Socially responsible investing (SRI) and Islamic finance share similar origins and aspirations. Common to both is an ethical underpinning that puts stewardship and societal value creation at the forefront of finance.
Yet for the most part, the two modes of finance have existed as distinct approaches in parallel worlds.
New research by CFA Institute - “Sustainable, Responsible and Impact Investing and Islamic Finance” - hopes to bridge the ethical gap between the disciplines by exploring their primary concepts and shared historical connections.
SRI investing developed before Islamic finance was established in the 1970s. It established some key practices and structures, such as exclusionary screening and mutuality, which have become part and parcel of modern Islamic finance. This is no coincidence - Islamic finance has studied and consciously employed the methods developed by SRI investing.
Indeed, the time lag between innovation in SRI investing and its adoption by Islamic finance seems to be decreasing. The Domini Social Index, made up of 400 primarily large-cap US companies, was launched in 1990. In 1999, the Dow Jones Islamic Market Index was launched. The World Bank launched the first green bond in 2008.
Less than ten years later, the first green Sukuk, also known as an Islamic bond, was issued. The first social impact bond was launched in 2010, and the first SRI Sukuk followed in 2015.
But there are differences too
Despite areas of convergence, there are significant differences between Islamic finance and SRI. Most obviously, Islamic finance is significantly smaller than SRI investing; most of its assets are in commercial banking, and it is concentrated in just 12 jurisdictions.
Additionally, although certain Islamic prohibitions can be seen as consistent with a negative screening approach under SRI investing, the concerns of Islamic finance extend beyond the purpose of finance - exclusion of alcohol, tobacco and gambling, for example - to the structure of financing itself, for e.g., the prohibitions against “riba” (lending money at interest) and excessive “gharar” (trading of risk).
Therefore, although investments can qualify as both Islamic and SRI, most SRI offerings in developed countries are unlikely to meet Islamic criteria. This is because SRI is not, for the most part, concerned with Islamic prohibitions, ie, lending money at interest and the trading of risk are not areas SRI seeks to avoid.
Furthermore, not all Sharia-compliant investing overlaps with responsible investing. For example, there is significant Islamic investing in extractive resources such as mining.
Shaping the future
However, several innovative Sukuks have come to market recently that meet advanced SRI criteria. For example, in 2017, a green Sukuk was issued in Malaysia, raising $59 million to finance a solar power plant. The issue received a “dark green” rating by the Centre for International Climate and Environmental Research (Cicero) in Oslo. (Cicero ascribes three shades of green ratings. Dark green is the highest rating and given only to initiatives that will lower carbon emissions in the long run such as wind energy.)
Additionally, in March 2018, Indonesia issued the first sovereign green Sukuk, with an oversubscribed offering raising $1.25 billion.
The critical question relating to products that meet both ESG and Islamic finance requirements is whether a tangible benefit exists from
utilising the strategies in tandem. An analysis of Islamic finance and SRI, which studied 5,000 non-financial companies, suggests beneficial synergies do indeed exist.
Shariah-compliant companies have SRI scores that are, on average, 6 per cent higher than those excluded by the Shariah screening process. For non-financial companies, the difference is 10 per cent. Overall, on average Shariah-compliant firms have 10.2 per cent higher SRI scores than those that are non-compliant.
Additionally, any concerns that restrictions imposed by SRI or Islamic finance, such as exclusionary screening, may adversely affect performance, is not supported by the empirical evidence. In 2015, Deutsche Bank’s Asset & Wealth Management division published a meta-analysis of how SRI considerations affect corporate financial performance.
It examined 2,250 academic studies from 1970 to 2014 and concluded that SRI made a positive contribution to performance in 62.6 per cent of meta-studies and negative results in 10 per cent. The remainder were neutral.
Demographic trends also point towards a future in which SRI and Islamic finance are synergistically employed to the benefit of society as a whole. According to the Pew Research Centre, between 2010 and 2050, the Muslim population is projected to increase by 73 per cent, while in 2019 millennials (1981-1996) overtook baby-boomers (1946-64) as the largest demographic cohort.
Millennials are especially keen advocates for SRI: in a recent survey by Deloitte 63% more millennial respondents cited “improving society” as being more important than “generating profit”.
For society at large, and for the future of our industry, the proliferation of a system of finance, whatever its origin, that places stewardship at its heart can only be a good thing.