World’s first ESG sukuk fund another step forward for Malaysia’s responsible finance

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Malaysia’s Shariah-compliant BIMB Investment Management launched the world’s first environmental, social and governance (ESG) sukuk fund on August 1. Reflecting a growing responsible finance sector in Malaysia, the company’s CEO told Salaam Gateway the move was in response to market interest.

BIMB’s ESG Sukuk Fund is the company’s fifth ESG-focused fund as a result of its partnership since 2015 with London-based Arabesque Asset Management, whose S-Ray proprietary methodology is used in the five funds’ portfolio strategy.

“We notice interest in Shariah, ESG and quantitative rules-based funds,” BIMB Investment chief executive officer Najmuddin Mohd Lutfi told Salaam Gateway in an e-mail.

“Going forward, we will launch more ESG that incorporates fintech like artificial intelligence, machine learning, big data, data analytics. The next investment focus could be in U.S. equity and multi-asset funds,” he added.

With 2.44 billion Malaysian ringgit ($600 million) of assets under management at the end of June, the company is a small player in the domestic Islamic fund management sector—valued at 162.80 billion ringgit in May—and has actively differentiated itself through its focus on ESG as well as technology.

BETTER-INFORMED DECISIONS

Arabesque’s S-Ray technology is the foundation of its own investment process and is also used by other companies, such as BIMB Investment. S-Ray uses machine learning and big data to analyse a universe of 7,000 publicly-listed companies on ESG metrics.

“Over the years we have seen the universe grow from around 5,000 companies in 2015, thanks to more data sources and as companies increase reporting around ESG,” Gabriel Karageorgiou, partner at Arabesque, told Salaam Gateway on the phone.

S-Ray evaluates companies on the core principles of the United Nations Global Compact (UNGC), which revolves around four dimensions: human rights, labour rights, the environment, and corruption. It assigns a corresponding GC score then analyses daily the performance of companies on ESG metrics.

The technology also allows Shariah investors or fund managers to filter out companies based on revenue streams, on top of the GC and ESG scores.

“Companies need to improve their sustainability performance and communicate what they are doing in terms of managing the company long-term and for all these [ESG] metrics,” Karageorgiou said.

Arabesque is seeing growth in the ESG investment sector.

“Asset managers in turn are looking more into ESG topics because their clients -- the pension funds, insurers, and endowments -- are asking for more of such investments. But asset managers need to improve their performance with disclosures from companies,” added Karageorgiou.

ATTRACTING NEW INVESTORS

BIMB Investment chief Najmuddin believes ESG investors who did not previously consider Islamic investment instruments will now be more open to the idea. This confidence appears to stem from the encouraging returns of its earlier ESG funds, despite volatile economic conditions globally.

Launched in November 2015, the BIMB-Arabesque i Global Dividend Fund 1 distributed 8 percent for the financial year ended March 31, 2018 and 7.1 percent for the previous financial year. These exceeded the fund’s MSCI AC World Index benchmark of 6 percent per annum growth.

The fund, the first from the BIMB-Arabesque collaboration, is ranked first on 1-year relative to its peers based on The Edge Lipper table, Najmuddin said.

According to Karageorgiou, there has been a misconception that ESG comes at the expense of performance. “ESG information allows us asset managers to make better-informed decisions. ESG integration does not mean lower returns. If anything, it means more sustainable, long-term returns, with lower risk,” said the Arabesque partner.

EXPANDING ESG-SUKUK CONVERGENCE

While the ESG-Islamic convergence is attracting new investors and healthy returns help boost retention, other developments also increase the profile of Shariah-compliant instruments in the global market.

“In August 2016, JP Morgan EMBI Global Diversified index had added sukuk for the first time to the index, and so that put sukuk on the radar of institutional investors that are constrained to universes defined by indexes like the EMBI,” thinktank Responsible Finance & Investment Foundation (RFI) chief executive officer Blake Goud told Salaam Gateway.

“That laid the groundwork for other applications: how do you target specific niche investor bases for funding on the sukuk issuer side and also the investor side?” said Goud.

The total assets under management of the United Nations' Principles for Responsible Investment signatories -- which roughly gives a sense of the total ESG universe -- flattened at around $63 trillion in 2015 and 2016, before jumping to $83 trillion in 2017.

