Exploring the Potential of Sustainabi lity Linked Derivatives in the Market for Sustainable Investments Abstract This research investigates the potential of using Sustainability Linked Derivatives (SLDs) in the market for sustainable investment s. Given the increase in global sustainability commitments, such as the 2030 Agenda and Paris Agreement, incorporating environmental, social, and governance (ESG) factors into financial strategies is essential for meeting these agreement commitments. The literature review sho ws a fast - growing sustainable investment market , emphasising the importance of considering ESG factors in investment decisions and the positive correlation between ESG and financial performance. T he literature review a lso highlight s where SLDs fit into the sustainable investment market and discusses the limited existing literature on SLDs. The discussion section explores SLDs in detail , demonstrating how co mpanies and banks may use SLDs to incentivise and foster support for sustainability initiatives, whi lst also addressing challenges that may arise with their implementation The f indings indicate that while SLDs show potential in reshaping corporate sustainability , they face issues such as greenwashing, inconsistent ESG ratings, and inadequate regulation The research concludes that for SLDs to be effective, they must align with material ESG issues, adhere to global sustainability standards, and be governed by strong regulation A collaborative regulatory approach involving regulators, financial institutio ns , and sustainability experts , is recommended to ensure transparency and credibilit y in implementing SLDs. Edit?? Table of Contents 1. Introduction ................................ ................................ ................................ ......................... 5 1.1 Background ................................ ................................ ................................ ................................ ... 5 1.2 Significance of the Research ................................ ................................ ................................ ......... 6 1.3 Aims and Objectives ................................ ................................ ................................ ...................... 7 1.4 Structure ................................ ................................ ................................ ................................ ........ 7 2. Basic Concepts ................................ ................................ ................................ ..................... 7 2.1 Sustainable Investment ................................ ................................ ................................ .................. 7 2.2 Financial Derivative ................................ ................................ ................................ ...................... 8 2.3 Sustainability - linked Derivatives ................................ ................................ ................................ .. 8 3. Literature Review ................................ ................................ ................................ .............. 10 3.1 Sustainable Investments ................................ ................................ ................................ .............. 10 3.1.1 Corporate Social Responsib ility ................................ ................................ ................................ ......... 10 3.2.2 ESG and Firm Performance ................................ ................................ ................................ ................ 10 3.2.3 ESG Rating Uncertainty ................................ ................................ ................................ ...................... 11 3.2.4 The Growth of Sustainable Investments ................................ ................................ ............................. 12 3.3 Traditional Derivatives ................................ ................................ ................................ ................ 13 3.4 Sustainability - linked Derivatives ................................ ................................ ................................ 14 4. Discussion ................................ ................................ ................................ ........................... 15 4.2 ESG Scores ................................ ................................ ................................ ................................ .. 15 4.2.1 Unreliable ESG Ratings ................................ ................................ ................................ ...................... 15 4.2.2 Towards Standardisation and Materiality in ESG Ratings ................................ ................................ 17 4.3 Greenwashing ................................ ................................ ................................ .............................. 18 4.3.1 Greenwas hing in Finance ................................ ................................ ................................ ................... 18 4.3.2 Sustainability - linked Derivatives and Greenwashing ................................ ................................ ......... 19 4.3.3 Regulation and Investor Education ................................ ................................ ................................ ..... 20 4.4 Greening Portfolios ................................ ................................ ................................ ..................... 20 4.4.1 Banks Greening their Portfolio s ................................ ................................ ................................ ......... 21 4.4.2 Banks using Sustainability - linked Derivatives ................................ ................................ ................... 22 5. Conclusion ................................ ................................ ................................ .......................... 23 5.1 Recommendations ................................ ................................ ................................ ....................... 24 Bibliography ................................ ................................ ................................ ................................ ...... 25 1. Introduction 1.1 Background The concept of sustainability centres around the idea of meeting “ the needs of the present without compromising the ability of future generations to meet their own needs ” (United Nations, 1987) Climate - related disasters caused $650 billion in economic damage between 2016 and 2018 (Morgan Stanley, 2020), and issues such as rising sea levels, recurring heatwaves, and melting glaciers are becoming more frequent (NASA, 2023). As the world grapples with the challenges posed by climate change, there has been a growing recognition of the significance of sustainability. In response to the se climate change issues; several international agreements have been established with a focu s on sustainability In 2015, member states of the United Nations adopted the 2030 Agenda for Sustainable Development, which outlines 17 Sustainable Development Goals (SDGs) ranging from establishing renewable energy infras tructure to halting deforestation and biodiversity loss (United Nations, 2015). Additionally, in 2016 the Paris agreement was adopted by 17 6 Parties, with an objective to limit the global average temperature increase to 2 degrees Celsius above pre - industri al levels (UNFCC, 2023). Furthermore, the European Green Deal serves as the foundation for the European sustainability strategy, which aims ensure that Europe is the first climate neutral continent by 2050. These combined efforts demonstrate a commitment t o wards ensuring the preservation of the environment in the future , while also maintaining economic resilience to climate related challenges. Everything above here is flagged for AI? However, in order to successfully ac hieve these large - scale sustainability goals, it is essential for the financial system to actively participate in mobilising and funding green investments. A global transition towards sustainable finance is crucial, where environmental, social and governance (E SG) factors will be considered in investment decision making. This transition to s ustainable finance will promote long - term investments in activities and projects that align the financial system with the wider international sustainability objectives (Europ ean Commission, 2023). ESG factors, which are seen as synonymous with sustainability (Karia, 2022) , are integral to the implementation of sustainable finance and will be discussed extensively in this research. ESG is split into three pillars, the environm ental pillar evaluates a company’s impact on the environment; the social aspect assesses how companies manage relationships with stakeholders such as employees, suppliers, customers, and shareholders; while the governance aspect focuses on a company’s lead ership including board composition, executive compensation, and shareholder rights. The transition towards sustainable finance can be helped along by the use of derivatives. Derivatives serve a purpose in this transition by raising and allocati ng significant capital while also providing a way to hedge against associated risks (ISDA, 2021; Lannoo, 2020). For example, derivatives are central to the European Union’s Sustainable Europe Investment Plan (SEIP), a part of the European Green Deal which aims to mobilise at least €1 trillion in sustainable inves tments over the next decade (ISDA, 2021b). More specifically, ESG derivatives, which incorporate an ESG component into a traditional derivative, are gaining p opularity in the sustainable finance landscape They serve as financial tools to promote and enc ourage the accomplishment of sustainability goals (Harrison, 2021 ; Kelly et al. 2021) , and while there are many types of ESG derivative, t his research specifically focuses on sustainability - linked derivatives (SLDs). This is