Dr Zeti Aziz With Azleena Idris and Yousuf Sultan IFSB Summit - - PowerPoint PPT Presentation

RESPONSIBLE FINANCE, ETHICAL & ISLAMIC FINANCE: MEETING THE GLOBAL AGENDA

Dr Zeti Aziz

With Azleena Idris and Yousuf Sultan

IFSB Summit Jakarta 12-14 November 2019

2

Following severe financial upheavals, global attention has since focused on resilience and sustainability of finance Regulatory regime

Supporting growth and economic development Sustainability To a more catalytic role Moving beyond

Equal importance is embedded in inherent features of financial intermediation

3

In In-buil ilt el elements tha that sup upport gr growt wth and nd de development Integration of

• f

ethi thical as aspects Emb Embedded fi fina nancial stab abil ility as aspects

Scope of the Report

Examines contribution of Ethical finance and Islamic finance in five key areas

4

Serving and supporting the economy Bringing value to society

Environmental sustainability

Address ethical aspects

• f finance

Contribution to financial stability

5 2 3 4 1

Both Ethical finance and Islamic finance had their origins derived from religion aimed at bringing long-lasting benefit to the economy, society and environment Focus is also on the ethical use

• f monies

5

This paper highlights

common and differentiating aspects of Ethical and Islamic finance to contribute towards a better understanding of the forms of finance that brings value to the economy, society and the environment

Hi High ghli lights ts so solu lutio ions and nd

• fferin

ings tha hat ma may y be be adop

• pted mor

more wi widely ly, the hereby accele leratin ing the he pot potentia ial l for

• r coo
• operati

tion amon

• ng the

he di different for

• rms of

f finance to to achie ieve com

• mmon

goal goals Considers strategies, approaches and practices that can be offered to

• ther forms of finance

and which may be adopted more widely

6

It weakened the positive role of finance on growth and development

Became potential for financial instability

Finance: Serving and Supporting the Economy

7

1

To serve e the Econo

• nomy
• To mobilise and allocate financial resources
• To drive growth and development

Finance prior to the financial crisis Origin

• f

finance

Finance is a means to an end

• Erosion of the link between finance and the

economy

• From enabler of growth, it became its own

source of growth Finance became an end in itself Finance became a source of instability

• Deviated from long-term value creation in

pursuit of short-term returns

Following the Financial Crisis that had Global Consequences

8

• Wide-ranging regulatory

reforms

• Strengthening of supervisory

frameworks

• Enhance financial crisis

resolution capability

Returned finance to its basic function:

• To add value to the economy

Prompted global response Prompted global consensus

Greater recognition of the forms of finance that are well anchored to the economy

Ethical finance and bringing value to the economy

9

Lo Long-ter erm

• rien

entation

• n

Avoid idance

• f

f hi high-ris isk, , spec specula lativ tive activ tiviti ities

• Pr

Protec ects s econo nomy from

• m dist

stor

• rtions
• ns
• Enhan

hances s ef effic ficien ent alloc

• cation
• n of

reso sour urces Encourag ages es compa pani nies es to participa pate e in gi giving ng back to societ ety and d env nvironm nment

Sustainability emphasised

• Pr

Protec ects s long-ter erm int nter eres ests

• Adop
• pting

ng ESG fram amework, focus uses s

• n env

nviron

• nmental

al, social al and d go gover erna nanc nce e cons nsider deration

• ns

Inves estment st strateg egies es tha hat maximise se bo both fina nancial re returns s and nd do doing goo

• od to societ

ety Ethical finance: 3 fundamental features

Bringing value to the economy is explicit in Islamic finance

10

Islam slamic ic finance Central l te tenets

Provided if it generates real economic value Must be supported by genuine activities that can generate legitimate returns Clear and transparent rights of parties involved

Rein inforces the link k be betw tween finance and nd the he econ

• nomy

Explicitly aims to intermediate and contribute to add value to economic activity A form of finance that is “value adding”

