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ISSUE 20/MAY 2021
Finance and Markets Foreword
Global Insight
UK-EU trade agreement: What’s next for financial services?
New form of Italian securitisation transaction structure
The statutory replacement of a benchmark
ESG finance: global warming has become a hot topic
How green are your hedges?
The Securitisation Regulation opens its doors to NPES and
synthetic securitisationFINANCE AND MARKETS GLOBAL INSIGHT Contents Foreword 3 UK-EU trade agreement: What’s next for financial services? 4 New form of Italian securitisation transaction structure 7 The statutory replacement of a benchmark 9 ESG finance: global warming has become a hot topic 11 How green are your hedges? 14 The Securitisation Regulation opens its doors to NPES and synthetic securitisation 18
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Foreword
Martin Bartlam Change and sustainability are the activities to develop green bonds,
Partner core themes of this issue. The year sustainability linked loans and
T +44 (0)20 7796 6309 is likely to see a momentous derivatives and ask if this is a real
martin.bartlam@dlapiper.com change in the current business and sustainable trend. We provide
environment with a return towards some examples of how sustainability
normality as mass vaccination linked derivatives are being used.
programmes are rolled out to
achieve a relaxing of lockdown rules In relation to benchmark indices
and a return to a more normal February saw the introduction of
business environment. Against the EU Benchmarks Regulation
this background there is a wave of providing a statutory replacement
regulatory change underway. benchmark in the event that key
indices cease to be available,
In Europe we are now seeing the however issuers are encouraged
UK operating outside the transition to assess and provide their own
period resulting from Brexit. applicable fallbacks without simply
This brings into sharp focus the relying on the statutory fallback.
lack of a coordinated approach to
financial services across Europe This issue also provides some
and whilst we wait to see policy insight into developments in the
develop there is a feeling that we securitisation market with new
may see more divergence than rules in Italy designed to allow
harmonisation in the route ahead. for loans to be made available
Here we look at the status of the into special purpose vehicles to
Memorandum of Understanding on expand the range of securitisation
Financial Services and the outlook structures available and we see
for equivalence or other approaches the addition of new EU regulations
to recognition or lack of recognition to address NPE and synthetic
of a joint approach between the securitisations across the EU.
UK and EU. Thankfully business Not to miss out on movement
continues to thrive in spite of the towards commitment to a greener
politics involved. and more sustainable future we
also look at initial developments
We are also seeing the development in establishing a sustainable
of ESG and climate change action securitisation framework.
come to the fore as businesses
have to get to grips with measure We hope you enjoy the insights
intended to bring about a more brought to you in this issue and
active era of commitment to welcome your feedback.
sustainability measures. We look at
3FINANCE AND MARKETS GLOBAL INSIGHT
UK-EU Trade Agreement:
What’s next for financial services?
What does the Trade and Cooperation Agreement mean for cross-border financial
services between the EU and the UK?
continue to rely on their European passports during
the transitional period. The absence of equivalency
In brief...
decisions and the fact that the Agreement does not
On 24 December 2020, after intensive down-to-the-
provide for broad-based market access rights means
wire negotiations, the European Commission and
that after the end of the transitional period, UK firms
the UK government reached an agreement on the
no wlonger have automatic access to EU markets,
terms of future trade and cooperation between the
whereas EU firms continue to have access to the UK
EU and UK.
market for a further transitional period under the terms
of the UK’s temporary permissions regime.
Trade and Cooperation Agreement Reflecting these concerns, the UK Prime Minister stated
The Trade and Cooperation Agreement (the Agreement) in the Sunday Telegraph that the Agreement “perhaps
outlines the future economic relationship between the does not go as far as we would like” on financial
EU and UK. A significant component of the Agreement services. The Chancellor of the Exchequer has sought
is on free trade, ensuring that no tariffs or quotas are to provide reassurance to the City of London in the
put in place for the cross-border trade of rule-compliant Times noting the Agreement provides for a regulatory
goods. The Agreement also puts in place a framework cooperative framework between the EU and UK while
for cooperation on energy, transport, social security and giving the UK the opportunity to regulate “a little bit
standard-setting, including in relation to climate change, differently” than it has done in the past.
labour rights and tax transparency.
Financial services in the Agreement
One area where the Agreement is noticeably light The Agreement commits both the UK and EU to
on detail is in relation to financial services. As widely maintain their markets as being open on a non-
anticipated by the industry, the Agreement does not discriminatory basis to firms in the UK and EU provided
extend an automatic right to access EU markets to these firms are appropriately established in the relevant
banks, insurers and other financial services firms country. The parties to the Agreement also commit to
authorised in the UK. ensuring that internationally agreed standards in the
financial services sector are implemented and applied in
The end of passporting their territories.
Under a variety of European directives and regulations,
UK financial services firms have been able to undertake Financial services are expressly excluded in the
regulated business in the EU (and vice versa) using Agreement from the most-favoured nation clause in
so‑called European financial services passports. terms of any future trade deal with a third country.
Financial services are also excluded from the provisions
Provided firms were appropriately licensed and in the Agreement on services more generally and
regulated in their home country, these firms could use from the requirement to review trade in services and
either a services or branch passport to undertake their investment relations in the future.
business across EU markets under the supervision of
local EU member state regulators without the need for As noted by the Chancellor, both the EU and the
a local presence and/or licence. UK committed in the Agreement to establishing
a Memorandum of Understanding, by March
The UK left the EU on 31 January 2020 and entered into 2021, for establishing a framework for regulatory
a transitional period where European law continued to cooperation on financial services. UK and EU
apply until 31 December 2020. UK firms were able to regulators already have a range of memoranda of
4WWW.DLAPIPER.COM
understanding. For example, the Financial Conduct is the European Commission and HM Treasury that
Authority has a memorandum of understanding may make such an equivalency decision about a third
in place with the European Securities and Markets country’s legislative framework.
