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JKAU: Islamic Econ., Vol. 32 No. 1, pp: 3-21 (January 2019) DOI:10.4197/Islec.32-1.1 3 Reforming Islamic Finance for Achieving Sustainable Development Goals Tariqullah Khan Professor of Islamic Finance, College of Islamic Studies, Hamad Bin Khalifa University, Qatar ABSTRACT. The paradigm of Islamic economics and finance is guided by the motivation of comprehensive human development (CHD) and its preservation as manifested in the objectives of Sharīʿah (maqāṣid al-Sharīʿah). However, the real world free-market economies are driven by the linear economy paradigm under the influence of Hotelling’s 1931 famous work concerning the economics of exploiting natural resources, in which, the ecological environment is not recognized as a resource. The global financial architecture is designed to protect and preserve the linear economic paradigm. In practice, Islamic finance has also remained a ḥalāl sub-set of this system. The resultant social, environmental, and governance imbalances have recently led to different initiatives sponsored by the UN including the Sustainable Development Goals (SDGs). Like the maqāṣid, the SDGs also aim at achieving and preserving human development. In practice, for the first time, a real paradigm shift from the linear to the ecological/circular economy is noticeably taking place, also inducing the transformation of the financial architecture. In this paper, in a broader perspective, we use the CHD and SDGs interchangeably, and discuss a number of paradigmatic and regulatory reforms that will be required to enhance the actual effectiveness of Islamic finance in achieving the ideals of CHD, and the SDGs at large. The paper in fact outlines a wider scope of the potential reform initiatives. Keywords: Maqāṣid al-Sharīʿah, SDGs and Islamic finance, SDGs and design of financial contracts, Reforming Islamic finance, Regulating Islamic finance, Circular economy and Islamic finance, Reforming Sharīʿah governance; Reporting SDGs, ESGs and Islamic finance. JEL Classification: Q01, Q56 KAUJIE Classification: B5, H51

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Page 1: Reforming Islamic Finance for Achieving Sustainable ... · KAUJIE Classification: B5, H51 . 4 Tariqullah Khan 1. Introduction Transformation of societies and economies, and ... nif

JKAU: Islamic Econ., Vol. 32 No. 1, pp: 3-21 (January 2019)

DOI:10.4197/Islec.32-1.1

3

Reforming Islamic Finance for Achieving Sustainable Development Goals

Tariqullah Khan

Professor of Islamic Finance, College of Islamic Studies,

Hamad Bin Khalifa University, Qatar

ABSTRACT. The paradigm of Islamic economics and finance is guided by the

motivation of comprehensive human development (CHD) and its preservation as

manifested in the objectives of Sharīʿah (maqāṣid al-Sharīʿah). However, the real

world free-market economies are driven by the linear economy paradigm under the

influence of Hotelling’s 1931 famous work concerning the economics of exploiting

natural resources, in which, the ecological environment is not recognized as a resource.

The global financial architecture is designed to protect and preserve the linear

economic paradigm. In practice, Islamic finance has also remained a ḥalāl sub-set of

this system. The resultant social, environmental, and governance imbalances have

recently led to different initiatives sponsored by the UN including the Sustainable

Development Goals (SDGs). Like the maqāṣid, the SDGs also aim at achieving and

preserving human development. In practice, for the first time, a real paradigm shift

from the linear to the ecological/circular economy is noticeably taking place, also

inducing the transformation of the financial architecture. In this paper, in a broader

perspective, we use the CHD and SDGs interchangeably, and discuss a number of

paradigmatic and regulatory reforms that will be required to enhance the actual

effectiveness of Islamic finance in achieving the ideals of CHD, and the SDGs at large.

The paper in fact outlines a wider scope of the potential reform initiatives.

Keywords: Maqāṣid al-Sharīʿah, SDGs and Islamic finance, SDGs and design of

financial contracts, Reforming Islamic finance, Regulating Islamic finance, Circular

economy and Islamic finance, Reforming Sharīʿah governance; Reporting SDGs,

ESGs and Islamic finance.

JEL Classification: Q01, Q56

KAUJIE Classification: B5, H51

Page 2: Reforming Islamic Finance for Achieving Sustainable ... · KAUJIE Classification: B5, H51 . 4 Tariqullah Khan 1. Introduction Transformation of societies and economies, and ... nif

4 Tariqullah Khan

1. Introduction

Transformation of societies and economies, and

development of the relevant institutional architecture

and infrastructure, is a continuous process. What is

the Islamic vison of development that can be used as

a criterion for benchmarking the desirable transfor-

mation? This question became pertinent during 2006

when the Islamic Development Bank (IDB) went

through an internal reform and a new ‘Vision 1440H’

for comprehensive human development (CHD) was

formulated and adopted. The intellectual discourse

concerning the reform, in fact, triggered a motivation

for more detailed and formal academic works on the

CHD, the first among these being Chapra’s “The

Islamic Vision of Development in the Light of

Maqāṣid al-Sharīʿah” (Chapra, 2008). Since then, a

sizeable literature on the maqāṣid and its contempo-

rary applications has emerged. Tag el-Din (2013), is

a good example of attempting to relate the maqāṣid

framework for achieving balanced socio-economic

development in the free market economy.