fine 1.2 Significance of the Research Unlike other ESG derivatives, SLDs have the ability to incentivise and generate support for sustainable projects, rather than simply directing how capital is allocated and spent They are rarely used for hedging or speculation, rather the pu rsuit of sustainability (ISDA, 2021a). This unique quality of SLDs positions them as tools that can change corporate sustainability practices and make s them a topic worth exploring in detail , to understand how they can drive change in the sustainable inves tment market The significance of this research area becomes evident when considering the severity of climate change and the concerns about the future of our planet. If the goals of international sustainability agreements are to be met, it will require su bstantial change at the corporate level. SLDs can encourage companies into i mproving their ESG score, pursuing cleaner investments and reducing greenhouse gases, highlighting the crucial role they play in the pursuit of sustainability. However, fully capit alising on the potential of SLDs necessitates a deeper understanding of these instruments. This research will bridge the knowledge gap in the existing literature by providing a comprehensive exploration of SLDs - an area that remains underexplored despite its growing prominence The impact of using SLDs will be investigated, along with any challenges that might be faced as these derivatives gain popularity and become more mainstream. By addressing these challenges, we can effectively h arness the potential of SLDs, ensuring that they serve their purpose of promoting and encouraging the achievement of sustainability goals. 1.3 Aims and Objectives The primary aim of this research is to examine the potential that SLDs have i n the market f or sustainable investments. To achieve this aim, the research is guided by several objectives. Firstly , the research aim s to explore the current state of the sustainable investment market with a particular focus on highlighting the growth and importance of SLDs within it. Secondly, the research will identify challenges associated with incorporating SLDs into investment portfolios, such as rating uncertainties, lack of regulation and greenwashing concerns. Lastly , the research will assess the practical imple mentation and uptake of SLDs by investigating how banks have integrated SLDs into their portfolios. Slightly flagged? 1.4 S tr ucture W rite this 2. Basic Concepts 2.1 Sustainable Investment In r ecent years there has been a change in the global discussion around sus tainable investment. This shift is primarily due to the introduction of international agreements such as the 2030 Agenda and the Paris Agreement, which highlight a commitment to adopting sustainability in both economic practices and cultural norms. As a re sult, sustainable investment has become a tool for driving this transformation. Investor activity has matched this trend of sustainability , with 50 percent of global investors expressing their intent ion to increase their allocation of sustainable investments in the up coming year (McNinch et al. 2023). Alongside these changes in investor behaviour, the sustainable finance market has seen significant growth, increasing by more than 10% to $5.8 trillion in 2022, despite economic turbulence from issues such as COVID - 19 and global warming ( United Nations Conference on Trade and Development [UNCTAD], 2023). However, it is important to note that the term ‘sustainable investment’ itself can be ambig uous since it has multiple definitions Scholars have used various terms throughout the years to refer to sustainable investment, such as Socially Responsible Investment (SRI) (Widyawati, 2020; Margolis et al. 2009), Environmental, Social and Governance (E SG) Investment, (Freide et al. 2015; Mango et al . 2020), Ethical Investment (Bauer et al. 2006), and Impact Investment Currently, the concept of ‘sustainable investment’ typically includes any investment that considers ESG factors (Beisenbina et al. 2022 ). For the coherence and consistency of this research, we shall adhere to the definition proposed by the Global Sustainable Investment Review: “sustainable investment is an investment approach that considers environmental, social and governance (ESG) facto rs in portfolio selection and management” (G lobal S ustainable I nvestment A lliance [GSIA] , 2020, p.7). It is important to mention that throughout this research, the use of alternative terms such as SRI or ESG investment implies reference to sustainable inve stment within the framework of our adopted definition. This is fine, slightly flagged but nothing bad 2.2 Financial Derivative A financial derivative is ‘a security with a price that is dependent upon or derived from one or more underlying assets’ (C hartered F inancial A nalyst [CFA] Institute , 2019). The value of the derivative is determined b y the volatility of these underlying assets, which can range from stocks