Green light for hedging innovations

ESG derivatives are financial instruments linked to a company's sustainability performance. Like conventional derivatives, they are used to manage interest rate, currency, or inflation risks, with an additional agreement on ESG key performance indicators (KPIs). If the KPIs are achieved, the company benefits, for example, from paying a lower swap rate or trading at a more attractive forward exchange rate. If the goal is not achieved, the company pays a penalty. RBI donates this predefined amount to a non-profit organization at the maturity of the trade.

Reducing negative environmental impacts is currently a top priority for management, investors, and stakeholders alike. By entering ESG-linked derivative transactions, a company underscores its commitment to its overall ESG strategy to its customers and stakeholders.

The ESG linkage of such derivatives can be structured to reflect specific ESG metrics, indices, or sustainability targets. These can range from reducing waste or CO2 emissions to the use of sustainable energy.  The derivatives in question are identical to their non-ESG counterparts and therefore equally flexible to hedge the underlying risks.

When defining KPIs for trading ESG-linked derivatives, companies can gather valuable feedback from the banks involved and challenge their current ESG strategy framework. Reputable and innovative financial institutions even offer their clients high-quality ESG advice as a service in addition to their traditional product range.

As ESG-linked derivatives usually work with benefit/penalty they offer the opportunity to reduce hedging costs if ESG KPIs are met. If not, the cost is higher than a normal derivative due to the penalty. Either way, companies can credibly demonstrate that they believe in their own ESG strategy.   

Raiffeisen Bank International's sustainable deposits create incentives for environmentally and socially responsible activities by depositors. By choosing a sustainable deposit, companies can support organizations or projects that prioritize environmental and social causes. Companies can use sustainable deposits to align their financial activities with their sustainability goals and support the transition to a more environmentally and socially responsible economy. Compared to a regular deposit, sustainable deposits offer a slightly lower return, but companies can include the positive impact of the investment in their sustainability report to inform stakeholders about their ESG related initiatives.

Mandatory emission trading requires companies in certain industries, e.g., utilities, steel production, etc., to purchase the right to emit one ton of CO2 or other greenhouse gases in the form of allowances. The EU trading system is well established and highly regulated. The certificates in the European system (EUA - EU Allowances) are traded daily on the stock exchanges in Amsterdam and Leipzig. RBI is able to accept them as collateral. With a repo transaction (repurchase operation), companies can sell the certificate to RBI on a certain day and buy it back on a later date (e.g., 3 months later) at a previously agreed price (including interest). Due to the high-quality collateral (immediately realizable in case of default), this repurchase transaction offers attractive credit conditions and is an interesting source of refinancing for companies or an opportunity to actively use an otherwise unused balance sheet position.

By the way: In addition to the mandatory market with the aim of setting a price for emissions, there is also a voluntary market with the aim of reducing or offsetting emissions. On this market companies can, for example, buy CO2 credits generated by planting mangroves in Brazil, reforestation in Canada or the renaturation of marsh in Austria. This market is attractive to companies that want to reduce their carbon footprint or have committed to achieving net-zero emissions at a certain point in the future. However, as the market is less developed and regulated, it is currently based predominantly on goodwill. Exposures to this market also carry some reputational risks, as some projects have proven to be fraudulent in the past. Our risk and sustainable experts are closely monitoring these market developments and trends.

Innovative financial products linked to ESG (Environment, Social and Governance) criteria are meeting the growing demand for sustainable finance, enabling the shift to a more sustainable economy. These processes are also developing ESG metrics and reporting frameworks that enable more accurate and consistent assessment of corporate sustainability performance.  All in all, investors can make more informed decisions and companies are encouraged to act responsibly.