Authority (ESMA) as well as national EU regulators
covering supervisory cooperation, enforcement and In the absence of passporting rights, equivalency
information exchange. The Agreement’s proposed decisions are sometimes seen as a way of replicating the
Memorandum of Understanding should build on the ease of cross-border business that previously was the
existing good work of EU and UK regulators in terms of status quo. The application of an equivalence regime is
fostering cooperation. a very different proposition to the ease of market access
provided by passporting. Financial services are regulated
The Agreement commitment to a Memorandum by a range of laws across the EU with few containing
of Understanding does fall short, however, of the substantive equivalence regimes which enable third
provisions of other such free trade agreements. country firms to provide services to local customers/
For example, the free trade agreement between the EU counterparties without local authorisation. The ability
and Japan expressly put in place regulatory cooperation of UK firms to operate in the EU under equivalency
measures in the free trade agreement itself. decisions and vice versa is much more limited than the
soon-to-end passporting arrangements. Importantly,
Unsurprisingly, both the UK and EU have also preserved equivalency decisions may also be withdrawn unilaterally
their respective rights to put in place measures for on very short notice.
prudential reasons (being the “prudential carve-out”).
This prudential carve-out permits the Bank of England Equivalency decisions to date
and the European Central Bank to act independently of There are around 40 areas where the EU may consider
one another when acting to preserve financial stability the UK regulatory framework as equivalent in respect to
and/or the integrity of financial markets. financial services.
What about equivalency decisions? In September 2020, the European Commission made
The Agreement does not include any decisions under one such decision with respect to central counterparties
equivalency frameworks for the financial services (CCPs). ESMA then proceeded to determine that the
industry. Decisions on equivalency are unilateral three UK-based CCPs should be recognised as third
decisions and not subject to negotiation. This is the country Central Counterparties (TC-CCPs). As TC-CCPs,
case both for financial services and other areas such as they continue to be eligible to provide their services
data protection. in the EU following the end of the transition period on
31 December 2020.
Generally, certain legislative frameworks in both the UK
and the EU allow for third countries to be assessed as In November 2020, HM Treasury announced that the UK
having “equivalent” legislative safeguards and standards. would be granting a package of equivalence decisions
Where such a decision is reached, market access to EEA states for certain intragroup transactions,
arrangements open up for firms to do cross-border regulated markets, market-making exemptions from
business between the UK/EU and those third countries. short selling restrictions, the certification for credit
Since 1 January 2021, the UK is considered a third rating agencies and under the Benchmarks regulation1.
country under EU law. Similarly, the UK now considers These equivalency decisions came into effect at the end
the EEA member states as third countries for the of the transitional period.
purposes of market access. Under this framework it
1
egulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks in
R
financial instruments and financial contracts or to measure the performance of investment funds and amending Directives
2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014
5FINANCE AND MARKETS GLOBAL INSIGHT
In the Questions and Answers to the Agreement, What’s next for financial services?
the European Commission noted that it is currently The failure to replicate market access arrangements
assessing the UK’s responses to the Commissions’ under passporting in the Agreement does not come as
equivalency questionnaires in 28 areas. According a surprise or shock to the financial services industry.
to the Commission, it is seeking further clarifications
on how the UK will diverge from EU frameworks after UK and EU firms, as well as national and pan-EU
31 December 2020 and so, accordingly, cannot finalise regulators, have been putting in place contingency
its assessment at this time. Notably, the Commission measures to allow cross-border business to continue in
acknowledged “the UK’s equivalence decisions the event that no agreement is reached.
announced in November, adopted in the UK’s interest.
Similarly, the EU will consider equivalence when they are In the UK, these measures have primarily consisted
in the EU’s interest.” of a temporary permissions regime which allows EU
firms to continue doing business in the UK without
Dialogue in respect to equivalency local authorisation for a period of time. No pan-EU
decisions temporary permissions regime exists for UK firms
In 2018 the UK had floated the idea of a “mutual seeking continuity of business. Instead, UK firms have
recognition” regime going well beyond the current proceeded to either scale back their EU business,
piecemeal “equivalence” patchwork, but it was firmly subsidiarise and seek EU member state authorisation
rejected by the EU negotiators and did not gain traction. and access to passporting, or rely on local EU27
national measures (such as overseas persons
Clause 1 of the accompanying Joint Declaration on regimes, which exist in certain countries) and/or on
Financial Services Regulatory Cooperation (Joint conducting business with EU customers on a reverse
Declaration) stated that the EU and the UK would solicitation basis.
“establish structured regulatory cooperation on financial
services, with the aim of establishing a durable and Following the end of the transitional period on
stable relationship between autonomous jurisdictions” 31 December 2020, more friction in cross-border
which will allow for “transparency and appropriate financial services has necessarily occured. The extent
dialogue in the process of adoption, suspension and of that friction continues to depend on the
withdrawal of equivalence decisions” and “enhanced willingness of regulators and governments to act on
cooperation and coordination.” equivalence decisions, regulatory cooperation and the
acknowledged shared interest in a vibrant financial
The concern is that a unilateral withdrawal of services sector.
an equivalency decision represents a significant
cliff-edge for firms and their customers in the sector. Author
The UK’s position had been to propose an initial period
Chris Whittaker
of consultation on possible solutions to maintain
Senior Associate
equivalence, and then clear timelines and notice
T +44 20 7796 6035
periods “appropriate for the scale of the change before
chris.whittaker@dlapiper.com
it takes effect” rather than the present 30-day period.
Additionally, the UK had proposed “a safeguard for
acquired rights” and that intractable disputes between
Mark Dwyer
the UK and the EU would ultimately be resolved by
Partner
independent arbitration.
T +44 20 7796 6005
mark.dwyer@dlapiper.com
As at 26 March 2021, HM Treasury confirmed that
technical discussions on the text of the Memorandum
of Understanding with the European Commission have
Michael McKee
concluded. The Memorandum of Understanding will
Partner
establish a Joint UK-EU Financial Regulatory Forum,
T +44 20 7153 7468
which will serve as a platform to facilitate dialogue
michael.mckee@dlapiper.com
on financial services issues. Formal steps need to be
undertaken on both sides before the Memorandum of
Understanding can be signed, but it is expected that
this can be done expeditiously.