The CHD is achieved by simultaneously uphold-

ing and preserving the human necessity for: (a)

religious faith, (b) life with dignity, (c) progeny and

future generations, (d) responsible mind and intellect,

and (e) wealth and graceful sustenance. As elaborated

in the above cited works of Chapra and Tag el-Din,

the maqāṣid framework was developed by scholars

like al-Ghazali, Ibn Taimiyyah, Ibn al-Qayyim and

al-Shatibi during the 12th and 14

th centuries. The fra-

mework has remained as the architectural founda-

tions of an ideal Islamic economics and finance

paradigm. As such, the maqāṣid represent the local

aspirations of the society.

Economic development parse has always remain-

ed in the agenda of national governments with differ-

ent ideological motivations, manifestations, achieve-

ments, and frustrations. In recent years, one measure

of the progress of countries was the UN millennium

development goals (MDGs). The MDGs era (2000-

2015) ended with mixed results. Progress was made

in several areas but MDG-1, concerning elimination

of absolute poverty, remained largely unaccom-

plished. Most of this failure still remains in member

countries of the IDB as documented in the IDB MDG

target study (Bello & Suleman, 2011). Since 2016,

the UN has embarked upon a new development

program termed as the sustainable development goals

– SDGs (see appendix section A for the complete

list). In IDB member countries, SDG-1 still remains

to be MDG-1 in scope and challenge. In this specific

SDG, financial inclusion is a priority area and Islamic

finance promotes access to financial services by

removing the faith-barrier to conventional finance.

Apart from SDG-1, there are several other simila-

rities between the SDGs and MDGs. However, the

SDGs are, in fact, a paradigm shift from MDGs. The

MDGs followed the conventional capitalistic linear

economy paradigm – its core being that the environ-

ment is not a resource and wealth creation is the

necessary and sufficient condition to cater to the

interest of the economy and future generations. The

SDGs, on the other hand, are augmented by the

United Nations (UN) Global Compact Principles

(GCPs), UN Principles of Responsible Investments

(PRIs), and the Global Reporting Initiative (GRI &

UN Global Compact, 2017). The goals of the SDGs

and the GCPs and PRIs are given in the appendix. In

addition to the UN, other institutions such as those of

the European Union are actively engaged in a para-

digm shift from linear to an ecological and circular

economy (see, for example, European Commission,

2017).

In the existing linear paradigm, wealth creation

could inflict further damage to the ecological envi-

ronment, and hence could be disastrous in its conse-

quences for the future security of humankind and

other species. With this background, a new global

financial architecture motivated by the SDGs imple-

mentation requirements is emerging, parallel to Basel

III. In addition, the pressure on the existing global

financial architecture is also increasing due to the

emergence of the distributed ledger technology (DLT)

and potential financial disintermediation.

Another important area of shift in paradigm is in

the role of faith (local aspirations) as a positive moti-

vating force for achieving SDGs as compared to the

MDGs regime, which took it for granted that faith is

a barrier to accessing health, educational, and finan-

cial services. Religious philanthropies and faith-based

finance can enhance resources for the SDGs in the

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Reforming Islamic Finance for Achieving Sustainable Development Goals 5

frame-work of a blended approach along with public

sector resources and private investments. Unlike the

MDGs, the SDGs give importance to local realities,

values, and institutions. More importantly, faith-

driven policies like Islamic finance can be consistent

with local aspirations and could be readily owned by

the relevant population segments. This brings the

SDGs closer to the maqāṣid al-Sharīʿah driven CHD.

The paradigm-shift in the SDGs opens up oppor-

tunities for Islamic finance that were not available

under the MDGs. Therefore, there is the expectation

that Islamic finance can play an important and wider

role in achieving the SDGs. This potential role of

Islamic finance can be enhanced by paradigmatic and

regulatory reform and support as well as surveillance.

In this regard, we identify the following broader areas

and these areas could also be themes for future

research:

(a) Facilitating a shift from the linear economy

paradigm to a circular/ecological economy par-

adigm;

(b) Transformation of the global financial archi-

tecture;

(c) Developing synchrony between local aspira-

tions (maqāṣid al-Sharīʿah), national goals,

and the SDGs;

(d) Reforming Sharīʿah governance by taking into

account the synchrony between the local aspi-

rations, national goals, and the SDGs, and by

integrating the Islamic institutions of compass-

ion in financial sector reforms;

(e) Strengthening the Islamic financial architecture

by removing structural risks in the design of

financial products;

(f) Incentivizing waste control and management

and promoting SMEs in ecological/circular

economy; and

(g) Encouraging integrated reporting on SDGs.