Islamic finance is based on profit sharing

11

At least 6 key features, including requirement to conduct due diligence

Risk sharing

Governance

Disclosure and transparency Sustainability Discourages excesses

Inclusive

Facilitates risk control and risk management Preserves rights and responsibilities of those involved in contract

Duty to preserve for future generations

Less prone to disruptions Balanced growth

• Inn

nnovatio ions are e scree eened to to ens nsure e they ey br brin ing valu lue e to to soc

• cie

iety

Growth of sustainable and responsible investment (SRI) strategies 2016-2018

12

Funds Guided by ESG Considerations

Development of capital markets indexes Dow Jones Sustainable Markets (DJSM) Issuances of ESG-related bonds

1,750 signatories 50 countries USD70 trillion AUM

(2006: USD4 trillion)

13

UN PRI

Catalyst for growth

Development of FTSE4Good Index

14

• Specific

performance indicators assessed against ESG criteria

• Applies negative

screen to exclude companies that may result in harm (e.g. tobacco, nuclear power, non-renewable energy and weapons industry)

Change the World List

15

• Addressing major

societal problems

• Reduce damage to

the environment

• Strengthening

communities

• Serving the

underserved to improve their lives

Source: Fortune Magazine

“Doing well by doing good”

16

Top Islamic Market Ecosystem 2017

17

Global Islamic finance developments

Islam slamic ic finance ass ssets gr grow

• wth

18

Com

• mpositi

ition of f Isl slam amic ic finan ancial ial ass ssets ts (20 2018)

Sukuk trend (2003-2018)

19

Islamic banking growth (2008-2018F)

Islamic indexes

20

Source: World Bank Islamic Finance Bulletin Feb 2019

Finance and Bringing Value to Society

21

2

ORIGINS

ISLAMIC FINANCE Originated from the Middle East and Asia since the 7th century SOCIALLY RESPONSIBLE INVESTING (SRI) Originated from the West in the 18th century from faith- based investing (i.e. to not participate in “sinful” activities)

• 1. Both focus at serving humanity and uplifting social well-being
• 2. Both focus on inclusion in securing economic prospects of every segment of society
• 3. Both avoid investments that are harmful to society

However societal aspects in financial practices tend to be less clearly defined compared to the environmental and economic aspects

Areas of commonality in bringing value to society

Ethical Finance: Bringing Value to Society

22

• Creating sustainable and meaningful value to society

‒ Aligning financial practices towards purposes that include social aspects

Internal l valu value dr driv ivers

• Showing support for its

employees

• Operating in a healthy and

safe condition

• Consider the entire supply

chain

• Performing corporate social

responsibility projects

• Address social and

governance issues

• How social issues are being addressed to
• ptimise positive impact on society, economy,

well-being and development

• Contributing back to the community

Achieving social good while generating financial returns

Social good

• Provision of specific goods or services aimed

at benefitting society

Doing social good

• A behavioural outcome to achieve desired

results ‒ Inclusion: dealing with the underserved ‒ Economic empowerment ‒ Social initiatives

Addressing specific social problems

23

Capital is directed to underserved individuals or communities

Businesses with a clear social purpose and addressing wider societal concerns

Doin

• ing soc

social ial goo good

• Denounce sinful industries (i.e. those that may

bring harm to society)

Provid

• vidin

ing so social al goo goods

• Providing social goods (i.e. clean air, clean

water, improving healthcare and sanitation)

Weapons Gaming Alcohol Clean water Clean air

Improving healthcare Improving sanitation

Greater econ

• nomic emp

mpowerment t and nd inc nclu lusio ion To

• tak

take into account the he imp mpac act of f clim imate chang hange on n com

• mmunit

itie ies Mak akin ing finance tran anspar arent t and nd easy to to unde understan and

Islamic finance and bringing Value to Society

24

Stimulates es economic act ctivi vity y and nd entrep epren eneursh ship p whi hile e add ddres essi sing g po pover erty y and nd ine nequality y

Prom

• motes

comprehensive hum human an de develop

• pment

Promotes s fair airness ss

Doin ing good

• od is

enc ncou

• uraged.

