A New Sphere of Sukuk: Linking the Pandemic to the Paris Agreement (The World Financial Review, Finance & Banking, December 28th, 2020)

https://worldfinancialreview.com/a-new-sphere-of-sukuk-linking-the-pandemic-to-the-paris-agreement/

By Greget Kalla Buana and Khairunnisa Musari

The number of reported COVID-19 cases is approaching 50 million across the globe, and the death toll has passed a million. Not only does it bring about severe health issues, but also economic, social and political instability. However, the environmental perspective seems to be a different story.

Apart from the pandemic, 2020 also marks the entry into force of the Paris Agreement, an accord within the United Nations Framework Convention on Climate Change (UNFCCC), signed five years ago in Paris. Adopted by 197 countries, this agreement was to tackle climate change and its negative impacts by means of mitigation, adaptation and finance, with the main objective of limiting global temperature rise to below 2 degrees Celsius.

Being among countries that have ratified the agreement, Indonesia is required to prepare, communicate and maintain successive Nationally Determined Contributions (NDCs) that it intends to achieve. Indonesia’s NDC outlines the country’s transition to a low-carbon and climate-resilience future and the commitment to reduce 29 percent of its greenhouse gas emissions, representing a reduction of up to 41 percent against the business-as-usual scenario, subject to the availability of international support for finance, technology transfer and development, and capacity-building.

So what is the connection between the pandemic and the agreement?

The World Economic Forum has cited 11 visualisations from NASA’s Global Modeling and Data Assimilation showing the dramatic knock-on effect of lockdowns, quarantining and travel restrictions on air quality in China, South Korea, Italy and India. There has been a sharp drop in carbon dioxide (CO₂) levels in the most polluted capitals due to the shutdown of factories, industries and transportation.

The pandemic is predicted to result in a record annual decline in carbon emissions of almost 8 percent, as reported in the International Energy Agency’s Global Energy Review. Global energy demand, especially for coal, oil and gas, falls by 6 percent, which is comparable to India’s total energy demand as the world’s third-largest energy consumer, and is equivalent to seven times the decline in the aftermath of the 2008 financial crisis, and the biggest shock since the Second World War.

In a similar shift, the air quality in Jakarta was moderate, according to the air quality index at the time the first wave of large-scale social restrictions (PSBB) was implemented. The city’s air quality used to have an index of 160 and, hence, was classified as “unhealthy”.

Indeed, miraculously, a decrease in the concentration of nitrogen dioxide (NO₂) has changed the environmental conditions during the pandemic, as happened in Paris, Madrid and Rome, according to observations from the European Space Agency’s Copernicus Sentinel-5P satellite. It also detected plummeting levels of NO₂ across China following the economic slowdown.

Looking at the bright side, it is undeniable that the pandemic has generated ‘positive’ outcomes with regard to the impact of climate change. In addition to misery, hardship and suffering, COVID-19 has also given rise to clear water and blue skies.

The pandemic and climate change both call for a “flattening of the curve”. The question remains, when the pandemic is over and humans get back to normal, will climate change worsen again? It depends on how societies adopt new habits to jointly address the two crises at once.

Innovative financing through Sukuk

In line with Sustainable Development Goals (SDGs), a financing gap stands in the way of implementing the Paris Agreement. An estimated US$1.6-3.8 trillion annually between 2016 and 2050 is needed to achieve the transition to low carbon. This figure refers to supply-side energy system investment alone (IPCC, 2018).

Attracting sufficient funding is one thing, but getting that funding to where it is supposed to be is something else. There must be a step change to pull money back into real economies – innovative financing. To this end, the drive for a green economy and green financing is echoed in many countries, including Indonesia.

In this context, the government of Indonesia committed to applying mainstream green economy principles to development planning in order to promote the SDGs, including taking steps towards the implementation of green financing for the banking industry through the Financial Services Authority (OJK).

The government allocated IDR728 trillion (~US$51 billion) for mitigation and adaptation actions in 2015-19 (NDC, 2017). However, with projected financing standing at IDR1,065 trillion (~US$75 billion) (TNC, 2017), there is a gap in finance. In response to this, a sovereign Green Sukuk was issued in 2018-20 with a total of US$2.75 billion, the proceeds of which are leveraged to finance a list of eligible green projects in nine sectors, such as renewable energy, climate resilience for disaster-prone areas, and waste and waste energy management.