2. Shift the Paradigm

One of the prime objectives of the Sharīʿah is the protection and preservation of the rights of future generations and the enhancement of opportunities and security for them. In this context, intergenera-tional equity is an important debate and environ-mental balance has significant implications for future welfare and security. With a similar perspective, the conservationist movement for protecting natural resources and the environment was initiated by the early 1900s. In a seminal article, Hotelling (1931) offers an economic refutation of the conservationist arguments. Briefly, he argues that in the interest-based financial system, the interest mechanism will dictate through market forces whether it is more profitable to conserve the environment or to trans-form the environment into financial resources and transfer these to financial institutions and markets and earn financial returns. Hotelling argued for the transformation instead of conservation of natural and environmental resources. Costanza et al. (1997) explain that:

According to Hotelling’s model, even when market prices fully reflect the value of a species, it will be efficient to exploit a species to extinction or totally degrade an ecosystem if the value of the species or the ecosystem over time is not increasing at least as fast as money deposited in an interest-bearing bank account. (p. 54)

This argument was so convincing that it has domina-ted economic thought and policies ever since its publication in 1931. It is obvious that, in the model, the environment as such cannot be considered as a resource. The more it is extracted, the man-made capital/wealth can be created, the more is consumed and wasted. Given an effective demand through the credit mechanism, the more resources could be extracted. In this manner, the economy becomes a linear system of extracting, using, wasting, and extracting more. The interest-based financial system essentially becomes an engine for driving such a linear economy.

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8 Tariqullah Khan

3. Transform the Architecture

There is no doubt that for achieving the SDGs, the

global financial architecture has to undergo signifi-

cant transformation. In the absence of a consensus

regarding the definition of international financial

architecture, we describe it as a set of intertwined ins-

titutional parameters. These include: (a) the unalter-

able foundational principles concerning business and

finance; (b) the universal ethical norms of market

practices and business conduct in financial services;

(c) the international best practice standards pertaining

to financial services and (d) the relevant institutions.

Traditionally, the relevant institutions are the

Bank of International Settlements (BIS), Basel Com-

mittee for Banking Supervision (BCBS), Financial

Action Task Force (FATF), Financial Stability Board

(FSB), International Accounting Standards Board

(IASB), International Organization of Securities Co-

mmissions (IOSCO), International Monetary Fund

(IMF), and the World Bank (WB). These institutions

have the man-date to ensure safeguarding and stren-

gthening those parameters of the architecture with

their different instruments of policy support. Histori-

cally, these institutions and the standards set by them

have completely ignored the relevance of ecological

concerns for systemic stability.

The paper by the University of Cambridge’s

Institute for Sustainability Leadership in association

with the UNEP Finance Initiative (CISL & UNEP-

FI, 2014) raises important questions concerning this

critical gap in the Basel III banking regulations.

However, the SDGs, PRIs, GCPs, and initiatives

like the research of the GRI and UN Global Comp-

act (2017) which focuses on ESG and SDG disclos-

ures, are radically influencing the behavior of busin-

esses and their reporting systems worldwide. Hence,

the UN and GRI principles and their institutional

base now play a proactive role in the transformation

of the global financial architecture.

The traditional description of financial architect-

ture is also applicable to the global Islamic financial

architecture, covering in particular the Islamic

Financial Services Board (IFSB), Accounting and

Auditing Organization for Islamic Financial Institu-

tions (AAOIFI), the OIC Fiqh Academy (OIC-FA),

and the Islamic Development Bank (IDB), in addi-

tion to the international institutions listed. These insti-

tutions also do not have any proactive agenda for the

ESG concerns and SDG implementation except that

in 2016 the IDB and UNDP have signed a MoU for

enhancing the role of Islamic finance in SDGs

implementation.

The global financial architecture and its Islamic

sub-set are designed to function within the frame-

work of the linear economy and cater to its needs and

requirements. As mentioned above, the linear econo-

my paradigm does not consider the ecological envi-

ronment as a depletable resource. It is market-driven

– earning more by maximum resource extraction,

production, usage, and even waste and more extrac-

tion. The global financial system is a part as well as

facilitator of this paradigm.

