Will Islamic finance help shape, or have to catch up to the sustainable finance discourse?
The past three years has seen traditional houses in the likes of Apollo, KKR and Vanguard introduce their ESG and impact strategies to the global market – a fitting response to the growing demand for a more altruistic form of finance among institutional asset owners. A 2020 survey by the Global Impact Investing Network (GIIN) estimates the global impact investing market at USD 715 billion[1], while Bloomberg forecasts global ESG assets to hit as much as USD 53 trillion by 2025[2]. Especially in Europe, demographic and regulatory trends are pressuring businesses towards integrating ESG into their policies. Just in March 2021, the Sustainable Finance Disclosure Regulation (SFDR) came into effect. The new EU regulation, which imposes mandatory ESG disclosures for financial market participants, was introduced in an effort to combat “green-washing” and provide investors with the data need to make an informed investment decision that is aligned with sustainability goals.
Yet, amidst the ongoing conversation about sustainability and impact, there are several corners of the world that remain noticeably quiet in comparison, and they usually have one thing in common: that is, they represent Muslim majority countries. This does not imply that social and environmental sustainability receives no attention in these regions – on the contrary, the narrative on the need for it finds a presence in the public policy space and is often incorporated into ambitious government plans.
The Gulf Cooperation Council countries’ Vision 2030, for instance, have framed it in the context of human resource development and tackling high rates of youth unemployment as a means to diversify their economies away from the hydrocarbons. More recently, there appears to be a growing trend in particularly Southeast Asia that attempts to align sustainability themes, such as the SDGs, with Maqasid al-Shari’a – a concept developed by Imam al-Ghazali (amongst others), who argued that higher objectives of the Shari’a is maslaha, or is to advance public (and hence, also individual) welfare. Importantly, the issuance of green sukuk by countries such as Malaysia, Indonesia and the UAE (for which as of 2020, USD 6.1 billion has been raised over a period three years)[3] also reflects an upcoming recognition that traditional, returns-only-oriented finance will no longer do.
Other than such top-down initiatives, the ethical/sustainable finance discourse has also been driven by the philanthropy and development sector. In some cases, it has also been driven by organizations based in the West such as the UK Islamic Finance Council, where sustainability issues such as climate change have perhaps occupied a larger portion of the public discursive space for a longer time.
Thus, the appetite for sustainability-oriented business within the global Muslim society is clearly emerging. Yet, among the majority, efforts and discussion on how goals such as fighting climate change, reducing inequality or preserving biodiversity should be formally incorporated into the investment strategy is still fragmented and in an embryonic stage. Despite that the global demand for ESG and impact is growing, Islamic finance’s fixation on Shari’a compliance has sometimes marginalized the question of what other Islamically desirable properties financial products should have in addition to being Shari’a compliant.
Obstacles to the growth of impact investing
The list below gives just a few examples of why ESG and impact investing may not yet have gained as much traction as they should have in Muslim majority countries:
Need for higher cultural awareness and a supportive regulatory environment
In order for ESG and impact investing to become more prevalent among Muslim investors, the market for it must first be built. While cultural awareness for climate action has gradually risen as the emergence of initiatives like EcoMENA and regional investor networks like ANGIN would suggest, this shift has yet to be reflected in a serious top-down, regulatory push from national governments. Indonesia, for instance, is one of the world’s largest green-house-gas (GHG) emitters, yet still too little is being done to curb this[4]. In fact, quite on the contrary, just last year, 36 global investors with a combined AUM of roughly USD 4.1 trillion expressed their concern about the deregulation of environmental protections in the recent Omnibus Bill on Job Creation in an open letter addressed to the Indonesian Government[5].
Furthermore, social economic issues such as human resource development and job creation have traditionally received political prioritization over those pertaining to the environment. Much education still needs to be done on the dramatic consequences that climate change will have on people’s livelihoods but also the financial risks associated with, for instance, desertification, rising sea levels and increased frequency of extreme weather-related natural disasters.
