Navigating Islamic Finance: Embracing Divestment or Engagement for Ethical Investments

The notion of convergence of Islamic Finance and ESG continues to be a point of interest particularly for those interested in investing. The question of whether to divest or engage is a continuous debate that is driven by a growing understanding of the significance of ethical investing and gathering momentum in the financial sector, however, with the prohibitions that exist in Islamic Finance which are based on Shariah. The question of whether to divest or engage is clear when it comes to Shariah compliance. This article focuses on divestment or engagement on ESG principles that are in tangent with Shariah principles. 

Islamic finance refers to financial practices that adhere to Shariah, the ethical principles of Islamic law.  As a result, Shariah compliance is a prerequisite for the completion of economic and financial transactions. The Shariah prohibits interest/riba, excessive uncertainty/gharar, games of chances and gambling/maysir and qimar. It also prohibits investments in industries such as alcohol, pornography, and production of ammunition.

Whether an investor decides to divest or engage, the primary motivation remains the reduction of harm.  This is based on Islamic legal maxim – there is to be no harm and no reciprocating harm, “Harm shall neither be inflicted nor reciprocated” (Sunan Ibn Majah, 2340). Everybody has an obligation, based on their capacity, to prevent harm based on the verse of the Quran (Qur’an 2:286) ‘Allah does not burden any soul more than it can bear’. 

Also, the concept of stewardship of the earth and its resources is emphasised in Islam. The responsibility of humans is to do good and refrain from doing bad as a vicegerent of Allah. The verse below underlines that since humans have been placed in charge of managing the earth, they have a duty to do so.

The Quran states that: 

“It is He who has made you successors on the earth and raised some of you in ranks above others, that He may try you in what He has given you. Indeed, your Lord is swift in penalty; but indeed, He is Forgiving and Merciful.” Qur’an 6:165

Divestment, also known as disinvestment, involves selling or giving up one’s shares to a company. This is often the result of objecting to a company’s practices or policies.  It involves investors taking out their shares from portfolio businesses that don’t fulfil ESG standards. 

Allah (swt) says in the Quran:

“Corruption has appeared on land and sea by what people’s own hands have wrought; that He may let them taste the consequences of their deeds so that they may turn back” – Qur’an 30:41

In 2019, three Islamic faith-based organizations – the Bahu Trust, Islamic Foundation for Environmental & Ecological Sciences (IFEES), and the Mosques & Imams National Advisory Board (MINAB)  issued a unified demand for the divestment from fossil fuels and reinvestment in cleaner renewable energy as the sole means of ensuring a sustainable future for the current and future generations. This resulted in the first divestment commitment by a Fiqh Council – the Islamic Society of North America on fossil fuels in 2016.

There are arguments for and against divestment. The positives include raising awareness regarding certain issues and impacting consequences on companies that fail to meet certain ethical standards. In industries that rely heavily on investors, this is a more significant threat. However, the negative side of divestment is the loss of maintained influence, as the moment an asset manager sells their shares in a company, they can no longer be a positive influence on said company or pressure its board to implement more pro-social or pro-environmental policies. 

Engagement involves investors working with portfolio firms or issuers to help them manage or disclose ESG performance or concerns more effectively. It can take many different forms, including proxy voting, shareholder activism, and open communication with the company’s management. It is often encouraged before divestment occurs because it motivates investors to improve portfolio firms’ performance in order to achieve ESG goals. For instance, Engine No.1’s engagement effort with ExxonMobil led to it adopting more renewable energy and sustainable value creation by convincing big investors to vote for three new board members with backgrounds in clean energy.

There are verses in the Quran that encourage ‘enjoining good’ which can be used to argue for engagement in Islamic Finance. Investors can lean in to engage with companies that are falling short of their ESG obligations. 

Divestment and Engagement in Islamic finance are effective ways to advance ethical investing while upholding the fundamentals of Islamic finance. Investors can help to create a more sustainable and socially just financial system by divesting from unethical sectors and engaging with companies to promote ethical behaviour. Through these actions, Islamic finance can play a significant role in creating a more ethical and sustainable future for the global financial landscape. The maxim ‘severe harm is removed by lesser harm’ allows an investor to opt for the lesser of two harms. Ultimately, the decision lies with the investor in how much they are willing to engage with a company.