However, over the last few decades as a response

to the climate change and the damage done to the

eco-logical environment, the competing circular eco-

nomy paradigm has emerged, in which the environ-

ment is considered an essential and depletable reso-

urce. The new paradigm which essentially replaces

the linear paradigm has received significant support

over the last decade and especially with the intro-

duction of the UN SDGs, interest in ESG and huma-

nitarian concerns (see figure 3). The new approach

has also received support by successful efforts made

in commercial use of solar energy, responsible inves-

tment, ethical banking, and companies voluntarily

adopting GRI standards and integrated reporting.

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10 Tariqullah Khan

Figure (4) Islamic financial architecture in the global context

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standard setting

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specificities

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Sharīʿah bodies

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notes are important)

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implement genuine Islamic financial services

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financial engineering and product development work)

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consensus); SDGs, ESG concerns, PRIs, GCPs, etc.

Received and given principles and architectural foundations of Islamic finance (unchangeable parameters); maqāṣid al-Sharīʿah

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12 Tariqullah Khan

On the other hand, Islamic finance offers a good

example of a prescription that caters to local prefere-

nces and hence guarantees inclusion. The same could

also be relevant for other services like educational,

health, and social development programs. Qatar

National Vision 2030, with four pillars – people,

economy, culture, and environment, is an example of

an outstanding policy prescription that caters to such

local preferences and hence, synchronizes local

aspiration and global goals. A mapping and compari-

son of the three in Figure 7 shows a complete syn-

chrony bet-ween the pillars with a realigned financial

architecture.

Figure (7) SDGs regime – reasons for optimism

5. Reform Sharīʿah Governance – Ḥalāl is

Essential but Insufficient

Compliance with local aspirations (maqāṣid al-

Sharīʿah) is a very broad and high-level policy re-

quirement in the national context, whether it is in the

juristic, educational, health, media, cultural, financial

domains, and so on. In the context of Islamic finance,

there is an internal process carried out by Islamic

financial institutions (IFIs). In at least five jurisdic-

tions, Sharīʿah governance (SG) is a regulatory requi-

rement prompted by the eventuality of systemic risk

of Sharīʿah non-compliance. Recognition of systemic

significance of Sharīʿah non-compliance necessitates

a two-tier SG system. Tier one of SG is at the level of

the regulator, who needs to oversee and have surveill-

ance on the second tier – the service provider. In

most other jurisdictions, where there are practices of

Islamic financial services (IFS), the systemic

significance of Sharīʿah non-compliance is not

recognized. In such jurisdictions, service providers

implement the SG voluntarily as a financial

engineering, product development, and behavioral

marketing strategy.

In the existing academic works and guiding notes

by regulators and standard setters, SG implies the

application and assurance of the principles of

Sharīʿah at these two levels. However, the focus of

SG has thus far been at the micro-level, covering the

Sharīʿah permissibility of products and services

offered by the IFIs. The purpose of the SG as such is

to establish the ḥalāl paradigm in financial services

covering business conduct and the earning of

permissible income. This is done within the overall

framework of the conventional capitalistic linear

economy paradigm.

Global goals (SDGs)

National Objectives

(QNV 2030)

Local aspirations (maqāṣid)

International financial

architecture

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Reforming Islamic Finance for Achieving Sustainable Development Goals 13

This micro approach is indeed essential but insuf-

ficient. Moreover, on one hand the approach creates

structural risks resulting in something being treated as

ḥalāl and not ḥalāl simultaneously, which will even-

tually impede the progress and resilience of Islamic

finance. On the other hand, society’s overall

aspirations and objectives (reflected in the maqāṣid

al-Sharīʿah) are left outside the scope of SG. Further-

more, the micro-objective approach also ignores the

significant transformation that is taking place in the

global financial architecture as mentioned above.

Therefore, there is a need to redefine the purpose of

SG to cover – in addition to establishing the ḥalāl

paradigm – the internalization of the institutions of

compassion which include qarḍ, zakāh, and awqāf ;

forbearance; and ecological and social concerns

(World Bank and Islamic Development Bank Group,

2016).

In Figure 8(a) we describe the different layers of

Sharīʿah governance. In addition to the micro-level,

IFS comprise of the intermediate meso-level compo-

nents including educational, financial reporting, tran-

sparency, information, and advisory infrastructures

and services. For example, the rising trend of

Sharīʿah, SRI, and ESG screening of investment

opportunities is one of the most effective uses of

technology to empower investors in the imposing

market discipline in favor of local preferences. The

macro-level layer of IFS includes the courts, the legal

and tax systems, and the regulatory and supervisory

infrastructures. These regulatory infrastructures

would also include the implementation of interna-

tional best practice standards and the provision of

systemic liquidity, safety-nets, and an overall level

playing field. At the global level, we are referring to

the setting of international standards and the intera-

ction of Islamic finance principles with international

institutions, standards, norms, and legal regimes.

