Malaysia – The Intersection of ESG And Islamic Banking Principles.

Introduction 

In today’s rapidly evolving world, businesses are no longer judged solely by their profits. Increasingly, investors, consumers and stakeholders are looking at how companies manage their environmental impact, social responsibility, and governance practices. This shift in focus has given rise to the concept of “ESG” — Environmental, Social and Governance criteria — shaping how businesses operate and influence the global economy. The finance sector, including banks, has also embraced this shift in recognizing the importance of ESG in driving sustainable growth. In parallel, Islamic banking principles with their focus on ethical investments, social justice and risk-sharing, align closely with ESG values, further bridging the gap between traditional finance and sustainable and responsible business practices. 

Building on this, this article will explore the intersection of ESG and Islamic banking principles, examining how these two (2) frameworks can complement each other in fostering more sustainable and ethical financial practices. 

ESG and Islamic Banking: Principles and Common Ground 

While the term itself was first coined in 2004 by the United Nations Global Compact, the principles of ESG have been shaping corporate behavior for decades.[1] ESG refers to the three (3) factors used to assess the sustainability and ethical impact of an investment in a company. The environmental factor focuses on encouraging efforts to mitigate climate change and reduce carbon emissions, manage pollution and waste generated during the production process, use energy and water efficiently and on biodiversity and deforestation.[2] The social factor examines the relationship between the company and its people and connections, while the governance factor looks into the running of a company.[3] 

As the global recognition of ESG grows, companies are incorporating ESG practices into their operations and decision-making process. Malaysia has emerged as one of the leading nations actively promoting and enforcing ESG principles. The nation’s efforts could be seen through various initiatives. For example, Bursa Malaysia had introduced a new Sustainability Framework in October 2015 that included changes to the Listing Requirements and a Sustainable Reporting Guide to assist public listed companies in improving their sustainability-related disclosures to satisfy the changing information needs of stakeholders.[4] Following the introduction to the framework, the Securities Commission (“SC”) had developed the Sustainable and Responsible Investment (“SRI”) Roadmap that introduced the five (5) strategies in the application of SRI[5] and to date, Bank Negara Malaysia has set an expectation that at least half of the financing issued by the banks must be related to climate-supporting or transitioning initiatives by 2026 as part of the Financial Sector Blueprint.[6] 

As ESG principles begin to integrate into the finance sector, the alignment between these practices and Islamic banking principles becomes increasingly evident. Islamic banking principles are derived from the Quran and the Sunnah, which subsequently led to the establishment of the Maqasid Shari’ah, where the ultimate goal of the Islamic banking sector is to execute the Maqasid Shari’ah in its highest level of integrity, especially in the compliance division.[7] Maqasid Shari’ah refers to the objectives or intents of Shari’ah. The main aim is to protect and promote the well-being of individuals and the society. The five (5) key areas that Maqasid Shari’ah focuses on are the protection of faith, life, mind, lineage, and property. It is believed that Maqasid Shari’ah and its goals are vital for the continuity of life and spiritual wellbeing; disobeying the principles would disrupt the regular operation of the society.[8] Therefore, Islamic banking as a significant part of Islamic finance not only provides financial products and services that comply with Shari’ah, it must also be able to advance the common good by prioritising the common good over individual interests and profit maximisation. Consequently, Islamic finance prohibits investments in haram (forbidden) activities, such as gambling, alcohol, and tobacco. In other words, Islamic finance encourages ethical business practices and social responsibility. 

Following the above discussion, it is evident that ESG is founded on the same core principles as Islamic finance. Its common concept of being accountable to society and the environment has allowed its seamless integration into Islamic finance. 

Synergies of ESG and Islamic Banking 

The alignment between ESG principles and Islamic banking is rooted in their shared commitment to promoting ethical practices, sustainability, and social responsibility. This has made them a natural ally in creating a more responsible and inclusive financial system. The synergy between ESG and Islamic banking offers a powerful foundation for sustainable development and positive societal impact. 

