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| {{a|myth|{{image|Easter Islands|png|A dead [[metaphor]], yesterday.}}}}{{c2|ESG|ISDA}}{{dpn|/səsˌteɪnəˈbɪlɪti lɪŋkt dɪˈrɪvətɪvz/|n}} | | {{freeessay|isda|sustainability-linked derivatives|{{image|Easter Islands|png|A dead [[metaphor]], yesterday.}}}}{{c|ESG}} |
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| It is said that the ancient people of Easter Island felled every tree on the island while erecting statues to their Gods and ancestors. Without the root systems the island’s topsoil crumbled and eroded, nutrients washed away, plants did not grow and eventually the whole ecosystem was wrecked. The island became all but uninhabitable and has not recovered in 400 years, but still has magnificent statues.
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| This was quite the disaster in the service of trying to please imaginary people.
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| 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]]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 everyone’s onward 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 pursuut of mad, hypercomplicated, illogical schemes to solve imaginary problems for nonexistent investors.
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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?
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| 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.
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| 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.
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| ===How “[[SLD]]s” are meant to work===
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| 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]].
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| 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.
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| 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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| Insofar as an [[SLD]] ''is'' a derivative, it is a ''self-referencing'' one. They don’t much ''like'' those, usually, at ISDA. There is a reason they don’t let athletes bet on games they are playing in.
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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?
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| 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?)
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| 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.
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| 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?
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| ===Financial sustainability much?===
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| 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]].
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| 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.
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| 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.
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| There is force in the idea that carbon credits are derivatives not so much of environmental damage as much as of regulatory fashion. SLDs aren’t event that. These aren’t even derivative at all. They penalise, and reward, innocent parties.
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| {{Sa}}
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| *[[Credibility derivatives]]
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| *[[Stakeholder capitalism]]
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| {{Ref}}
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