Goud thinks this surge was driven partly by investors looking at asset classes they would not have otherwise associated with ESG. He believes that adding either a green sukuk angle or changing issuer characteristics to be more environmentally- and socially-beneficial is a way to make the sukuk more appealing to the ESG investor base.

“We reviewed data from the Climate Bonds Initiative about green bond issuer characteristics from China  in the first half of 2018, and renewable energy was a big part of issuance volume, in addition to transport, waste and green buildings,” said Goud. In 2017, China was the second largest source of green bonds after the United States. Climate Bonds Initiative is an international, investor-focused not-for-profit based in the UK.

“In transport, Malaysia issued some unlabelled green sukuk to finance mass transit in the past,” said Goud, referring to $789.14 million raised in 2014 via three sukuk issuances to finance the country’s rail network project.

Bonds and sukuk financing projects that reduce carbon footprints, such as Malaysia’s Mass Rapid Transit, are considered “green” by some analysts.

“Investors in the green investment space in Asia will be more familiar with issuance that follows past issuance of China’s green bonds and Malaysia’s green sukuk,” Goud said.

He noted that development among issuers in the Gulf Cooperation Council (GCC) has been slower. Recent environmentally-focused projects includ the Dubai Green Fund launched in October 2017 and the National Bank of Abu Dhabi laying claim to Middle East’s first green bond in March 2017.

MALAYSIA’S RESPONSIBLE FINANCE FOCUS

Malaysia has been slowing building its Shariah-compliant responsible finance sector.

Its Securities Commission released the framework for SRI sukuk in August 2014 and shortly after, in June 2015, sovereign wealth fund Khazanah issued Malaysia’s first SRI sukuk.  

In July 2017, Malaysian company Tadau Energy issued the country’s, and world’s, first green sukuk with a 250 million ringgit paper to fund the construction of large-scale solar plants. 

The green sukuk drive has been top-down. Bank Negara Malaysia, the central bank, and the Securities Commission worked with the World Bank Group to develop an ecosystem to facilitate the growth of green sukuk, according to a report released in September last year by the central bank-linked Malaysia International Islamic Financial Centre (MIFC).

Most recently, the SC released new guidelines on SRI Funds in December 2017 to spur the growth of that responsible finance sector.

Malaysia’s responsible finance focus has also extended to the banking sector. The Shariah-compliant BIMB Investment is a wholly-owned subsidiary of Bank Islam, one of nine Islamic banks providing input to Malaysia's central bank on the creation of the country's Value-Based Intermediation (VBI) scorecard, which gives equal weight to economic value creation and upholding ethical values.

The VBI scorecard is expected to be launched in October this year, and another framework, the Environmental and Social Impact Assessment Framework (ESIAF) for the VBI is expected to be developed by 2020.

GREATER AWARENESS

Malaysia’s efforts are slowly bearing fruit. Worldwide, the responsible finance-Islamic finance convergence is also gaining interest, outside of the more widespread use of sustainable finance by the multilateral Islamic Development Bank, as pointed out in an RFI report released in April.  

In the same report, the RFI said its survey of 32 Islamic financial institutions had more than 90 percent of respondents saying they think sustainable finance practices are inherently related to Islamic finance principles, pointing to increased awareness from Shariah-compliant players.

This greater awareness is confirmed by another Islamic finance body. Chartered Institute of Islamic Finance Professionals president Badlisyah Abdul Ghani, who leads an organisation of 1,000 members across 30 countries, told Salaam Gateway over the phone that members have reported greater demand by investors and issuers for ESG products.

“Previously, many were somewhat reluctant because their internal investment policies or business direction did not coincide with any ESG agenda. But today, those agendas now incorporate ESG and they have allocations for these types of activities,” said Badlisyah.

Part of this change is due to greater consumer activism that is influencing market behaviours, he said. “[A]nd as a result of this, corporates need to accommodate such consumer desires to see more corporate sensitivity to environmental and social impacts of their activities.”

“Similarly, more depositors and subscribers are demanding that institutional investors put more into ESG investments," said Badlisyah.

Echoing BIMB Investment CEO Najmuddin, Badlisyah said the new ESG sukuk fund is a response to this demand.

"What this new fund does is it signals to the market that it is able to meet investor demands, it is listening to what investors want and making it available,” said Badlisyah.

($1 = 4.09 Malaysian ringgit)

(Reporting by Stephanie Augustin; Editing by Emmy Abdul Alim emmy.alim@thomsonreuters.com)

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