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New form of Italian securitisation
transaction structure
Financing securitisations through loans
In this case, the amounts paid by the underlying
debtor(s) (or in any event received in satisfaction of
In brief...
the transferred receivables) are intended exclusively to
The Italian securitisation law has recently been
satisfy the rights deriving from the loans granted to the
amended to extend its scope to transactions
SPV, as well as to cover any transaction costs.
involving the granting of loans to a special purpose
vehicle to finance the purchase of receivables.
In addition, it has been clarified that – in case of
With this amendment comes the possibility to
granting of loans to the SPV – any reference in the
implement new transaction structures, and offering
Italian Securitisation Law to:
greater flexibility to investors.
• the term "notes" shall be made to the "loans"; and
• the term "holders of the notes" shall be made to
Law No. 178 of 30 December 2020 (the 2021 Budget
"the entities creditors of the payments due from the
Law) introduced some amendments, and provided
borrower under such loans."
certain clarifications, to the provisions set forth by Law
No. 130 of 30 April 1999 (the Italian Securitisation Law).
As a consequence of the amendments described above,
third-party lenders (banks or other licensed financial
The provisions of the 2021 Budget Law which apply
intermediaries):
from 1 January 2021 (the New Provisions) have, inter
alia, extended the scope of the Italian Securitisation Law
• can now provide loan(s) to the SPV, in addition or in
to include transactions which involve the granting of
place of the issuance of the ABS by the SPV itself.
loans to a special purpose vehicle (the SPV).
Such loans should be strictly connected with the
securitisation (i.e. granted to finance the acquisition
The previous regulatory framework envisaged the issue
of the relevant underlying securitized assets); and
of asset-backed securities (the ABS) as the only way for
the SPV to raise funds, preventing such vehicles from • would benefit from the same segregation principle
using other funding instruments, except for bridge (applicable to the noteholder(s)) under the Italian
purposes with a view to subsequently issuing ABS Securitisation Law.
(and using the proceeds of the ABS for repaying such
bridge loan). The priority of the lenders (vis-a-vis the noteholder(s))
will be provided under the payment waterfalls (dealing
This development aligns the Italian securitisation with application of proceeds) set out in the relevant
framework with market practice in other European securitisation transaction documents.
countries, where SPVs can be funded through other
bank debt instruments. Due to the segregation principle, it is likely that these
loans should not benefit from further guarantees and/or
According to the New Provisions, to finance the securities (over the underlying assets and the relevant
purchase of the securitised receivables, the SPV may proceeds, as well as on the SPV’s bank accounts).
now receive loans granted by entities authorised to
carry out lending activity. No specific limits apply on the level of leverage.
7FINANCE AND MARKETS GLOBAL INSIGHT
The funding structure of an Italian law securitization The choice of the most suitable structure ((ie ABS,
transaction is therefore flexible, as it may entail an loan(s), or a combination of both funding tools) shall
investment made through the subscription of ABS be made from time to time, based on the purpose
(which can be also be issued in different tranches or of the transaction, the type of investors involved and
classes) and/or the granting of loans, in each case market valuations.
benefitting from the segregation of the proceeds
deriving from the underlying assets. Author
Luciano Morello
The use of ABS – which inevitably involves certain
Partner
administrative costs and complexities (i.e. the necessary
T +390 668 880 525
presence of a custodian bank or of a paying agent or
luciano.morello@dlapiper.com
the centralised clearing and settlement of the securities
in Monte Titoli) – does not always reflect the needs of
the parties involved in the securitization transaction.
Roberto Trionte
For instance, this would be the case in “private”
Lawyer
transactions in which the ABS are not intended to be
T +390 280 618 633
listed, rated nor placed on the capital markets, but they
roberto.trionte@dlapiper.com
would instead represent a buy to hold investment for
the first subscriber of the ABS.WWW.DLAPIPER.COM
The statutory replacement of
a benchmark
Thus, the EU established a mechanism for transitioning
In brief... affected contracts and/or financial instruments to
In February 2021, the EU Benchmarks Regulation suitable replacement benchmarks.
– which regulates indices used to price financial
instruments and contracts or to measure the How does it work?
performance of an investment fund – has The statutory replacement of a benchmark applies to:
been amended to ensure that a statutory
replacement benchmark can be put in place by • any contract or financial instrument as defined
the time a systemically important benchmark is in Directive 2014/65/EU (MiFID II) that references
no longer in use. The new provisions involve some a benchmark, and is subject to the law of an EU
considerations regarding fallback clauses and member state; or
actions to be carried out by market participants
• a contract that references a benchmark and is subject
and, in particular, by issuers.
to the law of a third country, where the law does not
provide for the orderly wind-down of a benchmark
(provided that all parties to such contract are
Background
established in the EU).
Regulation (EU) 2021/168 (the Amending Regulation)
introduced significant amendments to Regulation (EU)
The designation of a statutory replacement benchmark
2016/1011 of the European Parliament and of the
is an additional tool that applies if, inter alia, the above
Council of 8 June 2016 on indices used as benchmarks
contracts or financial instruments do not contain
in financial instruments and financial contracts or to
fallback provisions or do not contain “suitable” fallback
measure the performance of investment funds (the
provisions pursuant to the Amending Regulation. In
EU Benchmarks Regulation) as regards, inter alia, the
such cases, the designated benchmark shall replace
designation of replacements for certain benchmarks.
all references to the benchmark to be replaced in such
contracts and financial instruments.
The Amending Regulation, which is applicable as of
13 February 2021, has mainly been introduced to
The authority to designate one or more statutory
ensure that when a widely used benchmark is phased
replacements for a benchmark shall be vested in:
out, it does not harm financial stability in the EU and
result in disruptions to the relevant economy.