. Does

• es no

not t sub ubscri cribe e to to encr ncroa

• ach

chmen ent t on n anyone’s proprietary rights ts

Requ quires es balanc nce bet etwee een n indi dividua ual righ ghts s and d right ghts of society and nd st state

Advoc

• cates soc

socia ial l trust, coop

• operatio

ion and nd so solid lidarity Social responsibility activities to assist individuals or societies to enhance their living and environmental conditions

Islamic finance and forms of Social Financing Channels

25

Providing and doing social good

Waqf qf Sadaq daqa Zakat Clean eansi sing ng of tainted ed income (Islamic trust)

• Responsible for

supporting and founding of education establishments

• Cited for supporting the

founding and continued existence of many famous universities (Alms)

• Regular

giving of alms is encouraged as a means

• f cleansing

wealth (Tithes)

• Wealth

redistribution to the underserved is made

• bligatory on

a yearly basis In prohibiting committing what is forbidden (haram) in Islamic finance, a mechanism is in place for cleansing of tainted income by channeling them to charity

Environmental Sustainability Increasingly Integrated in Finance

26

Increased awareness of the effects of climate shocks and the impact to the environment on the economy, on macro-economic conditions and on the community

• Paris Agreement 2016 – participation of 197 countries
• In Ethical finance, the most attention is given to environmental

sustainability

• Prompted increased integration of environmental sustainability

in finance

3

Finance and Environmental Sustainability

27

Ethi hical fina nance Islam amic c finan nance

Value ue propo posi sition

Outlined in their stated intent: Environmental sustainability is one of the goals Stated intent expounded in the Quran and hadith from the principles of vicegerency

Ma Mann nner er env nvironm nmental al sustai aina nabi bility is achi hiev eved

Clear articulation on environmental considerations only began following Brundtland Report (1987) which embedded ESG in investing “Meeting the needs of the present without compromising the ability of future generations to meet their own needs” Do good and prevent harm by:

• 1. Treating the environment in a fair and

just manner

• 2. Moderation, avoiding wastage and

excesses

• 3. Treat every living being with Mercy
• 4. Duty of care to protect and keep safe

for next generation

Me Metho hodo dologi

• gies

es adop

• pted

ed

Different treatment processes:

• 1. Negative screening
• 2. ESG integration
• 3. Shareholder activism

Shariah screening processes:

• 1. Sector screening
• 2. Entity screening

Environmental sustainability agenda is achieved from the following

28

 Product offerings and instruments  Creation of markets  Sustainability reports by Corporations  Development of capital market indices  Impact investments: capital directed to clearly- defined purposes  Exclusion of investments that damage the environment  Application of ESG criteria – environmental considerations included in decision

In Ethical finance, the most attention is given to environmental sustainability

 Reducing carbon footprint  Avoiding wastage of resources  Increasing use of renewable energy  Making positive impact to the planet  Focus on addressing global warming, climate change, pollution and deforestation  Endangering wildlife is to be avoided

Areas of focus

Clear articulation in Ethical finance

29

Advancing Environmental Sustainability Agenda

30

Global Alliance on Banking for Values

• Founded in 2009 – network of

banking leaders committed to advance positive change in the banking sector

• Environmental sustainability is a

stated goal

• Achieved through greater

transparency and disclosure on assets committed to save the planet

• Development of social

responsibility reports Fortune 500 Change the World List

• Identified 50

Fortune 500 companies that are committed to doing good

• Areas

evaluated include efforts to change the world by reducing damage to the environment Dow Jones Sustainability Indices

• Selects leaders

across sectors committed to among others mitigate climate change

• Selection is

also based on specified environmental sustainability criteria FTSE4Good Index

• Environmental

sustainability criteria form part of the assessment in addressing ESG issues

• Companies are

assessed on environmental management and climate change Targeted or Impact Investment

