Shariah in the spotlight II: How to be environmentally friendly and socially responsible under Shariah law

Islamic Finance

By Emily Fuller, Deborah Low, Ellen McGinnis and Emma Russell, Haynes and Boone – Environmentally friendly investment guidelines have come to the fore recently due to increased focus on climate change and governmental action aimed at protecting our planet. With heightened focus on the economic impact and carbon footprint of corporations and industries, investors have an increased appetite to invest capital in sustainable projects such as renewable energy research, and development or real estate and infrastructure projects that seek to minimize environmental impact through sustainable construction.

At the same time, investors are also less inclined to invest in projects that are seen as harmful to the environment, such as coal power or development projects that displace or disrupt existing communities or green spaces. This shift in investor mindset, along with new regulation on many industries, has led investment funds to look for environmentally friendly investment opportunities in order to cater to investor demand and attract investors during the fundraising process.

The desire to make investments that promote sustainability closely correlates to the concept of stewardship under Shariah law, which states that humankind holds all property (including the Earth) in trust for God, and therefore, looking after the planet is humankind’s duty in its role as ‘trustee’. As a general rule, investing in compliance with Shariah law seeks to avoid causing harm, whether that is to others or the environment and, Islamic economics looks to efficiently allocate resources, with the aim of avoiding waste.

A fundamental principle of stewardship is protecting the environment and therefore, Islamic financial institutions are consciously incorporating climate concerns into products. One example of this is the Islamic Development Bank, a large financial institution located in Saudi Arabia, which operates akin to a central bank for other Islamic financial institutions. It announced in November 2019 that it would be issuing green sukuks (Islamic financial certificates which operate similarly to bonds) to invest in environmentally friendly projects. 

Unlike traditional government or corporate debt bonds, sukuks are backed by tangible (Shariah-compliant) assets and each certificate issued represents a portion of that holder’s ownership in the underlying asset. As such, any proceeds received by a sukuk holder represents a return on that asset. It is worth noting that non-Shariah-compliant corporations can issue sukuks, as long as the sukuk itself is in compliance with Shariah law (and indeed the UK government issued a sukuk in 2014). Additionally, in the third quarter of 2020, Saudi Electricity Company also issued a green sukuk at a value of USD1.3billion, the proceeds of which will be used to finance green projects relating to energy efficiency and renewable energy. 

Social responsibility is not only integral to ESG but also goes right to the heart of the purpose of Shariah law, which prohibits practices that can be harmful to society. One of the main prohibitions that underpins Shariah law is the prohibition of the assessment of interest (‘riba’). 

The prohibition of riba is founded in the belief that making money from money disconnects the economy from real assets driving economic growth and allows debt to grow at a faster pace than wealth. This imbalance can ultimately lead to social and economic inequality and create financial hardship for borrowers. An extreme example would be how high-yield pay-day loans can spiral and leave the debtor in a much worse position than they were originally in when they needed the initial loan.

Additionally, in order to ensure that wealth flows down to the neediest in society, Shariah law contains a number of mandatory and voluntary charitable obligations, such as ‘Zakat’, the concept of mandatory almsgiving under Shariah law. Zakat is driven by the belief that wealth should benefit society as a whole and is levied at 2.5 per cent on a person’s idle wealth above a certain threshold, ‘nisab’.

An Islamic financial institution may be required to pay Zakat by law, depending upon the jurisdiction for example, Zakat is mandatory by state law in Malaysia and Sudan, its own constitutional documents, or shareholder pressure. An Islamic financial institution will be responsible for calculating how much Zakat is payable by each shareholder and can either pay this on behalf of its shareholders or inform the shareholders how much Zakat is payable by them in relation to their returns.

Finally, similar to the “S” component in ESG, Shariah law mandates that compliant investors not invest in certain prohibited, or ‘haram’, industries. Haram products and industries will include those that harm society and endanger human health or life, such as investments in companies that produce tobacco or weapons.

While few other jurisdictions or laws mandate required charitable giving for entities not subject to Shariah law, engagement with community projects and robust donations to non-profit organisations have long been viewed as good business practice for for-profit organisations and can bring positive results from a public relations and brand recognition standpoint.

The social component of ESG is forcing companies to take these concepts a step forward and incorporate ideas of social well-being into their investment plans. Investing in accordance with socially responsible guidelines may mean avoiding certain industries that can be damaging to society, or actively investing in companies which support community projects or promote equality.

Conceptually, by investing capital in companies with proven track records on diversity or projects and technologies that support the community, such as education, sustainable housing, small businesses or access to resources, investors can expand the overall health and wealth of a community, thereby providing long term benefits such as boosting the economy, expanding the pool of qualified employees in the work force and fostering innovation that will improve quality of life.