Due to its emphasis on social and environmental effect as well as its connection to enhanced financial performance, environmental, social, and governance (ESG) is a topic that is growing globally and is gaining a lot of traction.
Similarly, another idea that is gaining popularity around the world is Islamic Finance, which complies with shariah. As they both address issues with social development, these two ideas have numerous shared ideals and characteristics.
Growing consumer interest in ethical banking and financial services means the Islamic finance industry has gained significant prominence over the past few years. Additionally, as governments throughout the world become more alarmed by the frightening rate of climate change, its effects to date, and the prospective effects it may have on our societies in the years and decades to come, net-zero commitments are gathering support.
What is ESG?
Environmental, Social, and Governance, or ESG, are non-financial principles that are increasingly being incorporated into financial operations in an effort to build a more just and sustainable future. According to specialists in shariah loans, as the market expands, the sector is attempting to include ESG considerations in projections and planning for the future.
Utilising three key variables to gauge the sustainability and societal impact of an investment in a company or business, the ESG is a criterion to assist predict how well companies will do in the future.
Corporate culture sustainability, talent management, product safety, and data security are just a few of the social issues that are covered by ESG. ESG aspects are included under commercial activities that have the potential to affect the environment.
The “Who Cares Wins” study, authored by impact investment expert Ivo Knoepfel, is where the ESG acronym was first used. In it, Knoepfel made the case that ESG variables in financial analysis should be taken into account in capital markets because they aid in risk identification, have an impact on how well a company is thought of, and promote positive social change.
ESG encompasses a range of business factors that typical financial assessments might not take into account but which frequently have financial significance for businesses. Significant financial losses could occur if ESG exposures are not measured.
Similarities between ESG and Islamic Finance
Essentially, shariah-compliant financial services are founded on moral principles. The businesses in which money is invested, how Halal loans function, and other things are determined by these principles.
A fundamental tenet of Islamic finance is the screening of shariah-compliant goods to steer clear of sectors like cigarettes, alcohol, firearms, and gambling that are prohibited by Islamic law and teaching. These topics are theoretically barred in ESG investing, according to specialists in shariah loans.
While there are times when the two ideas do not cross, this is evolving as financial institutions meet consumer demand.An increase in creatively packaged solutions has made it possible to access certain ESG investments that might not otherwise be Shariah-compliant.
Sustainability as part of Islamic teachings
It has long been asserted that Islamic finance has an impact that goes above and beyond what is expected of it in the market. So what do ESG and Islamic finance have in common? Sustainable investing has recently gained popularity in the investment and finance worlds, yet this is the basic principle upon which Islamic finance is based. Financial inclusion, investing in worthwhile industries, and forbidding investment in risky ones. Islam’s fundamental source, the Quran, has the following to say on how people should treat the environment:
“…Eat and drink from the provision of Allah, and do not commit abuse on the earth, spreading corruption” [Surah Al-Baqarah 2:60]
The potential of Islamic finance to reduce the likelihood of financial crises is one of its distinctive features. The argument’s supporting evidence is based on the characteristics of Islamic financial activity. The equity style of finance, where profits and losses are shared, is more the focus of the Islamic Finance model.
Adult content, high-risk speculation-based gambling, and other “haram” activities are also prohibited. In Western banking, all of these industries are regarded as high-risk (though not prohibited).
Governments and the commercial sector, as well as stakeholders in the Islamic finance sector, showed greater interest in sustainability in 2021, with initiatives ranging from regulatory changes to the introduction of new ESG funds as we saw the rapid uptake of ESG and green Sukuk.
According to Refinitiv, ESG sukuk were issued globally in 2021 for a total of US$5.34 billion. This was greater than in any of the other years and accounts for 3.2% of all Sukuk issued globally in 2021. In a similar vein, more Islamic loans and syndications are being used for ESG or green initiatives.
Growing interest in the finance sector
According to research done by Maybank Islamic Berhad, the Islamic banking division of Maybank Group, and IslamicMarkets.com, up to 88% of Islamic finance professionals think that the wider Halal economy will need to address ESG and sustainability more seriously as a result of the growing focus on these issues in their industry.
According to the report, 25% of experts in Islamic finance claim that throughout the pandemic, cooperation between Islamic finance and Halal enterprises has increased. The COVID-19 epidemic, according to around 67% of Islamic finance experts surveyed, has sharpened the attention on ESG and sustainability in their organisations, which include asset managers, banks, insurance, fintechs, and consultancies.
The study also revealed that fintech and regtech are anticipated to significantly contribute to future sector growth, with regtech being a “possible game-changer” for the sector.
The Islamic Finance sector and the Halal economy are both firmly on a development path, and optimism about their prospects for this year remains high. What is more intriguing are the opportunities they will provide, the increased adoption of ESG and sustainability, and their effects on future growth.
Part of the greater ‘green economy’
One of the major developments in finance over the past several years has been the rise of social consciousness. The sector is being rapidly disrupted by technology, which is another development. Companies are making attempts to accommodate and adapt as they become more conscious of the changing environment of customer behaviour. And rightfully so, given the important role that financial institutions play in both our daily lives and the development of a thriving economy.
This trend is aligned with what can be described as greening of economies, with Islamic Finance and the concept of ESG being prime prospects to lead the way for more sustainable economic activities.
The UNEP’s Green Economy Report reveals that “The greening of economies is not generally a drag on growth but rather a new engine of growth; that it is a net generator of good jobs; and that it is also a critical approach for the elimination of persistent poverty.” The green economy is a way of doing business that supports both sustainability goals and economic growth.
Financial institutions must walk the talk and make progress toward a more sustainable and environmentally friendly economy. ESG and sustainable financing should not be used as a marketing tool for businesses, but as a motivator for them to take responsibility. We can anticipate exciting new changes given the fast-paced development of Fintech businesses, their lower overhead costs, and increased accessibility.