Sustainability linked derivatives have a key role to play

Sustainability-linked derivatives (SLDs) have a key role to play in the transition to a more sustainable economy and in enhancing the flow of private capital to meet environmental, social and governance (ESG) objectives, according to a new report – Sustainability-linked Derivatives: Where to Begin – from the ISDA Future Leaders in Derivatives (IFLD), the trade group’s professional development program for emerging leaders in the derivatives market.

ISDA launched the IFLD program in October 2021, with an initial cohort of nearly 50 individuals drawn from buy- and sell-side institutions, law firms and service providers around the world.

The paper focuses on SLDs which are relatively new additions to the derivatives market. They are highly customisable transactions that use key performance indicators (KPIs) to set sustainability targets.

The first SLD was executed in August 2019 between SBM Offshore and ING to hedge the interest rate risk of SBM’s $1 billion five-year floating rate revolving credit facility.

Unlike green or sustainability-linked bonds, SLDs are not instruments that focus on the use of proceeds. Instead, they are used to incentivise ESG performance and/or to facilitate support for sustainable projects.

Sinead Beacom, Vice President at FinTrU.

The paper notes that they are an evolving product and can be structured in many ways, meaning there is currently no agreed definition of an SLD or any market-standard documentation.

The paper notes that as the volume of SLD transactions continues to increase globally, it is imperative that key information and considerations regarding these types of transactions be centralised and more readily available to bring greater transparency to the market.

Other issues to be address is the lack of readily available market standard documentation, This is because SLDs continue to evolve and their use varies significantly by jurisdiction.

As a result, existing OTC regulatory requirements are the most applicable to these transactions.

“The transition to net zero and a sustainable economy is an urgent challenge,” said Sinead Beacom, Vice President at FinTrU, representing the ESG working group. The development of a robust market in SLDs can play an important role in supporting this transition. We hope our paper will serve as a useful resource for anyone seeking to understand the key issues that will drive the growth and success of this market.”

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