Investors, customers, and regulatory authorities are increasingly putting more pressure on companies to focus on the outcomes of their Environmental, Social, and Governance (ESG) goals. As a result, sustainability is becoming a priority for many large corporations. With the rise of sustainable finance, new financial instruments, such as Sustainability-Linked Derivatives (SLDs), are gaining traction. In this blog, we aim to explain what SLDs are and the benefits of incorporating them into your ESG strategy. Additionally, we will provide guidance on how the right Investor ESG software and advisory services can enable you on this journey.
What are Sustainability-Linked Derivatives?
Sustainability-Linked Derivatives (SLDs) are financial instruments that are used to incentivize ESG performance and/or to facilitate support for sustainable projects. They create an ESG-linked cashflow that is a component of, or relates to, a conventional derivatives instrument by using key performance indicators (KPIs) to monitor compliance with ESG targets. SLDs are a relatively new addition to the derivatives market, with the first SLD executed in August 2019 between SBM Offshore and ING to hedge the interest rate risk of SBM’s $1 billion five-year floating rate revolving credit facility. They are an evolving product and can be structured in many ways, meaning there is currently no agreed definition of an SLD or any market-standard documentation.
Why are SLDs important?
SLDs directly connect a company’s financial performance with its ESG goals. They combine financial and economic terms, such as pricing or payment structures, with actually reaching the already set ESG goals. In doing so, SLDs manage to create strong motives for companies to achieve those set goals. This ultimately helps companies showcase their commitment by encompassing ESG practices in their overall strategy. At the same time, with regulations becoming stricter and investor requirements for transparency increasing, SLDs offer a way to align financial motives to ESG goals. This helps reduce the danger of greenwashing while enhancing company accountability.
Why use SLDs?
For Buy-side Counterparties – such as asset managers, pension funds, insurance companies, hedge funds, and corporations, SLDs offer financial motivation to reach sustainability goals. By linking financial performance to ESG outcomes, SLDs enable these entities to demonstrate their commitment to ESG principles. SLDs can also offer better financial terms if the company meets the agreed-upon ESG goals. Thus, creating a KPI framework can be useful for future transactions, aiding overall profitability.
For Sell-side Counterparties – such as financial institutions like banks, brokers, and dealers), SLDs enhance their ESG profile and offer the opportunity to support their clients’ ESG goals and manage related risks. SLDs also help these institutions meet their own ESG commitments and gain a competitive advantage by diversifying their offering across various financial categories. As with the buy-side, developing a robust KPI framework can be instrumental in driving profitability and efficiency in future dealings.
Key Considerations for Integrating SLDs
There are several things you need to consider when integrating SLDs into your strategy.
Selecting Appropriate KPIs
This is the first and the most crucial step. KPIs must be specific, and they must align with a company’s overall ESG strategy. The effectiveness of SLDs largely depends on the relevance and precision of these KPIs.
Ensuring Regulatory Compliance
SDLs need to comply with several regulations both financial and ESG-related. Companies must ensure that they also comply with those regulations to mitigate legal and financial risks. Achieving that includes accurate reporting and avoiding any practices that could be perceived as greenwashing.
Transparency and Documentation
It’s necessary to agree to a clear and transparent way in which KPIs are set and how their performance is calculated. Proper documentation helps with building trust between stakeholders maintaining the credibility of SLDs.
Alignment with Corporate Strategy
SDLs must be incorporated into the company’s overall ESG strategy. This ensures that SDLs aren’t just financial instruments, but also a tool that reinforces a company’s commitment to meeting their ESG objectives.
How Cority Can Help
Cority provides a robust platform that helps you track and manage the data and processes needed to meet your SLD-related goals. With Cority’s Investor ESG Management solution, you can monitor your KPIs, ensuring that you stay on track and can report your progress accurately to investors and stakeholders.
Cority’s software simplifies this process by integrating your financial and ESG data into one comprehensive platform. It supports seamless data collection from portfolio companies, custom reporting, and dynamic dashboards. This means you spend less time managing data and more time focusing on achieving your sustainability goals.
Sustainability-Linked Derivatives (SLDs) offer a unique opportunity to align financial success with sustainability. By connecting financial terms to ESG performance, SLDs create a powerful incentive for companies to meet their sustainability targets. With Cority’s Investor ESG Management software and advisory services, you can effectively integrate SLDs into your strategy, ensuring you meet your KPIs, comply with regulations, and maintain transparency with your investors.
Ready to explore how SLDs can benefit your organization? Contact us today to discover how our solutions can elevate your sustainability strategy and drive your ESG performance forward.
Resources:
https://www.isda.org/a/ZfVgE/Sustainability-linked-Derivatives-Where-to-Begin.pdf
https://www.isda.org/a/xvTgE/Sustainability-linked-Derivatives-KPI-Guidelines-Sept-2021.pdf
https://www.isda.org/a/58ngE/Regulatory-Considerations-for-Sustainability-linked-Derivatives.pdf
https://www.isda.org/a/qRpTE/Overview-of-ESG-related-Derivatives-Products-and-Transactions.pdf
https://www.isda.org/a/p7cgE/The-Way-Forward-for-Sustainability-linked-Derivatives.pdf
