Environmental, Social and Governance Investment: A Bridge to Sharia-Compliant Investments in the GCC? | Morgana Lewis

A version of this article first appeared in New private markets

It has been reported that some Gulf Cooperation Council (GCC) asset managers expect larger capital inflows amid growing demand for environmental, social and governance (ESG) and Islamic investments.[1] The rise in the global popularity of ESG investing presents a unique opportunity for GCC investors, asset managers and banks to offer more “green” Islamic investment products to attract and obtain investment from a wider group of potential investors looking to invest in an ESG-compliant manner. Additionally, while “green” investments that tick ESG and Shari’a compliance boxes may currently be limited, the rise of innovative structured solutions allowing exposure to certain ESG investments that would otherwise not be Shari’a compliant ‘a is increasingly used. by family offices, regional banks and institutional investors and could still close the gap.

With GCC’s large liquidity pool and the global popularity of ESG investing, the coming years could see an increase in ESG and Shariah-compliant products, as envisioned by asset managers in the world. region. However, it should be noted that there are currently no standards that must be met before an investment can be labeled or described as ESG compliant, therefore investors will likely perform their own due diligence on any compliant opportunity. Sharia claiming to be ESG investments to ensure that these investments are indeed in line with their investment objectives and are not misled by “greenwashing”. Nevertheless, given that the Sharia-compliant ESG investment market is still relatively nascent, there is significant potential for growth.

Additionally, with the growing appetite for ESG investments in the GCC and with investors and managers becoming more aware of the growth opportunities associated with ESG investments, there could be an increase in Shariah-compliant offerings that will s align with ESG principles. In this article, we explore both themes and the potential synergies between the two.

BACK TO ESSENTIALS: WHAT IS ESG?

ESG investing according to the CFA Institute[i] is an approach to asset management involving investors explicitly recognizing these factors in their investment decisions.

There are several ways for investors to engage in ESG investing, including active investing, which involves active engagement by using their voting powers to persuade entities they control to invest only in activities ESG-friendly and operate in an ESG-compatible manner. policies and trends; and screening, which involves refraining from investing in companies or asset managers that invest in non-ESG activities (e.g. those that engage in tobacco, gambling , alcohol or the sale of weapons).

As widely reported, investor demand for ESG investing has grown significantly in recent years,[ii] leading investment managers to integrate sustainability efforts into their investment practices. In addition, initiatives such as the Net Zero Asset Managers initiative,[iii] which brings together an international group of asset managers committed to supporting the goal of net zero greenhouse gas emissions by 2050 or earlier, build on this paradigm shift towards ESG investing across the globe .

BACK TO ESSENTIALS: ISLAMIC-COMPLIANT INVESTMENTS

Adherence to Sharia or Islamic law and the tenets of Islam rests on certain moral and human and social factors, including guiding principles that, for example, wealth should be generated from business investments and legitimate assets; therefore, the concept of using money to make money is prohibited. Lending money with the intention of receiving interest (Riba), contracts with excessive uncertainty (Gharar) and certain activities considered harmful (Haram) are also prohibited.

Although Shariah principles are not codified, they indicate how an investment must be structured to be considered Shariah-compliant or whether an investment can be made. These investments are also dependent on the Shari’a board or advisor who has been appointed to oversee the ongoing investment and without whom an investment would not be considered ‘compliant’.

Major areas of Islamic investment include Islamic banking, Islamic funds, Takaful or Islamic insurance, and the sukuk market. While these can all contribute to the Sustainable Development Goals, there has been a marked increase in the sukuk and asset management sectors, with great interest in the development of ‘green sukuk’ and compliant structured solutions. sharia law for investments with conventional asset managers. . These investments have increased in recent years and lend some credence to the idea that the coming years will continue to see the growth of the GCC, which continues to be one of the largest Islamic finance jurisdictions in the world.

SIMILARITIES BETWEEN ESG INVESTING AND ISLAMIC INVESTING IN THE GCC?

