INTERNATIONAL: ISDA Publishes Papers to Further Develop ESG Standards and Accounting Practices

Wednesday September 8 2021

ISDA has launched two new whitepapers examining key aspects of the fast-growing market for environmental, social and governance (ESG) transactions, with the aim of establishing robust standards and best practices for this sector.

The papers focus on key performance indicators (KPIs) for sustainability-linked derivatives and the accounting treatment for ESG transactions. They come in response to rapid developments in the scope and scale of ESG-related investments and hedges as market participants strive to meet climate and development objectives.

The sustainability-linked derivatives paper sets out proposed guidance for drafting KPIs, which are fundamental to the effectiveness and credibility of these transactions. Sustainability-linked derivatives tie cashflows on conventional hedging instruments to the meeting of specified ESG objectives using KPIs to measure compliance. The paper sets out principles to ensure those KPIs are specific, measurable, verifiable, transparent and suitable.

The other paper describes issues associated with the current accounting treatment of ESG transactions. Under US Generally Accepted Accounting Principles, the ESG component of a bond or loan could be classed as an embedded derivative requiring bifurcation and accounting at fair value. 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.

In response, the paper proposes alternative approaches that will improve the value of the information reported.

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