The Way Forward For Sustainability-linked Derivatives

With the growth of sustainable investing, there is emerging demand for derivatives products that are linked to environmental, social and governance (ESG) goals. Although a nascent market, these products – sustainability-linked derivatives (SLDs) – have the potential to contribute to the green transition.

Since the first SLD was executed in August 2019, an increasing number of market participants have expressed an interest in transacting these derivatives. SLDs embed or create a sustainability-linked cashflow using key performance indicators (KPIs) designed to monitor compliance with ESG targets. In simple terms, they are typical derivatives transactions with an ESG add-on that affects payment flows. These transactions are highly customizable and the KPIs can range from emissions reductions to renewable energy capacity.

In response to the growing focus on these products and the likely acceleration of ESG-related financial transactions, ISDA has published several SLD papers, including one that sets out best practices for drafting KPIs to ensure legal certainty and enforceability. Others examine the potential regulatory treatment of SLDs under the derivatives regulatory regimes of key jurisdictions. These papers generated interest among ISDA’s membership for the development of certain standardized terms and contractual provisions related to SLDs to improve trading efficiency.

In April 2022, ISDA launched a survey to assess the current state of SLD documentation. The survey was made available to both ISDA members and non-members. Sixty-nine respondents indicated they engaged in SLD transactions. The results and analysis in this paper are based on the information provided by these respondents.

This report summarizes responses relating to: (i) SLD structure and defining KPIs for ESG targets; (ii) achieving the ESG target, including payment, sustainability premium and non-payment; (iii) early termination of the underlying derivatives transaction; (iv) contractual provisions involving third-party verification entities; and (v) contractual provisions related to ESG rating entities. The paper then proposes a path forward for standard SLD documentation that aims to strike an appropriate balance between enhancing trading efficiency and maintaining the ability to tailor transactions to meet specific sustainability objectives.

Read the full survey by clicking on the attached PDF.

Documents (1) for The Way Forward For Sustainability-linked Derivatives

Paper on Liquidity Assessment for Single-name CDS

On September 5, ISDA submitted a paper to the European Securities and Markets Authority (ESMA) and the European Commission in support of its earlier response to ESMA’s Markets in Financial Instruments Regulation (MIFIR) review consultation package 4 (CP4) on transparency...

Response to EC on Delegated Regulation

On September 4, ISDA responded to the European Commission’s (EC) consultation on amendments to delegated regulation (EU) 2017.567. The key area of interest for ISDA was the proposed insertion of a new article 16a that establishes what constitutes a post-trade...

Raising Clients’ Awareness on Portability

Clients accessing a central counterparty (CCP) via a client clearing service provider (CCSP) for over-the-counter (OTC) and exchange-traded derivatives should consider what may happen to their positions and collateral in a scenario in which the CCSP defaults. While regulatory regimes...

Response to FCA on Ancillary Activities Test

On August 28, ISDA and FIA submitted a joint response to the Financial Conduct Authority’s (FCA) consultation paper CP25/19 on the ancillary activities test to determine if commercial users or producers of commodities that trade in commodity derivatives, emission allowances...