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A few weeks ago, headlines lit up with confusion and consternation as Philip Morris International (PMI), a cigarette producer, was awarded higher Environment Social and Governance (ESG) scores than electric car manufacturer Tesla. ESG was even termed the ‘devil’ by Elon Musk.

The criticism is premised on the fact that Tesla, which produces electric cars thus promoting a cleaner environment because it aims to reduce carbon emissions, got an ESG score of 37 on a 100-point scale. This is in comparison to PMI, the maker of Marlboro cigarettes which according to a WHO report causes the death of over 8 million people annually, was given a high score of 84!

This controversy in ESG underscores one of the primary differences between the conventional finance approach and the Islamic finance approach to potentially controversial industries. In a previous blog, we discussed the Islamic Finance stance on divestment versus engagement, which leans more heavily on negative screening than conventional finance. It, therefore, screens out any industries considered haram, meaning that it is forbidden to invest in alcohol, tobacco, or pork products. In doing so, Shari’ah-compliant investment funds are designed with a degree of controversy protection by excluding certain high-risk industries. In the case of PMI, tobacco is excluded from Islamic funds because it is an intoxicant and causes harm to its consumers. By removing these products from the pool of potential investments, it is easier to avoid conflict like that between Tesla and Philip Morris International. 

Tesla did score a 60 on the E which stands for ‘environment’ but scored 20 in social compared to PMI’s 84. It scored 34 in ‘governance’ against PMI’s 83. In ESG, the ‘S’ focus tends to be on employees within the company and external stakeholders from an environmental standpoint, meaning that a company will be positively viewed from a social standpoint for investing in community initiatives like education or development; however, this excludes a focus on the impact of the product itself on the community. For PMI, reinvestment in their environmental impact and pro-social policies pushed their ESG scores significantly higher than expected, with no consideration given to the fact that tobacco products kill over 8 million people a year. Tesla’s primary negative points were the mineral-heavy nature of electric vehicle manufacturing, plus poor social performance as controversy broke out regarding the negative treatment of employees. 

The ‘S’ focus from the Islamic finance standpoint has other elements. The conventional interpretation in the context of ESG is often restricted to workforce and diversity, safety management, customer management, and communities. Islamic finance has other social instruments such Zakat, Qard Hassan, and Waqf. Zakat is one of the five pillars of the Islamic faith, and it is comparable to a tax on assets that are worth more than a specific amount. It is utilized for social welfare without any reimbursement. It is a goodwill-based loan that is mostly given for welfare purposes. The borrower is simply required to repay the principal amount borrowed, not interest. Waqf or endowment, is a particular form of philanthropic deed that lasts forever. It entails giving away a fixed asset with the potential to generate income or offer benefits. 

In summary, the current ESG scoring can produce counterintuitive results by not considering product impact. Islamic finance on the other hand applies additional social screening to avoid investing in industries like tobacco that cause harm thereby focusing on the impact a product would have. Perhaps it would be a good time for an Islamic finance focused ESG scoring to be initiated which would close gaps on issues like this.

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