CFM: Debt-for-nature conversions ‘absolutely’ have room for commercial LPs

Climate Fund Managers structured Ecuador’s $656m debt-for-nature conversion – the largest in the world – and the firm wants to see more involvement from institutional LPs.

Climate Fund Managers chief executive Andrew Johnstone said debt-for-nature conversions could grow to have sufficient room for institutional investors to provide the liquidity component of the nascent debt restructuring facility.

Debt-for-nature swaps work by restructuring a nation or organization’s debt in a de-risked way, often involving political or credit risk insurance provided by a development finance institution, with the savings from the restructured debt invested into environmental conservation.

Climate Fund Managers, acting alongside portfolio company Ocean Finance Company, announced a $656 million debt-for-nature conversion provided to Ecuador on May 10, which will be used to restore and enhance the biodiversity, marine life and local economy of the Galapagos Islands.

“The answer is absolutely yes,” Johnstone told Agri Investor in response to a question about whether commercial LPs can participate in the debt structure. “For the commercial investor, one thinks about the structure in two aspects. One is the credit – who’s taking the credit risk? – and the other is who’s providing the liquidity?

“If you structure the credit risk separate from the provider of the liquidity, then you find the liquidity providers are prepared to go long on tenors, albeit at the same margin. So, the provider of liquidity could be any commercial institutional investor. That could be pensions, insurance companies or a bank.

“That being the case, as the insurance guarantee capacity grows for these transactions, so too will the ability for these liquidity providers to participate. And they do need to participate because the MDBs and the DFIs, they only have so much capacity,” said Johnstone.

The Galapagos conversion, which is the largest to have been closed to date, exchanged $1.6 billion in Ecuadorian government bonds for a $656 million impact loan. The transaction will generate savings of $1.126 billion through 2041 for the South American nation.

Credit Suisse acted as offeror for the international bonds. The US International Development Finance Corporation provided $656 million in political risk insurance, while Inter-American Development Bank provided an $85 million guarantee. A group of 11 private insurers are providing more than 50 percent reinsurance to facilitate the project.

“The early-stage risk capital was provided among others by Dutch Fund for Climate and Development and the European Commission via the development fund of CFM’s Climate Investor II fund,” said a statement from CFM provided to Agri Investor.

In terms of how savings are generated by debt-for-nature conversations, CFM regional head Latin America Juan Paez said: “The involvement of the US DFC provides the arbitrage opportunity because their involvement allows us to exploit the differential in the credit risk between the Ecuadorian sovereign and the US government sovereign.

“So that allows for amplitude of space, and then we can translate some of those savings to the government and some of those savings go to conservation.”

There have only been a handful of debt-for-conversions completed to date – the $15 million Seychelles facility in 2017 was the first. Others have followed in Belize and Barbados, all of which have featured involvement from The Nature Conservancy.