Recent Developments
- Whilst the growing number of these products is an interesting trend there are no set market practices/principles and we are not sure what the end game is on some of these products.
- Whilst we don’t think that costs related to derivatives can be counted under a use of proceeds approach, we believe that links to Sustainability outcomes on these instruments can offer some innovation opportunities in Sustainable Finance.
- Overall, anything that helps incentivize better sustainability performance is generally good, however, robustness and credibility needs to be upheld.
- Plenty of issues to think through and consider – lets peel off some layers below
Types of Sustainability Related Derivatives
We can break down the types of derivatives into the following:
- Traditional Derivatives with a Sustainability Link such as an interest rate swap connected to underlying Sustainable Finance Instrument (green bonds or loans eg/SLL/SLB’s etc).
- Conventional Bonds/Loans: Derivatives connected to underlying conventional finance Instruments (bonds/loans – not UoP or SLL instruments).
- Trading: Derivatives connected to underlying trading and purely profit-making activities.
- ESG Specific Derivatives (could be for trading or risk management), many of which are not established yet.
Discussion Points and Issues
- Best to only permit ESG derivatives for sustainable businesses and connected to underlying Sustainable Finance instruments?
- Consider tenor for derivative (maybe best to max 3-5 years) or else too short to link a sustainability outcome.
- Regulations for different markets (ie. Does this work in all markets for all currencies)?
- Support derivative structures which are primarily for trade and profit driven only? This is a difficult one. Maybe best not to support these with ESg derviatives.
- Reputational risks that might not have covered and thought of?
Best References in the Market
- https://www.isda.org/2021/01/11/overview-of-esg-related-derivatives-products-and-transactions/
- https://www.isda.org/2021/09/08/developing-standards-for-esg/
- https://www.ecmi.eu/publications/research-reports/derivatives-sustainable-finance
Future Developments
- More derivative instruments embedding sustainability links within them.
- New type of specific ESG derivatives to emerge.
- More transactions with a double whammy ie. Linked on the actual sustainability related bond/loan and also on the derivative.
- ESG derivatives will continue to evolve as it’s a large area of business with lucrative opportunities for Banks.
