Environmental Impact Sukuk: A Proposal for Environmental Sustainability

Abstract

The effects of climate change have been increasing rapidly in recent years and attracting attention in the context of a global problem. Climate change is leading to an increase in extreme weather events, including both excessive rainfall and droughts. These events lead to problems with serious consequences, such as flooding, combined sewer overflows and wildfires. Recently, the need to take measures against the negative impacts of events such as floods and wildfires on public health and the economy has been at the forefront of the agenda. However, governments attempting to take measures against floods, wildfires, and combined sewer overflows are often hindered by budget constraints. As a matter of fact, adaptation and mitigation measures against climate-related events such as floods and fires are quite costly and require substantial financing. Although traditional finance provides funding for such events, it is emphasized that the funding provided is insufficient, and innovative financing methods are required. In this study, we aim to propose for the first time environmental impact sukuk and a novel model of this sukuk structure in the context of innovative finance using a descriptive and explanatory method. In this model, similar to environmental impact bonds, environmental impact sukuk includes a “payment-for-success” mechanism. In this mechanism, before issuance of environmental impact sukuk, the project’s environmental goals (threshold values) are determined, and investors receive payments based on the performance of the project. Accordingly, if the project reaches the specified threshold values, investors receive higher payments; otherwise, they receive lower payments. Unlike previous “impact sukuk” structures, the proposed model in this study includes the local government as a beneficiary and allows beneficiaries to pay the project implementer (entrepreneur) based on project performance. Given the urgent need to address current environmental challenges, the implementation of environmental impact sukuk is crucial and holds significant potential, especially in the context of the growing sukuk and impact investing markets. However, challenges such as the complex structure and costly issuance process may hinder the launch of environmental impact sukuk in the future. According to the result of the study, for environmental impact sukuk to be launched more widely in the future, the problems encountered in the first stage must be resolved.