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 PDF below.