Modeling the Nonlinear Relationship between ESG Uncertainty and (Islamic) Green Finance

This study aims to investigate the nonlinear impact of environmental, social and governance uncertainty (ESGU) on the performance of traditional green finance instruments as well as their Islamic equivalents. Unlike prior work that examines the mean-based regressions between ESG performance and financial performance, to the best of our knowledge, this study is the first to (i) empirically measure the impact of ESGU on conventional green finance and Islamic green finance simultaneously, (ii) apply the machine-learning based QQKRLS approach to reveal the heterogeneous and regime-dependent effects across the distribution of ESGU and returns and (iii) compare the response of Shariah-compliant versus conventional green instruments to ESG-related uncertainty. The dataset covers the period between February 2016 and January 2026. The results shed light on the high degree of heterogeneity in the impact of ESGU on different distributions of returns: the lower the level of ESGU, the stronger the performance of standard green bonds, but at higher quantiles, there are positive and statistically significant associations between ESGU and Islamic green finance assets (particularly, the high-grade Sukuk). This indicates that, during escalated uncertainty about an asset, in the form of ESG-related uncertainty, Islamic sustainable securities might be more resilient, because they follow transparency and are involved in sustainability-related investments. Our findings are directly relevant to financial regulators and investors, as low-to-moderate ESGU is associated with stronger performance of green bonds, while higher ESGU is associated with weaker performance; hence, regulators should design and implement policies that reduce the variance of ESG information quality through standardized ESG disclosure templates for bond issuers to reduce cross-issuer comparability uncertainty. Moreover, Shariah supervisory boards can play a complementary role by enforcing transparency regarding the asset-backing and risk-sharing structures of Sukuk issuances, thereby converting regulatory ESG uncertainty into a differentiating competitive advantage rather than an additional source of market risk.