Islamic Finance and ESG: An eventual emergence for economic welfare

By Ahmed Siam

 

It’s been almost 10 years since the financial crisis crashed global capital markets and after all the difficult times that followed, investors have reached a precious conclusion; the key to any successful investment is sustainability. We cannot mention sustainability without turning our heads towards the concepts of socially responsible investments (SRI) or environmental, social and governance (ESG). The philosophy behind these two approaches is to increase wealth while preserving the environment and social welfare by considering the ESG factors in portfolio selection and management. According to 2014 Global sustainable investment review report, ESG investments have surpassed the UD$21 trillion globally in 2015, where North America and Europe are the biggest markets for such strategies.

 

On the other side of the world, Islamic finance has been gaining momentum since 2008 hitting the $2 trillion bracket in 2015 according to the IMF. In the recent years, Islamic finance has been fueled by the large savings accumulated by many oil exporting countries that seek to invest in Shari’a compliant investments, in addition to the huge activity of South East Asia with its large Muslim population density.

 

In terms of Islamic finance potential, it has been witnessed that in the last years some European jurisdictions started adapting Shari’a compliant instruments in financing governmental projects. For instance, in 2014 the UK financed governmental projects attracting £2 billion from global investors seeking Shari’a compliant investments. Also, Luxembourg played a major role in the last years to become the European Islamic finance hub, hosting large number of Shari’a compliant investment funds in attempt of attracting gulf investors.

 

As conventional finance has always capitalized only on returns, both SRI/ESG and Islamic finance have added the ethical view as an integral part of the investment cycle. Researchers have found that SRI and Islamic finance share lots of commonalties in terms of social welfare reflected in Zakat, community development programs and Negative screening strategy for harmful sectors/companies. Both Islamic finance & ESG/SRI emphasis on the need to care for the environment and forms of life on earth while ensuring the proper usage of natural resources. Furthermore, both concepts extend beyond being a part of the financial system, but as part of a total value based social system that is driven by principle of public interest.

 

It seems practical to join forces to exploit the obvious synergies between both given the global urge to achieve more sustainable, cleaner and resilient world ecosystem by offering investors innovative financing opportunities supporting green projects. According to official studies, the world population is expected to reach 9 billion by 2050. Such population will create an exceptional rise in demand for water, energy, transportation and other infrastructure upgrades. In such frame, Islamic finance has enormous opportunities to develop Shari’a compliant green financing facilities to meet the liquidity needs in this sector.

 

Regulators have a tremendous role in promoting Islamic finance/SRI and to cultivate the suitable environment to grow such investment approaches. Malaysia leads the global front with an initiative of promoting green financing through major financial channels that includes banking, equity and fixed income markets.  More importantly, the introduction of the SRI sukuk guidelines introduced in 2014 by the Malaysian securities commission to be used in issuing sukuk to fund sustainable and responsible investment projects. Such approach would be exceptional to attract issuers to raise green funds while attracting investors from the west that are familiar of SRI concepts.

 

In 2016, Islamic finance will experience huge challenges in light of the oil crisis and the global economic distress, but yet such conditions would urge governments to introduce new reforms that would eventually help the industry.

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