• the European Commission – with respect to (i)
benchmarks that have been designated as critical
The announcement of the Financial Conduct Authority
under the EU Benchmarks Regulation (such as
regarding the cessation of the London Interbank
EURIBOR) and (ii) third-country benchmarks, the
Offered Rate (LIBOR) after the end of 2021 has been
cessation of which would significantly disrupt the
a kind of wake-up call for Europe. There are many
functioning of financial markets in the EU or pose a
contracts and/or financial instruments documenting
systemic risk to the financial system in the EU (such as
debt, loans and/or derivatives that still reference LIBOR
LIBOR) – through the adoption of implementing acts
with a maturity date beyond 31 December 2021 and do
which shall, inter alia, follow a public consultation
not envisage contractual fall-back provisions that could
and include the date from which the replacement or
regulate the cessation of LIBOR. In other terms, LIBOR
replacements for a benchmark applies; or
is widely used in outstanding contracts and/or financial
instruments that cannot not be practicably transitioned • the national competent authority of a an EU
away from such benchmark by actions or agreements by member state where the majority of contributors
or between contract counterparties themselves. is located, with respect to the “critical” benchmark
set out in Article 20, paragraph 1, lett. b) of the EU
Benchmarks Regulation.
9FINANCE AND MARKETS GLOBAL INSIGHT
In any case, the parties to a contract may agree to apply Where appropriate, issuers should consider amending
a different replacement for a benchmark to the one contracts and financial instruments in advance before
designated by the European Commission or the national the relevant benchmarks cease to apply.
competent authority.
In addition, issuers should draft fallback clauses in
In addition, the Amending Regulation provides “new” contracts and financial instruments in the light of
for (i) specific trigger events that must occur for such new provisions and, where appropriate, the new
the purposes of the designation of one or more ISDA IBOR Fallback Protocol, which is effective as of
replacements for a benchmark by the European January 2021 and which includes new fallback provisions
Commission/national competent authority, and (ii) the connected with key interbank offered rates (so-called
conditions under which the fallback provisions shall be IBORs) in the event, inter alia, an IBOR becomes
deemed unsuitable for the purposes of the statutory permanently unavailable while firms continue to have
replacement of a benchmark. exposure to that rate.
In particular, a fallback provision shall be deemed European issuers should also review their “contingency
unsuitable for the purposes of the statutory plans” required by Article 28, paragraph 2 of the EU
replacement of a benchmark designated by the Benchmarks Regulation, where such plans designate
European Commission if: one or several alternative benchmarks that could be
referenced to substitute the benchmarks that would no
• it does not provide for a permanent replacement longer be provided. Such review seems necessary, even
benchmark; or if, as anticipated above, the designation of a statutory
replacement benchmark is an additional tool that does
• its application requires consent from third parties that
not apply when the parties to a contract agree to apply
has been denied; or
a different replacement benchmark.
• the replacement benchmark according to such
fallback no longer reflects or significantly diverges Finally, it is recommended for European issuers to
from the underlying market or the economic reality implement a strategy for communicating to end-clients/
that the benchmark in cessation is intended to users their plan to move to “alternative benchmarks”
measure, and its application could have an adverse and the transitions and steps to be taken to support
impact on financial stability.2 such a move.
In addition, the “unsuitability” of a fallback provision
Author
is limited to the cases where it does not provide for
a permanent replacement benchmark with respect to Martina Antoniutti
the replacement of a benchmark by national law. Lawyer
T +390 668 880 810
Actions suggested martina.antoniutti@dlapiper.com
First of all, it is recommended for market participants
and, in particular, European issuers not to sit back and
rely on this statutory replacement mechanism, but to Alessandro Nicolardi
focus on their fallback clauses. Lawyer
T +390 668 880 649
They should (i) identify all of their contracts or financial alessandro.nicolardi@dlapiper.com
instruments that reference certain benchmarks (such
as LIBOR) and verify if they include fallback provisions;
and, if this is the case, (ii) review all of their fallback
clauses to assess their “suitability” for the purposes of
the EU Benchmarks Regulation, as amended by the
Amending Regulation.
This case shall be considered triggered following a process specified in Article 23c, paragraph 5 of the EU Benchmarks Regulation, as amended by the
2
Amending Regulation, which provides for the involvement of the relevant national authority (which shall be designated by each Member State and
communicated to the European Commission and ESMA by 14 August 2021).
10WWW.DLAPIPER.COM
ESG finance: Global warming has
become a hot topic
ESG-related financing considerations are more and more in the ascendancy, and
the trend shows every sign of continuing
Some observers may challenge this as potentially
In brief... being too cosy and convenient, but when all is said
Corporates and lenders are increasingly and done, the credit margin has to reflect the risk to
considering the possibility of “green” or the lender, and the lender would not benefit financially
“sustainability-linked” bonds, loans and derivatives, if the ESG targets are met: quite the opposite; and so
in the face of scrutiny from activist investors and in theory, this could lead to fraught negotiations, with
lenders and allegations of greenwashing. the lender battling to make the targets very difficult
to hit to preserve the full margin. In practice, however,
this is unlikely, given the nature of healthy competition
In the last year or so there has been a huge increase in between finance parties to win a debt mandate, and the
talk about ESG generally, including in relation to finance probable impossibility of a lender being able to judge
and financial products, and our finance practice from whether a borrower is capable of achieving a certain
Australia through Europe and Africa down to California target or not, and so a more likely outcome – unless
has had no shortage of exposure to green bonds, funded by a lender whose own return to its investors
sustainability-linked loans and derivatives in one way is outcomes linked – is a range of targets which the
or another. It seems reasonable to say that this looks lender has to assume will be met, and so it has to price
like the hot topic to replace LIBOR transition in 2021 the loan on the assumption that they will be. Once
