We are seeing an increased pace in the growth of sustainable economy, mainly after the pandemic hit. This resulting in the financial markets to have a considerable increase in focusing on the deal values with respect to sustainability linked loans and bonds. The sustainability tress sprouts anew leaf with the development of the factors such as environmental, social and governance (ESG) linked derivatives and it has been proven to be a progression logically. Among other things, these products help the firms and the companies to manage its risks associated with the investments which include the project risks, interest rates and the currency risks they pertain.
ISDA outlined the broad range of derivatives in sustainable finance and continued the development of product type such as sustainability-linked derivatives, ESG-related credit default swaps, and exchange-traded derivatives on listed ESG-related equity indices, emissions trading derivatives, renewable energy and renewable fuels derivatives, and catastrophe and weather derivatives. It is important of understand the differences between the IRS ( interest rate swaps ) and FX 9( Foreign Exchange ) as these conventional derivative exchanges will be further used by market participants to avoid the risk emerging from the green bonds and loans.
Many sustainability linked derivatives were issued in the recent years which added an ESG pricing component to IRS and FX hedging instruments.
According to BNP Paribas and Siemens Gamesa, €174 million of FX forward, under which Siemens Gamesa will pay a premium on their forward if they do not meet certain ESG targets. This shall be used to finance the local reforestation projects in Spain.
According to Société Générale & Enel, there will be a cross currency swap which will enable Enel hedge their euro dollar exchange rate and interest rate risk under $1.5 billion sss linked bond.
According to New World Development (NWD) & DBS Hong Kong, there will be an Interest rate swap linked to the United Nations Sustainable Development Goals, hedging interest rate risk under NWD’s HK$1 billion sustainability-linked loan.
ESG linked derivatives have a take on numerous characteristics and structures like :
Derivative pricing. One party having a number of agreed ESG targets which if met, will lead to a downhill notch in the pricing of the derivative and these pricing often increase if the targets are not met.
Fixed payments. If ESG targets are not met by the company, a fixed payment can be acting as an obligatory to the delivering bank, which will be put towards as a green project.
Triggers linked to a company’s ESG rating. If in case the ESG rating of the corporate upsurges, a subsidy can be awarded to them (e.g. interest rate discount).
Both revelries having ESG targets marked into their derivatives contracts. Corporates can obtain a discount on the interest rate under the derivative if they meet their ESG targets, with that discount being grown if the issuing bank fails to meet its own ESG targets.
Charitable giving necessities. A failure by the corporate to obey or fulfil its ESG targets can lead to the aforementioned being required to make aids to non-profit organizations and with the bank having to make such charities if the corporate’s ESG targets are met.
Through the view of this, derivatives market contributors will be keen to continue to drive ESG-linked derivatives volumes and to advance in new and innovative ESG products enabling the deployment of capital towards ecological investments to guarantee that they continue to meaningfully improve ESG standards, and to reinforce their contribution to the green finance drive.
