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Islamic finance and sustainability

27 January, 2021Ouida Taaffe

How can society ensure that financial markets channel funds into sustainable investments and assets that tackle climate change? Islamic finance has some answers.

Green shoot growing out of moneyTraditional market finance is supposed to be the best way of pricing risk. But there can be many costs – so-called externalities – that are not captured by market prices.

If a firm produces poor quality baby food, for example, that can be a heavy burden for others. The firm, however, may not pay for any of those costs unless regulators and legislators step in.

The costs of climate change are another example of what many would see as market failure. Private investors often have little interest in protecting public goods like clean air and water.

Thomas Helbling of the IMF has said that “environmental issues often face a collective action problem”. But is there any way for private markets to try to tackle that?

Islamic finance is ethical and sustainable

“Ethical finance is fundamental to what Islamic finance represents.” That’s the view of Dr Scott Levy, CEO of Bedford Row, who was speaking at the IFN UK Islamic Forum in early December 2020.

Levy argued that in not learning from Islamic finance, markets had missed an opportunity. “Islamic finance is almost what sustainable investment and ESG investing is catching up with.”

However, there is still limited demand for Islamic assets.

What’s the future for Islamic finance?

Could the absence of commonly agreed and recognised standards be holding Islamic finance back?

Whether or not an asset is Shari’ah compliant can, in some regions, depend on an Islamic scholar’s interpretation. That increases the risk of unexpected defaults.

Razvan Dumitrescu, of the European Bank for Reconstruction and Development (EBRD), said the issue was lack of simplicity.

“If you think that your peer issued a Eurobond, it may be easier to go with something fast. You know the investor pool is there and sometimes it is also about overall pricing. When there is a bit of a distressed situation, clients start looking more at short-term.”

Dumitrescu added that people are starting to converge on best practices and to build case studies.

Scott Levy argued that the best way forward for Islamic finance was to focus on the outcomes and impacts.

“Institutional investors can measure and value risk,” he said.

“We need to lower some of the barriers created by overcomplication. Put the risks and rewards in front of them, and let them make the appropriate decisions.”

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