With a growing need for, and adoption of, environmental, social and governance (ESG) screening, integration and investment, we shed light on the areas of overlap and convergence between ESG and Shariah compliance.
- With a clear mandate or preference for Islamic finance, a fund or portfolio manager can use market tools to construct a portfolio of shariah-compliant equities or Islamic bonds – better known as Sukuk – or a mix of both and can track and evaluate against benchmark indices designed for that purpose.
- Using ESG screening tools and platforms, Shariah-sensitive investors have a more comprehensive way of ensuring their funds are invested in assets that meet Islamic principles beyond the classic taboos. This gives an advantage to instruments that meet certain minimum ESG criteria or rating and are Shariah-compliant as they would be best-in-class investments for Shariah-compliant investors.
- The same applies to non-Shariah-compliant sensitive investors and issuers or borrowers who can tackle a wider pool of funds from Islamic capital markets – which are embracing sustainability through increased selling of ESG and green Sukuk, especially in the GCC and Malaysia.
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Shariah, also known as Islamic Law, is the overarching law by which an asset class, a financial instrument be it a stock or a bond, a fund or a portfolio, are classified as Shariah-compliant based on a predefined set of rules – such as a ban on interest, and the prohibition of investment in alcohol, pork, weapons, gambling and the likes.
As such, Shariah compliance presents itself as a form of Ethical finance, a faith-based investment, and shares some aspects of negative screening and impact investing. It can also be compared to a rule-based investment strategy. With a clear mandate or preference for Islamic finance, a fund manager or portfolio manager can use market tools to construct a portfolio of Shariah-compliant equities or Islamic bonds – better known as Sukuk – or a mix of both and can track and evaluate against benchmark indices designed for that purpose.
Recently, both World FTSE Islamic/Shariah Equities and ESG Indices have performed better than the conventional FTSE All-World index
Source: Sustainable Islamic Finance App
While screening for ESG is evolving in terms of sophistication of tools, availability of data and level of depth and breadth of coverage, Shariah compliance screening has been in place for some time and, given its less diverse required set of data points, can be considered in a more mature stage of development.
Using ESG Screening tools and platforms, Shariah-sensitive investors have a more comprehensive way of ensuring their funds are invested in assets that meet Islamic principles beyond the classic taboos. For instance, a portfolio of assets which scores high on social factors such as equal pay, naturally aligns with Islam, which calls for justice and equality.
Radzuan Tajuddin, a senior consultant at the World Bank Group Malaysia (Green Taxonomy and Carbon Market Development) suggests that another way to look at this is to view it from a risk standpoint. Not integrating ESG or broader sustainability considerations into Shariah screening impacts Islamic assets – illiquidity, value impairment and stranded assets; and potentially drives the Islamic market as safe haven for unsustainable assets – as the global capital shift intensifies.
Islamic ESG Funds continue to gain momentum globally. According to Blake Goud, CEO of Responsible Finance and Investment Foundation, “It is important for asset managers to evaluate how the Shariah screens change the characteristics of the investment universe, which impacts what the most effective ways to incorporate ESG screening are”. A report by the RFI Foundation suggests that Islamic investment has significant complementary performance benefits with ESG integration.
Refinitiv Islamic Finance: Tools and applications to capitalise on Islamic finance opportunities.
Growth of Islamic ESG Funds
Source: Sustainable Islamic Finance App.
In other words, there is now an advantage for instruments that are winners which meet a certain minimum ESG criteria or rating and are Shariah-compliant as they would be best-in-class investments for Shariah-compliant investors.
The same applies to non-Shariah-compliant sensitive investors and issuers or borrowers who can tackle a wider pool of funds from Islamic capital markets – which are embracing sustainability through increased selling of ESG and green Sukuk, especially in the GCC and Malaysia.
A recent blog by the World Bank noted that “for international investors, ignoring Sukuk comes at a cost, as the product offers them diversifying credits and great credit stories”, let alone if it is an ESG or Green Sukuk.
FTSE IdealRatings Broad US Dollar Sukuk Index Series.
Historical Issuance of ESG Sukuk
Source: Sukuk Now App.
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