The global Islamic finance industry is moving towards integrating ESG concerns | Salaam Footbridge

Islamic finance industry looking for growth in new areas.

London: Global Islamic finance industry watchers predict significant growth in Sharia-compliant environmental and social governance (ESG) investments as demand from institutions to deploy funds ethically, as well as a awareness of climate change and social justice, increases.

According to research conducted by Maybank Islamic Berhadthe Islamic banking branch of the Malaysian group Maybank, and IslamicMarkets.coma UK-based financial intelligence and investment platform, more than a third (36%) of Islamic finance professionals expect “dramatic growth” from combined ESG/Sharia compliance funds over the of the next two years.

The research, published in a report titled Driving Sustainable Impact Through Islamic Finance in March this year, also showed that 73% of respondents believe the Islamic finance market has yet to meet demand for investment strategies. ESG investing.

They add that there is ample room for new Sharia-compliant ESG products. Maybank’s findings also indicated that the majority of these new funds could be purchased by non-Muslim investors whose appetite for ESG investing will potentially overtake Islamic investors given the relatively larger non-Muslim financial market.

These investors also do not care whether the key ESG component is Shariah compliant.

Search by Refinitiva US-British global financial market data provider owned by the London Stock Exchange (LSE), also published in March, says 2021 has been a particularly busy year for the launch of ESG-focused Shariah-compliant funds .

Refinitiv points to the creation of new funds in Saudi Arabia (SEDCO Capital), Swiss (Lombard Odier) and Malaysia (Pheim Global ESG Islamic Fund – PPGEIF) as examples of some of the more recent launches.

The group identifies Saudi Arabia as the global hotspot for Sharia-compliant capital targeting ESG. The kingdom’s preferred approach to ethical investing has been to issue ESG-focused sukuk (Sharia-compliant bond-like instruments used in Islamic finance).

Refinitiv data shows that in the first two months of 2022, the kingdom issued ESG sukuk totaling $1.5 billion, more than any other country. The Refinitiv Ranking Indonesia, Malaysia and the United Arab Emirates (UAE) are the next largest sukuk issuers.

Muhammed-Shahid Ebrahim, professor of finance at Durham University Business School in the UK, said part of the reason the Islamic finance market was catching up with investment opportunities focused on ESG was that “financial literacy” in the Muslim community had not historically prevalent to support the growth of Sharia-compliant ESG investing.

Unlike the non-Muslim financial sector, partly pushed towards ethical investments by retail investors, individual shareholders and members of pension funds, the attraction of ESG-focused investments in the Islamic finance market has been mainly limited to institutional and sophisticated investors.

“ESG-focused assets use a general value system instead of a religious value system. An average Muslim consumer is more interested in investment endorsed by religious scholars than investment based on general values,” Ebrahim explained, adding that a lack of development in Islamic finance theory has also limited the expansion. .

Despite this partial reluctance of the Islamic finance market to embrace ESG investing, according to some experts, integrating ESG principles into Islamic finance was a natural fit. A central pillar of Islamic finance is to screen Sharia-compliant products to avoid industries deemed illegal (haram) under Islamic guidelines and law. This includes tobacco, alcohol, weapons and gambling – areas theoretically also prohibited in ESG investing.

Amanjit Fagura, Dubai-based partner at an international law firm headquartered in the United States Morgana Lewisstates that because ESG-focused and Islamic investments are guided by principles of morality, transparency and fairness, it was possible for an investment to be simultaneously Shariah and ESG compliant.

However, the two concepts do not always overlap perfectly. Fagura cited an investment in a high-leverage solar power project.

“(This) can be a good ESG investment, but would not be Sharia compliant due to the ban on riba (earning interest on loans),” she said.

Improve access

Fagura recognizes that there is currently a lack of access to investment opportunities that explicitly satisfy both sets of values, but this is changing as financial institutions respond to market demand.

“While green investments that tick the boxes of ESG and Shariah compliance may currently be limited, the rise of innovative structured solutions that allow exposure to certain non-Shariah-compliant ESG investments are increasingly used by families. offices, regional banks and institutional investors,” Fagura said, noting that this could further bridge the gap between Islamic finance and ESG investing.

