Daily Management Review

Bankers Bet Billions Of Dollars On A New Wave Of Debt-For-Nature Transactions


Bankers Bet Billions Of Dollars On A New Wave Of Debt-For-Nature Transactions
The Galapagos Islands, which inspired Darwin's theory of evolution with their thousands of unique species, have incalculable ecological value. But how much are they worth?
According to people familiar with the talks, the size of a "debt-for-nature" swap deal that could see Ecuador's debts reduced in exchange for protecting its offshore territory's fragile ecosystem is around $800 million.
These types of agreements are part of efforts to address an impasse confronting world leaders at the United Nations COP27 summit in Egypt: who will foot the bill for the global fight against biodiversity loss and climate change?
"There's now a big push to get nature into sovereign debt markets," said Simon Zadek, executive director at NatureFinance, which advises governments on debt-for-nature swaps and other types of climate-focused finance.
"The tragedy of debt distress offers a real opportunity," he added, pointing to nature-rich countries who look like ideal debt swap candidates following big drops in their bond prices this year.
Ecuador is not one of the world's wealthier countries. It is a serial defaulter, and its sovereign bonds are once again trading at "distressed" levels, or at a significant discount to their face value. It does, however, have a rich biodiversity that it could use in a larger region where much of the wildlife has been wiped out.
According to three people with knowledge of the deal, who declined to be identified because the discussions are confidential, the country is in talks with banks and a nonprofit group in an attempt to reach an agreement in which about $800 million of its debt would be refinanced more cheaply, freeing up the savings for conservation efforts.
At that level, it would be the largest debt-for-nature swap ever struck. Others, however, including Sri Lanka, have been discussing a deal worth up to $1 billion, according to people familiar with the talks.
Meanwhile, Cape Verde, an archipelago nation off the coast of West Africa, is close to a nature swap worth up to $200 million, according to Jean-Paul Adam, a former Seychelles government official who now works for the United Nations Economic Commission for Africa (UNECA), providing financing advice to governments.
The governments of Ecuador, Sri Lanka, and Cape Verde did not respond to requests for comment for this story, despite Ecuadorian President Guillermo Lasso saying in a local newspaper on Oct. 12 that the Galapagos swap deal could be completed in four or five weeks.
The potential deals for Ecuador, Sri Lanka, and Cape Verde, which have been reported in detail here for the first time, indicate a surge in interest in this type of financial alchemy, which was conceived decades ago but has remained a niche area until recently.
According to global data published by the African Development Bank, only three of the over 140 or so swaps struck over the past 35 years - the first in 1987 - had a value of more than a quarter of a billion dollars. The average purchase price was $26.6 million.
According to the data, the total value of swap transactions to date is $3.7 billion. This is only a fraction of the $400 billion in emerging market sovereign debt that Capital Economics recently estimated had reached distressed levels.
Advocates claim that because of the current debt problems, as well as the growing political will and recent successful swap deals in the Seychelles, Belize, and Barbados, a slew of other countries are now looking into the model.
Indeed, Adam at UNECA said four African countries were now exploring potential swaps. He declined to name them, saying he wasn't sure if they were ready to go public.
"Lots of my members are looking at it, and we're looking at it with them," Patricia Scotland, secretary-general of the Commonwealth of 56 countries, told Reuters.
The stakes for the environment could not be higher.
According to this year's Living Planet Index compiled by the World Wide Fund For Nature (WWF) and the Zoological Society of London, global populations of mammals, birds, fish, reptiles, and amphibians have declined by nearly 70% on average since 1970, with Latin America seeing a drop of more than 90%.
Such swaps are frequently compromises.
If a country defaults, bondholders lose money or must wait much longer to recover it.
Debt-for-nature transactions can help because they can generate so-called green bonds, or blue bonds in the case of ocean conservation deals, which appeal to a rapidly growing number of investors who want to meet ESG and net-zero goals.
Carl Ross, a veteran debt crisis fund manager at GMO, said Belize's pledge to protect its sprawling barrier reef, the largest in the Western Hemisphere, helped get the country's restructuring "over the hump" last year in a deal he was involved with.
At their most basic, these transactions involve writing down expensive bonds or loans and replacing them with less expensive financing, usually with the assistance of a credit guarantee from a multilateral development bank.
Ecuador, for example, is in discussions with the Pew Charitable Trusts, as well as the Inter-American Development Bank and the United States. According to two people with knowledge of the planned transaction, the International Development Finance Corporation.
Both Pew and the banks refused to comment.
Obtaining the support of development banks is usually critical to the economics of a deal. However, because banks must closely guard their capital and credit ratings in order to maintain their ability to borrow cheaply, the growth of swaps has been stifled for a long time.
Axel van Trotsenburg, the World Bank's managing director of operations, told Reuters on the sidelines of COP27 that the World Bank supports debt-for-nature swaps, as did African Development Bank President Akinwumi Adesina, who said his bank would "absolutely" begin providing credit guarantees.
The G7 countries, as well as Barbados Prime Minister Mia Mottley's "Bridgetown initiative," have all demanded that the World Bank and International Monetary Fund increase climate-related funding.
At COP27, IMF chief Kristalina Georgieva stated that swaps were a valuable tool, but not a "silver bullet" in global efforts to fund conservation.