Shared values for share values: The overlaps between Islamic and ESG investing

Strategic alignment between ESG and Islamic investing has the potential to unlock new long-term investment trajectories and trends.

As ethical investing grows at pace, it is worth remembering that this category extends beyond the Environmental, Social and Governance (ESG) space. Islamic finance has been with us for decades, and its growth is going hand-in-hand with that of sustainable finance. Indeed, there are many commonalities between the two that could be strengthened still further.

Much has been written about the growth of ESG, and Islamic finance is likewise benefiting from a cultural megatrend towards ethical investment. Global assets managed by the Islamic finance industry grew by 14% in 2019 to USD2.88 trillion, even as major Muslim-majority economies were held back by low oil prices.¹ Assets are likely to rise to US$3.69 trillion by 2024, according to the 2020 Islamic Finance Development Report released by Refinitiv and the Islamic Corporation for the Development of the Private Sector.

Likewise, ESG finance is growing very fast. USD777.6 billion of sustainable finance bonds were issued during the first nine months of this year, up 57% on the same period of 2020. Almost half (USD362 billion) were green bonds supporting environmentally friendly projects, followed by social bonds (USD170.9 billion), which support human development and health, and sustainability bonds (USD143.7 billion), which are a mixture of green and social bonds.²

Investors’ pursuit of ESG assets is being mirrored by the corporate sector at a governance level. The integration of ESG factors into due diligence questionnaires, internal controls and investment practices has been underpinned by corporates’ rising demand for ESG indices and standards.

How Islamic investing converges with ESG

Both Islamic investing and ESG reflect a desire among a growing proportion of global investors to align their portfolios with their personal values. Both recognise that long-term, sustainable growth is only possible within an environmental and social context that is conducive to that growth, and that people with means should promote the responsible stewardship of the human and natural environment.

Convergence of ESG and Islamic finance streams is heavily dependent on the fundamental principles forming their respective foundations.

Shikkoh Malik
Head of Group Fiduciary and Fund Services and
Global Securities Services Islamic Champion,
Standard Chartered

If we analyse the focus of ESG fundamentals then they could be translated to: Planet corresponding to Environment; People corresponding to Social; and Profit – for and with a purpose – to Governance. With this 3P lens it’s clear that both ESG and Islamic finance focus on similar underlying elements.

There are also parallels at a practical level. Sharia-compliant investing requires the exclusion of certain industries, such as tobacco, alcohol and gambling. Likewise, ESG investing uses negative screens to omit companies whose activities are not aligned with the investment mandate – and in many cases, these negative screens will include industries (such as tobacco) that are also incompatible with Islamic financial instruments.³

However, ESG also uses positive screens to search not only for compliance, but for supererogation; that is, doing more than the minimum that negative screens dictate. Sharia scholars are now calling for such an approach to be brought to Islamic finance too, in order to identify and finance those enterprises that best embody the promotion of social and environmental responsibility. For both types of screen, the sharing of ESG data could be valuable.

More than an overlap

Research from Refinitiv’s EIKON database, which covers over 6,500 publicly listed companies, shows a clear link between sharia compliance screening and stronger ESG performance.⁴ Sharia-compliant companies – those to which Islamic financial institutions will direct capital – have ESG scores that are on average 6% higher than non-compliant ones, particularly for environmental (7.3% higher) and social (7%) scores. Non-financial sharia businesses perform even better, with ESG scores 10% above average. This complementarity has led to calls for the further integration of Islamic and ESG screening processes.⁵

A more direct connection is already visible in the issuance of ESG sukuks (sharia-compliant securities), which totaled a record USD4.6 billion in 2020.⁶ In the first quarter of this year, ESG sukuk issuance reached USD2.5 billion, more than half 2020’s full-year total, suggesting even stronger momentum. Islamic ESG funds are also multiplying in number, albeit from a smaller base, reaching a value of USD756 million in the first quarter of 2021 following the launch of several Islamic Socially Responsible Investment funds in Malaysia and Indonesia. More funds will be launched as the Islamic finance sector seeks to redress the unemployment and social damage caused by the COVID-19 pandemic.

There is increased awareness within the Islamic finance ecosystem to build on the fundamental commitment to social benefit, and for the sector to play a leading role in this space.

Khurram Hilal
Group CEO,
Standard Chartered Saadiq

Aiming to work towards a sustainable economy that is linked to a prosperous, peaceful and just environment is a focus that would allow Islamic finance to drive and contribute to this positive change.

Khurram Hilal
Group CEO,
Standard Chartered Saadiq

People, planet and profit with a purpose: these ideas will be the animating factors behind an ever greater share of global investment, as the Millennial generation – including Muslim Millennials, who were raised to be environmentally and socially aware – assume leadership of the world economy. In addition, the regulatory landscape is shifting in such a way as to increase the transparency of ESG reporting across the board, including data relevant to sharia investment. Strategic alignment between ESG and Islamic investing therefore has the potential to unlock new long-term investment trajectories and trends, while creating new opportunities for Islamic financial institutions and investors.