The cardinal triad of sustainable finance: environmental, social and governance (ESG) aligns with the fundamental objectives of the Shariah upon which Islamic finance is premised. The inherent attributes of Shariah as a means toward preservation of order, prevention or removal of hardship and promotion of shared prosperity perhaps explains the importance accorded to sustainable finance in the Islamic financial services industry (IFSI). Islamic sustainable finance, as a fusion of both Islamic finance and sustainable finance, therefore would entail a process through which ESG objectives are given due consideration in both investment and financing decisions in a Shariah compliant manner for the purpose of economic sustainability and shared prosperity.
Prior to the outbreak of the COVID-19 pandemic, there were already global concerns including in the IFSI relating to climate change, green economy and socioeconomic inclusion, etc, which are all very relevant in the context of Islamic finance. Global warming stemming from human expansion of the greenhouse effect due to activities related to oil and gas usage, power plants based on fossil fuels, oil drilling, transport and vehicles, consumerism, farming, industrialization and overfishing1 are all linked to global climate change. In fact, climate change is cited as one of the key manifestations of environmental degradation, which portends serious threats to both lives and livelihood in the form of extreme weather, rising sea level, natural disasters, famine, disease and even increased poverty.2
There has been notable successful issuance of green and other sustainability Sukuk prior to and after the outbreak of the pandemic. Nonetheless, the relative importance of Islamic sustainable finance for delivering the global environmental, socioeconomic and governance agenda has been brought further to the fore as the world enters into the recovery phase of the pandemic and investments are being made on critical sustainability projects and economic activities. To achieve a sustainable post-pandemic recovery would therefore require significant reforms in how the ESG considerations are taken into account in both Shariah compliant investment and financing decisions on related economic activities. This would also require widespread participation of the IFSI to transform and adapt in order to keep contributing to the global society and economy.
A considerable number of international organizations, global leaders as well as regulatory and supervisory authorities (RSAs) have been responding to this issue through various measures in order to reduce greenhouse gas emissions. Examples are: (i) Paris Agreement in which 197 countries were involved and pledged to a legally binding commitment toward climate change objectives, (ii) Declaration by the United Nation Human Rights Council on the 8th October 2021 stated that access to clean and healthy environment is considered as a fundamental human right and lately, (iii) UN Climate Change Conference (COP26) 31st October–13th November 2021 has agreed to: (a) secure global net-zero emission by mid-century and keep limiting global warming to above 1.5oC industrial levels ‘alive’ or within which, (b) adapt to protect communities and natural habitats, (c) mobilize finance, and (d) work together to deliver.
Principles and examples of Islamic sustainable finance
Indeed, the principle of ESG aligns with the Islamic principles and objectives set out in the concept of Maqasid Shariah which include: the safeguard of life, intellect, religion, wealth and dignity of mankind. Furthermore, as the term ESG, sustainable and responsible investment (SRI) and impact investing are gaining popularity, and there have been efforts in the IFSI to also key into this trend, for instance through the issuance of global green Sukuk, sustainability Sukuk, SRI Sukuk, etc. The presence of sustainable-driven Islamic financial instruments, along with the risks faced by the IFSI, would require the RSAs’ attention to ensure and guide the IFSI in their respective jurisdictions in incorporating the new climate-related risks into their risk management framework for the purpose of maintaining the overall financial system’s resilience and stability.
Green Sukuk have emerged in some IFSB member jurisdictions, notably Malaysia and Indonesia, in responding to achieving the goals of sustainable finance and resolving the climate change issues. In this case, green Sukuk channel investment which brings not only commercial value but also environmental benefits by avoiding environmentally-degrading activities. At least, Islamic principles of: (i) Wasatiyyah (equalibrium) to maintain the balance of Mizan (natural state of the world) such as avoidance of waste, extravagance and corruption and (ii) prohibition of Fasad (promotion of disorder) to prevent unethical transactions and dealings that have Riba (interest), Gharar (uncertainty) and Maysir (gambling) are among the main principles to promote and support the sustainable finance and environmentally friendly financing activities.3
Last but not the least is Islamic social finance which has also played a significant role prior to and during the pandemic, and will remain very crucial in the post-pandemic era. Notable Islamic social finance instruments such as Islamic charity (Shadaqah), alms giving (Zakat) and endowment (Waqf) have been extensively used to assist the needy and also promote wealth distribution and shared prosperity. During the current pandemic, many countries have adopted and intensively applied social and humanitarian policies and programs such as rental payment relief, pension funds, wage subsidies, capacity-building initiatives and mobilization of social funds to support certain sectors in the economy via Islamic social finance. They have not only reserved and secured the financial and purchasing power of the people but also balanced both commercial and social finance for the sake of public welfare.
