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ISDA Issues Guidance for Sustainability-Linked Derivative KPIs

Trade organisation’s second paper analyses existing issues with the accounting treatment of ESG-related transactions.

The International Swaps and Derivatives Association (ISDA) has published two new papers examining the ESG market, seeking to facilitate the establishment of robust standards and best practices for the sector.

The first paper sets out proposed guidance for drafting KPIs for sustainability-linked derivatives, which serve as hedges for ESG transactions by linking cashflows on a conventional derivative like an interest rate swap to the meeting of specified ESG objectives, where a set of KPIs is used to measure compliance.

While a variety of structures and payouts for sustainability-linked derivatives have emerged so far, there has not been a common format or configuration for the KPIs, which are “essential to the effectiveness and smooth operation of these transactions”.

The paper represents ISDA’s initial attempt to create a common framework to ensure KPIs are specific, measurable, verifiable, transparent and suitable.

The second paper covers accounting analysis for ESG-related transactions, seeking to address existing issues associated with the current accounting treatment of such transactions.

Under US GAAP, the ESG component of a green bond or loan could be classed as an embedded derivative, requiring that component to be split out and reported at fair value, the paper says.

However, a lack of observable data means ESG features are currently difficult to value, resulting in information that is unlikely to be useful to readers of financial statements. The paper proposes two alternative approaches to reduce the operational burden on firms and improve the value of the information reported.

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