ESG in Islamic Finance: A Growing Trend

ESG in Islamic finance: the latest trend

ESG principles are increasingly becoming part of the practice of finance. While the precedent of ESG investing can be seen earlier in conventional finance, Islamic finance has only recently adopted the same as Shariah law allows investment practices to be ethical. Besides, considering the rising level of concern related to sustainability, more recently, it has also struck the minds of those institutions who provide Islamic finance concerning how those institutions could remodel their affair by considering the ESG parameter.

Esg In Islamic Finance
It is three fundamental standards based on which an investor has to make judgments whether that particular investment would become meaningful in its environmental and social dimension, so from that context, it shall be sustainable as well.

Three factors are listed below:
Environmental Factors: Climate change, deterioration of resources, and pollution
Social Factors: Labor practices, community, human rights, and diversity
Governance: transparency, accountability, and wholesome management practices.
Islamic finance is essentially an ethical mode of investment under Shariah law. What the Islamic faith prohibits - alcohol, gaming, financial transactions based on interest - cannot be entertained. This is the rationale for why ESG in being in line with Islamic finance has seen a natural growth in both directions because the objectives of these two concepts of finance are quite complementary: both promote responsible investments and welfare of society.

Interrelation between ESG and Shariah Law
Although ESG is a well-defined concept in the conventional world, its applicability in the world of Islamic finance needs a much more profound understanding of Shariah law. A few of the principles of Islamic finance are:
Prohibition of Riba (Usury): Islamic finance forbids making profit through interest, which falls in the "social" category of ESG by making sure that all financial transactions be fair.
Avoid Haram activities: Companies such as alcohol, gambling, tobacco, and weapons industries should be avoided. This advances the ESG pillar over environmental and social issues by shunning industries that cause harm.
Ethical investment: Islamic finance calls for responsible and ethical investments. This advance the ESG pillar in governance in a sense that there's transparency and accountability.
The growing demand for ESG compliant products will also unroll innovations within the Islamic finance sphere in looking for opportunities presented by investors that bank on investments made on the grounds of Shariah principles and contemporary sustainability criteria.

ESG Implementation of Islamic Financial Products
Most of the institutions of Islamic finance consider ESG factors to be a very crucial factor in deciding what kind of investment would be made. Among the activities provided by most of the Islamic banks and institutions that are Sharia compliant, with ESG standards, green bonds, (Sukuk) and investment funds are included as other types of financial instruments.

Green Sukuk Sukuk are those bonds or Sukuk that finance environmental-friendly projects. With each passing day, the advantages of this type of funding through Sukuk are increasing mainly in renewable energy, clean technology, and infrastructure along the lines of Islamic finance principles.

Most of the investment funds monitored ESG compliant companies. No investment money funds channeled to any company deemed a wrong venture to engage in business through Shariah laws. In this respect, their money went to projects considered ESG compliant.

Social Welfare Investments: Social welfare forms one of the wings of ESG. An Islamic financial institution also thought how it could fund social projects, which happen to fall in good causes of affordable housing and educational and health programs wherein one agrees socially on responsibility under Islamic parameters about charity and justice.
Benefits through GES Islamic Finance
Highly powerful to integrate ESG into Islamic finance, along with lots of advantages for investors and society as well.

This is also supported by the principles strengthening the adoption of ESG in support of ethical investment through the mechanism of the capital that flows towards productive and constructive investments towards enhancing society and its surroundings.

With this further demand from newer generations of investors who, on occasions more youthfully and with greater sensitivity to social causes, will attract completely new sources of investors, some providers will even include Islamic finance institutes, now that they can contemplate the principles of ESG for their potential consideration of incorporation in order to attract this new investor base.

The ESG factor will further reduce risks, especially relating to environmental, social, and governance issues. Thus, this type of investment ultimately becomes sustainable in nature. Sustainable investment into a responsible or non-harmful project is risk-free and would not let reputation and monetary-related risks jeopardize the investor; it ensures reputational and financial benefits from investment based on those practices.

Shariah-compliant financial instruments, be it Green Sukuk or other Islamic ESG investment funds. This is also because the implementation of these funds will enable investor financial objectives in alignment with both their ethical/religious values that are not tainted by Shariah principles in place of the sustainability need of the same Islamic investors concerned.

Challenges and the Way Forward
Introduction of the ESG mechanism into the Islamic finance industry is quite a challenge despite various opportunities.

Non-uniformity: Although, as mentioned earlier, the traditional system is making use of the ESG standards currently, this field is entering the sector. It had discovered an unutilized area that holds crystal-clear and mutual consensus universal applied Shariah compliant ESG standards. So, the building of a standardized range of ESG products proves challenging to the institution under such circumstances.

Low knowledge and understanding: Low consciousness levels may exist among investors and financial institutions pertaining to how principles of ESG can best be fitted within Islamic finance. Such learning may be obtained through training programmes to eliminate the gap.

This is not all; ESG and Shariah law in most jurisdictions have no uniformly agreed interpretation leading to inconsistency at market levels. The government must, therefore, work with regulators in establishing conducive frameworks that seek to harmonize the standards that govern Islamic finance as well as the ESG.

Future of Islamic Finance with regards to its relation to the ESG principles
The constituents of ESG principles are always including Islamic finance in their ambit and are most likely to head that way in the near future. There is immense scope for the positioning of institutions engaged in Islamic finance as leaders in the ethical finance space with people being increasingly conscious about sustainability and ethical investment around the world. It would then attract a very larger investor base with an offering being kept in compliance with both Shariah principles and modern ESG standards.