The synergy between ESG and Islamic banking is evident in the concept of fixed income investing and sukuk. Conventional bonds are prohibited under Islamic law as they pay riba’ and are used as vehicles of debt trade, where the issuer is selling current for future money.[9] Following this, corporate and sovereign issuers have shifted to offering sukuk which is an Islamic bond option that complies with Shari’ah. A sukuk is an Islamic debt instrument where certificates will be sold to investors and the proceeds will be used by the issuers to purchase assets and investors will receive a portion of ownership in the assets. Malaysia had led the world in the issuance of the SRI sukuk when we became the first nation to issue a green SRI sukuk in 2017 to finance the construction of solar photovoltaic power plants. The emergence of SRI sukuk has proven that it is possible to integrate green bonds with Shari’ah principles to finance environmentally friendly projects and subsequently reduce the risk of climate change.[10] This is similar to how investors may apply ESG integration strategies to find ESG risks that could have a negative impact on bond yields and portfolio returns by affecting issuers’ creditworthiness.[11] The emergence of sukuk has led to events such as where the governments of Malaysia and Indonesia had issued ESG-linked sukuk throughout 2020 and 2021[12] and subsequently, Quantum Solar Park Malaysia Sdn Bhd had launched the world’s largest green SRI sukuk.[13] These commendable achievements demonstrate how sustainability and Islamic finance are increasingly overlapping. 

In addition to the above, the synergy can also be observed in impact investing. Impact investing is the act of investing with the explicit intention to create and measure social and environmental benefits when giving financial returns.[14] According to the Global Impact Investing Network, the concept of impact investing has four (4) core characteristics: (i) to have a social and/or environmental impact, (ii) the usage of evidence and available data to drive investment design, (iii) investments management through receiving feedback and observing performance, and (iv) the usage of shared industry terms, conventions, and indicators.[15] Islamic finance is a principle-based investment approach that emphasises shared rewards, the use of tangible underlying assets, and the avoidance of investing in haram activities or items.[16] This approach ensures compliance with Islamic principles and promotes the stability and sustainability of investments. It can be viewed as a long-term, low-volatility strategy that reduces risk, appealing to all types of investors.[17] ESG investing shares a similar focus on long-term risk reduction, with a comprehensive set of impact metrics aimed at minimising harm where investors will observe the environmental factors such as the impact of its investments towards carbon emissions, pollution, biodiversity and waste management, as well as social factors such as the compliance of the investors on labour standards. Investors will also observe the governance component of ESG which addresses oversight, accountability, executive compensation, and political lobbying.  In the context of Islamic finance in Malaysia, transparency and reporting are crucial to ensure that Islamic finance investments have the desired social and environmental impact. Clear disclosure of product details, including assets, profit-sharing ratios, and risk management techniques is required under Shari’ah compliance. The standardisation of ESG reporting, independent audits, and improved disclosure of project selection will help to ensure that Islamic finance investments will be able to provide a positive impact on the environment, which is central to the goal of impact investing. 

Following the above, it is undeniable that the rise of Shari’ah-compliant ESG investment products, such as sukuk and impact investing initiatives reflects a natural synergy between the Islamic banking principles and ESG principles. As the two (2) principles share a common foundation, it has evidently led to the creation of guidelines for ethical business and investing activities. 

Conclusion 

In conclusion, the intersection of ESG and Islamic banking principles highlights a powerful synergy rooted in shared values of ethical responsibility, sustainability and social justice. Both frameworks prioritise the well-being of individuals and society, ensuring that business practices do not only generate profit but also promote positive environmental and social outcomes. As seen in the rise of Shari’ah compliant financial products like sukuk and the alignment of Islamic finance with ESG standards, these systems are increasingly integrated, offering a compelling model for responsible and sustainable finance. By combining the ethical foundations of Islamic banking with the comprehensive impact metrics of ESG, businesses and investors can contribute to a more inclusive, sustainable and ethically-driven global economy. This convergence represents a promising pathway towards achieving long-term financial stability, societal welfare, and environmental sustainability. 

