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Friday, September 30, 2022

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Islamic vantage point of ESG investment: An eternal effort to sustain the fragile future

At the moment in 2022, the world appears to be gradually reaching an end of the COVID-19 saga. The virus may keep on mutating, but humans should collaborate together, be adaptable and be agile to mitigate the transition era within the next two decades. Environmental, social and governance (ESG) investment would play a crucial role in shaping a better world in the future. Adopting Shariah guidance, ESG investment may provide a better impact for the future, especially in the aspects of socioeconomic and bio-environment development at large. DR RIZKY WISNOENTORO delves further.

After two centuries, the current 7.95 billion global population has now seen the enlightening fact that 96 out of 100 newborn babies are able to survive their first five years of age. However, there needs to be more vigorous efforts as human civilization is still entangled by the vortex of environmental hassles and the predicaments of poverty, not to mention that humans are still very much dependent on fossil-based energy resources.

Further, research conducted by OurWorldinData.org showed that coal — which makes up 25% of global energy — results in 24.6 deaths per terawatt-hour of energy production, and 820 metric tons of CO2 emissions per gigawatt-hour of electricity over the lifecycle of a power plant. In second place is oil — which makes up 31% of global energy — which results in 18.4 deaths per terawatt-hour of energy production, and 720 metric tons of CO2 emissions per gigawatt-hour of electricity over the lifecycle of a power plant.

With regards to the socioeconomic poverty problem, the study also showed that prior to the COVID 19 outbreak, only 15% of the world’s population has an income of more than US$30 per day. According to the International Labour Organization and the World Bank, 255 million jobs were lost and 97 million people are in poverty because of the global COVID-19 outbreak in 2020.

As a scholar in sustainability, and as a Muslim, allow me to specifically honor the Quran Surah Al Hashr (59) Verse 18. This verse brought me to the essence of ESG: forward-looking. More than 14 centuries ago, God Almighty already provided the guidance that we need to find eternal balance between nostalgia (learning from the past) and ‘postalgia’ (projection of the future). Philosophically, in the Islamic way of eschatology, all creatures would face the ‘end’. So, like the creatures, what kind of ‘endgame’ that we humans would observe? Would it be a noble end?

The purpose, in this matter, lies at the core of human lives today to stand up strong in the future. The ‘long-termism’ objective (Niyat) to provide solutions for the entire ecosystem will be critical to sustain the fragile future. Indeed, human civilization is entering a new era of anomie. Some values in the past may not be suitable today, and future values may bring along unknown risks.

In the post-COVID-19 era, ESG investment takes the shape of a critical bridge to the new cycle of humanity. Indeed, it is interesting to delve into the facts embarked on by the media worldwide — especially Reuters — in late 2021 and early 2022. Despite the setbacks, ESG gained prominence in the global market. The US$649 billion poured into ESG-focused funds worldwide makes up 10% of global fund assets.

In the European context, 59% of the US$6.1 trillion in ESG funds is held in Europe, the Middle East and Africa. Moreover, in January–February 2022, while non-ESG stock funds recorded an inflow of US$543.56 million, ESG stock funds secured a net of US$622.28 million.

It is also interesting to observe how regulators have put ESG as one of the emerging priorities. In the US, the Securities and Exchange Commission (SEC) urges corporate disclosures on ESG, especially on carbon emission. Meanwhile, the European Commission has finalized the sustainable finance taxonomy, along with the subsequent fact that nearly 40% of EU-based assets are currently classified as sustainable.

This situation is also appearing in other countries such as Indonesia, where the government has initiated several policies regarding sustainable finance roadmaps, green bonds and green taxonomy, digital financial innovation (especially in fintech advancement), as well as digital payment systems, fiscal policies and other programs to empower SMEs initiated by the Indonesia Financial Services Authority, Bank of Indonesia and other related governmental entities.

What about the Islamic view on ESG investment? In this instance, I am intrigued by the guidance in the Maqasid Shariah to achieve Falah (well-being) embarked on by the noble scholars in Islamic jurisprudence such as Imam Al Juwaini, Imam Ibnu Al Qayyim, Imam Al Izz, Imam Al Qarafi and Imam Al Shatibi, especially the points emanated by Imam Al Ghazali that humans should preserve faith, soul, mind, offspring and wealth.

