Wall Street's New ESG Money-Maker: Nature Conservation With a Catch

Some of the world's biggest banks are considering a new experiment in financial engineering: offering debt relief to countries in exchange for environmental protections. This could be a win-win for both parties: the countries would get much-needed debt relief, while the banks would help to preserve the environment.

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Debt-for-nature swaps are an attractive option for countries facing increasing debt, especially those with ecosystems that need protection. In exchange for lower debt payments, a country agrees to set aside some of the savings to preserve a coral reef, forest, or build a wind farm. This benefits global investors by providing better returns and enhancing their green credentials. Wall Street also benefits from the fees associated with these transactions.

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According to a rough estimate by the Nature Conservancy, a US nonprofit that's taking a lead role in these deals, as much as $2 trillion of developing country debt may be eligible for this kind of restructuring. Belize inked a $364 million nature swap in 2021; Gabon signaled plans for a $700 million restructuring in October; Ecuador is said to be working on a $800 million transaction, and Sri Lanka is considering a $1 billion deal.

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The finance industry's newfound enthusiasm for biodiversity is giving a boost to backers of this latest type of swap. Investment banks and institutional investors are eager to get involved, and the potential for these "turbocharged swaps" is huge. According to Daniel Munevar, economic affairs officer at the United Nations Conference on Trade and Development and former adviser to finance ministries in Greece and Colombia, the only limit is how much debt can be swapped.

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Although these types of swaps may appear to be beneficial at first glance, it is unclear whether they will actually deliver the promised benefits. The terms can be murky, transaction costs are high, and experts question whether the complex and costly deals will achieve long-term financial stability. In December, as negotiators gathered at the United Nations’ COP15 biodiversity conference in Montreal, Greenpeace and dozens of other non-profits called for debt-nature swaps to be rejected.

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Debt-for-nature swaps are often popular for the wrong reasons. One of the main wrong reasons is that they generate the impression that you can kill two birds with one stone, that you can address a debt problem and improve nature conservation. Jeromin Zettelmeyer, director of Belgian think tank Bruegel and a former sovereign debt expert at the International Monetary Fund, said this is not the case.

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Debt-for-nature swaps first emerged in the 1980s, with small deals limited by what governments and nonprofits could contribute. However, with the rise of debt in emerging markets and the disproportionate impact of climate change on some of the most indebted countries, there is new interest in larger deals. According to Ramziissa, managing director for credit structuring at Credit Suisse Group AG, who helped arrange Belize’s $364 million deal, “there’s tons of demand.” Investors have not seen this type of opportunity before, he said.

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Many economies that are highly vulnerable to climate change are also at high risk of debt distress. This means that they may have difficulty repaying their debts, which can lead to economic instability and even collapse.

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Belize, a small country in the Caribbean, is the biggest test to date for the International Monetary Fund. Better known for Mayan ruins and a nearly 200-mile barrier reef, Belize has a history of debt default and by late 2020, was once again in financial trouble. The pandemic was keeping tourists away, depriving the country of its main revenue source. Its debt level approached 130% of GDP, almost double the International Monetary Fund’s sustainable threshold for the nation.

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"The IMF was insisting on a program," said Mark Espat, a former Belizean politician and consultant who advised the country on its debt-for-nature swap. The IMF provides loans to countries in debt, but its conditions are often strict, leading many governments to hesitate. For Belize, this would have meant higher taxes, job losses, and lower spending on social and conservation projects, Espat added.

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The Nature Conservancy offered an alternative to Belize's debt crisis. It had arranged a debt-for-nature swap with Seychelles a few years earlier and was looking for a bigger deal. Together with Credit Suisse, it proposed to finance the buyout of Belize’s $553 million “superbond,” if the government agreed to spend some of the savings to protect its fragile mangroves and coral reefs. After almost a year of negotiations, around 85% of bondholders agreed to take 55 cents on the dollar, in cash, and staked their claims to a role in Belize’s ocean conservation. This deal saved Belize's natural resources while also providing relief from the country's debt.

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The second part of the deal required TNC and Credit Suisse to re-sell the new debt - repackaged as "blue bonds," a maritime twist on "green bonds" - to investors. That was harder: Belize had defaulted, changed terms on or restructured its dollar bonds at least five times in 14 years. Investors like Swedish pensions manager Alecta only bought in after the US International Development Finance Corporation agreed to provide insurance.

