Europe

The Role of Derivatives Markets in Sustainable Finance

The derivatives market can contribute in the transition towards a low-carbon economy, due its ability to facilitate capital-raising via the hedging of risks related to sustainable investments.

The ECMI (European Capital Markets Institute), in cooperation with ISDA, has published a new paper on the role of derivatives in sustainable finance.

Over the past years, sustainability has risen in scope and importance on the agenda of policymakers. In Europe, this has been translated to the EU Sustainable Finance Action Plan, which aims to:

  • reorient capital flows towards sustainable investments;
  • manage financial risks stemming from climate/environmental/social issues; and
  • promote transparency and long-termism in financial and economic activity.

The derivatives market can play a significant role in the context of the European Green Deal and the transition towards a low-carbon economy, due its ability to facilitate capital-raising via the hedging of risks related to sustainable investments, the paper says.

Issuers of and investors in the greater than EUR 1 trillion of capital that is expected to be required support the transition to a low-carbon economy will want and need to manage the associated interest rate and other risks of these investments, and derivatives are the most efficient way to do so.

Derivatives also enhance the transparency and the price formation process of the underlying securities, and thus foster long-termism.

The report highlights how derivatives markets can contribute to sustainability goals by:

  • Enabling the EU to raise and channel the necessary capital towards sustainable investments;
  • Helping firms hedge risks related to environment, social and governance factors;
  • Facilitating transparency, price discovery and market efficiency; and
  • Contributing to long-termism.

The full report is available here.

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