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Sustainability-linked derivatives: Difference between revisions
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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? | 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? | ||
Some — such as the JC — say there has always been something quixotic about an organisation who proclaims it is there to promote “safe efficient, markets” | Some — such as the JC — say there has always been something quixotic about an organisation who proclaims it is there to promote “safe efficient, markets” but 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. | ||
The ’squad’s prior follies at least ''tried'' to cater to existing use cases, markets and regulatory imperatives, however cack-handedly. | The ’squad’s prior follies at least ''tried'' to cater to existing use cases, markets and regulatory imperatives, however cack-handedly. | ||
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Sustainability-linked derivatives feel like an attempt to create a new market no one is asking for out of — well — hot air. | Sustainability-linked derivatives feel like an attempt to create a new market no one is asking for out of — well — hot air. | ||
===How “[[SLD]]s” are meant to work=== | ===How “[[SLD]]s” 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 a clear idea what a sustainability-linked derivative should look like. ISDA proposes a sort of plug-in to a normal swap containing a ratchet device adjusting the spreads on parties’ respective payment obligations dependent on their own compliance (or not) with pre-agreed [[ESG]] [[key performance indicators]]. | 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 a clear idea what a sustainability-linked derivative should look like. ISDA proposes a sort of plug-in to a normal swap containing a ratchet device adjusting the spreads on parties’ respective payment obligations dependent on their own compliance (or not) with 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. But even so, greenwashing risk is the least of the challenges here. Higher up the list is attaining basic intellectual coherence. | |||
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. But even so, greenwashing risk is the least of the | |||
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 indicator, 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]] no-one will care to do just to execute a swap (among other things, it might bugger up your marginal carbon footprint) — ''no idea at all''. | 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 indicator, 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]] no-one will care to do just to execute a swap (among other things, it might bugger up your marginal carbon footprint) — ''no idea at all''. | ||
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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? | 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? | ||
And why, exactly, should a firm’s trading counterparties ''care''? What has any of this to do with them? What benefit accrues to the environment when one swaps desk pays more or less cash away to another? Why would | And why, exactly, should a firm’s trading counterparties ''care''? What has any of this to do with them? What benefit accrues to the environment when one swaps desk pays more or less cash away to another? Why would counterparties make themselves hostage to the firm’s ESG compliance effort? Why should they suffer a penalty just because the firm cracks its 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 people to promote staff fairly?) | ||
Nor will these be a kind of synthetic carbon credit (ISDA already has a [[Emissions Annex|product for that]]): no money flows into tax or environmental protection coffers as a result. | |||
Commerce does not work by gifting emoluments to virtuous strangers just because they recycle shopping bags. Swaps traders certainly don’t work like that. And besides, how are you supposed to ''hedge'' that? | |||
The “[[sustainability]]” a counterparty should really care about is | ===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: the [[JC]] is with {{author|Milton Friedman}} on this: that means [[shareholder capitalism|shareholder return]] — is after all reflected in my [[credit spread]]s: how likely does the market regard my [[bankruptcy]]. | |||
My brokers will not | My brokers will not discount my credit premiums just because I care about the polar bears. If they don’t get their money back, the knowledge that I did my bit for African water scarcity will be cold (wet?) comfort. | ||
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. | 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. | ||