and beyond. However, there lurks an uncomfortable that is done, the tension which could conceivably have
dichotomy that has undoubtedly given rise to more surrounded the negotiation of the targets is relaxed,
than a few suggestions of “greenwashing” – a cosmetic which allows the borrower to choose targets and
confection which does not survive close scrutiny. When attainment levels that it can conclude with a high degree
a borrower and lender (for convenience, in this article of confidence have at least a good chance of being met,
we refer to a loan, but largely the same issues would the lender being largely indifferent. There is a school of
arise with a sustainability-linked derivative or bond) thought that this dichotomy underpins a fundamental
decide to do an ESG-related financing, the borrower contradiction in an ESG-linked loan: cynics may claim
is likely to take the lead in identifying the targets in that while the parties’ motivation may appear to be to
discussions with the lead lender when issuing the loan incentivise good ESG behaviour, the real motivation is
mandate. A borrower’s desire to be a virtuous corporate to appear to incentivise good ESG behaviour so as to
citizen can be matched with ESG-dedicated credit funds allow all concerned to be able to proclaim their concern
looking for the right assets, which could be worth a for the environment etc to shareholders, contracting
cost of funds deduction of a few basis points to the parties and others. There is, of course, in reality very
borrower and enable it to widen its pool of investors often an underlying pro-ESG outcome or behaviour
if it can find and then meet some ESG-related targets. that the borrower has identified as a goal to which its
Given the width of what targets are encompassed by the organisation is working, and the loan terms will reflect
phrase “sustainability-linked,” most borrowers should this outcome or behaviour, and although the loan
be able to come up with some performance indicators terms are unlikely to be the sole driver of that outcome
that can be referenced. For convenience, in this article or behaviour, nevertheless, those terms can be a very
we use the phrase “sustainability-linked” as an umbrella useful concrete external statement of a borrower’s
term which includes linkage to societal and governance commitment to that goal with the result that it is more
factors, since similar considerations apply to devising a likely to achieve it than it would have been had it not
framework for the incentivisation of, say, more women entered into the loan on those terms. Both parties
in management as to a reduction in C02 emissions, should therefore work to ensure that the chosen
and since the only relevant LMA guidelines relate to ESG targets, and the measurement of the borrower’s
“sustainability-linked” loans. attainment of those targets, are real “stretch targets.”
Doing so will also avoid any claims of greenwashing:
11FINANCE AND MARKETS GLOBAL INSIGHT
some done deals have attracted criticism for being more climate change adaptation, protection of water and
holey than holy, and this is not where any well-advised marine resources, transition to a circular economy,
borrower or lender wants to be. protection and restoration of biodiversity and pollution
control) and will become applicable on 1 January 2022
So, when it comes to target selection, a borrower may (as regards climate change mitigation and adaptation,
well have some kind of existing ESG framework and for which the related “technical screening criteria”
certain targets which it is already monitoring, and on have already been adopted) or on 1 January 2023 (as
which it may already be reporting in its audited financial regards water, circular economy, pollution control and
statements. If so, choosing these targets simplifies biodiversity, for which the related TSC are not yet in
defining the targets and the ongoing measuring force). Its purpose is to create an EU-wide standard
and reporting of them, and does not require active classification of environmentally sustainable economic
monitoring by the lender or anyone else. To the extent activities to underpin policies supporting sustainable
a third party is involved, it may well already be verifying finance, including standards for environmentally
the data used for the purposes of the annual report, sustainable financial products and labels that formally
so that there is little incremental cost if it also provides recognise compliance with those standards across
some certification to the credit parties. the EU (and which could possibly serve as the basis
for other economic and regulatory measures). So, for
The range of performance targets in publicised deals example, these will inform the disclosures required by
around the world in the last two years stretches from the EU Sustainable Finance Disclosure Regulation –
the most obvious such as reducing CO2 emissions or and for the sake of consistency the ESAs have recently
increasing the use of renewable sources of energy, proposed having a single rulebook covering both these
through to those which focus on societal impact, such regulations. The Taxonomy Regulation was onshored
as the number of women or minorities in management, by the European Union (Withdrawal) Act 2018, and HM
and the percentage of a workforce which has taken part Treasury is consulting about the necessary technical
in training on inclusion, diversity, anti-harassment and standards that will be required. As the UK was closely
other similar causes. The measurement of the targets is involved in developing the EU taxonomy, the UK’s
non-standardised: “management” may mean board- standards are unlikely to deviate much from the EU’s.
level, or it may be all levels of management. Greenhouse
gas emissions could be measured widely (scopes 1-3) This is an ambitious undertaking by the EU and not
or narrowly, and so on. Deal-watchers have questioned without difficulty: as Yves Mersch of the European
whether many of the targets are really quite as difficult Central Bank said in November 2020, “I see the risk
as they are proclaimed to be, especially where the of informational market failures if information on the
chosen base measurement is set several years before sustainability of businesses and financial products
the signing date, and in at least one case a critical is inconsistent, largely not comparable and at times
examination showed that a particular pollution-related unreliable or even completely unavailable. Definitions
target could be met by a borrower achieving economies of what constitutes a sustainable investment are often
of scale through increased production, even though that subjective and inconsistent. The EU taxonomy is a
would in turn entail increased pollution by reference promising initiative, albeit incomplete. Its practical
to other (non-targeted) measures which had not been usability remains a challenge. Plans are also under way
selected as targets. for widely applicable industry standards.”
