• 29 September 2023
  • Insights

Can we wipe out debt and save the planet at once?

As discussed in a previous article, foreign debt is a major burden for developing countries both economically and environmentally. Often, more money is spent on debt repayment in these countries than on any other service or sector, including conservation and climate adaptation.

Unsurprisingly, 58 of the developing countries most vulnerable to climate change are also some of the most debt-ridden, with nearly US$500 billion owed to their creditors. With limited options for financing debt repayments, this in turn forces them to exploit natural resources to raise capital. As many such countries are also biodiversity hotspots, this makes debt a serious ecological threat in its own right.

But what if we could ease the debt of developing countries, and in doing so not only reduce their need to exploit nature, but also encourage them to protect it? Sound like a utopian fantasy? It’s actually a very real form of debt relief known as a debt-for-nature swap.

What is a debt-for-nature swap?

In a debt-for-nature swap, if a debtor country is in danger of defaulting on its debt, creditors can forgive (or reduce interest rates for) a portion of that debt in exchange for the savings being invested in climate action or conservation in that country.

The concept originated in the 1980s when, in response to the Latin American Debt Crisis, creditors created a secondary market to sell and trade debt at discounted rates over fears of otherwise never recouping loans. Seeing the negative environmental impacts of the debt crisis in affected countries, ecologist Thomas Lovejoy proposed using debt relief under this new market as a source of environmental funding. This eventually lead to the first debt-for-nature swap in 1987, when the NGO, Conservation International, arranged the cancellation of US$650,000 of Bolivia’s debt in exchange for the protection of 3.7 million acres of rainforest. Since then, over 140 debt-for-nature swaps have occurred, with a combined value of US$3.7 billion.

Despite existing mainly as a niche mechanism for the past three decades, debt-for-nature swaps have recently become increasingly popular against the backdrop of a burgeoning ecological and debt crisis. In the summer of 2023 alone, Ecuador had US$1.6 billion of its debt cancelled in exchange for a US$656 million blue bond to protect the Galapagos, while Gabon pledged US$125 million for marine conservation after buying back nearly US$500 million of its debt. Other debt-for-nature swaps have also occurred in (or are being planned for) Belize, Barbados, the Seychelles, Sri Lanka and Laos.

Types of debt-for-nature-swaps

There are two types of debt-for-nature swap:

  • Multilateral:
    In a multilateral (often three-way) swap, an NGO (or several) acts as a broker between creditor and debtor, offering expertise and facilitating investments in conservation. First, the NGO buys an outstanding debt from the creditor at a discounted rate on the secondary market. The debt is then repurchased from the NGO by the debtor country at a lower price than what the original debt payment would have been (though higher than what the NGO paid for it). That portion of the debt is then forgiven and some of the capital that would have gone towards paying it off is directed towards conservation investments or enacting environmental policies.
  • Bilateral:
    In a bilateral swap, creditors restructure a portion of a debtor country’s debt or sell it to them at a discount. Any capital the debtor country has left after repurchasing the debt is used to fund conservation or the enactment of environmental policies. Alternatively, this capital can be raised through interest payments on the restructured debt.

Case Study: Belize

One of the most high-profile examples of a debt-for-nature swap is that which occurred in Belize in 2021.

Prior to securing this swap, Belize was in serious fiscal trouble, having already defaulted on its debt several times. Things went from bad to worse when the COVID-19 pandemic halted tourism (one of Belize’s main sources of income), increasing the debt levels to over 125% of its GDP. This in turn left little to invest in protecting the country’s rich marine ecosystems –including the world’s second longest coral reef– which are threatened by coastal development, agricultural runoff and climate change.

To alleviate this problem, Belize entered a multilateral swap with The Nature Conservancy (TNC) and Credit Suisse. As per the deal, Belize was loaned US$364 million at a low interest rate, on the condition of new commitments to finance marine conservation, allowing it to buy back a previously issued US$554 million superbond at a significant discount (55 cents per dollar). In return, TNC and Credit Suisse restructured the debt into blue bonds –insured (de-risked) by the US International Development Finance Corporation (DFC)– to sell to a variety of investors.