At each level of the micro, intermediate, macro

and global layers, the basic parameters of SG need to

be identified, discussed, analyzed and modified. This

needs to be done with perspectives of the changing

global financial architecture where SDGs, ESG,

PRIs, GCPs, and humanitarian issues are becoming

added concerns. We attempt to identify and discuss

the fundamental elements of SG and existing institu-

tional gaps at each layer. Looking ahead, we suggest

how best these gaps may be addressed and filled for a

locally genuine and globally credible and robust IFS

industry.

In light of the above discussion, the strategic goals

of Islamic financial services development and

implementation are:

(i) Enhancing financial inclusion and access to

finance by all businesses and segments of the

population;

(ii) Genuineness, stability and resilience of the

Islamic financial services;

(iii) Depth (meeting all needs) and breadth

(reaching all geographic areas and population

and business segments) of the financial

services; and

(iv) Promoting alertness and sensitivity to climatic

and humanitarian concerns and responsible

investment.

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14

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Reforming Islamic Finance for Achieving Sustainable Development Goals 15

6. Redesign Financial Products

Hotelling’s basic argument was that the design of

interest-based financial contracts will efficiently

facilitate the transformation of natural resources into

man-made financial capital and ensure wealth

creation. The aspiration of society to preserve the

ecological system did not make economic/rational

sense to him. The same conflict of societal aspira-

tions vis-à-vis wealth creation still prevails even

within the framework of Sharīʿah governance, which

is the central theme of Islamic finance. The design of

financial contracts instead of being instruments of

risk transference could better reflect societal aspira-

tions by risk-sharing. The existing Sharīʿah gover-

nance institutions, which are core institutions of the

Islamic financial architecture, do not address this

concern at all. In most of these existing works, SG

implies the application and assurance of the

principles of Sharīʿah at the micro-level covering the

governance and conduct of providers of the Islamic

financial services (IFS) with the core and targeted

objective of making the services ḥalāl. The relevant

guidance notes issued by the IFSB and the AAOIFI

are also anchored by the micro-approach. Regulators,

whether they have Sharīʿah boards housed inside

national regulatory authorities (e.g., Malaysia, Indon-

esia, Pakistan, etc.) or whether they do not have such

national institutional set-ups (e.g., Saudi Arabia,

Bahrain, Qatar, etc.) all share the same micro-outlook

towards SG. The consequences are structural risks,

financialization, and ecological indifference.

6.1 Structural Risk in the Design of Financial Products

It may be argued that this overall micro and more

individuated approach to SG provides enough space

and incentive for financial engineering and product

development. However, in fact, such a micro appro-

ach that considers being ḥalāl as essential and

sufficient conditions for Islamic financial architecture

replicates interest-based contracts where the Hote-

lling argument prevails. Moreover, this approach also

gives rise to structural risks in the design of financial

products impeding the achievement of the strategic

goals set for the IFS and the SDGs.

Figure (9) Structural risk in the design of ṣukūk

Credit risk

Rate of return risk

Price risk

Interest rate

risk Credit risk

Price risk Bond

Equity

Ṣukūk with structural

risk

Ṣukūk

Ṣukūk

(a) (b)

(c)

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16 Tariqullah Khan

Structural risk in the design of a financial contract is

the fragility of the contract due to opposing views

concerning the contract’s Sharīʿah validity. In figure

9 (a) ṣukūk replaces a bond having identifiable credit

risk and rate of return risk. This position concerning

ṣukūk is the consensus view of stakeholders – issuers,

underwriters, legal advisors, investors, and above all

the Sharīʿah advisors who allow repurchase of ṣukūk

assets at initial price. However, figure 9 (b) shows the

position of Sharīʿah scholars who allow repurchase

but only at market price prevailing at the future time

of repurchase. The contradictory positions underlying

figure 9 (a) and (b) give rise to figure 9 (c) which

means that since (a) and (b) exist, it is not possible to

separate the three risks; price risk as in (b), and

interest rate risk and credit risk as in (a) are bundled

and inseparable in (c). This state of affairs concerning

the design of financial products makes the

architectural foundations of Islamic finance shaky.

Structural risk may be confused with what is refe-

rred to as Sharīʿah risk where the two need to be dist-

inguished. If there were a consensus on the Sharīʿah

validity of these contracts that are dominating Islamic

finance, there would not have been any structural risk

in the design of these cont-racts. In that case, there

could still have been Sharīʿah risk showing the

potential distance of a specific contract from what is

considered as a Sharīʿah compliant structure. Howe-

ver, the reality in the present case is that the contracts

are Sharīʿah comp-liant to one group of scholars and

non-compliant to another group, complaint to one

apex Sharīʿah body and non-compliant to another

one. Such disputes on fundamental issues not only

follows the linear economy paradigm but also shakes

the architectural foundations of Islamic finance.

