The World Federation of Exchanges ("WFE") has published a white paper on sustainability and commodity derivatives.

The white paper explores sustainability in the context of commodity derivatives markets, and is intended to stimulate discussion amongst the WFE membership and the wider commodity derivatives industry about how they might respond to the potential impact of sustainability issues on commodity markets. Today’s paper follows on from the WFE’s five Sustainability Principles, which were launched in October 2018, which constituted a formal declaration by the WFE and its membership to take a leadership role in promoting the sustainable finance agenda.

Users of commodities increasingly demand greater oversight and understanding of the supply chain, to ensure the commodities they use (e.g. agricultural commodities, energy and precious/non-precious metals) accord with some definition of sustainability. This demand will impact not only commodity spot markets, but potentially the corresponding derivative markets. In the absence of a single set of sustainability standards that specifies requirements for a commodity to be deemed sustainable, the WFE explores potential ways in which commodity derivatives exchanges may seek to address the impact of sustainability. These are to:
• Create new risk mitigation/investment tools to allow users to manage evolving risk. Several exchanges already have listed contracts that respond to environmental challenges, namely renewable energy certificates traded at ICE; emissions allowances traded at ICE and CME; and low sulphur oil contracts traded at both ICE and CME.
• Incorporate sustainability elements into existing contracts, perhaps by amending contracts to incorporate specific sustainability factors; introducing parallel ’sustainable’ versions; or incorporating a premium to recognise a verifiably sustainable version of the existing underlying.
Tackling these issues will require addressing some key challenges including the limited agreement around what constitutes a sustainably-produced commodity; the plethora of sustainability standards; the fact not all commodities lend themselves to full traceability along the entire supply chain; liquidity concerns; and, potential technical challenges for exchanges and their clearing members to ensure the smooth delivery of sustainability certificates alongside delivery of the actual traded commodity.

The white paper concludes with some starting principles to try and address these concerns, in an effort to prompt discussion on the topic:
• Sustainability as a quality standard, whereby a commodity is produced according to certain accepted sustainability standards.
• Picking one (or more) widely-recognised and accepted industry standard, rather than creating a new one.
• Verifying that the commodity meets the standard; however, there are a great deal of issues to consider here, such as what is being verified and how is verification demonstrated. Additional related costs should also not make risk management prohibitively expensive for smaller market players.
• Different approaches to traceability i.e. must the commodity comply with a product segregation model, or does mass balance or book and claim suffice?