The 185-mile-long Belize Barrier Reef encompasses vibrant marine environments that support thousands of animal and plant species.

The debt-for-nature swap helped Belize raise US$180 million for marine conservation, with tangible on-the-ground results already being achieved. According to a recent TNC report, as of the summer of 2023, the swap has allowed the government of Belize and the Belize Fund for a Sustainable Future to:

  • Expand marine protected areas from 15.9% to 20.3% of its waters (contributing to the national goal to protect 30% by 2026)
  • Designate new mangrove reserves.
  • Develop a marine spatial plan to identify new areas for protection.
  • Approve over US$7 million in grants for conservation projects, including manatee conservation, coral restoration and mangrove monitoring.

This conservation funding (US$4 million per year) is due to continue until 2041. After 2040, a US$23.5 million endowment fund will be used to continue financing conservation efforts.

However, it should be noted that the debt-for-nature swap ultimately erased only 12% of Belize’s debt, bringing into question its effectiveness for debt relief.

Too Good to be True?

While debt-for-nature swaps have yielded promising environmental results and are growing in popularity, they still have yet to become widely used due to concerns about their overall effectiveness and efficiency.

Firstly, negotiations often involve a lot of parties and so can take years to come to fruition, with those concerning the scope of conservation measures being particularly time-consuming. Political will is also key to successfully implementing debt-for-nature swaps, as protecting nature will likely require sacrificing potential revenue created by resource exploitation. Delays increase operational costs and, in some cases, deals may ultimately be derailed due to inflation, exchange rate fluctuations and fiscal or liquidity crises in debtor countries, creating the risk of lost investments.

There are also concerns about the extent of positive environmental and social change caused by debt-for-nature swaps. As the case of Belize shows, swaps may not actually relieve a country’s debt very much, while countries with unstable or corrupt governance may misallocate funds meant for environmental protection. There are also cases where banks take large fees for participating in debt-for-nature swaps while only a small fraction of the money goes to conservation. Conditions of deals may also be overly restrictive, prohibiting countries from spending savings on more immediately pressing matters than conservation, like emergency responses to natural disasters.

Moreover, attracting large numbers of investors to participate in buying debt is difficult to arrange on even a small scale. Notably, countries where it has happened have either been small island nations or small developing economies, raising questions as to whether debt-for-nature swaps can be scaled up globally.

Room for Improvement

Despite their flaws, the case for debt-for-nature swaps is nonetheless getting stronger. In addition to mounting environmental losses, the global deficit has skyrocketed due to the COVID-19 pandemic, growing by US$19.5 trillion in 2020.

Solving crises of this magnitude requires the engagement of all types of institutions. One of the great strengths of debt-for-nature swaps is their proven ability to incentivise and engage in conservation financial and commercial institutions that would otherwise exacerbate the ecological crisis, more so than other debt relief initiatives. For that reason alone, they are an invaluable tool for environmental financing.

Amplifying the impact of swaps will require making them more mainstream, more numerous and increasing their financial value, which currently falls well short of the US$1 trillion required annually by developing countries to tackle climate change and biodiversity loss. To do this, governments and other institutions should be encouraged to buy more debt for debt-for-nature swaps on the secondary market, particularly China, which as the world’s biggest holder of foreign debt and a rapidly growing economy, could potentially buy lots of debt. Greater financing will in turn allow deals to target larger debt cancellations.

As for the obstacles to structuring debt-for-nature swaps, many of these can be addressed with determined political will from creditor and debtor countries. Improper spending can be prevented through swaps with an independent third party, like an NGO, that can oversee savings use. Meanwhile, clauses or similar mechanisms can be used to prevent overly restrictive terms for savings use. For instance, the agreement for the Belize debt-for-nature swap includes natural disaster insurance that allows savings to be spent on disaster relief and rebuilding should the need arise.

While debt-for-nature swaps are unlikely to ever solve the debt or ecological crises on their own, they can still be useful complements to other existing forms of debt relief and environmental finance at a time when we desperately need more of both.

Author: Thomas Gomersall, Seneca Impact Advisors

For more information, please contact info@senecaimpact.earth