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The ESG potential of Islamic finance

Susannah Hammond  Senior Regulatory Intelligence Expert

Susannah Hammond  Senior Regulatory Intelligence Expert

Financial service firms wishing to burnish their ESG offerings and promote sustainability with their clients may want to look into Islamic finance opportunities

It is fair to say that the internationally agreed shift towards environmental, social, and governance (ESG) issues is showing signs of strain resulting from an uneven global approach, the war in Ukraine, and increasing economic challenges.

Towards the end of 2021 the sense was that there was a defined direction of travel for all things ESG coming out of the COP26 meeting in Glasgow. The International Sustainability Standards Board had put forward its thinking on disclosure and reporting requirements; and the world, financial services firms in particular, was gearing up to meet the emerging expectations and requirements with the road to “net zero” looking relatively clear.

Since then, the world has shifted. The war in Ukraine, the resulting sanctions imposed on Russia, and the associated impact on the world’s energy supplies, increasing economic and supply chain issues, together with fines being imposed for greenwashing, and jurisdictions taking potentially distinctly different approaches to climate risk legislation have all increased the challenges around ESG.

One possible strategic solution for firms seeking to build their sustainability and ESG approach is to consider the potential offered by Islamic finance. Not every financial services firm is going to choose to consider Islamic finance as a strategic opportunity, of course, but it is an area with substantial global potential both in terms of growth and in its “green” credentials. It is also one in which risk and compliance functions would be required to play a critical role.

Islamic finance is underpinned by Sharia law with the Islamic economic model emphasizing fairness. There is, for instance, a requirement that everyone involved in a transaction makes informed decisions and is not misled or cheated. On a macro-level, the Islamic model aims at social justice and prosperity for all — there are specific Sharia rulings that seek to reduce the concentration of wealth in a few hands that may be detrimental to society.

Many people know what Islamic finance does not permit such as riba, usually defined as usuary or interest; and gharar, which is undue uncertainty — and that’s before the prohibitions on alcohol, pork products, armaments, and gambling.

Sharia scholars are required to approve Islamic finance products probably the most well-known of which are sukuk, the Islamic finance equivalent of bonds; and takaful, the Islamic finance equivalent of insurance. While Sharia scholars do not necessarily always agree with each other, the guiding principle is that of risk- and profit- (or indeed loss-) sharing together with contractual certainty.


“But it also goes deeper – because the core principles of Islamic finance are strikingly well suited to responding to some of the biggest challenges we will all face in rebuilding our economy once Covid has passed. Prioritizing equity-like risk-sharing over debt. Factoring ethical and environmental considerations into investment decisions. And embracing innovative financial solutions beyond traditional banking.”

Andrew Hauser, executive director of the Bank of England, in a speech to announce the launch date for the new Sharia-compliant, non-interest-based deposit facility, the first such account from a Western central bank (December 2020)


Islamic finance predominates where there are large Muslim populations, but jurisdictions such as the United Kingdom are seeking to be a global hub for Islamic finance. This is not only because the UK has a relatively large Muslim community (estimated at around 3% of the population), but also due to the consistently high-growth rate in Islamic finance combined with London being one of the world’s leading financial centers.

Islamic finance is small compared to conventional finance but is growing fast, Here are a few facts and figures:

      • According to the Cambridge Institute of Islamic Finance, the assets under management of Islamic banking and financial institutions around the world in 2021 were more than US$2.7 trillion — small compared to estimated global financial services assets of US$500 trillion but still substantial.
      • The average annual growth rate of the industry over the last 10 years is 11.7%, according to the Cambridge Institute, as the industry remained bank-centric with three-quarters of global Islamic financial assets held by banks.
      • According to Refinitiv, 2021 was a strong year for sukuk (bonds) with more than US$185 billion worth of issuance. There was also growth in sustainability and green-themed sukuk with that marketplace reaching US$15 billion.
      • Also on the sukuk front, the UK government returned to the market in 2021, with a US$500 million 5-year sukuk issuance, double the previous offering in 2014.

Islamic finance has much to recommend it with its high-growth rate and inherent alignment with ESG. That said, it is not an area to be entered into lightly, and firms will need to consider carefully the potential strategic opportunity and the resources (risk and compliance in particular) which would need to be devoted to making the opportunity a success.

Among the issues which would require detailed consideration is the nature of the products themselves and how, in practical terms, to combine conventional and Islamic finance methods. Firms would potentially need to get better understand the use of Islamic finance windows, the interpretation of deposit guarantee schemes in a regime where losses (as well as profits) are shared, the need for parallel governance structures including a Sharia board, and the segregation of conventional and Islamic assets.

Islamic finance is a long-term investment for firms but could well be an extremely useful way of diversifying both risk and income streams as well as a way of entering a high-growth marketplace with longstanding ESG credentials.


In the ninth episode of season 4 of the Compliance Clarified podcast, Susannah Hammond is joined by Lindsey Rogerson to take a look at look at all things Islamic finance. (The Compliance Clarified podcast is available on GoogleApple, and Spotify.)

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