and bonds to interest rates and exchange rates (Kolb & Overdahl, 200 3). Derivatives serve three primary functions: hedging, speculation, and arbitrage, offering a mechanism for managing specific financial risks, such as interest rate or currency volatility. (Baker, 2022). Crucially, this is achieved without the need to tr ade the underlying asset or commodity (I nternational M onetary F und [IMF] , n.d.). Derivatives are trade d either on exchanges or in over - the - counter markets, with the latter dominating in terms of total trading volume (Hull, 2015). The key classifications of derivatives include futures and forwards, options, and swaps (Hirsa & Neftci, 2013). The global financial derivatives markets are among the most substantial and influential markets in the economy (Baker, 2022). Despite this, the market has faced signifi cant scrutiny since its involvement in the 2007 - 2008 financial crisis. Here, the brunt of the blame fell on unregulated credit derivatives, casting a shadow on their reputation (Gonzalez & Yun, 2010). Moreover, while derivatives were primarily designed for hedging purposes, their use in speculation has amplified their scrutiny. This is fine 2.3 Sustainability - l inked Derivatives There are many types of transactions that can constitute an ESG - related derivative, including “sustainability - linked derivatives (SLDs), ESG - related credit default swap (CDS) indices, exchange - traded derivatives on listed ESG - related equity indices, emissi ons trading derivatives, renewable energy and renewable fuels derivatives, and catastrophe and weather derivatives”(ISDA, 2021b, p.1). However, for the purposes of this research, the focus will be on the more generalised ESG derivatives – SLDs. These hav e been chosen due to their bespoke nature, as they are inherently tied to a company's ESG targets, which could reference a range of environmental and social commitments, like greenhouse gas emissions, waste reduction, or diversity initiatives (Fletcher & Burrett, 2023). The International Swaps and Derivatives Association (ISDA) has released a series of reports that highlight the rising significance of derivatives that are tied to ESG factors, with a special emphasis on SLDs. Several publications have addr essed topics such as, best practices for developing SLD Key Performance Indicators (KPIs), the regulatory treatment of SLD’s in major jurisdictions, and surveys to assess the status of SLD documentation (ISDA, 2021; 2021a; 2022a). Distinctly, SLDs are not directed towards the use of proceeds like green or sustainability - linked bonds, rather, they are designed to incentivise ESG performance and foster support for sustainable projects (ISDA, 2022). To achieve this, SLDs incorporate an ESG pricing element int o conventional hedging tools like interest rate swaps (IRS), cross - currency swaps, or forwards (Baker, 2022). This ESG - pricing component is typically tied to the compliance of one or both parties to the KPIs outlined in the transaction, with ESG performanc e metrics usually applied to the non - financial institution (ISDA, 2021b; 2021). SLDs are unique in the sense that e ven if the underlying instrument isn't ESG - related, the KPIs will still be driven by ESG objectives (BDO, 2021). If the company meets the targets for KPI’s that reference ESG objectives, then the derivatives pricing is adjusted, for example, the reduction of a coupon on an interest rate swap (Fletcher & Burrett, 2023) This also works the opposite way, with consequences for not meeting mandated ESG targets, for example, having to make a payment to a charity or a change in the margin (ISDA, 2021). It is wort h mentioning that the transparency and verification of KPIs is crucial to the success of SLDs, as suggested by two of the five overarching principles recommended by ISDA (ISDA, 2021). In the instance of Siemens Gamesa and BNP Paribas, a €174 million FX he dging contract was established in 2019. The agreement not only addressed Siemens Gamesa’s FX exposure from its offshore wind turbine sales in Taiwan but also contributed towards climate action and affordable, clean energy UNSDGs. The contract states that t he fulfilment or failure of Siemens Gamesa’s sustainability targets dictates the reinvestment of any premium into reforestation projects (Siemens Gamesa, 2019). The growing interest in SLDs has been motivated by their potential to lead the worldwide trans ition to a more sustainable economy, while also increasing the amount of money that can be channelled toward ESG objectives (ISDA, 2022). Although SLD’s lack an acknowledged definition or standard documentation, they represent a unique and emerging financi al product that offers up new opportunities for sustainable investments. This is fine 3. Literature Review This section delivers a comprehensive review of the literature surrounding SLDs. The review is s egmented into three strands — sustainable investments, traditional financial derivatives, and SLDs 3. 