Amanjit Fagura and Tomisin Mosuro, Morgan Lewis

It has been reported that some asset managers in the Gulf Cooperation Council expect stronger inflows amid growing demand for environmental, social and governance and Islamic-compliant investments. The rise in the global popularity of ESG investing presents a unique chance for investors, asset managers and banks in the GCC to offer more ‘green’ Islamic investment products to attract and obtain investment from a broader pool of potential investors that seek to invest in ESG-compliant opportunities.

With the GCC’s significant pool of liquidity and the global popularity of ESG investing, the coming years could see an increase in ESG and sharia-compliant products.

How does sharia-compliant investment work?

Compliance with sharia or Islamic law and the principles of Islam rests on certain moral factors. These include guiding principles whereby, for example, wealth must be generated from legitimate trade and asset-based investments – therefore the concept of using money to make money is forbidden. Lending money with the intention to receive interest (riba), contracts with excessive uncertainty (gharar), and certain activities that are deemed harmful (haram) are also forbidden.

While sharia principles are not codified, they guide how an investment needs to be structured to be considered sharia compliant, or whether an investment can be made at all. Such investments may also involve a sharia board or adviser that has been appointed to oversee the investment at hand, without whom an investment would not be deemed ‘compliant’.

Are there similarities between ESG and Islamic investments?

In short, ESG investing and Islamic investments may be united in one investment opportunity, given that they are both guided by principles of morality, transparency and fairness. Hence, it is possible for an investment to be both sharia compliant and ESG compliant. For example, an ESG investor may screen and eliminate companies that are involved in gambling or alcohol, on the basis that such companies do not create a positive social and environmental impact. A sharia-compliant investor would do the same on the basis that such activities are contrary to the principles of Islam (haram).

However, notwithstanding certain similarities between ESG investing and Islamic investing, it should be noted that it is possible for an investment to qualify as an ESG investment, but not be sharia-compliant, and vice versa. For example, an investment in a solar farm project that is highly leveraged may be a sound ESG investment, but would not be sharia compliant due to the prohibition on riba. Similarly, a sharia-compliant sale-leaseback financing for a coal-powered power plant would likely be sharia compliant, but would not be appropriate as an ESG investment.

Therefore, there are limitations on the synergies that can be achieved in this space. That said, it is worth noting that the relevance and growth of ESG principles in investment more generally has captured the attention of the global business community, particularly during the pandemic years. The GCC has taken heed of this. Similarly, sharia-compliant investing has also continued to grow, and the markets have witnessed the development of innovative sharia-compliant structures that align with ESG principles.

For example, in March 2021, the Islamic Development Bank in the Kingdom of Saudi Arabia issued its $2.5 billion sustainability sukuk. The addition of a sustainability component to a sukuk offering attracted socially responsible investors, which were outside the traditional sukuk investor space, and encouraged them to seek to diversify their holdings and participate in such offerings.

What does the future hold?

ESG investing continues to make strides, globally as well as regionally. Additionally, sharia-compliant investments continue to grow, despite the challenges faced of late in the global economy. That said, as outlined above, the concepts of ESG and sharia compliance do not always align and, as such, the types of potential investments available in the GCC and wider afield may be limited until additional structures and products are developed and/or relaxation takes places with regards to sharia compliance tolerance levels themselves.

The authors are partner Amanjit Fagura and associate Tomisin Mosuro of global law firm Morgan Lewis. Paralegal Samia Mechernene also contributed to this article