The government of Ecuador recently announced the world’s largest debt for nature swap, under which it will exchange $1.6bn in sovereign bonds for a $656m ‘Galapagos bond’, structured by Credit Suisse.
As well as reducing the country’s debt burden, and creating much lower debt service costs, the transaction will release an annual amount of $18m to be spent on marine conservation around the Galapagos islands.
Debt for nature swaps are all over the news at the moment, as Ecuador’s announcement came shortly after Cape Verde, an archipelago off West Africa, reported that it would swap €140m of debt owed to the government of Portugal in a deal that includes investing in an environmental and climate fund.
Barbados is another island nation that has recently announced a deal, whereby it will swap existing debt for a blue bond, the proceeds of which will be used for protecting and rehabilitating the surrounding Caribbean Sea. And the European Investment Bank has said it expects to back its first debt for nature swap for an African country later this year.
Committing to protecting biodiversity
Debt for nature swaps are one way to address the challenge that the countries that most urgently need to invest in climate and the natural environment are the least able to afford it because their budgets are burdened by debt.
Traditional debt swaps are a financial mechanism that allow a government to agree with its creditors to change the terms of a loan obligation to make it more manageable. By negotiating more favourable conditions, such as lower interest rates or longer repayment terms, debt swaps can help the world’s poorest nations avoid default and to redeploy part of their debt service costs to invest into policy priorities. Creditors are also likely to support a proposal that reduces default risk and ensures that at least part of the loan is eventually repaid.
In the case of debt for nature swaps, debt restructuring comes with a commitment from the debtor government to ensure action on climate, biodiversity or environmental protection, and part of the scheduled repayments will be reallocated for investment to support these targets.
Belize leads the way
The first debt for nature swap was carried out in Bolivia in 1987. Since then, nearly 150 transactions have been completed around the world, but most of the deals have tended to be relatively small.
This began to change in 2021 when Belize’s government reached an agreement with environmental group, The Nature Conservancy, under which its external debt would be reduced by $553m, or 10% of national GDP. Belize was able to buy back part of its existing debt at a discount and replace it by issuing $364m of blue bonds. The US government’s development bank, the International Development Finance Corporation, also provided support for the deal.
In return, the Belize government agreed to spend around $4m every year on marine conservation until 2041. It will increase the area of its marine protection parks – containing coral reefs, mangroves and sea grasses, which are habitats for some 1,400 species – from almost 16% of its oceans to 30% by 2026. In addition, an endowment fund of $23.5m will finance conservation after 2040.
Scaling up further
The potential to free up capital for investment in climate resilience and biodiversity through debt restructuring may be considerable. Research by the IIED last year found that debt relief in countries in or at high risk of debt distress could help to make as much as $105bn of government finance available for climate and nature.
In order for debt for nature swaps to have a real impact, the number and size of transactions must be scaled up significantly. There needs to be greater standardisation to move from niche products, often linked to small projects that are expensive to structure and monitor, to more mainstream instruments.
Improvements are also needed in how government pledges on nature and client are monitored and verified so that creditors will be satisfied that countries are meeting their commitments.
Debt for nature swaps in Asia – a coming trend?
Several countries in South Asia, which have high levels of sovereign debt, are thought to be looking at potential debt for nature swap deals.
Pakistan is particularly indebted and is still struggling to recover from the floods in 2022, which have resulted in costs estimated at over $30bn. Governments in the Maldives, Nepal and Bangladesh are all having to cope with rising food and housing costs. Sri Lanka, which defaulted on its debt in April 2022, is thought to be the most advanced. The country will announce a comprehensive restructuring plan in just a few days, and is also thought to be discussing a debt for nature swap worth as much as $1bn.
In South East Asia, the government of Laos, where nearly 100% of GDP is funded by debt, has also begun the process of exploring a potential debt for nature swap in order to reduce its debt burden and increase resources available for protecting its forest coverage, currently among the highest in countries in the region. The United Nations Development programme is supporting a cross ministry Debt for Nature Technical Working Group in the design of a potential programme.