A 2019 report published jointly by the World Bank and the Securities Commission Malaysia suggests that these innovative structures could include sukuk designed exclusively to manage green projects, mortgage-backed securities that could act as a new asset class to bridge sustainability and profit; waqf (a special philanthropic act of donating a fixed asset to produce a financial return or provide a benefit) and zakat (an annual obligation to donate a portion of wealth to charitable causes) structured funds in broader funding objectives that have societal impacts and environmental dimensions.

Another solution to the access problem could be to develop Islamic fintech which promises to bring retail investment to Muslim consumers who have so far not had the opportunity to participate in financial markets.

Bashir Yusuf Ahmed, Founder and CEO of eTijara Nigerian Shariah-compliant fintech platform providing Islamic investment and savings services to Muslims and non-Muslims, expects young Islamic consumers to be attracted by the prospect of making straightforward ethical choices about their investments.

eTijar selects Shariah-compliant investments and mutual funds to offer to its users, allowing clients to build their portfolios using its platform and earn profit instead of interest.

“For the general ethical user, (our screening process means) that they know we play by ESG rules and don’t deal with anything that conflicts with (Islamic) principles and beliefs,” said explained Yusuf.

However, he admits there is work to be done to persuade potential investors to choose ethical investments.

“Some people think that when you say halal or ethical (investment) that means there is no return on investment, but in fact there is the possibility of very good returns. Some of the eligible industries or companies (as ESG investments) are entities that pay dividends,” Yusuf said.

Ebrahim believes that removing cultural barriers and better financial education would allow Muslims to become more informed and participate in financial markets while broadening the appeal of Islamic finance in a wider market.

“The integration of Muslims with the rest of society can lead to the development of ESG Sharia funds. There are problems in Islamic scriptures and traditions… which are not understood or applied by religious scholars or political Islamists. If these issues are understood in context, it will broaden the reach of ESG Sharia funds and attract non-Muslims,” he added.

Standardization

An issue repeatedly cited as a barrier to the growth of ESG investing in Islamic finance is the lack of agreed standards on what constitutes ESG investing and how it aligns with Shariah principles.

According to the Maybank report, 72% of grantees believed that the introduction of a global standard for ESG and Sharia would drive demand for ESG investment opportunities among Islamic investors. However, immediate progress in this area was not expected.

“Respondents are concerned about the lack of a global standard for ESG and Shariah,” he said, with 55% of respondents believing the launch of a global standard was two years or more away. .

While global ESG standards were being developed by bodies including the new International Sustainability Standards Council (ISSB) which incorporate work developed by the former Sustainability Accounting Standards Board (SASB), there has been no current movement to link these standards to Sharia rules.

Meanwhile, standards were being set in different markets, which presented the challenge of harmonization. A joint report 2019 Through the UN-backed Principles for Responsible Investment (PRI) and the CFA Institute, a US-based financial education organization, exchanges are developing reporting guidelines and rating standards for ESG that have an impact on Islamic finance.

According to the report entitled ESG and Islamic Finance: Complementary Investment Approaches, this normalization method was followed by the Dubai Financial Market (DFM), a Sharia-compliant exchange. In 2019 it updated its DFM Shari’a standards to meet growing investor interest in sustainability and a green economy and in 2020 launched its own ESG index.

In principle, until more comprehensive regulation was approved, particularly internationally, anything could be marketed as an ESG/Sharia investment and it was up to investors to decide whether they accepted – a situation that puts some investors Muslims uncomfortable.

Fagura said: “Investors will likely perform their due diligence on any Shariah-compliant opportunities claiming to be ESG investments to ensure that these investments are in line with their investment objectives and are not misled by greenwashing. “.

Some national regulators are taking steps to address this issue by personally verifying ESG claims. Securities Commission Malaysia launched the FTSE4Good Bursa Malaysia Sharia Index in July 2021 which measures companies demonstrating strong ESG practices.

It seems likely that Shariah-compliant and ESG investing are destined to remain separate approaches for now, but will increasingly converge as market factors and financial and technological innovations find common ground.

Ebrahim said the Islamic finance industry has a long way to go before we see “a truly Islamic financial architecture” that could comfortably accommodate ESG investing.

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