Three key takeaways from responsible finance in 2021

• Responsible finance has gained significant momentum during the past year; many of the big next steps from regulators are already clear enough to take action
• Responsible finance and ESG are not a singular process where compliance is the goal, they are constantly evolving; investors and financial institutions should prepare to adapt, not to meet a single standard
• No-one has all the data needed for responsible finance; collecting and understanding the data requires collaborative approaches and starting with imperfect data and iterating over time.

This week’s newsletter will be the final one for the year — a year that has seen huge challenges as we deal with Covid-19. The pandemic has had a significant impact on so many aspects of all our lives. Amidst these challenging times, one of the things that we have found to be a hopeful development to take into 2022 is how much responsible finance has grown in relevance globally, including across the Islamic markets where the RFI Foundation has focused most of our work.

Even with a backdrop of the global pandemic, there has been remarkable progress in the growth of interest in responsible finance across many Islamic markets. There have been efforts to create national and regional taxonomies to provide further clarity about what ‘sustainable’ means. Financial institutions are being challenged by their regulators, investors, employees and customers to conduct more detailed analysis of their exposure to physical and transition-related risks from climate change. Green bonds and sukuk, and sustainability-linked financing, are becoming more common outside of the developed markets where many of the early issuances originated.

On a global level, the COP 26 climate summit created a new momentum to introduce some common approaches for climate change and sustainability disclosure in general. The formation of the International Sustainability Standards Board brings together many of the standards setters focused on how companies should report their environmental, social and governance (ESG) impacts to those concerned with the financial impact they could have on the company.

Regulatory efforts to find common ground in the rapidly multiplying taxonomy landscape, under the auspices of the International Platform on Sustainable Finance, will be especially important for many Islamic markets where international investors, local companies and local, regional and global financial institutions all operate. Having a common-ground taxonomy won’t be the end-all to address the discontinuities present where multiple taxonomies are overlaid within a single market. However, it does offer at least a starting point and a common language for creating some consistency.

Meanwhile, work done by IOSCO and the Basel Committee for Banking Supervision relating to sustainability disclosures & ESG ratings, and management of climate-related financial risks can become the foundation for the actions by regulators across Islamic markets. These three areas of focus feed into the work of the ISSB, and together are starting to draw outlines for what financial institutions — wherever they are located — should anticipate will be the contours of responsible finance regulation.

There is a great temptation at this stage for investors and financial institutions to take a wait-and-see approach to responsible finance in the absence of binding regulation or specific investor inquiries. If global standards on climate risk or ESG disclosures are still in an early stage, the thinking goes, then the prudent thing to do is to change the least while waiting for regulators to mandate action.

The reason that’s the wrong approach is because there isn’t a single policy or ‘right answer’ to be found that can address the environmental and social challenges that we’re faced with. Instead we need to broaden our focus beyond today’s financial results to recognize the links between economic, social and environmental impacts created today and financial results realized tomorrow and in years to come.

The wait-and-see approach is only appropriate if there is a magic bullet — a single technical approach that can be outlined in regulation and standards — for how to address a litany of environmental and social challenges including climate change. Unfortunately, there is no ‘easy button’, although a consistent effort to find the answers can yield results.

• As we’ve had to learn and re-learn throughout the course of the pandemic in our management of public health (which is analogous to how we need to approach ESG and climate-related issues) we have to be adaptable and collaborative and get to work with the information we have on-hand, even where it is imperfect. That same spirit has defined RFI’s work during the past year, and will define our work into 2022:Where we have seen gaps in understanding the connection between different types of financed emissions in Islamic markets where disclosure is limited, we have adapted a top-down methodology to estimate it for Malaysia and Indonesia, and with several other significant Islamic markets to come in early 2022.
• As ESG became more of a focus for Islamic asset owners and asset managers, we released detailed quantitative research together with INCEIF to identify what the available data says about how the combination of ESG and Shariah screening could be improved rather than just advocating for the similarities between the two without considering practical challenges..
• As we’ve seen financial institutions struggle with the change management process to integrate ESG and a climate focus into their business, we worked together with HSBC Middle East to develop a Global Virtual Innovation Hub to help FinTech startups avoid having to go through the same growing pains by embedding responsible finance at an earlier stage into their businesses.

We’re looking forward to continuing these initiatives, and more, into 2022!

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