Derivatives and ESG

Financial markets are increasingly developing innovative, ESG-related derivatives and relying upon these instruments to hedge ESG-related risks. The global derivatives markets are among the largest, most consequential financial markets in the world. Derivatives are financial contracts that derive their value from an underlying reference entity which can be almost anything, including interest rates, credit, equities, foreign exchange, the weather, or the price of carbon. They provide for hedging, investment (speculation), and arbitrage, and trade on regulated exchanges and in over-the-counter markets. Derivatives can also facilitate access to the tremendous amounts of capital necessary for the transition to a cleaner energy future and to the objective of net zero emissions by 2050 of governments around the world. Through an exploration of recent innovations and developments in the exchange-traded and over-the-counter derivative markets, this article explores the role of the derivatives ecosystem—the instruments themselves, trading exchanges, and clearinghouses—in promoting ESG objectives.