Islamic Finance and ESG investments: differences and contact points

ESG investing is a form of socially responsible investment when the decision to finance a business is based on the contribution of a company or project to the development of the society. This contribution is assessed by several factors:

Environmental (E) This factor allows to evaluate company's activities for the protection and preservation of the ecological situation and the natural environment. Such activities are manifested in the control of harmful emissions and air pollution, the creation of a developed waste management system, a responsible attitude to land use and work to reduce the carbon footprint;

Social (S)
This factor allows to evaluate social influence. Such influence is manifested in providing decent working conditions and equal opportunities to the company's employees, as well as in supporting public organizations;

Governance (G)
This factor allows to evaluate the quality of company's management. It's important to take into account the company's standards and business practices that guide management. This includes the ethical standards that the company adheres to, as well as the overall transparency of the business.

Islamic finance and sustainable or responsible investing have a lot in common. They share a fundamental principle - prevent any harm. The basic rules by which Islamic financial organizations operate are very similar to the principles of ESG investment, and therefore there is a possibility of market convergence, which could bring such popular products of Islamic finance as sukuk bonds in line with the requirements of ESG investors around the world, and provide Islamic banking institutions with access to a growing share of investment the sector in the future. But first, ESG investors and specialists in the field of Islamic finance need to come to terms with the differences and find similarities between these two investment approaches. It must be recognized that Islamic finance is still heavily dependent on certification, and the coverage of indicators and the underlying settings are not synchronized.

Islamic finance is the approach to investing and financial transactions in general based on certain principles. It uses criteria such as shared responsibility, dependence on real assets, transparency and a ban on activities related to certain products and services. This is an approach designed to ensure not only compliance with the principles of Islam and Shariah, but also the stability of financial systems as a whole. This can be seen as a long-term risk reduction strategy with low volatility, recognizable by all investors.

ESG investing pays comparable attention to reducing long-term risks and a wide range of impact indicators, also designed to limit possible harm. However, in comparison with Islamic finance, a wider range of environmental and social indicators are used here, taking into account the impact of production on the environment, compliance with human rights and labor standards. In ESG investing, much attention is paid to financial supervision, reporting, and even political lobbying. Although there are no established global definitions, ESG investment proposals are already beginning to apply recognized standards (for example, Global Reporting Initiative (GRI), standards and EU regulations).

When achieving the goals of Islamic finance and ESG investment, common approaches can be applied, but the ways in which they follow the implementation of these goals still remain completely different. ESG is based on proactive actions, when investors are increasingly looking for evidence of a positive goal when choosing a company to include them in an investment portfolio, rather than relying on rules for excluding certain industries and areas of activity. Islamic finance is based on the general principles of "positive contribution" regulated by the norms of Islam. Therefore, the main differences are in the approach to the selection of investments.

The approach used in ESG investing involves constant interaction between company management and shareholders, which is rare in Islamic finance. In addition, investing in ESG is often seen as "integrated", defining the entire financial analysis and investment practice of the company, while investing in Islamic finance is usually an independent practice.

There are also special financial restrictions when investing in Islamic finance, which are not applied in ESG. The sustainable investment industry is larger than the Islamic finance market, and it is growing at an equally rapid pace. According to one recent Bloomberg estimate, the likely size of the ESG asset market by the end of 2025 will be $53 trillion, which means that it will account for about a third of the projected global volume. According to the latest forecast of S&P Global Ratings, the volume of the market of Islamic investment products by 2025 will be about $ 3 trillion, provided that the market continues to grow by about 10%.

Such a difference in markets' size is very important because it demonstrates its capabilities and needs. The processes used in ESG require a large amount of data used, which means that entering the ESG market for Middle Eastern banks specializing in Islamic finance may require significant costs.

The discrepancy between the scales of these two markets is also determined by the fact that in Islamic finance there are a lot of prohibitions on investment activities: alcohol and non-halal products, prohibited methods of trading (high leverage), charging interest, etc. Investment methods in ESG are defined more freely and are subject to constant development. The broader scope of ESG investment opportunities means that many factors that may be crucial to making a decision are simply not considered as investment goals in Islamic finance. In addition, Islamic investors approach asset management from the point of view of their transparency and reliability, while ESG investors are more focused on shareholder decisions.

Nevertheless, the differences listed above also open up opportunities for the convergence of ESG and Islamic finance markets. One of these possibilities is certification. Investments must be certified in such a way that both forms of responsible investment are mutually recognizable and trustworthy.

Shariah certification is relatively simple. There are many organizations that carefully check investments for compliance with the principles of Islamic finance, and they are recognized by traditional investment companies. And although there is no generally accepted ESG certification for Islamic financial products yet, banks and companies themselves have all the capabilities and tools for this.

And there is already evidence of this. For example, sukuk bonds issued in 2022 by the National Bank of Saudi Arabia and the Bank of Riyadh ESG, as well as special "Green Sukuk" bonds issued by the First Bank of Abu Dhabi in 2021. ESG Investment companies, as well as the Organization of Accounting and Auditing of Islamic Financial Institutions in Bahrain, took an active part in the process of releasing these products.

But the most obvious possibilities of integrating Islamic finance into the sphere of ESG investment are their capabilities in organizing the "business cycle". It is an indisputable fact that investments in Islamic finance outperform stability indicators during downturn cycles in the markets. They focus on protected and sustainable sectors of the economy. And as the world enters a period that is highly likely to become a new period of low growth and even recession, the philosophy of Islamic finance and investment is becoming increasingly attractive to investors.

For Islamic financial structures, this means the emergence of new opportunities for ESG investments without significant initial costs. After all, where investors are looking for conservative investment strategies with low volatility and compliance with ESG principles, Islamic finance has an obvious opportunity to start creating new markets and opening up new investment opportunities.

IslamicCoin is the first project to provide the community with powerful financial technology that allows for seamless transactions, support innovation and charity. The project is 100% compliant with Shariah law and benefits the community. Developers focus on sustainable development and use technology and innovation to ensure financial sustainability.

"At the heart of Islamic finance is the prohibition on charging interest. Islamic finance has always been focused on not shifting most of the risks to one side of the financial relationship. In Islamic finance, balance and transparency of transactions should be observed, which can negatively affect our society," says Mohammed AlKaff AlHashmi, one of the founders of IslamicCoin.

IslamicCoin is aimed at 1.1 billion Muslims using the Internet. The project creates convenient tools designed for users who have never been owners of cryptocurrencies. Thus, the creators of IslamicCoin are expanding the capabilities of the Muslim online community by providing it with opportunities to use a new form of digital money and involving them in the modern digital world.