6.2 Financialization

In terms of the design of financial contracts, the

typical consequence of Hotelling theory for the glo-

bal economy was summarized in figure 2. Global

financial assets and derivatives far exceed global

GDP. In theory, Islamic finance controls financialize-

tion as finance cannot be created without real goods

and services. However, this theoretical premise of

Islamic finance does not hold in practice. Important

examples are bayʿal-ʿīnah (selling on cash and

buying-back on credit) and bayʿ al-tawarruq (buying

on credit and selling-back on cash); the first contract

is now dominant in the global ṣukūk market and the

second is dominant in the financing offered by the

Islamic banks. Both are designed to bypass the

theoretical premise and are effectively applied with

the approval of Sharīʿah scholars within the micro-

Sharīʿah governance framework. One group of scho-

lars working for banks and service providers argue

that selling on cash and buying-back on credit or

buying on credit and selling-back on cash whichever

best represents the client’s economic circumstances is

a legitimate out-come of a trading transaction and the

client’s need for cash is fulfilled in a Sharīʿah comp-

liant (ḥalāl) manner. However, another group of

Sharīʿah scholars mostly independent in their

standing argue that both these contracts are fictitious

trading and are, in fact, a legal arbitrage to circum-

vent the prohibition of ribā and therefore are Sharīʿah

non-compliant. So much so that even the two apex

Sharīʿah bodies of the IFS, namely, the OIC Fiqh

Academy and the AAOIFI Sharīʿah Boards have

opposing guidance notes pertaining to the two

contracts; the first banning and the second allowing.

The result of the ḥalāl is sufficient approach has the

added disadvantage of leading to excessive leverage,

and potentially a market for “Islamic” derivatives,

having the same consequence as depicted in fig 2;

financial assets and derivatives exceeding real GDP

10-fold.

The stability and resilience of the financial archi-

tecture will depend on the robustness of the founda-

tional principles. The structural risk identified as such

is related to the architectural foundations of Islamic

finance and, therefore, is more severe in nature than

recognized. Since there is no agreed upon Sharīʿah

compliant structure, the Sharīʿah risk becomes irrele-

vant. Hence, within the IFSB universe of identified

risks, this rather most virulent risk remains unidenti-

fied posing a real threat to the genuineness, stability,

and resilience of the Islamic financial architecture.

6.3 Sustainability Gaps

The existing Islamic financial contracts including

ṣukūk are, in their design, either indifferent or even

implicitly counter sustainability. A sustainable design

of a financial contract will explicitly be pro towards

ecological and social concerns. Many sovereign

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Reforming Islamic Finance for Achieving Sustainable Development Goals 17

ṣukūk are designed to serve social purposes by deve-

loping the physical infrastructure. An example is the

Hamad Medical City in Doha, which was financed

by a ṣukūk issuance. The structure of similar ṣukūk

can be designed to be sustainable by documenting,

for example, the waste management systems, use of

green energy, and the social aspects of the project

being financed. There is an obvious gap in the design

of Islamic financial contracts and products in this

regard which can be conveniently filled with proper

policy inducement and regulatory support.

7. Incentivize Waste Control and Management

Waste control and management (WCM) is of primary

importance to ensure safeguarding environmental,

promoting recycling, and the ecological economic

paradigm. WCM strategies and targets have been

given an important status and priority in the Euro-

pean Union and in other parts of the world. In these

countries separate collection of waste remains one of

the challenges. Increasingly, companies are integra-

ting disclosures about their WCM policies in repor-

ting. However, in the IDB member countries, except

for a few exceptions, WCM is an unfamiliar idea.

Government policies at various tiers as well as regu-

latory guidelines can contribute substantially in

introducing WCM initiatives at different levels inclu-

ding house-holds and businesses.

Significant emphasis has been attached to the role

of SMEs in promoting inclusive economic develop-

ment and promoting shared prosperity. Regulatory

guidelines and support to SMEs within the ecological

economic paradigm could be more consistent with

the SDGs and ESG concerns. Infrastructure financing

is another pertinent area where Islamic finance is

expected to contribute and where waste reduction and

management has to attract attention on priority basis.

For a comprehensive coverage of the potential policy

guide-lines, legislative proposals, and potential initia-

tives on waste, see European Commission (2017) on

the action plan for the implementation of the circular

economy.