1 Sustainable Investments 3. 1 .1 Corporate Social Responsibility Understanding t he relationship between sustainability initiatives and financial performance is essential, as it can influence corporate decisions, investor behaviour and the state of the market for sustainable investments. One accepted me asure to study this relsationship is Corporate Social Responsibility (CSR), which is a management concept tha t evaluates how much a company incorporates environmental and social and social concerns in to their operations Research by Waddock & Graves (1997) studied th is relationship, suggesting that one can argue for a positive, negative, or non - existent relations hip between CSR and corporate financial performance. Despite th e initial ambiguity of the relationship between CSR and corporate financial performance , the majority of the literature inclines towards a positive correlation between them (Eccles et al. 2014 ; Margolis et al. 2009; Orlitzky et al. 2003). Many of the studies researching this relationship use a meta - analysis as their methodology , to synthesise the extensive amount of pre - existing literature on the topic. Notably , Orlitzky et al. (2003) conducted a n extensive meta - analysis that includ ed 52 studies and 33,878 observations , bringing clarity to the topic, and finding a positive correlation for the relationship. Building on the foundation that Orlitzky et al. (2003) created, Margolis et al. (2009) expanded the scope and conducted a meta - analysis of 167 studies, finding a smal l but positive correlation between CSR and financial performance. However, the keyword - based search method used in these meta - analyses to identify research has limitations that could potentially impact the results, leading to biased samples that exclude cr ucial findings. This is fine 3.2.2 E SG and Firm Performance In a literature review by Brooks et al. (2018), 45 years of empirical research was analysed to show that ESG disclosures are associated with improved firm performance. However, the research by Brooks et al. (2018) acknowledged that the relationship between ESG disclosures and firm performance is complex, and there is still much to learn. A study by Khan et al. (2016) illustrates this complex relationship, which was the first piece of academic li terature to distinguish between ‘investments in material versus immaterial sustainability issues’ (Khan et al ; 2016; p.1 ). The research from Khan et al. (2016) revealed that fir ms which exhibit superior performance on material sustainability issues significantly outperform firms with poor performance on these issues, suggesting that investments in material sustainability issues can enhance shareholder value These results were supported in a stu dy by Steinbarth and Bennett (2018), who found that low ratings on material sustainability issues was costly for the firm. Research by Freide et al. (2015) dispels some of the scepticism of the relationship between ESG criteria and financial performance by providing an exhaustive review of 2200 individual studies. They found that the majority of studies report a nonnegative relationship between ESG an d corporate financial performance (90%), thereby endorsing the financial rewards of ESG investing. Supporting this, recent studies by Mango et al. (2020) and Pastor et al. (2021) empirically show that companies with high ESG scores report higher excess ret urns. Interestingly, Pastor et al. (2021) also proposed that despite lower returns from green assets due to their popularity, these green assets can outperform when positive shocks impact the ESG factor. Their findings suggest that sustainable investing fo sters positive societal impact by encouraging firms to adopt greener practices and redirecting investment towards ecologically responsible firms. This is fine 3.2. 3 ESG Rating Uncertainty A study conducted by Amel - Zadeh & Serafeim (2017) revealed that in vestors primarily consider ESG information in their investment decisions because they believe it has an impact on investment performance. However, Amel - Zadeh & Serafeim (2017) also highlighted the lack of co mparability in reported ESG infor mation across firms, which can hinder an investors ability to accurately evaluate corporate sustainability. The main reason for the lack of comparability in ESG information across firms is the divergence of ESG ratings, which are published by rating agenc ies and measure a company’s exposure to ESG risks (Cheng & Davis, 2023) Previous research has extensively discussed the concept of rating divergence ( Chatterji et al., 2016; Christensen et al., 2020; Gibson et al., 2019) , and a study by Avramov et al. (20 22) demonstrated that such divergence can discourage investor demand for the company’s stock. Berg et al. (2019) were the first to delve in to why ESG ratings diverge, with their analysis identifying measurement divergence - the different ways in which raters assess the same firm – was the main cause