Skepticism with regard to a just transition
While Muslim majority countries will likely bear the brunt of climate change, many have shown reluctance to cooperate with regulations that may be viewed as a form of Western environmental colonialism. Carbon offsetting and the European Commission’s 2019 decision to start limiting the import of palm-oil produce[6], just to name a few, have previously been criticized as ways by which industrialized countries let the “Global South” pay for centuries of unrestrained economic development and resource exploitation[7]. As such, any appeal made for a global transition to a climate-resilient and low-carbon economy must be a just transition.
The assumption that avoidance of what is impermissible is sufficient
There is often the assumption that Shari’a compliance necessarily results in public welfare, which tends to marginalize the subject of to what extent ESG and impact should be included in the Islamic finance discourse. Perhaps this follows the belief that obeying Allah by simply avoiding that which has been explicitly forbidden and reaping from all else that is permitted (i.e. not forbidden) should be sufficient not only from a religious duty point of view, but also to create a prosperous society. One might even be reminded of a hadith in which Bedouin convert Talha ibn ‘Ubaidullah told Prophet Muhammad (PBUH) that he would perform the minimum compulsory duties that Allah has commanded His servants to do, upon which Prophet Muhammad (PBUH) said “If what he said is true, he will be successful (i.e. granted paradise).”[8]
Under ideal circumstances, this might have been true. Indeed, through limitations imposed on, for instance, riba (interest), Islamic investment guidelines arguably serve to avoid unjust or exploitative business transactions, concentration of wealth, overleveraging and overexposure to downside risk. However, it may also be argued that given the damage that humans have already caused upon the planet (and the natural sources of their own livelihoods), avoidance of harm is no longer sufficient. Rather, repairs are required. There is, therefore, a practical need to shift from a restrictions-oriented approach to a solutions-oriented approach. Furthermore, one might also argue that the Shari’a must be practiced from the point of view of its purpose and ethics – i.e. that one should shift their approach from merely halal (permissible) to tayyeb (good).
Misperceptions about ESG and impact investing
Many organizations have entirely separated their investments and business activities from their beliefs, arguing that they have ticked the “impact box” or compensated for their perhaps less-than-sustainable practices by simply paying their annual 2.5% zakat or funding philanthropic programs. The realization that such bifurcation might be unnecessary, or even inefficient, is generally lacking. This is not unique to asset owners who invest with an Islamic lens. While some asset owners are simply not familiar with ESG or impact investing, others are stopped by their assumptions such as:
ESG and impact mean compromising financial returns
ESG and impact will result in higher fees
There is not enough deal-flow, especially in the Shari’a-compliant investable universe
Existing impact and ethical frameworks are not necessarily aligned with Islamic values and objectives
Lack of infrastructure and ecosystem
Without the right infrastructure and a conducive ecosystem, it will be hard for ESG and impact investing to grow. In a nutshell, growth would necessitate infrastructures such as:
An impact investing infrastructure
A common language/taxonomy, industry standards for impact measurement, analysis and risk assessment tools, benchmarking data and ratings systems and database of investment opportunities[9]. Such infrastructures must ultimately also be able to accommodate the needs of Muslim asset owners from an Islamic and Shari’a compliance point of view.
Shari’a advisory
While Shari’a advisory boards already make up part of the infrastructure needed to do Shari’a-compliant investing, the discourse on financial stewardship and what investors’ responsibilities are in the field of asset management (as opposed to banking, which has received most of the attention since the emergence of Islamic finance) may also need to be approached from a jurisprudential point of view. The following questions might need to be addressed:
What will be the role of Islamic (legal) scholars in shaping a Shari’a-compliant, sustainable/impact investment framework?
How can modern challenges of social and environmental sustainability be contextualized in Islamic (economic) philosophy?
As the framework for sustainability and impact often draws on development theory, what defines “Islamic” development?
How to ensure or identify alignment between Shari’a and sustainability/ethical/impact investment frameworks?
A conducive ecosystem
As the discussion around ESG and impact investing in Islamic finance is still nascent, an ecosystem is needed for field building. Indeed, access to existing networks and initiatives that address practical topics like sourcing, deal-flow and impact measurement is needed. Also interest groups are needed to push for supportive regulatory conditions that will accelerate the growth of the market.
