Sustainability-linked derivatives: Difference between revisions

This “ecocide” theory, popularised by Jared Diamond a generation ago, is out of favour with hand-wringing [[snowflake]]y academic types nowadays. ISDA’s council of elders may feel the same way about the JC’s corresponding “swapicide” theory.<ref>Sunk without trace: [[2011 ISDA Equity Derivatives Definitions]], [[2022 ISDA Securities Financing Transactions Definitions]], [[2023 ISDA Digital Asset Transactions Definitions]]. Those that did bear fruit were no great scream of exhilarating clarity: the [[2014 ISDA Credit Derivatives Definitions]], [[2016 Credit Support Annex for Variation Margin (VM)|2016 ISDA Regulatory VM CSAs]] and [[2018 ISDA Credit Support Deed for Initial Margin|2018 ISDA Regulatory IM CSA]] being cases in point.</ref>  

Is ISDA desperately trying to stay ''relevant''? Recent clumsy land-grabs of [[ICMA]]/[[ISLA]] territory and forays into [[2023 ISDA Digital Asset Transactions Definitions|crypto]] give that impression. In any case, the irony that ISDA’s latest foray into the new normal — “sustainability-linked derivatives” — should so resemble a notorious example of environmental disaster is rich:

A community of earnest toilers, supposedly there to vouchsafe the community’s onward prosperity, falls into the throes of a voguish collective delusion and sets about a wastes every tree in sight pursuing mad, hypercomplicated and illogical schemes for imaginary investors who no-one has seen, let alone heard expressing demand for such an offering.

ISDA’s recent missteps Even so this feels like a step further through the looking glass, deeper down the rabbit hole.  ISDA’s previous follies at least tried to cater to existing markets and regulatory imperatives, however cack-handedly. Sustainability derivatives are an attempt to create a new one out of — ~cough~ — hot air.

If its discussion paper is anything to go by, not even ISDA has a clear idea what a sustainability-linked derivative would look like. Their best suggestion is that it would be some kind of plug-in to a normal swap — say an interest rate swap — containing a ratchet device to adjust the parties’ respectively spreads dependent on their compliance (or not) with certain pre-agreed  [[ESG]] [[key performance indicators]].  

Perhaps ISDA hasn’t followed the media coverage of greenwashing, but objectively measuring environmental impact is hard, and open to abuse.

Nor is this a ''[[derivative]]'' in the sense normally understood, but rather more a random [[penalty clause]]: a payment derived not from some observable third party indicator, but an internal metric entirely within the counterparty’s gift to game: I know what targets I can plausibly meet; my counterparty has no idea at all.  

This becomes an open invitation to systematic insider dealing on ones own operations, especially since swaps are by their nature bilateral. What is to stop buisnesses [[Short sale|''shorting'']] their own sustainability credentials, and incentivise their own transition ''towards'' carbon and modern slavery?

And what has any of this to do with my counterparty? Why is paying, or not paying, cash away to a random stranger any kind of benefit to the environment? Why would a counterparty make itself hostage to my compliance effort? What incentive does it have to offer a discount just because I have cracked my own gender pay gap? Just by way of applause for its moral aspiration? That is not how commerce works. Besides, how is it supposed to ''hedge'' that?

The sustainability a counterparty should really care about is that of its counterparties’ solvency. Good corporate governance — and sorry, millennials, the [[JC]] is with Milton Friedman on this: that means focus solely on shareholder return — is after all reflected in my [[credit spread]]s: how likely does the market regard my bankruptcy. This is coded into my spreads when I trade swaps. But once traded, these are not then adjusted during the life of the trade — hence a rich lifetime of employment for [[credit value adjustment]] traders. But in any case, my incentive is to manage my business as best I can so that ''when I trade I achieve the tightest spreads''.  That is all the incentive the market has needed, until now, to promote sustainability. Hardcore [[Libtard]]s may differ — we are all libtards now — but nothing has changed.