8. Encourage Integrated Disclosures

In the impact investment field, the socially response-

ble investors – SRI and ESG oriented companies –

have already started offering voluntary disclosures on

SDG and ESG strategies, activities, and achieve-

ments. Khan and Mohomed (2017) show that some

Islamic banks like the Bangladesh Islamic Bank

Limited are offering more voluntary information on

ESG related concerns. GRI and UN Global Compact

(2017) offers a comprehensive template for such

disclosures. The template is 223 pages in size cove-

ring all the 17 SDGs and 169 targets. Since it is not

possible to present a meaningful abstract of such a

large document, here we present two quotes from the

Chief Executive of GRI and from the CEO of the UN

Global Compact who have jointly published the

report. In the words of the Chief Executive of GRI:

At a time when the revenues of large companies

exceed the GDP of many countries and supply

chains stretch around the world, the private sector

plays a vital role in achieving the Sustainable

Development Goals (SDGs). This analysis of the

goals and targets is a first step towards a unified

mechanism to help companies report on the SDGs

in a comparable and effective way. By reporting on

their progress, companies will improve their perfor-

mance which will enable meaningful progress tow-

ards achieving the SDGs. (p. 9)

The CEO of UN Global Compact said:

The SDGs provide a unique opportunity to elevate

communication on sustainability. Governments

have emphasized this agenda through SDG 12 –

recognizing how important it is for companies to

adopt sustainable practices and integrate this infor-

mation into their reporting cycles. The expectations

on companies are huge. Companies that align

repor-ting and communication with the SDGs will

be speaking in the same language that increasingly

is adopted by governments, foundations, NGOs and

even investors. (p. 9)

Some companies have already initiated disclosure co-

ncerning their contributions to SDGs implementation.

Regulatory authorities can play a tremendously impo-

rtant role in expecting from the companies to start

using the template and gradually adapting it within a

reasonable period.

9. Conclusions and Implications

Our foregoing discussion shows that the linear

economy paradigm is transforming into the circular

economy paradigm, especially driven by SDGs and

through active policy support and strategic targets

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18 Tariqullah Khan

within the European Commission. The global finan-

cial architecture is transforming because of the

responses of businesses to the various UN initiatives.

The ways that companies had been doing businesses

is also changing and reporting is becoming more

comprehensive covering SDGs and ESG concerns.

However, the global best practice standards – Basel

III, IFSB standards, financial reporting standards etc.

– still cater to the linear economy paradigm. The

CISL and UNEP-FI (2014) study formally raises this

important gap in the standards and is calling upon the

standard setters and regulators to revise the existing

standards in the light of the new but rapidly changing

realities. This call is equally relevant for the IFSB

and AAOIFI standards. Some of these are listed here:

(a) IFSB to recognize in its approach and stan-

dards the ESG concerns and SDGs, PRIs,

GCPs, etc., and to identify tasks and response-

bilities under Pillar 2 and disclosures require-

ments under Pillar 3. Under Pillar 1 the IFSB

can encourage green ṣukūk by different

incentives.

(b) AAOIFI to consider GRI and UN Global

Compact (2017) and encourage replication by

its members wherever applicable.

(c) Central banks to encourage green assets and

design of contracts based on long-term risk

sharing.

(d) Security regulators to enhance the ethical

screening methodologies in line with SDGs,

PRIs, GCPs, and GRI.

(e) Finance Ministries to enhance coordination

with regulators and other stakeholders on the

SDG implementation.

This paper has only described the broader outline for

a paradigmatic and regulatory reform of Islamic

finance. The transformative global scene provides an

excellent opportunity for researchers to undertake

more work with an objective to contribute to transfor-

ming economies to become more responsible, inclu-

sive, and resilient and to ensure shared prosperity and

wellbeing.

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Reforming Islamic Finance for Achieving Sustainable Development Goals 19

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Tariqullah Khan is currently Professor of Islamic Finance at the College of

Islamic Studies, Hamad Bin Khalifa University, Qatar Foundation, Doha. He was

previously with the Islamic Development Bank Group as Co-Lead of Global

Islamic Financial Industry Development Initiative and Division Chief, Islamic

Banking and Finance, Islamic Research and Training Institute (IRTI). He was also

a visiting scholar at the Harvard University Law School during summer 2011, as

well as at the Stanford University Law School during the summer of 2017.

E-mail: [email protected]

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20 Tariqullah Khan

Appendix

Sustainable Development Goals, Global Compact Principles, and Principles of Responsible Investment

This appendix shows the principles that are transforming

the global financial architecture. The UN Sustainable

Development Goals (SDGs) are given in section A.

Section B presents the UN Global Compact Principles.

The Principles of Responsible Investment, which are

supported by the UN, are given in section C.

A. UN Sustainable Development Goals

SDG Goal 1: No poverty.

SDG Goal 2: Zero hunger.

SDG Goal 3: Good health and wellbeing.

SDG Goal 4: Quality education.

SDG Goal 5: Gender equality.

SDG Goal 6: Clean water and sanitation.

SDG Goal 7: Affordable and clean energy.

SDG Goal 8: Decent work and economic growth.

SDG Goal 9: Industry, innovation, and infrastructure.

