Socially Responsible Investments and Islamic Finance

NEWHORIZON July – December 2014.

Islamic finance could already claim to be ethical in its approach. The industry is based on adherence to a set of morals and principles enshrined in Shari’ah. It eschews investment in gambling, alcohol, pornography, armaments and tobacco, all of which are considered haram by Islam. It also forbids riba, which it sees as the exploitation of one person or group by another leading to unjust gains.

There is, however, a growing cadre of investors, Muslim and non-Muslim, looking for something more. They are looking for positive discrimination in favour of projects that bring some gain to society rather than simply screening out unacceptable forms of investment. Various terms are used to describe these investments including socially-responsible, sustainable or green, although the term that seems to be gaining the greatest traction currently is socially-responsible investing (SRI), perhaps because it is a more all-encompassing term that better describes a wider range of investments designed to benefit mankind as well as providing a return for investors.

These investors want, for example, to support renewable energy rather than fossil fuels; sustainable agriculture rather than schemes that involve deforestation and affordable housing rather vanity building projects targeted at the super rich. Such aims sit well with the teachings of the Prophet (PBUH) expressed in the Qur’an, which enjoin believers to do nothing that would cause harm to the environment and to mankind in general.

Clearly, some investments, which would be Shari’ah compliant, would not meet the additional requirements of socially-responsible investments, e.g. investments in fossil fuel extraction and processing. This article is not suggesting that all Islamic funds will want to take the extra steps needed to be able to apply the ‘socially-responsible’ epithet to their funds, but Islamic finance industry is beginning to take an interest in this segment of the market, developing policies and products to meet an apparently growing demand. Those that do go the extra mile are hoping to increase the industry’s footprint in the financial world by appealing to non-Muslim investors as well as to Muslims.

A Brief Historical Background

The concept of socially responsible investing is not new, nor is it exclusive to Islam. For example in the 18th century, the Methodists, a non-conformist Christian sect, discouraged its adherents from investing in tobacco, alcohol and gambling. In the 19th century the Quakers pioneered the idea that profit should not be made at the expense of the people employed in factories, providing decent, affordable accommodation and education for their workforces. It was not until the latter part of the 20th century, however, that people began to be aware of the damage that certain types of human activity could do to the world in which we live. For a long time these early environmentalists were seen as sandal-wearing, bean-eating eccentrics until science began to demonstrate that our exploitation of the planet’s resources were causing such harm to the environment that we were in danger of irreparably damaging the world in which we all live.

In the last 10 15 years the socially-responsible investment industry has been moving slowly out of the shadows and increasingly into the mainstream. For example, the Climate Bond Initiative has reported that $11 billion of green bonds were issued in 2013; by the end of October 2014 the figure was already more than $32 billion, suggesting the market could double by the end of the year. The Climate Bond Initiative is confidently forecasting the market will double again in 2015 to $100 billion and this is just one single element of the broader ‘socially-responsible’ investment space.

In the past the Islamic finance industry has often been criticised for being merely emulators of conventional finance, looking for ways to offer conventional finance products in a Shari’ah-compliant form. In the socially-responsible investment space Islamic finance with its declared adherence to certain moral values and principles has a real opportunity to be the trend setter and the latter half of 2014 saw a number of significant announcements designed to position the Islamic finance industry firmly in the forefront of this market trend.

Framework for Socially-Responsible Sukuk

In the late summer of 2014 the Securities Commission Malaysia (SC) launched the Sustainable and Responsible Investment (SRI) Sukuk framework to facilitate the financing of sustainable and responsible investment initiatives. ‘The introduction of the SRI sukuk framework is part of the SC’s developmental agenda to facilitate the creation of an eco-system conducive for SRI investors and issuers and is also in line with the rising trend of green bonds and social impact bonds that have been introduced globally to facilitate and promote sustainable and responsible investing. Combined with Malaysia’s leading position in the global sukuk market, this framework will further enhance the country’s value proposition as a centre for Islamic finance and sustainable investments’, said Datuk Ranjit Ajit Singh, Chairman of the SC.

The SRI sukuk framework is an extension of the existing sukuk framework and therefore, all the other requirements in the Guidelines on Sukuk continue to apply. The additional areas addressed in the framework for the issuance of SRI sukuk include utilisation of proceeds, eligible SRI projects, disclosure requirement, appointment of independent party and reporting requirement. The types of projects that are eligible include sustainable land use, sustainable waste management, renewable energy, energy efficiency projects, affordable housing and urban revitalization.

