Investor preferences are becoming more and more driven by the global mood regarding the environment and social justice. Greta Thunberg, for instance, was able to galvanize the young generation with her climate strikes. Insurance companies and investors alike are increasingly staying away from carbon-emitting industries. Over the past decade, coal has become a bad word in investor circles and oil companies are forced by their investors to show how they address carbon dioxide emissions and climate change goals. It is a double whammy for any investment class when it is put on the “black list” of insurance companies, as it not only starves the industry of the insurers’ investment pool but also renders the company’s activities significantly more expensive as they become uninsurable.
ESG investors want to do good. However, they increasingly also want to avoid the risks of ignoring societal trends and the resulting legislation, because that can become costly further down the road. This, in turn, induces more companies to issue ESG-compatible instruments. Supply follows demand. For instance, Verizon recently issued a $1 billion green bond, which was oversubscribed in no time. The cost of issuing these instruments goes down as volume goes up, rendering them more cost competitive. Accounting and governance criteria have also improved, helping transparency and broadening the appeal to mainstream investors — a virtuous circle.
There may be a certain element of “greenwashing” ESG investment instruments that do not hold up to scrutiny. Still, one can argue that even if an issuer is not 100 percent true to ESG criteria, something will stick and it will help broaden the appeal of ESG criteria. Issuers who disguise non-compliant instruments as being ESG-compatible will increasingly be found out, as transparency and scrutiny increases and as the asset class matures.
The momentum behind ESG instruments is good news for getting funding behind the UN’s Sustainable Development Goals (SDGs). The president of the Islamic Development Bank, Dr. Bandar bin Mohammed Hamza Al-Hajjar, estimates that it will take about $1 trillion of investment a year to achieve the SDGs by 2030. The multilateral development banks disburse $145 billion a year, not all of which is directed toward the SDGs. The funding gap is immense and every dollar is welcome.
This brings us to another emerging asset class: Islamic finance, or Shariah-compliant investments. Its principles are very compatible with ESG guidelines.
This was discussed at length at the Islamic Development Bank’s annual meeting in Marrakech in April. Indeed, many of the side events and workshops were dedicated to the SDGs and ESG investment principles. The environment and social justice featured particularly high on the agenda.
The RFI Foundation addresses how to incorporate ESG in Islamic finance. According to Goud, “they (ESG and Islamic finance) share values focused on environmental and social impacts, fairness and working to promote social welfare and avoid social harm. This provides a foundation for Islamic banks to manage both the positive and negative impacts of their activities.” The foundation’s summit in Abu Dhabi earlier this year managed to attract the “who’s who” of both worlds.
All in all, ESG has to be seen in the context of growing societal awareness. The environment and climate change feature particularly high on the public’s agenda. We have reached an inflection point in terms of awareness, which is translated into the investment offering. Similarly, Islamic finance is also coming of age, serving a potential market of 1.8 billion Muslims and beyond.
The value systems of both are inherently compatible, as well as in line with societal and population trends. In other words, the future is bright for both asset classes and the opportunity for synergies is huge.