How debt-for-nature swaps are evolving

In 2021, Belize signed the first commercial debt-for-nature swap. The deal was facilitated by charity partner The Nature Conservancy and bank Credit Suisse, which rallied a group of investors, including Legal & General Investment Management (LGIM).

Given Ecuador’s economic capacity its public debt was trading at a significant discount. Ecuador, working with its own financial advisors, as well as Credit Suisse and the Pew Bertarelli Oceans Legacy Trust, was able to create a debt-for-nature proposal. This allowed Ecuador to undertake a tender offer on its current debt which would be financed by the new investors in the to-be issued debt-for-nature swap notes. When the transaction went ahead in May 2023, Ecuador swapped $1.6bn  of its sovereign debt for a new loan of $656m, according to S&P Global Ratings.

The US Government insured the transaction in order to attract private investors. “Ecuador is a higher credit risk country,” says Harper. “We don’t want to be investing our clients money into investments that have a higher probability of default. So, the US Government agency, the U.S. International Development Finance Corporation, insures the transaction such that if Ecuador does not make a payment, investors can reclaim their interest and principal back from them. This results in the rating of the agency being applied to the transaction due to the insurance, rather than the sub investment grade rating of the country.”

It’s also good for Ecuador. “Because the US Government insures the transaction, investors don’t require as much interest being paid,” explains Harper. “Their sovereign bonds at the time [May 2023] were yielding between 17% and 26%, but they are paying 5.645% on these bonds [as reported by Reuters].”

As part of the arrangement, Ecuador have agreed to use a proportion of their debt savings for marine conservation. Between an endowment and conservation fund funded over the life of the transaction c.$450m will be used for marine conservation.

Pew Bertarelli Ocean Legacy are the advisor to Ecuador as well as the endowment and conservation funds. They will be providing annual public reporting on how Ecuador are performing versus milestones.

“Credit Suisse approached us as a lead investor given our position in the very first debt-for-nature swap,” says Harper. “We spoke to our clients and suggested our total appetite would be up to a maximum of $250m, or 38% of the total,” with the remaining bonds to be sold to other investors via a secondary process run by Credit Suisse.

The transaction does not solve Ecuador’s debt problems. But it does save the country money, creating the means to invest in biodiversity.

Penalties were baked into the transaction to ensure the Ecuadorian Government kept its promise on biodiversity, with 18 legally binding commitments.

So far, the complexity of these transactions has meant extra work for investors. But ultimately the aim is to simplify the process in order to make the product available to more investors.

“It’s going to be a large market in our view,” says Harper. “It’s always going to be about choosing the right countries at the right time and having the right structures. These transactions have multi-faceted risks and whilst the insurance covers the credit risk due consideration needs to be applied when looking to underwrite transactions like this.”

The potential sustainability benefits make this complexity worthwhile at present, but the returns are also a critical factor with potential commoditisation risking investors future interest.

While these transactions have focused on marine biodiversity so far, they are likely to evolve a wider scope.

“There has been a lot of discussion about doing some debt-for-nature swaps focused on land” says Harper.

Under the Kunming-Montreal Global Biodiversity Framework, signed at the 2022 UN Biodiversity COP15, governments pledged to protect 30% of the world’s land, freshwater and oceans by 2030. They also agreed to increase funding for biodiversity issues.

The following year, the Nature Conservancy launched a ‘nature bonds’ programme, which aims to help indebted countries unlock money to address climate change and preserve ecosystems.  

Other novel structures are also emerging into the ESG investing space.

“We continue to see novel and untested structures and believe the market for instruments such as these will continue to develop which provides investors an opportunity to work with us to gain exposure to these investments” says Harper.

“We got approached last year to invest in rhino conservation bonds. It was a World Bank initiative that encouraged investors to carry some of the risk related to the animal population,” Harper adds.

“We are approached about new structures quite often. As an example we have looked at financing mangroves for carbon sinks, water bonds, clean air bonds – they’re all out there.

While Legal & General hasn’t yet invested in these novel structures or rhino conservation bonds, Harper says: “It’s just finding the right investors.”

Legal & General has been among the vanguard in the new generation of debt-for-nature swaps, investing in the first commercial swap in Belize and now the world’s largest in Ecuador. As the debt-for-nature space evolves, we continue to seek to innovate for biodiversity and sustainability.