Islamic Finance Goes Green: Green Sukuk’s Role in the Global ESG Investment Wave

Research authored by the United Nations Development Programme (UNDP), the UNDP Istanbul International Center for Private Sector in Development (ICPSD), and the Kuwait Finance House (KFH) offers a sweeping exploration into Green Sukuk, a fast-evolving financial instrument at the intersection of Islamic finance and climate action. As the global economy pivots toward low-carbon development, Green Sukuk stands out as a Shariah-compliant means of financing environmental projects while aligning with ethical investment principles. Designed to fund climate-resilient infrastructure, renewable energy, and sustainability-linked initiatives, these instruments promise to unlock significant capital, particularly in emerging markets grappling with both development and climate finance gaps.

Since the first corporate Green Sukuk was issued in 2017 by Malaysia’s Tadau Energy, the market has gained steady momentum, despite economic headwinds. By the third quarter of 2024, global Green Sukuk issuances had surged to $11 billion. Yet, this represents only a fraction of the broader ESG bond market. The UNDP projects that $30 to $50 billion could be raised annually via Green and Sustainability Sukuk by 2025, provided key structural, regulatory, and awareness challenges are addressed. Interest is certainly there: surveys indicate that over 55% of institutional investors are ready to invest in Green Sukuk, drawn not only by their ethical and religious alignment but also by potential pricing advantages such as the “greenium,” a premium associated with high demand for sustainable instruments.

Bridging Faith and Sustainability with Strong Global Standards

What distinguishes Green Sukuk is its unique combination of Islamic finance’s ethical guidelines with global sustainability goals. Built around the core tenets of Maqasid al-Shariah, which promote human welfare, environmental stewardship, and social equity, Green Sukuk provide an added layer of governance and assurance beyond traditional ESG products. The recent guidance issued by ICMA, the Islamic Development Bank (IsDB), and the London Stock Exchange Group (LSEG) affirms that Green Sukuk structures can be aligned with the ICMA Green Bond Principles, the ASEAN Green Bond Standards, and other internationally accepted norms. These principles ensure transparency, use-of-proceeds clarity, impact reporting, and the legitimacy of “green” claims.

Such alignment is critical to mitigating greenwashing risks, an increasing concern for investors. Shariah supervisory boards add another safeguard by disqualifying proceeds from being used in environmentally or socially harmful industries, such as fossil fuels or weapons manufacturing. This is further reinforced by rigorous reporting and the requirement for second-party opinions and external verifications. These mechanisms not only ensure that the instrument stays true to both Islamic and ESG values but also provide investors with credible, measurable outcomes tied to carbon reductions, renewable energy uptake, or sustainable infrastructure development.

The Government’s Role: From Regulators to Market Makers

The report underscores the instrumental role that governments play in scaling up Green Sukuk markets. Policy frameworks, tax incentives, grant schemes, and sovereign benchmark issuances all contribute to shaping the market. Malaysia has emerged as a model jurisdiction, introducing the world’s first corporate Green Sukuk and backing it with supportive policies like the SRI Sukuk Framework and Green Investment Tax Allowance. Indonesia, meanwhile, has issued sovereign Green Sukuk multiple times since 2018, raising over $3.9 billion for projects in clean energy, sustainable transport, and climate resilience, while also integrating climate budget tagging into its national budgeting process to enhance transparency and investor confidence.

These efforts are not only strategic but catalytic. By creating pricing benchmarks through sovereign issuances, governments establish a "green yield curve," enabling private issuers to price their Sukuk more effectively. Climate budget tagging helps investors trace how funds are aligned with nationally determined contributions (NDCs) under the Paris Agreement. Moreover, several countries, including Malaysia, Indonesia, and the UAE, have implemented sustainable finance taxonomies to clearly define what qualifies as a “green” activity, thereby lowering ambiguity and reducing the risk of greenwashing.

Market Challenges: High Hopes Meet Structural Realities

Despite the optimism and demand, several hurdles continue to restrain the Green Sukuk market’s full potential. Issuance costs remain high due to added layers of verification and certification that are not required for conventional Sukuk. In markets without government support or grant mechanisms, this cost differential acts as a deterrent. There is also a lack of harmonized standards across jurisdictions, leading to market fragmentation. Many investors, particularly outside the Islamic world, remain unfamiliar with the structure and principles of Sukuk, further narrowing the investor base.

The scarcity of credible, standardized ESG data exacerbates the challenge. Investors require robust disclosures to assess climate risks, project sustainability, and financial viability. Yet, many issuers lack the capacity or tools to meet these expectations. In Islamic jurisdictions without a mature ESG ecosystem, investor awareness is still developing, and incentives are unevenly distributed. All these factors combine to limit market depth and stunt the scaling of what could otherwise be a highly potent instrument in the global climate finance arsenal.

A Promising Future for Green Sukuk

Nevertheless, the outlook for Green Sukuk remains broadly optimistic. With rising global awareness around climate risk, stronger international collaboration, and improving regulatory harmonization, the foundations are being laid for exponential growth. Private sector interest is expanding into new sectors like digital infrastructure, clean tech, and electric mobility. Digital innovation, such as blockchain-based Sukuk issuance, is also opening new possibilities for greater transparency and accessibility.

What emerges from this detailed UNDP-KFH report is that Green Sukuk is far more than a financial instrument; it is a convergence of ethical finance, climate ambition, and inclusive development. With the right policy environment, market infrastructure, and investor engagement, Green Sukuk could well become a central pillar in financing the global transition to a low-carbon, resilient, and equitable future. As Islamic finance markets mature and global demand for sustainable capital accelerates, the Green Sukuk stands poised to turn climate finance into a faith-aligned force for good.