Jamal Arif Jamaludin
The notion of Islamic Finance is often characterized by financial activities that are guided by Shariah principles (Islamic Law). The growth of Islamic Finance has blossomed in recent years and is expected to reach a size of US$3.4 Trillion at the end of 2018. Despite the admirable growth, some posit that Islamic Finance has recently paid more focus on the compliance of transactions rather than promoting financial activities that are derived directly from the Sharia principles. It propounds that Islamic Finance is merely imitating its conventional counterpart, providing similar services that have been reworked to comply with Shariah.
It beckons the question of whether the move to imitate its larger counterpart is strategic despite given the nascent development. Albeit being a second mover, the potential information uncovered from observing the innovations by others could allow more rapid development of offerings that are able to take advantage of potential synergies in the market, establishing a strong relevance of Islamic Finance in that space. Conversely, should the Islamic Financial Industry attempt a more innovative approach by offering innovative products with a new value proposition to set itself apart from the competition?
A Sustainable Future
There has been ample literature studying the relationship of Islamic Finance to its Conventional counterpart. However, a gap exists in understanding the strategic relationship of Islamic Finance and its conventional counterpart in creating value propositions and the potential synergies shared between the two realms. Here we will attempt to contribute to the discussion by observing both financial realms towards promoting sustainable finance and attempts to convey a rudimentary understanding of the underlying nature of the relationship. The scope of observation is limited to the field of sustainable finance as it is an increasingly pertinent field in both financial systems and provides a suitable foreground which will allow vis-a-vis qualitative comparison of the two realms.
The market for green and sustainable products has been garnering attention despite its nascent stage of development. In the wake of the 2008 financial crisis, investors were increasingly concerned about the ethical implications of their investments. Moreover, the burgeoning effects of global warming have scaled up to a level that has become an imperative concern. The effects of global warming can be felt around the world, the recent typhoons that brought devastation to Philippines, Hurricanes and wildfires in the United States, and a series of earthquakes that rocked the Island of Bali- leading up to the annual Institute of International Finance meeting. In addition, the relevance of sustainable finance is further bolstered by the changing characteristics of investor, as millennials slowly succeed their predecessors. Millennial investors have been brought up in an environment shaped by multiple financial crises, climate disasters, and ongoing conflict which they have been exposed through digital social networks in comparison to their outgoing counterparts. These new waves of investors that take into consideration the sustainability and ethical implications of their investment decisions are growing which will influence the market landscape.
An Ethical System
The existing process of ethical finance, a subset of Conventional finance, and Islamic Finance seek to exclude business activities that do not align with investors’ political, ethical, personal, and religious views. However, despite the coherent goal of achieving a sustainable financial system, the two do not share a common approach. The Conventional approach merely aligns its practices to the social norms and trends that are deemed ethical in today’s society. Ethical Finance has been argued to be vast with a lack of definition. In relation, there have been multiple acronyms thrown around and used interchangeably. The most notable are Socially Responsible Investing (SRI) and Environmental, Social, Governance (ESG). However, ‘ethics’ itself is difficult to define in conventional businesses. Ethical investing practices may encompass views that are beyond religion such as social and political ideals. Thus, not everything that is deemed ethical is acceptable in religion.
On the other hand, Islamic Finance packages involve some specific screening requirements such as vulgar entertainment, and dividend purification that is unique relative to ethical finance. Due to the heightened screening, it is posited that not all ethical investments may meet the Islamic screening criteria. The criteria are guided by Shariah principles described in the Quran which touches upon a wide spectrum of items that are deemed relevant in a person’s journey through life. Pertinently, the proponents of Maqasid al-Sharia postulate that the principles should centre around the idea of preservation of religion, life, intellect, family, and wealth. The core objective of Maqasid al-Sharia is to promote positive values and prevent harm in serving society. The guide that Islam promotes permeates through the social, economic, political, and cultural aspects of life. Thus, the approach to Islamic Finance should be one that is holistic and beyond mere numbers. The role of Islamic finance should be as an intermediate. An enabler that encourages financial activities that bring value to the wider community and environment in addition to making a financial profit.
Thus, the need to define the scope of ethical finance could be provided by Islamic Finance as ethics is required of an Islamic firm, not just expected. Ethics are considered a key element for Islamic Financial practice. The tie between religion and ethics has been extensively studied by a cross-religious group from the three major monotheistic religions (Christianity, Islam and Judaism). Further to the Observatoire de la Finance, a very restrictive way to describe it would be as an “umbrella concept” for a philosophy of investing based on a combination of financial, social, environmental and sustainability criteria. All transactions in an Islamic Financial system are governed by norms of Islamic ethics as pronounced by the Sharia, in essence following the Maqasid al-Shariah. Arguably, the Islamic Financial system is, in itself, an ethical system. Thus, there should not be elements of Islamic Finance that do not comply with ethical principles because the principles of Islamic Finance are fundamentally ethical.
The coexistence of two approaches to Sustainability will culminate to a moment that the two industry approaches either converge or shift to a dominant system. This will be dictated by market forces and investor preferences. Thus, it is imperative to deepen the study of Sharia in order to better serve the perimeters of sustainable products. Concurrently, it addresses the requirements of ethical investors whilst fulfilling the Maqasid al-Sharia. Moving forward, it is suggested Islamic Finance broadens its investment portfolio by inculcating the overlapping core values of ethical finance. There are positive trends in Islamic incorporating ethical nuances, mainly in the field of Sukuk. In 2014, the World Bank Treasury was instrumental in tying the Islamic and ethical markets together through its support of a US$500 million Sukuk facility from the International Finance Facility for Immunization (IFFIm), bringing the concept of socially responsible investing to the Sukuk market.
To summarise, the study of competitive dynamics in the realm of business strategy posits that market participants can either innovate or imitate a competitor’s offerings to either gain or defend market share. The lack of conclusive evidence on an industrial level interaction to posit this relationship prevents it from arriving at a definitive conclusion about the relationships between two financial systems. It is suggested that, assuming the dynamics between two businesses are the same as two systems, that the competitive advantage of the conventional realm’s ethical finance could be blunted through imitation, in which a similar shariah compliant package is offered.
Therefore, understanding the scope of other ethical financial frameworks such as SRI is pivotal for Islamic Finance to match the segment opportunity available in this space. It is worth noting that the role of innovation with the ultimate goal of adding value that is consistent with the Maqasid al-Shariah will allow the Islamic Finance industry to better serve all customers as the teachings of Islam have incorporated ethical principles.