SDG Goal 10: Reduced inequalities.

SDG Goal 11: Sustainable cities and communities.

SDG Goal 12: Responsible consumption and production.

SDG Goal 13: Climate action.

SDG Goal 14: Life below water.

SDG Goal 15: Life on land.

SDG Goal 16: Peace, justice, and strong institutions.

SGG Goal 17: Partnership for the goals.

B. UN Global Compact Principles

Human rights:

Principle 1: Businesses should support and respect the

protection of internationally proclaimed human rights;

and

Principle 2: Make sure that they are not complicit in

human rights abuses.

Labor:

Principle 3: Businesses should uphold the freedom of

association and the effective recognition of the right to

collective bargaining;

Principle 4: The elimination of all forms of forced and

compulsory labor;

Principle 5: The effective abolition of child labor; and

Principle 6: The elimination of discrimination in respect

of employment and occupation.

Environment:

Principle 7: Businesses should support a precautionary

approach to environmental challenges;

Principle 8: Undertake initiatives to promote greater

environmental responsibility; and

Principle 9: Encourage the development and diffusion

of environmentally friendly technologies.

Anti-corruption:

Principle 10: Businesses should work against corruption

in all its forms, including extortion and bribery.

C. UN-Supported Principles of Responsible

Investment

Principle 1: We will incorporate ESG issues into

investment analysis and decision-making processes.

Principle 2: We will be active owners and incorporate

ESG issues into our ownership policies and practices.

Principle 3: We will seek appropriate disclosure on ESG

issues by the entities in which we invest.

Principle 4: We will promote acceptance and

implementation of the Principles within the investment

industry.

Principle 5: We will work together to enhance our

effectiveness in implementing the Principles.

Principle 6: We will each report on our activities and

progress towards implementing the Principles.

.

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Reforming Islamic Finance for Achieving Sustainable Development Goals 21

إصالح التمو�ل اإلسالمي لتحقيق أ�داف التنمية املستدامة

طارق هللا خان

قطر، جامعة حمد بن خليفة، �لية الدراسات اإلسالمية ، أستاذ التمول اإلسالمي

(CHD) 'س%$شد نموذج االقتصاد والتمول اإلسالمي بدوافع التنمية ال�شرة الشاملة. املستخلص

ملقاصد الشر8عة اإلسالمية، ومع ذلك فإن اقتصادات السوق ا01ر /. العالم يحرك)ا ًوحفظ)ا وفقا

استغالل املتعلقة باقتصاديات م١٩٣١نظرة Jوتلينغ /. عام نموذج االقتصاد اF1طي تحت تأث@$

املوارد الطبيعية، حيث ال يتم االع%$اف بالبRئة اإليMولوجية كمورد، إذ تم تصميم ال)يMلة املالية

العاملية 01ماية وحفظ النموذج االقتصادي اF1طي. ومن الناحية العملية ظل التمول اإلسالمي

الجتماعية والبيdية أيًضا عبارة عن فرع بقى /. Jذا النظام بمس^[ حالل. لقد أدت االختالالت ا

واM01ومية /. اآلونة األخ@$ة إgh املبادرات الf[ ترعاJا األمم املتحدة بما /. ذلك أJداف التنمية

ا ملقاصد الشر8عة الo ]fسgn إgh تحقيق التنمية ال�شرة وا0lافظة علjkا وفًق (SDGs) املستدامة

قيقي فعq. من االقتصاد اF1طي إgh اإلسالمية. ومن الناحية العملية، وألول مرة، يحدث تحول ح

اإليMولوy./الدائري بصورة م0vوظة، مما يحفز أيًضا تحول ال)يMلة املالية. tستخدم /. Jذه الورقة

zشMل (SDGs)والتنمية املستدامة (CHD)من منظور أوسع دوافع التنمية ال�شرة الشاملة

مية املطلو|ة لتعزز التأث@$ ا01قيقي متبادل، ونناقش عدًدا من اإلصالحات النموذجية والتنظي

، وأJداف التنمية املستدامة zشMل (CHD)للتمول اإلسالمي /. تحقيق التنمية ال�شرة الشاملة

عام. كما تناقش الورقة بصورة أوسع مبادرات اإلصالح ا0lتملة.

الةال لمات َّ

املالية، إصالح ، التمول اإلسالمي، تصميم العقود اإلسالميةمقاصد الشر8عة :الد

التمول اإلسالمي، تنظيم التمول اإلسالمي، االقتصاد الدائري والتمول اإلسالمي، إصالح ا01وكمة

.عن التنمية املستدامة، والتنمية الشاملة والتمول اإلسالمي التقرر ،الشرعية

JEL: Q01, Q56 تص�يف

KAUJIE: B5, H51 تص�يف