• Capital is for a

defined purpose

• Measurable

impact on environment alongside financial return

• n investment
• Exclusion of

investments that damage the environment

Environmental Sustainability: Strategies and Approaches

31

Development of indices focused on environmental sustainability Development of dedicated markets and dedicated financial instruments

Supported by G20 (7 recommendations were made). Green financing market (being developed in China, Pakistan, Brazil and Malaysia)

Application of ESG criteria Investment decisions taken into consideration in the ESG criteria

Islamic finance and the objective of environmental sustainability

A detailed framework for assessment of the environment has yet to be developed

32

Adl

Treat the environment just and fairly

Wasat Rahmah

Treat every living beings with mercy

Amanah

Achieved through set of core values

Explicit is negative screening to exclude activities that are harmful to the environment

Midd ddle path h or

• r

mo mode derat ation n (avoid d was astag age & excesse ses) s) Trust and custodianship of the earth

Emergence of Shariah Compliant Sustainability-Focused Asset Classes

Green sukuk and SRI sukuk and Shariah-compliant sustainability funds, Securities Commission Malaysia green sukuk guidelines

Development of Sustainability-Focused Asset Classes

33

Adoption of the ESG criteria would be consistent with Islamic finance and can serve as a powerful tool for advancing environmental sustainability agenda

Key observations on Ethical finance and Socially Responsible Investing

34

Adoption of Environmental Social and Governance (ESG) framework

Own sets of screening methodology Own sets of screening methodology Own sets of screening methodology Own sets of screening methodology Financial institutions Ethical and SRI related products and services ESG-related indices

ESG-related capital market instruments

Rapid growth despite adoption of non-uniformed approaches

Key observations on Islamic finance

35

Consistently applied Shariah screening methodology

Rapid growth with consistent approach

Exclude businesses with haram elements Ensure business is aligned with requirements of Shariah Ensure the financial and

• ther operational

aspects are conducted within permissible limits

Development of complete and comprehensive Islamic financial system Institutions

[including banks, takaful companies, fund management companies]

Instruments [including sukuk and funds] Markets

[Islamic financial market, Islamic capital market and Islamic equity markets]

Shariah-compliant indices

Financial regulators and environmental sustainability: increasing awareness that climate risk can affect financial stability

36

Increasing role of regulators in climate risk and environmental sustainability seen in recent years.

Among central banks that have taken own initiative are Bank of England, People’s Bank of China, Banco Central du Brazil, State Bank of Pakistan and Banque du Liban (Central Bank of Lebanon)

Source: Bank of England

Recommendations for the Future

Develop commonly- accepted standards on environmental sustainability

Sourcing for bankable projects based on environmental sustainability to encourage more private sector participation Development of a governance process acceptable across many diverse stakeholders For Islamic finance, integrating ESG screening after Shariah process

37

• Increased recognition of

the essential role of ethics and the building of trust in finance

• The financial crisis of

unprecedented proportions has been in part due to lapses in ethics that precipitated mistrust and loss of confidence

• Also, occurrences of

misbehaviour including fraud, rate manipulations, greed, bribery, deliberate compliance failures, false misrepresentations, misaligned incentives leading to excessive risk taking

Ethical aspects of finance

38

Ethics has a fundamental role in ensuring that funds are channelled to productive activities

4

International response

39

The efforts have been directed to influence behaviour

Regulation and compliance Enhancing capability and competence

Achieving the goals

• f greater

good

Strengthening governance

Greater transparency

Address remuneration and compensation

40

While both Ethical finance and Islamic finance integrate ethical values, it remains a voluntary behavioural norm

Important virtues

Justice Moral values

Transparency

Competence Culture of accountability Concern for

• thers

Honesty

Integrity Good governance Fairness in decision making

Recent Global Response to Financial Stability Challenges

41

Regulatory reforms

Forward- looking surveillance

Added macro- prudential measures

Global response to the recent financial crisis centres

Enhanced role of regulators in imposing discipline on financial industry towards achieving financial stability

