Islamic finance and environmental, social and governance (ESG) are complementary, both impacting social good and are ethical. Shariah’s objective is to benefit mankind and prevent harm as well as ensure the sustainability of life on earth. The correlation between Islamic finance and the UN Sustainable Development Goals (SDGs) is most notably in climate protection; biodiversity; alleviation and eradication of poverty; as well as environmental sustainability. Due to its nature of being ethical, sharing risk equitably and being asset-backed, Islamic finance has obvious an inherent crossover with the SDGs.
Review of 2021
Accelerating financial resources in Shariah–ESG development targets and private sector investment toward profit with a purpose in demonstrating impact is vital and pressing in the coming decade. The timing is appropriate and imminent as recent research has shown that completing Shariah with ESG screening improves overall risk-adjusted returns, whereby Shariah compliant businesses with ESG scores have higher earnings that others excluded by the Shariah screening process.
However, Shariah–ESG investments have yet to demonstrate a global impact parallel to the momentum of conventional ESG investments. Initiatives by the UN’s Principles for Responsible Investment (PRI), Principles for Responsible Banking (PRB) and Principles for Sustainable Insurance indicated that only 1% of PRI and 10% of PRB commitment pledges come from the OIC.
It has been some years since the Paris Agreement in 2015, hence surely Islamic financial institutions ought to have passed the awareness and communication stage. Strong pledges and step-up commitment are not yet visible for Shariah–ESG investment globally.
A commitment toward demonstrating Shariah relevance to ESG challenges is of utmost importance, according to market players. Shariah practitioners in the financial markets have made remarks saying that establishing green assets is challenging and time-consuming, for example, sustainability-linked bonds have yet to catch on globally in the Shariah space.
Shariah experts are short of having in place policies on environmental sustainability and only a handful had developed evaluation tools to measure their impact.
What about Shariah–ESG finance focusing on the urgent climate finance? While speed is of the essence, global Shariah–ESG climate finance needs a special focus on validating its authentication of being Shariah-ESG compliant.
A set of norm-based standards with requirements and a reporting framework needs to be globally applicable to address the gap from the global Shariah–ESG investors.
Understandably, this is a major hurdle due to regulatory challenges since the structure of Shariah–ESG funds vary according to jurisdictions.
Many global Shariah–ESG equity funds have shown to have outperformed, thanks to their focus on defensive and resilient sectors during recent low economic periods. It is no wonder that there is a huge demand for Shariah–ESG focus currently.
However, to marry the two convergences of Shariah and ESG, there is still a long way to go before it goes mainstream.
Nevertheless, since this is a pressing moment for all mankind, market players cannot continuously allow the converging challenges to be an excuse to delay. Climate issues have now made Shariah–ESG finance an obligation and no longer just a requirement.
Since 2019, the IsDB and the Islamic Corporation for the Development of the Private Sector (ICD) have made a commitment to integrate SDGs into their funding and reposting processes across their investment in member countries.
Other SDGs in Islamic finance are notably in the Securities Commission Malaysia’s Sustainable and Responsible Investment Sukuk Framework, Bank Negara’s Value-based Intermediation (VBI) Financing and Investment Impact Assessment Framework and the UAE’s Guiding Principles on Sustainable Finance.
The COVID-19 pandemic since 2020 had slowed down a lot of major commitments in this space internationally. It is observed that ESG Sukuk issuance reached a record value of US$4.6 billion in 2020.
In 2021, the most significant issuance was Malaysia’s maiden sustainability Sukuk — the world’s first US dollar sustainability Sukuk issued by a sovereign — with investors’ confidence clearly reflected in the offering being oversubscribed by 6.4 times.
Refinitiv and the ICD reported that global Islamic finance assets are expected to hit US$3.69 trillion in 2024. With the convergence of Islamic finance and ESG, this is undoubtedly a space where innovative structures and products will be spurred to align with Shariah components with sustainability and ESG efforts.
Shariah–ESG drivers should be at the core of this global economic agenda as ESG commitment and socially responsible investment benefit mankind and nature, but why is Shariah–ESG lagging and far from the conversations in COP26 [2021 United Nations Climate Change Conference]?
How can Shariah–ESG communication alignment be stepped up? A trajectory can be possible with more success stories and market players can be propelled into making an impact.
Certainly, any alignment in the nearest future for Shariah–ESG will be toward the commitments from the outcome of COP26 in Glasgow.
Preview of 2022
The outlook for 2022 is promising although regrettably the mobilization of US$100 billion per annum from developed countries was not met in 2020–21. The COP26 Glasgow Climate Pact stresses urgency in the coming decade, notably in that finance needs to play a major role in addressing the gaps between current efforts and the pathway to achieving climate change and its impacts. A great concern still lies, namely the current provision of climate finance remains insufficient, particularly in developing countries. Developed countries are still urged to deliver on the US$100 billion goal urgently through to 2025.
Developed countries are also strongly urged to scale up their provision of climate finance, technology transfer and capacity-building for developing countries in need. Operating entities such as the financial mechanism, multilateral development banks and other financial institutions are pressed to continue to scale up the effectiveness of climate finance from all sources globally, including grants and other highly concessional forms of finance.
We may expect a first report outlining the needs of developing countries from the Standing Committee of Finance emphasizing on mobilizing climate finance based on COP26, the Paris Agreement and the 4th Biennial Assessment and Overview of Climate Finance Flows.
It is emphasized that finance and its mobilization need to be done with simple accessibility, transparency, proper eligibility and scaling-up of financial resources. While financial risk mitigation is still expected to be addressed by the financial institutions, it is important that vulnerability to adverse effects to climate change be considered an important aspect during mobilization. All these too must be embedded across Shariah–ESG investments.