Practical analysis for investment professionals
07 October 2013

Why Isn’t There More Collaboration between Islamic Finance and SRI?

Islamic finance and the forms of finance generally referred to as sustainable and responsible investing (SRI) are yet to actively collaborate with each other. One would think that to strengthen their position in a market dominated by conventional finance, Islamic finance and SRI would be sharing their successes and failures, coming together for joint ventures, and supporting each other on issues for which they have similar views. But such collaboration has not occurred. Building bridges between the two remains an opportunity that is waiting to be seized upon by the industry leaders from the two sides.

Islamic finance and SRI share some obvious similarities in their objectives (do good; avoid harm), methods (e.g., exclusionary screening) and claims (such as emphasis on ethics). Both seem to trigger similar expectations among their proponents of being ethically different from conventional finance. They also face similar criticism of not being able to live to up to these expectations as shown by the “form versus substance” debate in Islamic finance and “greenwashing” debate in SRI. Although SRI is older and larger than Islamic finance, which is estimated between USD $1 to $2 trillion in terms of global assets, both are relatively small and growing segments.

Why then are Islamic finance and SRI not actively collaborating? Some apparent reasons are different countries of concentration, differences in target markets, preoccupation with their own growth, perception and reputational concerns, cultural barriers, lack of initiative by industry leaders, and simply insufficient understanding of each other. But in the absence of  survey data, it is difficult to get to the bottom of this lack of collaboration.

Islamic finance is practiced by international financial institutions offering conventional finance, such as HSBC. It has also drawn increasing interest from other international organizations, such as the World Bank, which has organized an annual conference with the Islamic standard setter, Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). Similarly, many conventional financial institutions are active in SRI. For instance, Goldman Sachs has participated in the first social impact bond in the United States, it has its 10,000 Women initiative, and its asset management arm is a signatory to UN Principles for Responsible Investment. If both Islamic finance and SRI can work with the leading and sometimes controversial faces of conventional finance, why can’t they work with each other?

At times, we do observe financial products that meet some traditional Islamic and modern environmental, social, and governance (ESG) criteria. For instance, the Sustainable Resources Fund, which was launched in 2012, invests in a mix of agro-forestry, land, and sustainable agricultural sectors, and it is supposed to appeal to both Islamic and “green” investors. Similarly, there are increasing news reports about green sukuk — Islamic financial certificates that are also environmentally friendly —
and just last year an Australian solar company tapped the huge Islamic finance market to fund projects in Indonesia. Other earlier examples include the Dow Jones Islamic Sustainability Index introduced in 2006. Nonetheless, such examples remain rare.

The fields’ general lack of interaction can also be observed in professional education. For instance, the curricula for the Sustainable Investment Professional Certification Program (offered by the John Molson School of Business) and the Islamic Finance Qualification (offered by the Chartered Institute for Securities & Investment) have limited, if any, content about each other.

The same trend is observed in industry reports, even in a country like the United Kingdom, which is home to both SRI and Islamic finance. For instance, a 2012 report on Islamic finance by TheCityUK does not talk about other forms of ethical finance, and the UK Sustainable Investment and Finance Association’s annual review does not talk about Islamic finance. Unsurprisingly, one sees the same trend of lack of interaction in industry conferences in Islamic finance and SRI.

There are, of course, differences between Islamic finance and SRI. One significant difference is that the concerns about Islamic finance go beyond the purpose of financing and also cover its structure. This is because of Islamic prohibitions of riba and excessive gharar, which are generally interpreted to include lending money on interest and the trading of risk. Also, the exclusionary screening applied in Islamic finance goes beyond the usual suspects (such as alcohol, tobacco, and gambling) and covers conventional financial services because of prohibition of riba. However, the current form-oriented and legalistic compliance in Islamic finance that often has little effect on economic substance of transactions suggests that these prohibitions cannot explain the lack of collaboration with SRI.

Recently, we had two experts, one on Islamic finance and one on impact investing, at CFA Institute Middle East Investment Conference. Speaking on Islamic finance in the global economy, Ibrahim Warde, professor at Tufts University, was clear that offering social value ought to be a part of Islamic finance. Talking about impact investing, Harry Hummels, professor at Maastricht University and a European liaison for Global Impact Investing Network (GIIN), said that it is intending and measuring a positive impact on society that defines impact investment, and by implication Islamic finance could be structured as impact investing. Listening to Warde and Hummels reinforced the idea that there is room for collaboration between Islamic finance and SRI, and at the core of expectations from them is the desire to see finance making a positive difference for society.

In London this month, there are two significant events planned: one on impact investing and the other on Islamic finance. First is the GIIN Investor Forum on 10–11 Oct, to be held in partnership by the Global Impact Investing Network and the City of London Corporation (which also has an Islamic finance secretariat). Second is the World Islamic Economic Forum on 29–31 October, a mega Islamic finance event that will be hosted in a country without a Muslim majority for the first time. At this stage, the most likely scenario is that the two events will take place independently of each other with no planned interaction. Had Islamic finance and SRI actively collaborated, then these two events in London could have been a golden opportunity for further collaboration between and growth in both fields.

With so much in common between Islamic finance and SRI, and so much to gain from active collaboration with each other, bringing the two sides together is an opportunity waiting to be taken up by the leaders from the two sides. Let’s see if this opportunity will indeed be realized, who those leaders will be, and most importantly what gains will be brought about by active collaboration.


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
Usman Hayat, CFA

Usman Hayat writes about sustainable, responsible, and impact investing and Islamic finance. He is the lead author of "Environmental, Social, and Governance Issues in Investing: A Guide for Investment Professionals," and the literature review, "Islamic Finance: Ethics, Concepts, Practice." He is interested in online learning and has directed three e-courses for CFA Institute: "ESG-100," "Islamic Finance Quiz," and "Residual Income Equity Valuation." The other topics he writes about are macroeconomics and behavioral finance. Previously, he was a content director at CFA Institute. He is a former executive director at the Securities and Exchange Commission of Pakistan (SECP). He has experience working in securities regulation and as an independent consultant. His qualifications include the CFA charter, the FRM designation, an MBA, and an MA in Development Economics. His personal interests are reading and hiking.

7 thoughts on “Why Isn’t There More Collaboration between Islamic Finance and SRI?”

  1. Serban says:

    Hi Usman,
    You have highlighted very interesting links here that have not been much investigated so far (at least to my knowledge). I imagine that there must be great potential for Islamic banking to finance sustainable development projects and good compatibility matches particularly from an ethical perspective. One aspect which would probably deserve further attention is the distinction between private banking and public finance (including government monetary policies) within the Islamic finance world, and how these two could link up in fostering investments based on robust ESG criteria.
    Thanks
    Serban

    1. Serban

      Thank you for your thoughtful comment. Yes, many observers are emphasizing the need to use ESG criteria in Islamic finance. Public finance is probably a less explored area in Islamic finance as the sector is largely made up of commercial banking.

  2. Adil Mansoor says:

    just a thought..
    maybe lack of collaboration between the two indicates that they’re competing against each other within the same limited space?

    1. Adil Mansoor,

      Thanks for the comment. In my view, so far Islamic finance and SRI are competing in largely different market segments with mainstream finance rather than with each other.

  3. assalam o alaekum mr usman hayat i would like to ask some questions if u allow

  4. Hamzah AL-khrasani says:

    Do you think the recent introduction of SRI SUKUK in malaysia will bridge the gap between these two markets?

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