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{{freeessay|isda|sustainability-linked derivatives|{{image|Easter Islands|png|A dead [[metaphor]], yesterday.}}}}{{c|ESG}}
 
{{quote|A derivative transaction with an [[Environmental, social and corporate governance|ESG]] overlay, taking into account specific measures and targets in the form of [[Key performance indicator|Key Performance Indicators]].<ref>Deliciously unenlightening definition courtesy of [https://insightplus.bakermckenzie.com/bm/banking-finance_1/global-sustainability-linked-derivatives-isdas-case-for-standardisation-in-a-globalised-world Baker & McKenzie]. If you have any idea what “an ESG overlay” to a “derivative transaction” might be, do write in. JC considered ending this article with “[[key performance indicator]]” as that neatly captures the absurdity of this asset class, but felt oddly compelled to carry on.</ref>}}
 
{{drop|I|t is said}} that the ancient people of Easter Island felled every tree on their island while erecting statues to their Gods and ancestors. Without these vital root systems, the island’s topsoil eroded, nutrients washed away, plants could not grow and eventually the whole ecosystem was wrecked. The island became uninhabitable, It has not recovered in 400 years.
 
The magnificent statues remain, but still: this was quite the disaster in the service of trying to please imaginary people.
 
This “ecocide” theory, popularised by Jared Diamond a generation ago,<ref>''Guns, Germs, and Steel: The Fates of Human Societies'', Jared Diamond, 1997.</ref> is out of favour with hand-wringing [[snowflake|snow-flake]]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> in which a community of earnest toilers, bent on vouchsafing collective prosperity but caught in the throes of a voguish delusion that [[this time it’s different|everything is different this time]] sets about demolishing every tree in sight in the pursuit of mad, hyper-complicated, illogical schemes to solve imaginary problems for non-existent investors.
 
No better example could there be than its initiative to introduce “sustainability-linked derivatives”. What is ISDA up to? Is It trying to stay ''relevant''? <Ref>Recent clumsy land-grabs of [[ICMA]]/[[ISLA]] territory, and forays into [[2023 ISDA Digital Asset Transactions Definitions|crypto]] certainly give that impression.</ref> Are we watching an industry association having a midlife crisis?
 
There has always been something quixotic about an organisation whose avowed purpose is to promote “safe efficient, markets” but which promulgates things like [[credit derivatives]], but — even so — this feels like a step further through the looking glass; a tumble deeper down the rabbit hole.
 
[[Crack drafting squad|The ’squad]]’s prior follies at least ''tried'' to cater to existing demands, markets and regulatory imperatives. This new push feels like an attempt to create a new market no one is asking for out of — well — hot air.
===How “SLDs” are meant to work===
If its own {{plainlink|https://www.isda.org/2022/11/21/the-way-forward-for-sustainability-linked-derivatives/|discussion paper}} is anything to go by, no-one (yet!) has much of an idea what a sustainability-linked derivative would even look like. ISDA proposes that it would sort of plug-in to a normal swap, containing a ratchet that would adjust spreads on the parties’ respective payment obligations should they hit (or miss) pre-agreed [[ESG]] [[key performance indicators]].
 
Now, objectively measuring environmental impact is hard,<ref>Readers are invited to [https://www.google.com/search?q=measuring+sustainability Google it] and note how many management consultancies are shilling to help you do it.</ref> and open to abuse,<ref>[https://www.google.com/search?q=greenwashing/ Readers are invited to Google this, too.]</ref> even when you aren’t talking your own book as you do it. But the “greenwashing” risk is the least of the challenges here. Higher up the list is basic intellectual coherence.
 
For a start, this is not a ''[[derivative]]'' in any normally understood sense. It is more like an arbitrary [[penalty clause]]: a payment derived not from some observable third party measure, but an internal [[metric]] entirely within the counterparty’s gift to game: it knows what targets it can and cannot plausibly meet; its counterparty has — short of [[due diligence]] it will not care to do just to execute a swap (among other things, it might bugger up your marginal carbon footprint) — ''no idea at all''.
 
Insofar as an SLD ''is'' a derivative, it is a ''[[Self-referencing derivative|self-referencing]]'' one. Regulators don’t much ''like'' those, usually. There is a reason they don’t let athletes bet on games they are playing in.
 
So this becomes an open invitation to systematic [[insider dealing]] on one’s own operations. And that is assuming a wily trader stays “long” her own firm’s sustainability performance at all times. But swaps are by their nature bilateral. What is to stop her [[short sale|''shorting'']] her own sustainability credentials, incentivising her employer’s transition ''towards'' carbon and modern slavery?
 
Secondly, the need for robust, measurable [[Key performance indicator|KPI]]<nowiki/>s implies a grand, work-creating, rent-generating, carbon footprint-inflating bureaucratic infrastructure of little drones running about, setting targets, measuring them, publishing them, making determinations about them, resolving disputes about them and so on. Who is going to fund the sustainability determinations committee? And will the whole enterprise not, by wasting trees, do more environmental damage than it solves?
 
Thirdly. why should my trading counterparties ''care''? What has any of this to do with them? What benefit accrues to the environment when my swaps desk pays more or less cash to theirs? Why would they make themselves hostage to my ESG compliance effort? Why should they suffer a penalty just because I have cracked my own gender pay gap? (Isn’t there reward enough in just ''doing'' that, by the way? What does it say about economic incentives that we must bribe each other to promote our own staff fairly?) 
 
And besides, how are you supposed to ''hedge'' that?
 
Nor will these be a kind of [[Emission allowances|synthetic carbon credit]] (and, anyway, ISDA already has a [[Emissions Annex|product for that]]). No money flows into tax coffers or environmental protection funds as a result under this proposal. It just means parties pay more money than they need to to each other. This is an odd way of vouchsafing efficiency.
 
Commerce does not work by gifting emoluments to virtuous strangers just because they recycle shopping bags.
 
===Financial sustainability much?===
It feels like there is a [[category error]] here. The “[[sustainability]]” a financial counterparty should really care about is ''solvency''. 
 
''That'' kind of good corporate governance — and sorry, millennials, but [[JC]] is with Milton Friedman on this one: that means [[shareholder capitalism|''shareholder return'']] — is reflected in [[credit spread]]s: how likely does the market regard my [[bankruptcy]]. Not [[Environmental, social and corporate governance|ESG]] [[Key performance indicator|KPI]]<nowiki/>s.
 
My brokers will not discount my credit premiums just because I care about polar bears. If they don’t get their money back, the happy knowledge that I did my bit for water scarcity will be cold (wet?) comfort. What will — should — matter a lot more is that I ''keep up my payments on my swaps and loans''.
 
This is what is coded into my spreads.  Spreads are set at trade date and are not then adjusted — 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”.
 
There is force in the idea that [[Emissions Annex - Emissions Annex Provision|carbon credits]] are derivatives not so much of greenhouse gas pollution as regulatory fashion. Sustainability-linked derivatives aren’t event that. They aren’t a derivative at ''all''.
{{Sa}}
*[[Credibility derivatives]]
*[[Stakeholder capitalism]]
*[[Emissions Anatomy|Emissions trading]]
{{Ref}}
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