The very first sovereign Green Sukuk issued in the world has opened the doors to more participation from investors – those whose intention is to generate financial returns and those who are impact-oriented. The nature of sukuk indicates partial ownership by its holders over underlying assets or projects, which are backed by the government, making this kind of Islamic instrument more favourable. Unlike the regular variant, the Green Sukuk entails an annual impact-measurement report. This mechanism is suited to the concept of impact investment, which considers social and environmental impacts as its benchmarks.

Despite being innovative, the three greens (economy, financing and instrument) exclude certain sectors from their framework, which triggers new constructs, one of which is the blue economy.

The World Bank defines blue economy as the sustainable use of ocean resources for economic growth, improved livelihoods and jobs, while preserving the health of the ocean ecosystem. Going beyond conservation, fisheries or aquaculture, the blue economy also covers tourism, mining, transportation and marine infrastructure development, some of which have been hit by COVID-19.

The blue economy equally plays an important role in reducing carbon. Having said this, the notion of blue carbon – carbon produced underwater and stored in oceans and coasts – for lowering global emissions has not been widely discussed. Using the same approach as the green framework, a Blue Sukuk for the marine and fisheries sectors has begun to be considered in Indonesia, where the Blue Financial Framework is being eagerly pushed forward.

Law No. 19/2008 on Indonesian Sovereign Sukuk (SBSN) clarifies that an object and/or state-owned property that has economic value can be used as the basis for the issuance of SBSN, meaning that natural resources (land, sea, air) are considered to be prospective underlying assets. The aerospace sector requires further exploration. In reality, the aviation industry and information and communication technology each contributed a minimum of 2 percent carbon emissions, according to the Air Transport Action Group and the International Telecommunication Union.

A country’s air territory is the domain of flight traffic. In recent years, air transportation has shown its concern about climate-related subjects by initiating zero-carbon flights. In addition, the radio-frequency spectrum and electromagnetic waves from transmitters, radars and satellites propagate through the air. Thus, airspace is a strategic resource.

Identical to Green and Blue Sukuk, the aforementioned areas of airspace and their development have the potential to be underlying assets and projects for the issuance of White Sukuk, strengthening the air sectors and associated industries.

Is it still worth exploring, if not many people feel directly connected to airspace? Let’s take a look at the work-from-home arrangements that have been set up in the course of the COVID-19 pandemic.

Currently, the world is facing a new equilibrium because of physical and social restrictions. Nearly all activities are carried out remotely. In this particular case, technology becomes crucial. The pandemic has demonstrated the importance of telecommunications infrastructure in keeping governments, business, societies and individuals in operation. Humans are highly dependent on technology as a source of information and as a tool for distance learning and working from home.

Although they experienced a significant stock market correction during the pandemic, listed companies in the Asia Pacific regional telecommunications sector are projected to remain resilient, with minimal impact on performance, since the public interest for data and information access continues to increase. The sector has proven its essential nature in serving domestic economies in a connected world and, hence, boosting investor appetite for infrastructure funds.

In the near future, the surge in demand for the Internet will trigger the application of microwave spectrum technology through such innovations as direct-broadcast satellites, wireless networks, and the emerging 5G to support high-speed connectivity and data-intensive applications. No fewer than 98 percent of people in Indonesia rely on mobile data to connect to the Internet.

This phenomenon points to the possibilities of White Sukuk in entering the market. With the support of a fatwa from the National Sharia Board of the Indonesian Council of Ulama (DSN-MUI) and government regulations, the issuance of White Sukuk is feasible. Notwithstanding the national economic downturn, this breakthrough helps maintain fiscal and monetary sustainability by optimising local resources and supporting the deepening of an inclusive Islamic financial market.

Three sectors have been severely hit by COVID-19, namely tourism, transportation and agriculture. The issuance of the three-coloured sukuk is attainable in order to finance post-pandemic recovery.

Islamic finance is confronted with the challenge of offering liquidity instruments that can be utilised at any time of disaster or any other emergency situation. Innovation in the area of sukuk is expected to answer this challenge.