Where does Islamic Finance belong in ESG, and could it help save our planet?

All over the world, companies are being called out for the lack of corporate responsibility, and are under growing pressure to pursue progressive commitments for positive social change. As humanity becomes more scrutinous towards various industries, can we look at the world of finance practices – and maximise the yield of eco-friendly results?

The surge in social consciousness has been one of the notable changes in finance, in most recent years. The other change being the rapid disruption of the industry, led primarily by technology. As the consumer behaviour landscape changes, companies become more aware – and so, efforts to accommodate and adapt are now underway. And rightly so, as financial institutions play a huge role in our lives – and a critical role in shaping a prosperous economy.

In our not-so-perfect world of financial crises and economic downfalls, hindrance does occur to growth – but also to the prospects of any sustainability efforts. Financial bubbles usually occur due to excessive debt, asset-liability mismatches, and corruption, to list a few. These practices, and the lack of market discipline, create a market that is harder to regulate from the very offset – and, of course, easier to collapse. What some stakeholders have begun to realise, is that this approach is not sustainable – and it results in a cycle of a financial crisis once every 5 to 10 years. This has a direct impact on our environment – and a more prevalent one than we imagine.

One of the unique elements of Islamic Finance is its ability to minimise the likelihood of financial crises. The supporting logic to this is based on the nature of Islamic finance activities. The Islamic Finance model is more focused on the equity mode of financing – where profits and losses are shared. It also restricts high-risk speculations-based gambling, adult content, and other ‘haram’ practices. These industries are all seen as high-risk (but not forbidden) in Western banking.

The Green Economy Report, which aims to motivate policymakers to create enabling conditions for a greener economy, published by the UNEP demonstrates 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 decent jobs, and that it is also a vital strategy for the elimination of persistent poverty.” The green economy is an economy that promotes economic growth while also achieving sustainability objectives. 

To acknowledge efforts sustainable financial investing, as part of their sustainability ambitions, the well-established Islamic Development Bank, IsDB, which promotes social and economic development in 57 member-state Muslim countries, released a Sustainable Finance Framework that aims to “boost its commitment towards sustainability through the potential issuance of Sukuk to finance sustainable investments.”

There have been many initiatives and campaigns to encourage social responsibility in finance, from the United Nations’ Sustainable Development Goals, to ESG (which stands for Environmental, Social, and Corporate Governance). In a recent breakthrough, in 2020, EU legislators announced a new set of rules on responsible investment finance which will go ahead in 2021 whereby “financial firms which claim to pursue a green or social investment strategy will have to detail the impact of their investments, disclosing any that could pollute water, damage bio-diversity or cause large layoffs for example.”

The ESG is a criterion to help determine future performances of companies, using three central factors in measuring the sustainability and societal impact of an investment in a company or business. ESG includes factors under business activities that have the potential to harm the environment and covers social issues like corporate culture sustainability, talent management, product safety and data security.

It has been long argued that Islamic Finance brings impact beyond the conventional market expectations. So what does Islamic finance and ESG have common ground on? Sustainable investing has suddenly become a hot topic among investment and finance, however, the very foundation on what Islamic finance is built on is exactly this. Financial inclusion, investing in beneficial sectors, and the prohibition of investment in high-risk industries. On the topic of human’s relationship with the environment, the Quran, a primary source in Islam, states: 

“…Eat and drink from the provision of Allah, and do not commit abuse on the earth, spreading corruption” (Holy Quran 2:60)

Another important question is, could a company’s environmental and social performance affect its financial performance? A study done by BofA Global Research shows that companies that actually integrate social and sustainable practices – and not only use them for marketing purposes – actually do perform well in the long run, and may in fact even enjoy advantages over companies that do not take ESG factors into account.

Bank of America estimated that due to the change in demographic, investing in ESG funding could rise by $15-20 trillion over the next 2 decades. Currently, a tracking system of financial sustainability that companies can follow does not exist but many research giants, like MSCI are attempting to quantify data to allow investors to make decisions.

Financial institutions need to walk the walk and take steps towards a greener, and sustainable economy. ESG and sustainable financing should not become a company marketing opportunity, but rather a reason for companies to take accountability. With the speedy developments in Fintech companies, their lower overhead costs and better accessibility, we can expect promising innovative changes. There is no Planet B, and finance needs to be a big part of the conversation.

Rizq is still a small startup, but we have grand ambitions. We will be looking to lead the way on some green initiatives, with a few fun and productive activities planned in the near future – so watch this space!

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