ISDA Assesses Regulatory Considerations for Sustainability-Linked Derivatives
ISDA assessed how existing derivatives regulatory regimes would apply to sustainability-linked derivatives.
In a newly released paper titled "Regulatory Considerations for Sustainability-linked Derivatives", ISDA outlined factors for determining (i) whether SLDs would be considered swaps under U.S. regulations, (ii) whether SLDs would be considered OTC derivatives under EU or UK regulations, (iii) the impact that sustainability-linked cash flows may have on derivatives otherwise exempt or excluded from certain regulations and (iv) compliance issues based on how SLDs are classified.
ISDA evaluated how those determinations would impact (i) risk management and documentation requirements, (ii) reporting, (iii) disclosures, (iv) benchmark considerations, (v) bankruptcy/recovery and resolution and (vi) prudential requirements.
Separately, ISDA considered the legal implications of voluntary carbon credits, emphasizing that "[a] robust voluntary carbon market must be grounded in a strong legal foundation." In a white paper, ISDA offered recommendations on how regulators can provide greater legal certainty regarding voluntary carbon credits and how the derivatives markets can facilitate raising capital for green investments while mitigating risks.
As ESG products and investing gain popularity, regulators struggle with how to assess and monitor financial products. SLDs have an additional hurdle to overcome, such as how they should be classified under U.S., EU, and UK regulations. Currently, ESG disclosure requirements are most extensive in the EU, where regulatory reforms relating to sustainable financing already exist, and second-most extensive in the UK, where the focus has been primarily on preventing greenwashing.