What is a sustainability-linked derivative?
A sustainability-linked derivative (SLD) creates a cash flow tied to an environmental, social or governance key performance indicator (KPI). In a type-one SLD, the KPI terms and cash flow sit in the derivative confirmation. In a type-two SLD, a separate agreement creates the KPI cash flow and uses a conventional derivative as its reference; the derivative's ordinary terms generally stay unchanged.
Why does a sustainability-linked derivative matter to you?
Your treasury, sustainability and legal teams must agree on the KPI result before settlement. An unclear boundary, test date, data source or notice deadline can produce a disputed payment. An immaterial or easily met KPI can also undermine any sustainability claim.
How does a sustainability-linked derivative work?
The contract should state the KPI, baseline, sustainability performance target, measurement period, formula, data source, verification requirement and payment rule. It should cover acquisitions, methodology changes, late reports and an unavailable verifier. On the test date, use the named data and formula, obtain verification, send the result notice and calculate only the identified cash flow.
What mistakes should you avoid?
- Calling the trade type one when the KPI terms sit in a separate type-two agreement.
- Leaving the KPI boundary, formula, test date or payment consequence open to interpretation.
- Changing a cash flow before the required verification and result notice are complete.
Does an SLD finance green projects?
Not necessarily. An SLD links a cash flow to KPI performance. It does not by itself restrict how the company uses funds or prove that the underlying hedge is environmentally sustainable.
What records support an SLD payment?
Keep the signed confirmation and any separate KPI agreement, calculation method, baseline, measurement data, verification report, result notice and settlement record. Mark whether the trade is type one or type two.