Transitioning to sustainable development economies and mitigating climate change are major issues that are currently at the forefront of the global consciousness. DR BELLO LAWAL DANBATTA, the secretary-general of the Islamic Financial Services Board (IFSB), explores the role of regulatory and supervisory bodies in supporting financial institutions through this transition.
In recent years, there has been an increase in the efforts to promote more sustainable development, both within the public and the private sectors, including through the financial markets, reflecting a growing recognition of the potential economic and financial impact of climate change and environmental, governance or social risks. Accordingly, investment instruments designed to be, or labelled as, sustainable has increased significantly in recent years.
Some jurisdictions, including core Islamic finance jurisdictions, are taking policy or regulatory steps to enhance the role of the financial system in the transition toward sustainable development. There has also been increasing recognition of climate-related risks as a source of financial risk that can affect not only specific firms or sectors but more broadly the stability of the financial system. This has increased the focus by prudential regulators on these issues within their mandate of ensuring the resiliency of the financial system to material risks.
Islamic finance regulators can play a key role in the transition toward sustainable investments and a sustainable economy by promoting transparency in markets through the disclosure of material information that allows investors and market participants to identify and assess sustainability-related risks and opportunities and to make investment choices based on that information. Access to such information, when material, is fundamental for investor protection, efficient risk management and transparency. As the market for sustainable investing grows rapidly, such disclosures can become crucial for the credibility of investments that claim to pursue sustainability objectives.
These issues tie in with the IFSB’s mandate of ensuring stability and resilience in the Islamic financial services industry. Sustainability issues in general, and the more specific climate-related issues, pose important challenges in meeting this mandate, in relation to how they are applied to the unique aspects of Islamic finance, making these issues highly relevant. In particular, given that Islamic finance instruments are structured differently from conventional financial instruments, and the additional layers of governance involved in Islamic finance, there is a need for identifying how principles related to sustainability apply to the peculiarities of Islamic finance.
With its real economy approach to financing, Islamic finance provides a strong proposition as a solution for achieving commitments under the climate change agreements as well as the UN SDGs. The principles of Shariah impose a positive obligation of enhancing welfare and preventing harm. This includes environmental stewardship and conservation, protection of human health and welfare, and economic inclusion. Accordingly, Islamic finance has embraced the trend toward sustainable investing, including increasing green and social Sukuk issuances by several originators both public and corporate as well as sustainability-related Islamic funds in some jurisdictions.
International guidance, or common frameworks on application of sustainable finance principles such as the work being done by the International Sustainability Standards Board (ISSB), can support the integrity of sustainable finance in Islamic finance. The IFSB’s ongoing work in this area seeks to complement the work of the ISSB by recognizing the specific structural differences between the Islamic financial services industry and the conventional market. Adequately addressing the gaps in Islamic finance that are not addressed within conventional frameworks is important in encouraging the growth of sustainability-related Islamic finance products and providing the necessary confidence to the markets in Shariah compliant Islamic financing mechanisms.
The principles and recommendations for sustainable finance in the conventional market provide a relevant starting point for sustainable Islamic finance. However, although the conventional principles provide a baseline of procedures, there are Islamic finance-specific elements that warrant a separate set of procedural guidance. For example, one difference in procedures relevant to a green Sukuk offering is the requirement for Shariah opinion on the elements of the issuance. Another difference is the nuanced structural requirements of various forms of Sukuk instruments, including the role of trustees. There are other issues, such as the relationship between the underlying assets and the use of proceeds. For example, underlying assets that are detrimental to the environment cannot be used to fund a “green” project. The variety of configurations for sustainable Islamic finance instruments, as well as the different purposes for which the instruments are used, presents the need for a set of consistent procedural guidelines for sustainability-related practices and disclosures for Islamic finance.
The IFSB’s standard-setting work in this respect aims to provide guidance and highlight best practices sustainability-related issues specific to the Islamic finance by providing guidance on unique sustainability-related issues, including regulatory and supervisory issues related to governance and structural differences in Islamic finance; providing guidance on sustainability-related disclosures requirements specific to Islamic finance; and promoting the harmonization of sustainability-related regulation and supervision across Islamic finance jurisdictions.