It is likely that the first sukuk to be issued under the new guidelines will come from Malaysia’s state-owned sovereign wealth fund, Khazanah Nasional Bhd., which is reported to be considering an issue in the second half of 2015 to fund expansion in its education and renewable energy businesses.

Dubai’s Green Investment Programme

Dubai launched its Dubai Integrated Energy Strategy 2030 (DIES) in 2010 and began deployment in 2011 under the guidance of His Highness Sheikh Mohammed bin Rashid Al Maktoum, Vice


President and Prime Minister of the UAE, and Ruler of Dubai. The DIES sets the strategic direction of Dubai towards securing sustainable supplies of energy and enhancing demand efficiency.

In 2014 the Dubai Supreme Council of Energy (DSCE) and the World Bank signed an advisory services agreement to partner together and design a funding strategy for Dubai’s green investment programme, which is expected to involve green bond and sukuk products.

Sukuk for Vaccines

In December 2014, the International Finance Facility for Immunisation (IFFIm) issued a $500 million, three year sukuk to fund immunisation programmes. It is the largest ever debut issue by a supranational non-profit organisation and the largest Sukuk al-Murabaha issuance in the public markets and is also the largest inaugural Sukuk offering from a Supranational.

The sukuk was oversubscribed, even with its unique structure for sukuk market participants. IFFIm achieved strong diversification in its investor base with 85% of the order book coming from new and primarily Islamic investors. The regional distribution of investors was 21% based in Asia, 11% in Europe and 68% in the Middle East and Africa. Banks took 74% and central banks/official institutions took 26%.

The hope is that it will encourage other similar humanitarian institutions to use the market.

Agricultural Investment Opportunities in Canada

AGInvest Properties is a Canadian-based company that owns and manages farmland in Ontario. In June 2014 they launched a scheme to offer Shari’ah-compliant investment partnership opportunities with the aim of increasing the inflow of capital into the Canadian agricultural sector. To do this they have signed a partnership agreement with Bahrain’s Shari’ah Review Bureau, who provide outsourced Shari’ah certification and advisory services.

The aim is to provide Islamic investors in Canada and elsewhere with investment opportunities in arable farmland, which they believe is a sustainable sector, to some extent insulated against the prevailing somewhat depressed economic environment around the world.

Stimulating Green Sukuk

The Green Sukuk Working Party (GSWP) was established in late 2014 by the Clean Energy Business Council (MENA), the Climate Bonds Initiative and the Gulf Bond and Sukuk Association (GBSA) to promote and develop Shari’ah-compliant financial products to invest in climate change solutions.

GSWP is a collaboration of experts in project development, environmental standards, capital markets, actuarial compliance and Islamic finance.

The GSWP will:

• Design green sukuk architecture, so that product issuers can offer and investors can access products with confidence about their compliance with Shari’ah law and ethical standards.
• Promote the concept of green sukuk and other green Islamic finance products to governments, investors, product originators and other interested parties.
• Engage with governments and development banks about supporting appropriate project development and the growth of a green sukuk market.
• Inform the market by promoting best practice, convening industry forums and developing template models.

Caveat Emptor

When an idea begins to take off, everyone will want to jump on the bandwagon and get a slice of the action. The food industry is a good example As people have become more aware of the need to avoid excessive amounts of fat, sugar and salt in their food, the food industry has scattered terms like ‘low fat’ or ‘low sugar’ on their product labels. They should more accurately have labelled them ‘lower fat’ or lower sugar’, because a little research will demonstrate that some of these products are only 5-10% lower than the standard product.

The problem with any plain language term is that it can mean exactly what a product or service provider wants it to mean. A casual search will reveal a number of Islamic financial service providers who are using the term ‘socially responsible’, when in fact they are doing no more than complying with current Shari’ah requirements. Yes, they are avoiding investments in alcohol, tobacco, etc., but there is no positive discrimination in favour of investments that are beneficial to society and no avoidance of industries such as petrochemicals, which may meet Shari’ah requirements, but would be unacceptable to SRI investors.

Obviously, Malaysia’s decision to regulate socially-responsible sukuk is very helpful. The fact that they have defined very clearly the types of projects that can be included and required disclosure of precisely how the proceeds of sukuk issuance will be used provides SRI investors with a high degree of assurance that they are going to get what they want. Other national regulators would do well to consider following Malaysia’s lead and perhaps the Green Sukuk Working Party has a useful role to play here. The sukuk for vaccines from the International Finance Facility for Immunisation offers investors a similar degree of assurance.

Ultimately, however, it is definitely a case of buyer beware. Unscrupulous providers in both conventional and Islamic finance will attempt to cash in on a trend that looks as though it is finally getting off the ground.