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ESG: the outlook for derivatives and structured products

We have seen a wide range of sustainable derivatives and structured products being issued over the last couple of years and expect volume and variety to increase further in 2021 as investors actively seek more sustainable investment opportunities. These types of products include “green” regulatory capital transactions and synthetic securitisations (where the regulatory capital saving is used for sustainable lending), “green” securitisations and CLOs (where the underlying loans are green or sustainable), sustainable swaps (where the price of the hedge goes up or down depending on the counterparty’s ESG performance), “green” structured and repackaged notes and complex structures providing financing to developing countries designed to address the “S” element.

2020 saw increased focus and movement on the ESG regulatory side notwithstanding the Covid-19 crisis, with regulators noting that the outbreak shows the critical need to strengthen the sustainability and resilience of our societies and the ways in which our economies function. It seems that there is no intention to slow down the pace of ESG reform in 2021 because of Covid-19. Those in the derivatives and structured products space will need to be aware of this new body of regulation, which is intended to create a level playing field for relevant products, give companies and financial instruments easily comparable suitability credentials and clarify ESG disclosure requirements for investors and asset managers.

In particular, the Low Carbon Benchmarks Regulation will apply to all administrators of benchmarks (other than interest rate and FX), whether ESG benchmarks or not. Although this came into force at the end of 2019, the delegated acts providing detailed minimum requirements for the disclosure did not enter into force until December 2020. Benchmark administrators will therefore need to start making the relevant amendments to their benchmark statements and methodologies to disclose ESG factors in accordance with the Level 1 text. We expect parties to be busy addressing this in early 2021. Administrators are also required to include disclosure in their benchmark statement by the end of 2021 on how their methodology aligns with the target of carbon emissions reduction or attains the objectives of the Paris Agreement. In addition, administrators of significant benchmarks located in the EU must “endeavour” to provide at least one EU Climate Transition Benchmark by 1 January 2022, so will need to work towards putting this in place during 2021.

Also of note in the regulatory space are the ESG Disclosure Regulation (which requires certain disclosures to be made at entity and product level and will largely apply from 10 March 2021) and the ESG Taxonomy Regulation (which creates a framework for an EU wide classification system on what is an environmentally sustainable economic activity and is due to apply from the beginning of 2022). Although neither directly capture derivatives and structured products, asset/fund managers, insurers and pension providers will be caught. It is therefore important that those in the derivatives and structured products space are aware of what the investors subject to the rules are required to disclose and, consequently, what they may be looking to invest in. It will also be key to think about how structured products are being marketed and what is disclosed in issue level documentation, particularly where such products are being promoted as green.

For more information, please see our note: An overview of EU ESG regulation and its impact on derivatives and structured products and our ESG Legal Outlook 2021.

This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors.

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