To sustain the economy of the grassroots, the recent initiatives enumerated by the World Zakaf Forum (WZF)4 to extend the roles of Islamic social instruments should be appreciated and noted as another role of Islamic finance during the difficult conditions due to the pandemic. These include:
a. Strengthening collaboration with the respective governments to mitigate the spread of the pandemic.
b. Establishing a contingency plan to assist the most vulnerable and underprivileged group of people due to possible multidimensional crises.
c. Consolidating Zakat resources to assist the medics, paramedics and humanitarian volunteers in the front line with the endeavor to overcome the negative impacts of the pandemic.
d. Exchanging information and experience in handling the pandemic among WZF member countries.
e. Providing critical assistance to those working in the informal sector of the economy which highly depends on daily income sources.
f. Strengthening global cooperation among WZF member countries for potential collaboration to conduct crowdfunding donations in order to help member countries.
Furthermore, such Islamic social finance instruments (ie Zakat, Sadaqah, Waqf) could be coordinated together and integrated with the fiscal policy of the governments in the form of safety nets and pro-poor expenditure. Governments could look at issuing Sukuk that is linked with temporary cash Waqf to mobilize social and benevolent funds at below market rates for financing various safety net measures. Cash and corporate Waqf funds could also have a useful role when a government begins unwinding its holdings of corporate assets in the recovery phase.
IFSB initiatives on Islamic sustainable finance
The mandate of the IFSB is to promote the stability and resilience of the IFSI through issuing and facilitating the implementation of global prudential standards and other initiatives that foster knowledge-sharing and cooperation. In relation to supporting sustainable finance, the IFSB acts as a body for coordinating and giving guidance on good practices in the regulation and supervision of Islamic financial services, which would also serve to promote sound growth and support the resilience and stability of the global IFSI.
The IFSB, in December 2020, issued ‘IFSB-25: Disclosures to Promote Transparency and Market Discipline for Takaful/Retakaful Undertakings’. Also, in December 2018, the IFSB issued ‘IFSB-22: Revised Standard on Disclosures to Promote Transparency and Market Discipline for Institutions Offering Islamic Financial Services [Banking Segment]’. In these standards, a dedicated section is provided on the ESG disclosure requirements in order to promote market discipline and transparency in the IFSI. The IFSB also issued in December 2019 ‘TN-3: Technical Note on Financial Inclusion and Islamic Finance’. In this document, the IFSB provides a detailed technical guide on the priorities and considerations that are pertinent for regulatory and supervisory oversight for financial inclusion through the IFSI of member jurisdictions.
In addition to a dedicated research paper titled ‘The Role of Social-Impact Sukuk in the Recovery-Phase of COVID-19’ to be issued in December 2021, the IFSB has also included in its strategic work plan for 2021 a dedicated paper on ESG. Furthermore, in its flagship Islamic Financial Services Industry Stability Report, the IFSB has consistently addressed developments relating to green and sustainability financing in the IFSI especially in the Islamic capital markets segment of the report. Specifically, in the recently issued Islamic Financial Services Industry Stability Report 2021, a chapter is dedicated to the role of Islamic social finance in a post-COVID-19 recovery phase. Notable examples and best practices across jurisdictions were highlighted.
To ensure the sustainability of the IFSI during and post-pandemic, the IFSB has assessed the impacts of the pandemic on the IFSI (Islamic banking, Takaful and Islamic capital market) and held various events (conferences, webinars, forums, etc) to elaborate the issues and ways ahead with regulators, market players and Islamic scholars on ESG issues. These platforms provided by the IFSB offer opportunities to various stakeholders to identify extant ESG investment gaps and financing initiatives, best practices, exchange of ideas and information, regional and international collaboration, etc.
For instance, the IFSB recently held its 15th Summit in November 2021 in Jeddah, Saudi Arabia where nine central bank governors, 24 other distinguished high-level speakers representing key stakeholders in the IFSI and 200 other participants from the RSAs, international organizations, the private sector, academia and the media attended. ESG issues featured prominently across the seven panel discussion sessions and keynote addresses delivered during the global event.
As the IFSB will not relent in its efforts toward providing guidance and support to its member jurisdictions in order to promote the stability and growth of the IFSI through Islamic sustainable finance, the IFSB will be conducting its 13th Public Lecture in Abu Dhabi that is co-organized and hosted by the Central Bank of the UAE on the 8th December 2021 with the first session lecture to be on sustainability.
The IFSB also issues public statements and updates its compendium of policy responses to COVID-19 in its member jurisdictions on related matters. All related IFSB materials are available for free download via: www.ifsb.org.