I read with interest news about Netherlands bank trading several novel products in which a counterparty pays floating cash flows linked to the counterparty's ESG (environment, social, governance) score from an external rating agency. The worse the rating, the higher the payments. Thus, the corporation is incentivized to improve its ESG rating in order to pay less. It's been done in the format of loan interest and floating swap leg:
I'm curious, how would a bank mark to market such receivables? Could they assume that the ESG score would not improve, but take negative PL if the score did improve? Could the bank conservatively assume that the score might improve and then recognize more PL once the score did not improve? Also I'm curious, how could the bank hedge the possibility that the score would improve and the bank would receive less? Could they assume some relationship between ESG score and counterparty's equity price and/or CDS spread?