Operational challenges for investors
Shifting an investment portfolio into impact is in itself an operational challenge. It requires an organization to receive approval from its board, incorporate its values into its investment objectives, reassess its existing assets and allocation, and implement investment selection, management, measurement and reporting processes that are aligned with said objectives.
Shaping sustainability and impact through Islamic finance
While impact investing is still a (albeit rapidly growing) niche, the field is being shaped as we speak. Networks, investors and fiduciary intermediaries who maintain an active presence in ongoing discussions around topics such as impact due diligence, measurement and taxonomy will be the ones to define the standards of best practice in the field. For instance, The Global Impact Investing Network’s (GIIN) IRIS+ metrics, which proposes indicators for measuring, managing and optimizing impact (among others), has been the result of a broad consultation with leaders in the impact space and is on its way to become an industry standard. The IMP framework for measuring, assessing and reporting on impact is also gaining traction as a best-practice tool.
Islamic teachings can provide a meaningful contribution to the field. In addition, Muslim majority countries comprise some of the largest underserved markets in the world. Now would be the time for Muslim investors and fiduciary intermediaries to engage. The Islamic finance industry has the advantage that the necessary regulatory infrastructure for faith-based impact investing are, to some extent, already present. Amongst others, Shari’a supervisory boards and the processes by which jurisprudential and moral needs inform financial decisions have been in place for decades. Historically, Islamic finance has had to play “catch up” with conventional finance. The emergence of impact investing, however, presents an opportunity to contribute towards creating a more inclusive and workable financial system.
[1] The Global Impact Investing Network (GIIN). (2020). Annual Impact Investor Survey. Available at: https://thegiin.org/research/publication/impinv-survey-2020 (Accessed: September 28, 2021)
[2] Bloomberg Intelligence. (2021). ESG assets may hit 53 trillion by 2025, a third of global AUM. Available at: https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/ (Accessed: September 28, 2021)
[3] World Bank. (2020). Pioneering the Green Sukuk: Three Years On. Available at: https://www.worldbank.org/en/country/malaysia/publication/pioneering-the-green-sukuk-three-years-on (Accessed: September 28, 2021)
[4] Özdemir, I. (2020). What does Islam say about climate change and climate action? Available at: https://www.aljazeera.com/opinions/2020/8/12/what-does-islam-say-about-climate-change-and-climate-action (Accessed: September 28, 2021)
[5] Robeco. (2020). Open letter to the Indonesian Government on the Omnibus Bill on Job Creation. Available at: https://www.robeco.com/en/media/news-item/2020/open-letter-to-the-indonesian-government-on-the-omnibus-bill-on-job-creation.html (Accessed: Spetember 28, 2021)
[6] Keating, D. (2019). EU Labels Biofuel From Palm Oil as Unsustainable, Bans Subsidies. Available at: https://www.forbes.com/sites/davekeating/2019/03/14/eu-labels-biofuel-from-palm-oil-as-unsustainable-bans-subsidies/?sh=68271ce39c9d (Accessed: September 28, 2021)
[7] Wang, J. (2021). Carbon Offsets, a New Form of Neocolonialism. Available at: https://climatesociety.ei.columbia.edu/news/carbon-offsets-new-form-neocolonialism (Accessed: September 28, 2021)
[8] Sahih al-Bukhari: 46. Available at: https://sunnah.com/bukhari:46 (Accessed: September 29, 2021)
[9] The Global Impact Investing Network (GIIN). (2018). Roadmap for the Future of Impact Investing: Reshaping Financial Markets. Available at: https://thegiin.org/research/publication/giin-roadmap?gclid=Cj0KCQiA2ZCOBhDiARIsAMRfv9LZhR0tBVRsQ6PMa4u0PUiPRrK56jqEojg0Q47fnX7WfnWiKNQU7LoaAnn6EALw_wcB (Accessed: September 28, 2021)
