The agreement allows Belize to reduce its debt burden and generate some $180mn for marine conservation. The heavily-indebted country has committed to protecting 30% of its ocean, strengthening fisheries governance, and establishing so-called blue carbon projects, such as the expansion of mangroves along the coast.
Both tourism and fishing are vital to Belize’s economy and are at risk from climate change impacts. Tourism has also been hit hard by travel bans during the Covid-19 pandemic.
Under a trilateral DNS such as this transaction, a non-governmental organisation and its partners provide financing to a heavily-indebted country on discounted terms to repurchase debt from international creditors.
The country then uses the money it saves through lower repayments on the NGO loan to fund environmental projects, often with the NGO involved in managing these projects. DNS deals can also be bilateral agreements under which a creditor government forgives or restructures part of a country’s debt in return for nature conservation measures.
The first pioneering DNS deals were developed in the 1980s, but ever since the financial instrument has struggled to gain traction.
The Belize deal is significant for reasons beyond its environmental benefits. Firstly it’s big: under the agreement, $553mn of Belize’s external debt will be restructured. That compares with a total of around $1bn for all other DNS deals since the first one in 1987 between Conservation International and Bolivia to protect forests.
But the deal also stands out because it involves commercial debt held on private markets, rather than the more usual concessional lending by governments.
“This is the first time I know of where a significant amount of commercial debt, in the form of a Eurobond, was involved in a debt-for-nature swap,” Giancarlo Perasso, a Lead Economist for investment manager PGIM Fixed Income, told Impact Investor.
The DNS involves the repurchase of all issuance related to Belize’s single international bond, known as the ‘superbond’.
This superbond was the result of a 2006 decision by the government to exchange its various external commercially held public debt instruments, including loans and bonds, into one US dollar-denominated bond.
The bond lost value, due to a poorly performing Belize economy. It was already trading at around 63 cents on the dollar by early 2020 before market assessments of the pandemic’s impact on Belize’s tourism industry pushed the price down below 40 cents.
DNS seduced bondholders to offload distressed debt
Faced with a ballooning public debt-to-GDP ratio, the government looked for ways to restructure its external debt and found commercial debt holders receptive to an innovative DNS proposition put together by Belize and TNC.
And faced with the choice of holding on to distressed debt or selling it at a premium to the market price – albeit still well below the issuance price at around 50 cents on the dollar – the bondholders agreed to sell under the DNS.
“There was a good pick up on the price and the DNS was a good way for investors to offload this debt – and also help to facilitate environmental projects,” says Perasso.
PGIM Fixed Income held part of Belize’s superbond paper and tendered the bonds for redemption.
Bridging the climate finance gap
"This deal is huge for Belize, especially during a tremendously difficult time for our economy," Belize's Prime Minister John Briceño said at the COP26 meeting, adding that the impact would extend far beyond his country.
Proponents argue that debt-for-nature swaps have a valuable role to play in tackling climate change impacts in the developing world at a time when rich nations are still falling well short on their commitment of 2009 to provide $100bn a year in climate finance from 2020.
Meanwhile, developing countries whose external debt has grown during the pandemic seek ways to control it, so DNS could look attractive to them. "The Belize DNS can totally be replicated for other countries with external debt trading at a discount," Kevin Bender, TNC’s senior director of sustainable debt told Reuters during COP26.
However, it remains to be seen if the Belize DNS can provide the catalyst for further large-scale debt-for-nature swaps. The size of the Belize deal remains exceptional.
DNS deals have rarely involved figures greater than $50mn and are usually a lot smaller than that. In the other recent DNS of note – again involving TNC – the Seychelles bought back $22mn of sovereign debt in 2015, as part of what was said to be the world’s first debt refinancing for ocean conservation.
“It’s down to the usual question: who puts the money in to buy back the debt? The debt-for-nature sector has mostly been charity-led so far, therefore the amount of money involved is unlikely to be huge,” says Perasso.
That means debt-for-nature swaps may work best for smaller countries, like the Seychelles, seeking to restructure smaller amounts of debt without bigger lenders becoming involved.
Key role for multilateral lenders
Another problem is that Belize is an exception among heavily indebted developing countries in consolidating its commercial debt into one bond. Indeed, most are usually reliant on debt deals with sovereign or multilateral lenders rather than commercial lenders.
That means countries seeking to use DNS structures would likely be involved in talks with rich governments, or the institutions funded by them such as the International Monetary Fund, rather than those on private markets seeking to cut their losses.
Kristalina Georgieva, the IMF’s managing director said in April that she believed green debt swaps had the potential to contribute to climate finance and that the institution would work with the World Bank to “advance that option” by COP26.
However, the IMF’s rhetoric going into the conference was more cautious and few signs of new initiatives likely to stimulate large-scale debt-for-nature swaps emerged from Glasgow.
In practice, introducing a nature protection component into already difficult debt negotiations with the most heavily indebted countries under the IMF-supported ‘Common Framework’ agreement may prove a level of complexity too far for all concerned.
Nevertheless, Perasso believes it is necessary for international financial institutions to keep seeking new ways to address the impact of climate change and human activity on nature.
“Green debt swap transactions need to be on the menu of options for institutions like the IMF or the Paris Club of creditor nations. Yes, it is complicated, but if there is a will, there should be a way,” he says.
Seychelles blueprint provides hope
Debt-for-nature swaps have always attracted scepticism over whether they offer value for money. However, the Seychelles example indicates that, in the right circumstances, these deals can reap rewards.
In 2012, the low-lying Indian Ocean archipelago made an ambitious pledge to increase the area of its waters placed in designated Marine Protected Areas from less than 1% to 30%.
The country announced it had hit that target in early 2020, supported by the funds generated by the 2015 DNS. An area larger than Germany is now receiving protection from climate change impacts and unregulated fishing.