Subsequently, the prohibition of Maysir (gambling), Gharar (uncertainty) and Riba (interest) has the potential to trigger safer and sounder portfolios. Thus, it leads to the other uniqueness of Islamic ESG investments such as the types of contracts as well as the shared risks and rewards.

In 2019, a CFA Institute and UN Principles for Responsible Investment report noted that global Islamic finance assets reached US$2.05 trillion with the majority, up to 76% of global Islamic finance assets, related to Islamic banking.

Further, the second asset class of Sukuk is deemed as 5.9 times bigger than the Islamic fund market. With regards to Islamic investment funds, the most common instrument is equity funds that make up 42% of global Islamic fund assets. Moreover, the report also noted that Islamic fixed-income funds make up 10% of global Islamic fund assets.

Geographically, global Islamic finance assets are mostly located in Saudi Arabia (37.1%) and Malaysia (31.7%). It is also recorded that a significant percentage of Islamic finance assets is outside of the Middle East and Southeast Asia, especially in Ireland (8.6%), the US (5.3%) and Luxembourg (4.8%).

The sheer advancement and diversification of Islamic investment funds may also lead to another question: with the development of global trends in ESG, how should we determine that Islamic guidance is truly important for safe and sound portfolios? An ESG rating is one of the important means to apply.

In this instance, it is interesting to delve into an example featured by IFN in partnership with S&P and Dow Jones indices. Based on Dow Jones data on the 30th September 2021, a total of 299 stocks in the S&P Global 1200 Shariah Index (after screening for compliance with Shariah law) resulted in the float-adjusted market cap of US$26,035 billion. Interestingly, the ESG score for these portfolios was 69.

This signifies a promising outlook as compared with the total of 1,223 stocks in the S&P 1200 Global (non-Shariah compliant in general) with an ESG score of 62. The difference in the ESG scores may indicate the prudence of Islamic ESG investment.

It is also worth mentioning social finance, namely Zakat and Waqf. For instance, a total of US$27.52 million in Zakat funds collected by the United Nations High Commissioner for Refugees helped 584,586 refugees in 2021. Imagine how powerful the impact would be if a similar system is applied worldwide under the purpose of helping the extremely poor to recover from COVID-19 predicaments.

At this point, in the Indonesian context in 2021, I am also intrigued by the potential of Waqf assets and cash Waqf that captured a total of IDR2 quadrillion (US$139 billion) and IDR180 trillion (US$12.5 billion) respectively, especially the advancement of cash Waqf-linked Sukuk to be disbursed for socioeconomic infrastructure for the poor, including in the aspects of healthcare and SME development. Hence, it resulted in the comeback of green Sukuk to the yield of 3.55% per annum in 2021 compared with 2.3% per annum in 2020, and allocated ultimately for highly vulnerable areas and sectors.

So the main question here is: what would we face in the future? In approximately two decades, the world will generally be in a transition era. Therefore, we need more stress tests to mitigate the impending transition risks that may lead to more advanced physical and liability risks.

New procedures will be needed to mitigate the digital transformation (including digital waste and cybercrime). This comes along with the upcoming new types of investments, such as environment-friendly businesses. Also, the growth of new cultures may shift consumer behavior and market segmentation at large.

Immersive technology, in this instance, would also play a pivotal role in the advancement of virtual social capital. The new meta-reality will require serious attention for risk mitigation and business opportunities at the same time.

However, there must be greater willingness to utilize digitized platforms for financial inclusion and poverty eradication. In short, future leadership will rely on ESG-based knowledge, vision and action that can balance the nostalgia of previous values and the ‘postalgia’ of a future digitized era.

Deontologically, the system of Islamic finance is deemed as perfect guidance from God Almighty. So, it is the duty of mankind to provide evidence that this system truly has the power to empower. Further, it depends on the deportment of humans to exemplify that the Shariah system proffers a solution to the entangled vortex of bio-environment, psychological, socioeconomic and cultural aspects.

Some parts of this article were presented at the Global Islamic Investment Forum held on the 24th March 2022 in Jakarta, commenced by Badan Pengelola Keuangan Haji.

Dr Rizky Wisnoentoro is CEO and co-founder of IMPAC+, a newly established ESG rating and research company based in Jakarta. He can be contacted at [email protected]

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