The recent focus has been in the development The LMA, APLMA, LSTA and ICMA have all issued
of common taxonomies to bring about some principles and guidelines which parties may choose to
standardisation, and there are some signs, and hope, follow, although inevitably they tend to be rather high
that the recommendations made by the Taskforce level, and for the most part the measurement of the
on Climate-related Financial Disclosures (an FSB- level of attainment of a particular target is to some
sponsored body) and the UK or EU taxonomies will degree qualitative rather than quantitative. There is no
gain traction in coming years. The EU’s Taxonomy shortage of third-party agencies offering verification
Regulation3 is gradually becoming applicable. It and certification services, but these too necessarily
identifies six criteria for defining what “environmentally involve qualitative judgments being made, or else
sustainable” activity is (climate change mitigation, measure an enterprise’s exposure to ESG risks rather
Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable
3
investment, and amending Regulation (EU) 2019/2088
12WWW.DLAPIPER.COM
than its virtuousness; for example, a coal producer Returning to the dichotomy mentioned earlier, one
might rate poorly, not because coal is per se a bad obvious solution would be to provide some form of
thing, but because, as things stand, the financial outlook subsidy to lenders for any ESG-related margin discount,
for a coal-seller is not rosy. One rating agency has and possibly the obvious way of doing this – so far
gone further and attempted, as objectively as it can, to as regulated lenders are concerned, at any rate –
measure and score an entity’s ESG goodness, which is would be to allow an offsetting incentive by way of a
an interesting attempt at replicating the familiar credit reduced regulatory capital charge. This is not the case
ratings, but so far just over a dozen entities have been at present, and even in the medium term it seems
given a public rating, so this is probably little more than an unlikely outcome, as it runs counter to the central
essentially conceptual at present. tenet of prudential financial institution regulation,
which is principally concerned with the liquidity and
On 10 February 2021, the European Commission creditworthiness of a regulated institution; and in any
published its “Summary Report of the Stakeholder event would face major practical impediments given the
Consultation on the Renewed Sustainable Finance lack of a consistent definition of what might be given
Strategy,” and its conclusions included that the quality, favourable capital treatment, and lack of data to be used
reliability and comparability of ESG data and ratings to decide what the risk differential might be.
was currently poor, and that the growing level of
concentration in the market for ESG ratings and data Author
providers, and potential conflicts of interest suggested
Mark Daley
a need for some kind of regulation of the sector.
Head of Knowledge Management
This indicated the direction of travel for the EU (which
T +44 20 7796 6294
has been ahead of most of the world on ESG), and
mark.daley@dlapiper.com
the UK chancellor’s November 2020 announcement
regarding introducing ESG disclosure standards for
corporates and financial institutions by 2025 which
Mark Dwyer
would be aligned with the TCFD recommendations, and
Partner
comments from the Bank of England that there needs
T +44 20 7796 6005
to be an orderly market transition to a low-carbon
mark.dwyer@dlapiper.com
economy, indicate a similar direction for the UK.
13FINANCE AND MARKETS GLOBAL INSIGHT
How green are your hedges?
Market developments in ESG-related derivatives
well as expand their funding sources. These products
In brief... will contribute to the expansion of green and
What ESG-related derivatives are available in the sustainability-linked financing and play an important role
market? Why they are helpful in a sustainable in the transition of many businesses to sustainability.
finance context? And how can your ESG-related
goals be more efficiently achieved via ESG At the same time, there have been innovative examples
derivative products? of bespoke derivative transactions where the economic
terms of the derivative trade itself is linked to ESG
or sustainability-linked targets of the counterparties
One silver lining to come out of the COVID-19 pandemic involved. In the Overview of the ESG-related Derivatives
has been the sharp reduction in carbon emissions Products and Transactions4 (the ESG Products
over the last 12 months. As governments set out Overview), the International Swaps and Derivatives
their roadmaps out of lockdown, they have a rare Association (ISDA) introduced a number of recent
opportunity to completely reshape large sections of transactions which incorporate ESG targets into pricing
global economies going forward. Derivatives as an of the transactions or impose obligations on one party
essential part of sustainable finance and investment to make charitable donations when another party meets
will have an important role in supporting governments ESG targets.
and businesses in building back a better and a more
sustainable future. One example is a EUR1.1 billion sustainability-linked
syndicated loan for Italo – Nuovo Trasporto Viaggiatori,
In the same way as market participants incorporate a private rail operator, structured by Natixis in January
green and sustainability-linked loan principles for 2020. The company entered into a sustainability-linked
loans and green and sustainability-linked bond interest rate swap to hedge interest rate under the
principles for debts in capital markets, players in the loan with a EUR900 million green loan to finance the
derivatives market have also been actively engaged in company’s low-carbon rolling stock. The interest rate
“greening” their derivatives trades. We consider the key swap contained an incentive mechanism aligned with
developments in this area with respect to sustainability- the sustainable performance indicators set out in the
linked derivatives, ESG-related credit default swaps loan agreement. Another example is a one year USD/
and indices, exchange-traded derivatives on listed THB FX forward linked with ESG performance targets
ESG-related equity indices, renewable energy and entered into by Olam International, a major food
fuel transactions, emissions trading derivatives and and agri-business company with Deutsche Bank in
catastrophe and weather related products. We also June 2020. Olam International uses the FX forward to
discuss potential development of these products in hedge currency risk in connection with the export of
the future and explore how clients may use these its products. The transaction allows Olam International
traditional financing tools to achieve their sustainable a discount when it meets agreed ESG targets which
development goals. supports the United Nations Sustainable Development
Goals. Other notable examples include preferential
Sustainability-linked derivatives pricing for interest rate hedges for property developers
Derivatives products assist and facilitate sustainable when their buildings are certified to meet green or
investment in different ways. We have seen businesses energy efficiency standards, and discounted pricing for
and new projects continue to use conventional FX transactions for power and gas companies when
derivatives in connection with a growing amount they meet renewable electricity generation targets.
of green and sustainability-linked loans or bonds. Due to the flexible nature of derivative contracts, we
Interest rate or currency hedging and credit default expect to see market participants devising more and
swaps enable companies to effectively manage risks as
ISDA: Overview of ESG-Related Derivatives Products and Transactions, January 2021, https://www.isda.org/a/qRpTE/Overview-of-ESG-related-Derivatives-
4
Products-and-Transactions.pdf
14WWW.DLAPIPER.COM
more highly customised derivatives transactions to Renewable energy and corporate
incentivise companies in meeting their individual ESG power purchase agreements
performance targets. In a world where many countries have reduced or
withdrawn subsidies for renewable energy, renewable
ESG-related credit default swap energy derivatives contracts are increasing important
(CDS) index in supporting the development of new renewable
Market participants use CDS to manage credit risks of energy projects.
a counterparty where such counterparty’s credit risk
may be adversely affected by climate change. Generally We have seen various derivatives instruments being
speaking, CDS can help either (i) hedge future potential created to purchase or trade renewable energy, the
losses that would be realised following a catastrophic most significant development in recent years are the
event, or (ii) hedge the risk of changes in the market corporate synthetic power purchase agreements (PPAs),
value of catastrophe-linked bonds/loans. also called financial PPAs.