of ESG rating inconsistencies. They also found that the cor relation between ESG ratings was slightly above 50%, which differs hugely to the nearly perfect correlation observed in credit ratings, which is around 99%. Supporting the findings from Berg et al. (2019) , Dimson et al. (2020) highlighted that despite the significant role played by ESG information in investment decision making, there is minimal agreement between rating agencies on how to weight that information. This disconnect was further emphasised by Serafeim & Yoon’s (2022) research, which showed that the predictive value of an ESG rating decreased significantly when there is disagreement among raters. Adding to this narrative, Liu (2022) discovered that increased quantified ESG disclosure could actually amplify the divergence in ESG ratings, due to lar ger volumes of information confusing the rating agencies. Doyle (2018) made an attempt to assess the consequences of ESG rating divergence and revealed that inconsistencies in rating systems can enable companies to portray an excessively positive image of themselves, therefore potentially causing greenwashing. The research also identified geographical biases towards countries in regions with high reporting requirements, and the inappropriate assignment of weights for ESG factors without considering compa ny specific risks. Furthermore, there is currently no regulatory body overseeing the development of ESG ratings. Senadheera et al. (2021) have emphasised the need for a set of metrics that can effectively address the various aspects of scoring the environ mental pillar in ESG. Policymaking must prioritise the establishment of a transparent, consistent, and rigorous framework for ESG ratings, to provide a robust foundation for making investment decisions. This is fine 3.2. 4 The Growth of Sustainable Investments In our progressively eco - conscious world, the importance of sustainable investment is becoming more evident. Gielen et al. (2019) highlighted how renewable energy can potentially supply two - thirds of our global ener gy demand. Sustainable investments often channel money towards these renewable energy sources (IMF, 2021) , thus demonstrating the critical role that sustainable investments can play in tackling major world issues and meeting the aims of international agree ments such as the 2030 Agenda. Empirical evidence of the growing support for sustainable investments is provided from the research by Bauer et al. (2021). Their study, a survey in a pension fund, found that two - thirds of participants were in favour of en gaging with companies based on selected SDG’s, even at the cost of financial performance. A survey from Capital Group (2022) supported these findings, finding that 89% of investors incorporate ESG factors into their investment strategy. This strong appetit e for sustainable investments indicates a promising future where sustainability considerations become important when making investment decisions. Nonetheless, the body of literature also presents a complex landscape where ethics and profitability interse ct with sustainable investments. A systematic review by Widyawati (2015) reveals that there is a fixation on the financial paradigm within Socially Responsible Investing (SRI) literature, which suggests a need for future research that finds a balance betwe en ethical and financial aspects to foster comprehensive sustainable strategies. This is complemented by the more recent systematic review by Daugaard (2020), in which the current literature was criticised for focusing solely on measuring performance, mean ing ethical themes such as climate change were being overlooked. The conclusions from Daugaard (2020 ) and Widyawati (2015) are also supported by Talan & Sharma (2019), who argue that sustainable investments hold more potential than just mere financial pro fitability, that they can serve as instruments of societal and ecological transformation. By viewing sustainable investments as agents of change, they may attract amplified interest and support in the future. This perspective complements the research by Ba uer et al. (2021), w here the respondents choice for more sustainability was dictated by social values rather than financial views. Despite Revelli & Viviani (2015) criticising previous works by Orlitzky et al. (2013) and Margolis et al. (2009) for exclusi ve focus on managerial studies and neglect of effect sizes, they proposed that we must shift beyond the debate of financial performance of sustainable investments. Their meta - analysis of 85 studies examining the relationship between SRI and financial perfo rmance concluded that the focus should lie on whether these investments improve ethicality and positively influence the behaviour of companies. Cunha et al. (2021) advance the conclusions drawn by Revelli & Viviani (2015) by suggesting that that the performance of sustainable investments should be viewed from a wider lens than solely at the corporate