In short, ESG investing and Islamic investments can unite given that they are both concepts guided by principles of morality, transparency and fairness, so it is possible for an investment to be at the both Shariah and ESG compliant. For example, an ESG investor may screen and weed out companies involved in gambling or alcohol on the basis that these companies do not create positive social and environmental impact, and similarly a Sharia-compliant investor would do the same on the basis that such activities are contrary to the tenets of Islam (Haram).

However, notwithstanding some similarities between ESG investing and Islamic investing, it should be noted that it is possible for an investment to qualify as ESG investing but not be Sharia compliant and vice versa. For example, an investment in a highly leveraged solar farm project may be a good ESG investment but would not be Sharia compliant due to the ban on Riba. Similarly, a Shariah-compliant sale-leaseback financing for a coal-fired power plant would likely be Shariah-compliant but not appropriate as an ESG investment. Thus, there are limits to the synergies that can be achieved in this space. That said, it should be noted that the relevance and growth of ESG principles in investments in general has captured the attention of the global business community, particularly during the pandemic years, and the GCC has taken notice of this as well. Similarly, Shariah-compliant investing has also continued to grow and markets have witnessed the development of innovative Shariah-compliant structures that align with ESG principles.

For example, in March 2021, the Islamic Development Bank of the Kingdom of Saudi Arabia issued its $2.5 billion sustainable sukuk. Adding a sustainability component to a sukuk offering attracted socially responsible investors who were outside the traditional fixed income sukuk investor space and encouraged them to seek to diversify their holdings and participate in such offers. Another clear example of this approach that aligns Islamic investing and sustainability is Kuveyt Türk Katilim Bankasi, a major Turkish bank majority-owned by Kuwait Finance House, which issued US$350 million of fixed-rate Tier 2 sustainability certificates due in 2031, and which is listed on the Irish Stock Exchange. These certificates were at the time the world’s first trusted Tier 2 regulatory capital certificates compliant with ESG and Islamic standards.

Other examples demonstrating increased ESG and Sharia-compliant investment and policy-making in the GCC include the Dubai Islamic Economic Development Centre, the Dubai International Financial Center and the Dubai Financial Market creating a new focus group in 2020 comprised of relevant experts in capital markets and environmental protection with responsibility for developing “sustainable sukuk standards”. In addition, at the G20 Climate Solutions Forum, the Islamic Development Bank made an ambitious commitment that by 2025 at least 35% of its operations will be directed to climate finance, and First Abu Dhabi Bank, which is the largest bank in the United Arab Emirates. by assets, issued a 200 million Swiss franc green bond in 2021 with a five-year term and participated in the issuance of US$1.3 trillion green sukuk by Saudi Electricity Company. Similarly, international banks have made progress on ESG investing, including Standard Chartered Bank which issued the first green Islamic loan in the Middle East to DP World in 2018 and the listing of Majid Al Futtaim in May 2019. This was the first benchmark corporate green Sukuk in the Middle East. , worth US$600 million and lasting 10 years to mark its long-term commitment to supporting the transition to a low-carbon economy; and in May 2021, the signing of its first sustainability-linked loan of US$1.5 billion (AED5.51 billion), a financial instrument guaranteed primarily on ESG-related performance.

WHAT DOES THE FUTURE LOOK FOR?

The progress of ESG investing in recent years illustrates the importance that ESG is taking in investment decisions globally and regionally, and will continue to do so, as we develop a generation that places more value on ESG than its predecessors may have. Moreover, Shariah-compliant investments continue to grow despite the difficulties in the global economy lately.

Nevertheless, as noted above, the concepts of ESG and Shari’a compliance do not always align and as such the types of potential investments available in the GCC and beyond may be limited, up to that additional structures and products are developed and/or relaxation takes place within the Shariah compliance tolerance levels themselves.

Paralegal Samia Mechernene also contributed to this article.

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