For further information, please contact:

Ahmad Syahir Yahya, Partner, Azmi & Associates

syahir@azmilaw.com

1. Tom Krantz., ‘The history of ESG: A journey towards sustainable investing’ (IBM, 8 February 2024) <https://www.ibm.com/think/topics/environmental-social-and-governance-history> accessed 4 February 2025. 

2. Siti Hirdayu Mohd Radzi, Nadiah Abd Hamid & Rina Fadhilah Ismail, ‘An Overview of Environmental, Governance & Social (ESG) and Company Performance’ (2023) International Conference in Technology, Humanities and Management 2357-1330 <https://doi.org/10.15405/epsbs.2023.11.90> accessed 5 February 2025. 

3. Refer to footnote 2 above 

4. Law, A, ‘Sustainability Reporting: Meeting the Evolving Information Needs of Stakeholders’ (Crowe) <https://www.crowe.com/my/insights/sustainability-reporting#:~:text=In%20October%202015%2C%20Bursa%20Malaysia,evolving%20information%20needs%20of%20stakeholders> accessed 5 February 2025. 

5. Prof. Dr. Mohamad Akram Laldin, ‘Islamic Finance and Sustainable Development Instruments in the Light of Maqasid Shariah’, International Shariah Research Academy for Islamic Finance <chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.bursamalaysia.com/sites/5bb54be15f36ca0af339077a/content_entry617bfd2839fba20f54a06574/61935ffb39fba205220c5754/files/ISRA___Islamic_Finance_and_Sustainable_Development_Instruments_In_The_Light_of_Maqasid_Shariah.pdf?1637111189> accessed 6 February 2025. 

6. Fintech News Malaysia, ‘BNM Sets Ambitious Climate Financing Goal by 2026, RM200 Billion Pledged to ESG’ (Fintech News, 23 October 2023) <https://fintechnews.my/40521/various/bnm-sets-ambitious-climate-financing-goal-by-2026-rm200-billion-pledged-to-esg/#:~:text=Various-,BNM%20Sets%20Ambitious%20Climate%20Financing%20Goal%20by,RM200%20Billion%20Pledged%20to%20ESG&text=Bank%20Negara%20Malaysia%20(BNM)%20expects,of%20the%20Financial%20Sector%20Blueprint.> accessed 5 February 2025. 

7. Siti Fariha Muhamad, ‘Measuring Sustainable Performance of Islamic Banks: Integrating the principles of Environmental, Social and Governance (ESG) and Maqasid Shari’ah’ (2022) 4th International Conference on Tropical Resources and Sustainable Sciences 2022 <doi:10.1088/1755-1315/1102/1/012080> accessed 5 February 2025. 

8. Refer to footnote 6 above. 

9. CFA Institute, ‘ESG Integration and Islamic Finance: Complementary Investment Approaches. Principle for Responsible Finance’ (2019) <https://www.unpri.org/download?ac=9578> accessed 6 February 2025. 

10. Tabassum Riaz, Aslam Izah Selamat, Normaziah Mohd Nor & Ahmad Fahmi Sheikh Hassan, ‘Do Investors Get Benefits From Corporate Green Sukuk Issuance’ (2024) Journal of Islamic Monetary Economics and Finance, Vol. 10, No. 3 (2024), pp. 445 – 470. 

11. Refer to footnote 8 above. 

12. Refer to footnote 6 above. 

13. Refer to footnote 5 above. 

14. CFA Institute, ‘Sustainable, Responsible and Impact Investing and Islamic Finance: Similarities and Differences. CFA Institute’ (2019) <https://www.cfainstitute.org/sites/default/files/-/media/documents/survey/sri-investing-and-islamic-finance.pdf> accessed 6 February 2025. 

15. Refer to footnote 12 above. 

16. Ashruff Jamal & Shireen Osman, ‘Islamic Finance & ESG Investing’ (PwC Malaysia, August 2022) <https://www.pwc.com/m1/en/publications/documents/islamic-finance-and-esg-investing.pdf> accessed 6 February 2025. 

17. Refer to footnote 12 above.