level , and to reduce the emphasis on companies behaviour Instead, it is important to understand how sustainable investments affects real people and ecosystems. This is fine 3.3 Traditional Derivatives Derivatives have played an important role in influencing firm values, investment strategies and financing decisions. They are predominantly used for speculation purposes and as risk management tools through hedging techniques (CFA Institute, 2023) . Traditi onal derivatives have largely transformed corporate risk management practices, as observed by Froot et al. (1992), where a framework for assessing risk management practices highlighted how hedging with derivatives can greatly enhance a firms internal finan cing capabilities. Nevertheless, there is conflicting evidence in the literature regarding the impact of using derivatives on firm value. Early studies suggested that derivative use had no effect on market valuation (Guay & Kothari, 2003; Jin & Jorion, 20 06) , however recent research utilising large datasets has challenged this view by indicting a positive correlation between derivative use and firm value (Mackay & Moeller, 2007; Gonzalez & Yun, 2010). For instance , the research conducted by Gonzalez & Yun (2010) highlights how the use of weather derivatives has a beneficial impact on electric and gas utilities, translating into higher market valuations and leverage. This research demonstrates how innovative financial derivatives , such as weather derivatives, can empirically contribute to firm valuation, suggesting that similar benefits can be seen for SLDs in specific industry sectors. Consistent with this, Bartram et al. (2009) c arried out a study involving 6,888 non - financial firms from 47 countries, concluding that derivatives have the ability to reduce a compan y’s systematic risk. Additionally, their research revealed a positive correlation between derivative usage and higher firm value, superior abnormal returns, and larger profits during economic downturns While SLD s primarily focus on the pursuit of sustaina bility (ISDA, 2021a) , they can also be structured to hedge against specific risks, such as foreign exchange rate fluctuations (Fletcher & Burrett, 2023) . Given that the usage of derivatives has been shown to enhance firm value, it's evident why SLDs might be attractive for companies seeking both sustainability alignment and risk mitigation This is fine 3.4 Sustainability - l inked Derivatives The existing literature on SLD’s is highly limited given the recency of their introduction into the market, with th e first SLD being introduced in August 2019 (ING, 2019). It was noted by the United Nations Sustainable Stock Exchanges (SSE) that in recent years, the subject of sustainability in derivative markets has gone from being largely overlooked, to being the foc us of four significant industry studies (SSE and WFE, 2021) The shift towards sustainable financial instruments is also drawing more attention from scholars and academics, as evidenced by the work of Beisenbina et al. (2022). Through a comprehensive review of current research trends and keyword analysis, they forecasted a shift in future research focus, moving from SRI funds analysis toward the analysis of green financial instruments. The evidence for this anticipated s hift is supported by findings from Tolliver et al. (2019), who hypothesise that the binding obligations placed on countries by the Paris Agreement could be accelerating the growth of green bond issuances, as countries must demonstrate efforts to make measu rable environmental changes. However, findings from the literature review by Beisenbina et al. (2022) further underscore the potential challenges that the sustainable finance landscape could encounter if there continues to be an absence of a standard ES G metric or mandated reporting obligations. This resonates with the concerns voiced by Amel - Zadeh & Serafeim (2017) and Baker (2022), proving that there is a substantial obstacle that must be confronted for green financial instruments to realise their full potential. In an effort to enhance the understanding of SLD’s and combat the issues arising from a lack of standardisation, the International Swap and Derivatives Association (ISDA) have published several guidance papers that feature the main regulatory considerations (ISDA, 2021) and KPI guidelines (ISDA, 2022). Baker (2022), however, highlights the little attention dedicated to the role of derivatives in sustainable finance, particularly within the ESG realm. Despite this, there is strong evidence to suggest that the market for SLD’s will continue to grow, fuelled by an escalating global concern with climate change. Although the private nature of these transactions limits the accessibility to detailed information, the potential size of this market is s hown by the amount of multinational corporations across diverse sectors, such as rail, property, and agriculture; that have engaged in SLD’s (Fletcher and