The International Swaps and Derivatives Association (ISDA) published two new whitepapers examining key aspects of the fast-growing market for environmental, social, and governance (ESG) transactions, with the aim of establishing robust standards and best practices for this sector. The papers focus on key performance indicators (KPIs) for sustainability-linked derivatives and the accounting treatment for ESG transactions. They come in response to rapid developments in the scope and scale of ESG-related investments and hedges, as market participants strive to meet the climate and development objectives.
The paper on KPIs for sustainability-linked derivatives sets out proposed guidance for drafting KPIs. Sustainability-linked derivatives tie cashflows on conventional hedging instruments to the meeting of specified ESG objectives using KPIs to measure compliance. The paper provides an overview of sustainability-linked derivatives, describes KPIs in the context of sustainability-linked derivatives, and sets out overarching principles for drafting KPIs for sustainability-linked derivatives. It sets out principles to ensure those KPIs are specific, measurable, verifiable, transparent, and suitable. Given the nascent state of the market for sustainability-linked derivatives and the need to tailor KPIs to the circumstances of specific counterparties and sustainability goals, this paper is intended to provide general guidelines rather than uniformly applicable recommendations. Appropriate factors to consider in structuring and documenting a sustainability-linked derivative may vary by transaction and may evolve with the market over time.
The paper on accounting analysis for ESG-related transactions aims to identify and illustrate how financial transactions linked to ESG features impact accounting and reporting under the U.S. GAAP. As ESG features become more pervasive in the market, alternative approaches to assessing these components could be introduced to alleviate the operational burden on companies when entering ESG-related transactions. Existing accounting under U.S. GAAP creates a burden for issuers to identify, analyze, and value the ESG features. Due to the level of estimation and assumptions required to assign a value to an ESG feature, the outcome may not provide decision-useful information to users of financial statements. Instead, this paper indicates that these issues are better covered through qualitative sustainability disclosures which many entities already provide. The paper then proposes alternative approaches that will improve the value of the information reported. One approach is to introduce guidance similar to that existing under IFRS 9 on financial instruments. An alternative approach would be to expand the revenue scope exception under ASC 815 to include ESG features.
- Press Release
- Paper on KPIs for Sustainability-Linked Derivatives (PDF)
- Paper on Accounting Analysis for ESG Transactions (PDF)
Keywords: International, Banking, Securities, Accounting, ESG, Climate Change Risk, Sustainability Linked Derivatives Sustainable Finance, KPI, US GAAP, IFRS 9, Financial Instruments, Derivatives, ISDA
Dr. Denton provides industry leadership in the quantification of sustainability issues, climate risk, trade credit and emerging lending risks. His deep foundations in market and credit risk provide critical perspectives on how climate/sustainability risks can be measured, communicated and used to drive commercial opportunities, policy, strategy, and compliance. He supports corporate clients and financial institutions in leveraging Moody’s tools and capabilities to improve decision-making and compliance capabilities, with particular focus on the energy, agriculture and physical commodities industries.
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