In May 2020, HIS Markit launched the iTraxx MSCI ESG Financial PPAs of renewable energy are entered into
Screened Europe Index (the ESG Screened Index), between a renewable power generator, often from
a broad European corporate CDS index derived after solar and wind sources (the seller) and a purchaser of
screening companies against a set of ESG criteria. renewable energy (the buyer), often a financially strong
The ESG Screened Index can be used as a macro corporate entity. Under such financial PPAs, no power is
instrument by investors to gain exposure to ESG physically traded. Instead, the agreement functions as
companies as well as to hedge broad ESG European a financially settled fixed-for-floating commodity swap
risk. The ESG Screened Index is cleared through LCH where the buyer and seller agree a defined “strike price”
CDSClear from September 2020 and therefore will for power generated by a renewable energy facility. Each
become increasingly liquid and easier to invest in. party will then enter into separate agreements with their
electricity supplier/utility to sell or acquire (as applicable)
Exchange-traded derivatives on electricity at the spot price. The financial PPA then
listed ESG-related equity indices works as a financial hedge: the monetary difference
Many global exchanges (including ICE, Euronext, between the spot price and the strike price in successive
CME Group and Nasdaq) have launched equity index settlement periods are settled between the parties
futures and options contracts tied to ESG benchmarks. periodically, so the seller always receives the net strike
Asset managers can use ESG futures and options to price throughout the duration of the PPA. The certainty
allocate their target ESG investment more efficiently in electricity sale price achieved through these financial
without directly investing in underlying stocks. They can PPAs will provide much needed “bankability” support
also hedge their ESG investments better and implement for renewable energy projects, enabling more new
their ESG investment strategies in a more efficient and renewable projects to be financed and built.
cost-effective manner.
Many large corporates in the US and UK have entered
ESG index derivatives reference ESG indices. ESG indices into financial PPAs. DLA Piper has a market-leading
can be based on exclusion methodology, allowing practice on corporate PPAs and has in-depth first-hand
market participants to invest in underlying benchmarks experience in this area.5 We have advised lenders,
but eliminating certain non-compliant companies based developers and corporate purchasers on their PPAs –
on certain ESG standards (eg excluding companies from generators and their funders to the corporate end
linked with fossil fuels or tobacco products). Conversely, users and their licensed electricity suppliers – we have
ESG indices can also be based on positive inclusive acted on many of the largest European corporate PPAs
methods, including companies with high ESG ratings, in recent years.
a certain specific ESG theme, and/or having a particular
positive ESG impact. The ESG Product Overview listed
more than ten examples of ESG index derivatives
offered by different exchanges.
5
For DLA Piper Intelligence on corporate PPA in different countries, see https://www.dlapiperintelligence.com/corporateppa/
15FINANCE AND MARKETS GLOBAL INSIGHT
Emissions trading use voluntary Chinese Certified Emissions Reduction to
Emissions trading is a market-based solution to meet up to 5% of their compliance obligations, which
reducing pollution (mainly CO2 emissions). Companies in would be a significant boost to the voluntary market.
specific industry sectors are subject to a capped limit for In addition, observers believe that the new national ETS
their CO2 emissions within a specified geographic area. would lay the foundation for the development of China’s
These capped annual emission allowances are either first carbon emission futures on the new Guangzhou
allocated to each of the companies within an industry Futures Exchange.
for free or through purchase at auctions, and they will
be reduced annually, thus incentivising companies to Catastrophe and weather
reduce emissions year on year. Companies that emit derivatives
more pollutant than their allocated allowance will Catastrophe derivatives are flexible and customisable
have to purchase additional allowance in the market, financial instruments to transfer losses connected
or face substantial fines for non-compliance with the with natural disasters between counterparties. Market
capped amount. participants can enter into OTC swap contracts where
one party seeks protection by transferring part or full
Market participates use derivatives contracts (based losses caused by natural disasters (such as earthquakes,
on ISDA template for emission allowances) to trade hurricanes or pandemics) to the other party, while
swaps, options and forwards in secondary markets. the other party takes on such risks in return for
These derivatives products, based on carbon allowances premium payments, similar to an insurance contract
and carbon offsets, enable companies that are subject or securitisation. Parties seeking protection through
to compulsory cap-and-trade programs to meet catastrophe derivatives may be countries or insurance
their emission reduction obligations and manage or reinsurance companies, and catastrophe swaps allow
risks in a cost efficient way. In this regard, both the them to transfer disaster risk to the financial market
liquid exchange-traded products and the flexible, without increasing their debt liabilities.
customisable over-the-counter (OTC) products are
needed to meet the varying demands of companies The World Bank has organised several successful
in their respective risk management strategies. catastrophe swaps including one USD206 million 2017
swap issued for the Philippines (the World Bank acted
In addition to the mandatory compliance market as an intermediary and transferred risk outside the
scheme which existed in different geographic regions Philippines to international investors).