Burrett, 2023). Research by Pastor et al. (2022) highlights how environmental regulations can ampli fy consumers demand for green products, with Karia (2022) also observing that SLD’s respond well to consumer demand and increased regulatory pressures. The number of environmental regulations is increasing globally, and if consumer demand for green product s increases alongside this, it points towards an upward trajectory in the demand for SLD’s The existing literature also underscores the many vital roles that SLD’s can play, from hedging risks associated with sustainable investments and mobilising capital for a cleaner energy future, to contributing towards the achievement of the UN SDG Goals (Baker, 2022). Lannoo & Thomadakis (2020) made a commendable step forward in assessing the role of derivatives in sustainable finance, suggesting that they can: “Enable capital to be channelled towards sustainable investments; help firms hedge risks related to ESG factors; facilitate transparency, price discovery and market efficiency; and contribute to long termism” (Lannoo & Thomadakis, 2020, p.9) However, it i s important to note that the study by Lannoo & Thomadakis (2020) considered traditional derivatives as well as ESG derivatives when assessing their impact on the market for sustainable investments. While research by Karia (2022) and Baker (2022) also make promising steps in evaluating this topic, there is no singular study that solely concentrates on the impact of SLD’s on sustainable investments. This is fine, 100% human 4. Discussion The literature review has addressed the first objective of this research, highlight ing the growing sustainable investment market and the gradual shift towards an increased use of green financial instruments, specifically SLDs. The literature review has also pinpointed critical area s of concern, most importantly the pressing need for improved methods of ESG scoring and more regulation. Regarding the second research objective, the discussion will examine these concerns within the context of SLDs, assessing how they may affect the usa ge of SLDs and proposing strategies to overcome them A section of the discussion will also examine how the challenges linked to using SLDs can lead to greenwashing and will recommend solutions to greenwashing concerns. Furthermore, the discussion will ad dress the third research objective by looking at the practical implementation of SLDs. This includes their integration into banks portfolios and their role in aligning financial strategies with global sustainability goal s The exploration will contribute t o a comprehensive understanding of the financial system in which these derivatives exist, aligning with the primary focus of the dissertation. This is fine 4.2 ESG Scores 4.2.1 Unreliable ESG Ratings The potential of SLD’s in the market for sustainable investments is evidently promising, SLD’s offer a strong mechanism for incentivising ESG performance and investment in sustainable issues. However, their potential is complicated by challenges, particula rly those linked to ESG ratings , the foundations upon which SLD’s are built. The value of an SLD is closely tied to Key Performance Indictors (KPI’s) , which are specified in the SLD contract and are often based o ff of ESG ratings As such, the accuracy, consistency, and reliability of ESG ratings have a direct impact on the effectiveness of SLDs. Fluctuations and discrepancies in ESG ratings can influence the pricing, trading, and overall market perception of SLDs. Furthermore, a n i naccurate or inconsistent evaluation of a firm's ESG performance could misdirect the allocation of funds from an SLD , undermining the very sustainability objectives these derivatives are designed to support. Research has shown that the investment community lack’s confidence in the present ESG disclosure and scoring system, as evidenced by analytical endeavours to extract financially material information for investors (Khan et al. 2022). Various organisations, including the Global Initiative for Sustainabil ity Rankings (GISR) , Sustainability Accounting Standards Board (SASB), Morningstar Sustainalytics, and M organ S tanley C apital I nternational (MSCI) , provide ESG ratings for companies. However, the unique methodologies adopted by each of these organisations has led to significant divergence in ESG ratings, or “measurement divergence” (Berg et al., 20 19 ). Consequently, the same company could receive different ESG ratings from different organisations, highlighting a lack of transparency about methodologies and a lack of clarity on ESG definitions (Chatterji et al., 2016 ; International Organisation of Securities Commissions [IOSCO], 2021 ). Compounding this issue , increas ed ESG disclosure does not guarantee agreement among rating providers (Liu, 2022) . As companies disclose more ESG information, different rating agencies may interpret and weigh t this information differently. The problem can be illustrated by