Resolution and crisis management capability Strengthening Supervisory

• versight

5

Ethical finance: Contribution to financial stability

1. Longer-term orientation

• 2. Avoidance of short-term transactions
• 3. Avoidance of high-risk, speculative activities
• 4. Governance process in ESG framework
• 5. High degree of disclosure and transparency
• 6. Emphasis on ethics, culture and values

Elements of Ethical finance that contribute to financial stability

42

Requirement that financial transactions be supported by real economic activity Profit and risk sharing hence built- in risk management Robust governance process Embedded transparency Avoiding speculative

• r illegal

activities

Elements

• f Islamic

finance that contribute to financial stability

Islamic finance: Contribution to financial stability

43

Exists as a complete and comprehensive financial system

Oversight by Sharia boards

Sharia forms the foundation for operation

• f financial

intermediation

Further distinctive elements of Islamic finance that reinforces the Financial Stability Agenda

Islamic finance – A comprehensive financial system with a centralised assessment arrangement to ensure its consistent application

44

Sustainable Development and Regulations and Standards for Financial Stability

45

01 01 02 02 03 03

International financial standards and sustainable development (SD)

• Generally, SD has yet to be

explicitly considered

• But nothing to prevent

regulators or financial sector to act consistent with SD

• Financial inclusion,

strengthening ethics and culture, and environmental sustainability have drawn recognition

Elements incorporated by regulators

• Financial

inclusion and climate change

• Introduction of

principle of proportionality

Potential Role

• f international

supervisory structures

• Financial Stability Board
• Bank for International

Settlements (BIS)

• IMF/World Bank

Financial Stability Assessment

• IMF Reports on

Observance of Standards and Codes

• Central banks’ own

initiative

46

International financial architecture exists for financial stability

• IFSB
• AAOIFI
• Some form of

consistency in practices exist Culture and ethics underpin Sharia compliance

• Practices may be

divergent but fundamentals are consistent and to a large extent convergent International supervisory structures apply

• Subject to similar

requirements of Financial Stability Board, Bank for International Settlements (BIS), IMF/World Bank Financial Stability Assessment and IMF Reports on Observance

• f Standards and Codes

Regulations and standards for financial stability that relate to Islamic finance

Preserving Interest of the Next Generation Economic well-being Ethical values Inclusion

Long-term

• rientation

and sustainability

47

Islamic finance and Ethical finance Share Common Goals

Areas of Differentiation in Focus

Priority to the environment Adding value to society

Ethical finance

Strongly anchored to real economy Strong built- in elements

• f financial

stability

Islamic finance

48

Strategies & Approaches

49

Ethical finance

• Adopting the ESG

considerations

• Wide-ranging

screening process to assess its adoption

Islamic finance

Operates a Sharia screening methodology that is consistently applied

• Ensuring fairness and

inclusivity

• Both adopt principles
• f transparency,

disclosure and good governance practices Scr Screening

Same primary intent

• Building greater

awareness on the potential role of these forms of finance

Great use

• f

technology

• Leveraging on

greater use of financial technology

Standards for culture

• f ethics

and trust

• Incorporating a

more structured approach to build a culture of ethics and trust in the financial system

50

Potential areas for collaboration

Building greater awareness

Concluding thoughts

51

Beyond financial stability and building a safe and sound financial system lies forms of finance that have longer-term orientation which focus on sustainability and is reinforced by ethics Therefore, they provide the foundations to achieve the aspired economic advancement and development

Authors

52

Dr Zeti Aziz Le Lead ad Au Autho hor

Council of Advisors, RFI Foundation Group Chairman, Permodalan Nasional Berhad

Azleena Idris Co Co-au autho hor

Director, Corporate Services Division Payments Network Malaysia Sdn Bhd

Yousuf Sultan Co Co-au autho hor

COO & Head of Shari’ah Ethis.co