for many years, there is also a voluntary carbon
emission trading market. The voluntary market enables There have been some very significant developments
individuals, companies and government entities to in Asia in the last few years in the area of Catastrophe
purchase carbon offsets on a voluntary basis, typically financial instruments, including insurance-linked
driven by ESG and corporate responsibility goals securities (ILS). Singapore led the region by adopting
and undertakings. legislations to facilitate the issuance of catastrophe ILS
and has seen nine ILS issuances since 2018 covering
Emissions trading has significant growth potential in risks such as earthquake, typhoon and flood, all of which
Asia, particularly in view of China’s commitment to meet DLA Piper’s teams in Asia have advised on together with
the targets of carbon emission peak by 2030 and carbon our US teams. At the same time, legislative initiatives
neutrality by 2060. China has issued new trial carbon for ILS are underway in Hong Kong aiming to create the
emission trading rules (Trial Rules), effective February legal framework for ILS in Hong Kong.6
2021, pursuant to which a new national emissions
trading system (ETS) is expected to be launched by the The focus in Asia on catastrophe loss transfer is not
middle of 2021. The Trial Rules apply to companies in surprising given Asia has the lowest loss coverage rate
specific sectors with more than 26,000 mt/year of CO2 for natural disasters compared with elsewhere in the
equivalent emissions, but will start with 2,225 coal- world. The COVID-19 pandemic has further increased
fired power plants initially, which last year accounted the urgency of such endeavour. As a result, there is
for about 40% of China’s total emissions, making it the potential for catastrophe derivatives products to play
world’s largest carbon market for the power sector. a role in Asian markets. Compared with ILS, catastrophe
Entities registered under the ETS will also be allowed to derivatives offer more flexible and bespoke solutions
See DLA Piper briefing at https://www.dlapiper.com/zh-Hans/hongkong/insights/publications/2021/01/update-on-hong-kongs-new-insurance-
6
linked-securities-regime/
16WWW.DLAPIPER.COM
to meet an individual party’s needs while at the same associated with various financing. They also contribute
time avoid the structural complexities and associated to pricing transparency and help channel more
costs of ILS. Established financial hubs in Asia, such as investments into ESG compliant companies, renewable
Singapore and Hong Kong, can play a leading role in energy projects, or those achieving sustainable
the newly established Guangdong-Hong Kong-Macau development goals. Market participants have so far
Greater Bay Area and elsewhere in Asia by offering been very innovative in creating tailor-made products
Catastrophe derivatives products alongside ILS to for specific ESG-linked objectives. To move to the next
insurance/reinsurance companies and governments in stage of the development and scale up the adoption
the area, to assist their efforts in managing risks and, of ESG-related derivatives, market participates should
more importantly, in bridging the huge gap in uninsured strive to develop common taxonomy in definition
economic losses resulting from significant natural of sustainability, disclosure requirements as well as
disasters in China and other countries in Asia. standard measurement metrics. Meanwhile, now is the
time for companies and organisations to familiarise
Weather derivatives are financial contracts that derive themselves with the increasingly versatile derivatives
value from weather-related variables, typically including tools available and build them into their overall
precipitation and temperature. Parties to weather long‑term strategy for future sustainable business.
derivatives transactions hedge and mitigate risks
associated with adverse weather conditions affecting Author
their business. Payments on weather derivatives are
Bryony Widdup
generally based on an index that measures particular
Partner
weather factors, e.g. amount of rainfall during a specific
T +44 20 7153 7005
period, or number of days on which the temperature is
bryony.widdup@dlapiper.com
above or below a certain threshold. While this appeals in
particular to the agricultural sector, it can also be used
by wider sectors such as holiday resorts, manufacturers
Jennifer Jin
of ice creams or electric fans or air conditioning units.
Legal Director
Transaction parties typically enter into transactions
T +44 20 7796 6214
on the basis of ISDA produced weather derivatives
jennifer.jin@dlapiper.com
template agreements.
Future outlook
James Tighe
Derivatives as a core component of financial markets
Associate
can play a significant role in the global transition
T +44 20 7796 6662
towards a low-carbon and sustainable economy.
james.tighe@dlapiper.com
They facilitate sustainable investment by hedging risks
17FINANCE AND MARKETS GLOBAL INSIGHT
The Securitisation Regulation opens
its doors to NPEs and synthetic
securitisation
Luciano Morello, Gilemma Nugnes, Roberto Trionte Removing regulatory obstacles to
securitisations of NPEs
• Definition of NPE securitisation (Article 2 of the
In brief... Securitisation Regulation): a definition of “NPE
A review of the recently published amendments securitisation” has been inserted in Article 2, being
put in place to manage the risks of an increasing “a securitisation backed by a pool of non-performing
number of non-performing exposures following the exposures (being the exposures that meet any of
COVID-19 crisis. the conditions set out in Article 47a(3) of Regulation
575/20137 (CRR), including, without limitation, (a) an
exposure in respect of which a default is considered
to have occurred, (b) an exposure which is considered
Regulation (EU) 2021/557 of 31 March 2021 (the
to be impaired in accordance with the applicable
Amending Regulation) – which was published on 6 April
accounting framework, and (c) an exposure under
2021 in the Official Journal of the EU – introduced a
probation, where additional forbearance measures
number of amendments to the provisions of Regulation
are granted or where the exposure becomes more
(EU) 2017/2402 of 12 December 2017 (the Securitisation
than 30 days past due) the nominal value of which
Regulation) to, inter alia, manage the risks of an
makes up not less than 90 % of the entire pool’s
increasing number of non-performing exposures (NPEs)
nominal value at the time of origination and at any
following the COVID-19 crisis. The targeted changes to
later time where assets are added to or removed
the Securitisation Regulation should ensure that the
from the underlying pool due to replenishment,
EU securitisation framework provides for an additional
restructuring or any other relevant reason.”
tool to foster economic recovery in the aftermath of the
COVID-19 pandemic. • Requirements for SSPEs (Article 4 of the Securitisation
Regulation): as a result of the amendment to Article 4,
The provisions of the Amending Regulation – which will the securitisation special purpose entities (the SSPEs)
apply from 9 April 2021 (the New Provisions) – are aimed shall not be established in a third country if, inter
namely to: alia, the third country is listed (i) as a high-risk third
country having strategic deficiencies in its regime
• remove regulatory obstacles to securitisations on anti-money laundering and counter terrorist
of NPEs; financing, or (ii) in the EU list of non-cooperative
jurisdictions for tax purposes.
• extend the STS securitisation framework to synthetic
securitisations; and • Due diligence requirement (Article 5 of the
Securitisation Regulation): in Article 5(1) a due
• start to develop a sustainable securitisation
diligence requirement in the case of NPEs is added,
framework.
being to verify that “sound standards are applied
We briefly summarize below the content of the in the selection and pricing of the exposures.”
New Provisions. However, quite surprisingly and differently from the
amendments made to Article 9 of the Securitisation
Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and
7
investment firms and amending Regulation (EU) No 648/2012
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