Sustainability-linked Derivatives: KPI Guidelines

Since the first sustainability-linked derivative (SLD) was executed in August 2019, market participants have entered into a variety of SLDs, mainly in Europe but more recently in Asia and the US. SLDs embed or create a sustainability-linked cashflow using key performance indicators (KPIs) that are designed to monitor compliance with environmental, social and governance (ESG) targets. KPIs are therefore critical to the effectiveness and integrity of the SLDs to which they relate. KPIs need to be accurately defined in order to have legal certainty over how they operate and impact cashflows and so they can be objectively verified. This will enhance the credibility of SLDs and the sustainability-linked market as a whole. This paper sets out proposed guidelines on KPIs for SLDs in order to meet the following objectives:

• Educate: As SLDs are currently a niche and nascent market, this paper is intended to provide further information to market participants on the types of transactions that have been executed to date, along with guidance on the overarching principles that need to be considered when structuring KPIs.
• Contribute to best practices: Although this is an area in which customization and bespoke innovation are important, the guidance seeks to establish a transparent, common framework of best practices that can be applied across KPIs and their related SLDs more widely.
• Promote safety and soundness of the market: By establishing best practices and addressing key risks, the guidance seeks to help address greenwashing by encouraging adequate disclosure of how SLDs help attain sustainability objectives, therefore supporting the integrity of this developing market.
• Enhance liquidity: By setting out a best practice framework, the guidance seeks to promote the use of SLDs. This will help build liquidity and ensure SLDs provide an effective tool for counterparties to participate in the transition to a green economy.

This paper provides an overview of SLDs, describes KPIs in the context of SLDs and sets out overarching principles for drafting KPIs for SLDs.

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