’s growth trajectory is not without obstacles. Geopolitical risks, inflation, and evolving interpretations of Shariah compliance can all impact market stability. For example, geopolitical tensions in the Middle East or South Asia could disrupt financial flows, while inflation may drive up the cost of borrowing, affecting sukuk returns. Additionally, differing Shariah rulings across jurisdictions create fragmentation, making it difficult for international investors to navigate the market confidently.

In 2023, local currency sukuk issuance declined by approximately 16.8%, mainly in markets like Saudi Arabia and Indonesia, where fiscal policies aimed at preserving liquidity led to reduced government issuances. Yet, this trend could reverse in 2024 as these countries seek to bolster local capital markets and address financing needs for major infrastructure projects. Moreover, anticipated interest rate cuts by mid-2024 may improve global liquidity, supporting higher issuance volume.s​

Digitalization

Digital transformation is emerging as a powerful catalyst for the sukuk market’s growth. The advent of blockchain technology and tokenization in sukuk issuance can streamline processes, reduce costs, and enhance compliance with Shariah principles. Tokenized sukuk, which leverages blockchain for greater transaction transparency and security, presents a promising avenue for issuers looking to tap into the Islamic finance market more efficiently. By minimizing intermediaries and automating compliance checks, digital sukuk can lower the barriers to entry for smaller issuers, making the market more inclusive.

Despite these benefits, challenges remain, including the need for a unified regulatory framework and technological infrastructure to support digital sukuk. Countries like the UAE and Bahrain have begun exploring regulatory sandboxes to facilitate the testing and adoption of financial technologies in the Islamic finance sector. However, widespread adoption will require collaborative efforts across multiple jurisdictions to standardize digital sukuk issuance and legal recognition.

Market Drivers

The regional distribution of sukuk issuance reflects diverse market drivers. The Gulf Cooperation Council (GCC) countries, particularly Saudi Arabia and the UAE, continue to dominate the market, accounting for nearly 70% of total sukukSukukance. These countries’ ambitious economic diversification plans and infrastructure development projects create a high demand for Shariah-compliant financing. In Southeast Asia, Malaysia remains a leading sukuk hub, with a mature regulatory environment that supports innovation in the market. Indonesia is also emerging as a key player, with a focus on sustainable sukuk to fund renewable energy projects.

New entrants to the market, such as Egypt, have made significant strides by issuing sovereign sukuk, which attracts both local and international investors. The success of Egypt’s debut sukuk has paved the way for other African and Asian nations to explore sukuk as a viable funding option. Additionally, companies in non-Muslim-majority countries, such as the United Kingdom, have started issuing sukuk, highlighting the growing appeal of Shariah-sharia-complaint beyond traditional markets.

What Lies Ahead for Ethical Sukuk?

Looking forward, several factors will shape the sukuk market’s trajectory. The ongoing integration of ESG principles into Islamic finance, along with efforts to harmonize Shariah standards, will likely enhance the market’s appeal. Sustainable finance initiatives, particularly in the GCC, will continue to drive the issuance of green and social sukuk. Moreover, digitalization efforts, including blockchain and tokenization, will play a critical role in making sukuk issuance more accessible and efficient.

However, the market will need to address challenges related to standardization and regulatory harmonization. Countries that fully or partially adopt AAOIFI standards may experience smoother market integration, while jurisdictions with divergent practices could face fragmentation risks. The success of the sukuk market will depend on collaborative efforts to develop a unified approach to Shariah compliance, alongside innovative financial instruments that meet the evolving needs of ethical investors.

The ethical sukuk market is set to continue its upward trajectory, offering investors a blend of financial returns and ethical investment opportunities. With a growing focus on sustainability and digital transformation, the sukuk market is poised to become a mainstream asset class that appeals to a wider range of investors. The ongoing efforts to standardize Shariah compliance and promote digitalization will be crucial in ensuring that sukuSukukain is competitive in the global financial landscape.

As the market matures, sukuk will likely play an even greater role in financing projects that align with ethical and sustainable development goals, providing a valuable pathway for responsible investment in today’s rapidly changing world. Investors, issuers, and regulators must continue to work together to unlock the full potential of the ethical sukuk market, making it a cornerstone of sustainable finance for generations to come.