There have been several interesting articles by Funds-at-Work about Islamic finance, which use a network analysis to highlight aspects of the industry that may not be as clear from other forms of analysis (I wrote a few blog posts about their analysis on Shari'ah scholars in 2010).
Their latest is a short article (PDF) that compares the factors used in conventional finance, Islamic finance and conventional finance with ESG (environmental, social and governance) consideration. They find that there is very little overlap between finance incorporating ESG considerations and Islamic finance, specifically that both use a set of negative screens to exclude certain sectors, for which there is overlap between the two in terms of what is excluded.
However, there is a much more robust set of other criteria for ESG-centered conventional finance, including positive screening (adding positive weights for best-of-class companies), active engagement with the companies in which they are invested including voting their proxy votes in line with the ESG criteria they use, as well as incorporating far more non-financial factors in their financing decisions.
Islamic finance, as described in the report, focuses on negative screening, incorporating zakat and other forms of distributions to the needy, avoiding excessive debt, and linking to real assets. I would put an asterisk on avoiding excessive debt and linking to real assets. On the debt issue, most Islamic financial institutions do use less debt than some conventional financial institutions, but there are other Islamic financial institutions that employ significant leverage in their financing, so long as it can be structured to be Shari'ah-compliant.
I put less of an asterisk on the point of linking products to real assets. There are fewer products that build on other financial products (rather than serving as financing to another business directly), although the most talked about exception is commodity murabaha, which is used to synthesize as much as possible a conventional loan. There are situations where that is appropriate (where there are no good alternatives) but there are others where it is probably applied in situations where another structure could function equally as well, but which is more connected with the financing of a specific activity (rather than creating an unsecured loan).
The main point, however, is that there is much that ESG and Islamic finance can gain from greater appreciation of the goals of each. For example, in almost every place where finance of any kind operates, there are members of society who are in need of assistance, and so perhaps companies that extend financing that includes ESG consideration can set aside a portion of their profits for specific financial assistance within the communities they operate (and many probably already do, but maybe not with as much connection between the level of profit and the level of giving).
Islamic finance can incorporate greater consideration to ESG criteria in their financing decisions, to incorporate not just the financial and sectoral screens, but consider whether companies have good relations with their workers, with the environment and the best-in-class systems of governance to protect the 'stakeholders'. Where these analysis come up short (or where the company proposes changes that would impact the ESG criteria, or the criteria specific to Islamic finance, like proposing taking on additional debt), Islamic financial institutions can become more engaged with management to suggest alternatives, or at least use their ability to participate in proxy voting to encourage changes.
It's beyond my pay-grade to suggest the specific ways these are implemented, and most of the changes would probably be set with a discussion between the management and Shari'ah board at the individual Islamic financial institution. They can adapt their implementation of selecting the aspects of the ESG criteria, and how they are applied, to fit within their Shari'ah board's idea of what will encourage positive outcomes and avoid creating any issues with the existing Shari'ah rules.
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