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This is how it worked:
The Nature Conservancy has established a Delaware-based subsidiary, Belize Blue Investment Company, and has raised $364 million from Credit Suisse.
The BBIC loaned funds to Belize so that it could buy back $553 million in debt at a 45% discount from bondholders.
Credit Suisse, through a special purpose vehicle in the Cayman Islands, has issued $364 million in blue bonds to finance the deal. This provides a new source of financing for the company and helps to diversify its funding sources.

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Belize will repay the new, smaller loan from BBIC over 19 years, with an interest rate starting at 3% and rising to 6% in 2026. To secure the loan, Belize must establish a $24 million conservation endowment and commit to spending $84 million on conservation efforts and protecting 30% of its oceans.
The US International Development Finance Corporation insured the BBIC loan, meaning that if Belize is unable to pay, the US government will be responsible.

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The deal was widely seen as a success at the time, as it cut the country’s debt by 12% of GDP, reopened its access to financial markets, and redirected money once destined for foreign creditors into the local economy. Belize promised to funnel almost $180 million over two decades into protecting its oceans, and investors were glad to have backed a worthy cause.

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This was a perfect example of blended finance, where public funds are used to reduce the risk of private investment. This strategy is seen as a way to fill the enormous financial gap for decarbonization, climate adaptation, and nature protection in developing countries.
We're all striving to reach a state of nirvana, where we're free from suffering and can find true happiness.
Debt swaps offer a great opportunity to achieve the goals of scalability and replication, according to Oliver Withers, head of biodiversity at Credit Suisse. He notes that these products have the potential to make a real difference in the fight against biodiversity loss.

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Munevar noted that Belize's costs were much higher than the initial $10 million price tag, and that millions more are hidden in Belize's interest payments. Munevar compared what Belize pays with what Credit Suisse returns to investors in the new blue bonds, and estimated that over the life of the deal, the difference adds up to $84 million.

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According to an organization spokesperson, the $86 million spread covers insurance premiums for DFC and private-sector reinsurers, along with $14 million to repay a $10.5 million loan from TNC to Belize at 3% interest and "standard financing costs (such as audit, accounting, rating agency expenses)." TNC will be reimbursed at cost for staff time spent on conservation work.

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Credit Suisse and Belize will pay different amounts to borrow for the debt-swap deal. Credit Suisse will pay $86 million more than Belize over the life of the loan.
The cost of the deal is much higher than the $10 million initially disclosed, which is concerning, Munevar said. "This leads to a misleading assessment of the cost-and-benefits of the arrangement and second, because this is an arrangement based on taxpayer money from both Belize and the US."

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Munevar said that the costs of the swap make it one of the most expensive debt restructurings in recent history, relative to the size of the transaction. Sean Newman, chief investment officer at Sagicor Group and an expert on emerging markets debt, agreed that the deal is very expensive.
Bruegel's Zettelmeyer is not surprised by the cost of these operations. He explains that they are "small and complicated to arrange," which means that the country ends up paying a lot for very little gain. In other words, these types of operations are inefficient and ultimately costly for the country.

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Credit Suisse said that any lower borrowing costs were passed on to Belize. The difference was used to cover ongoing transaction costs, including insurance premiums and third-party maintenance expenses. The Zurich-based bank declined to specify how much it earned on the deal.
Christopher Coye, minister of state in the Belize finance ministry, said the country’s transaction costs totaled $14 million. This included financial and legal expenses related to the Eurobonds buyback, the issuance of the new blue loan and blue bonds, and conservation agreements. Coye said that the government was “completely transparent with this transaction.” He added that “every single blue bond related agreement was tabled in Parliament for debate and passage.”

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Greenpeace and a group of 30 other advocacy organizations have raised concerns about the use of public funds to finance new marine conservation organizations. They argue that this could jeopardize wider and lasting reforms to debt management. In a letter to the World Bank in December, the organizations said: "The risks and pitfalls of turning to financial markets to fund marine conservation are being ignored."

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Belize is committed to its transaction, costs and all. "Whatever spread there is in there for Credit Suisse or for any other entity, Belize is far better off than it would have been otherwise," said Espat, the domestic financial consultant. To the growing number of countries interested in this kind of restructuring, he had the following advice: "Negotiate as hard as possible."