According to research by the International Swaps and Derivatives Association (ISDA), the nascent sustainability-linked derivatives (SLD) space is starting to take off, with nearly 70 financial institutions offering SLDs on interest rates, currencies, and other underlying assets. is completed from the beginning. Traded in August 2019.
- ISDA will initiate the standardization of interest rate derivatives related to sustainability.
- Market participants have already included sustainability targets in ISDA documents.
- Emission targets are a major focus of the SLD.
ISDA launched an investigation in April. The findings, which aroused “strong member interest”, are the most comprehensive picture of SLD’s work to date. Against this background, ISDA is beginning to draft standardized terminology for documenting transactions.
Respondents cited interest rates as the most important underlying asset and priority for ISDA to create standard terms and conditions. They ranked the importance of currency swaps slightly higher than cross-currency swaps, but cross-currency swaps garnered more support for standardization.
Trading references from other asset classes such as commodities, credits and equities is not common, ISDA found.
Sustainability goals
Market participants, including companies such as Associated British Ports and Italy’s Enel, and major investors such as UK’s Aviva, have already included key performance indicators for their sustainability goals in their ISDA documents. The ISDA master agreement and the 2021 interest rate derivative definition are the most common.
KPIs are usually included in the SLD’s trade confirmations, but a minority report that they are included in separate contracts mentioned in the confirmations.
One potential initiative by the association would be a stand-alone confirmation template containing its own set of ESG terms, possibly in the form of a clause library. “This will allow members to create her SLDs for different asset classes,” he said.
Given the predominance of interest rate SLDs, participants will use the terms from the 2021 ISDA Interest Rate Derivatives Definitions along with ESG terminology for their templates. According to ISDA, confirmation templates can also be included.
SLD Key Performance Indicators
Reflecting the sustainability-related bond market, SLD’s most common KPI refers to reducing greenhouse gas emissions. The type of emissions was not examined in this study. In particular, whether the SLD’s trading partners include indirect Scope 3 emissions along the entity’s value chain.
Nearly three times as many respondents cite emissions as a key SLD KPI compared to ESG ratings from independent providers, the next contender. Other key KPIs include renewable energy as a percentage of energy production, and also feature ESG-related investment and diversity goals, although respondents are split on how prevalent they are.
ISDA’s research explored areas such as non-payment, early termination, third-party verification, goal attainment, and ‘greenium’ as well as the ESG bond market. These are sustainability premiums paid if targets are met or not met, depending on the deal structure.
While the association leaves the trade counterparties to negotiate prices bilaterally, SLD Greenium was found to be based on the notional value of the deal, although the duration could also be a factor.
A minority reported that multiple trades or portfolio notional value percentages were the most common criteria.
ISDA has already published several papers on SLD.[i]This is in response to the increased focus on these products and the potential acceleration of ESG-related financial transactions. These include his KPI best practices to ensure legal certainty and enforceability, as well as potential regulatory treatment of his SLD in various jurisdictions.
This article was written by Julian Lewis
