Year in review, 2023: Debt for nature swaps take hold

The nascent debt restructuring facility has been lauded as a silver bullet for conservation finance in some quarters, but needs to continue its growth if it is to have a material global impact.

Looking back, 2023 may well be remembered as the year when debt-for-nature swaps really began to receive the attention they need if they are to make a material global contribution to nature finance.

Four such financial structures were closed throughout the year as Cape Verde, Ecuador, Peru and Gabon all completed a DFT swap, with each varying in size and Cape Verde’s swap with Portugal varying in its structure.

Debt-for-nature swaps work by restructuring a nation’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.

Cape Verde’s DFN swap was agreed in January and became the first of the year, as Portugal agreed to write off the full €140 million owed to the state in exchange for the debt repayments being directed to climate and nature restoration.

This was an unusual structure given that the two main actors were the nation states, with the creditor, Portugal, not so much accepting a concession on its loan notes but essentially engaging in debt forgiveness to facilitate the unique deal.

The biggest DFN headline of the year was created by Ecuador in May, as the South American nation agreed a deal to exchange $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 Ecuador, and will be used for investments to restore and enhance the biodiversity, marine life and local economy of the Galapagos Islands.

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

In terms of how savings are generated by debt-for-nature conversions, Climate Fund Mangers 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.”

A $500 million DFN swap followed in August for Gabon, which will generate $163 million in dedicated marine conservation funding over the next 15 years, and was backed by $500 million in political risk insurance by the US DFC.

And in September, Peru completed a $20 million swap with the US, which was “facilitated by contributions of $15 million by the US government under the TFCCA and a combined donation of $3 million from four international non-governmental organizations,” said a US treasury statement.

While these structures remain inefficient due to the number of parties involved, the time taken to bring them to fruition and the structuring costs they can incur, CFM chief executive Andrew Johnstone believes institutional investors can provide the liquidity component for a DFN swap.

Proponents of the structure will be encouraged by the growing number of traditional fund managers and institutional investors supporting blended finance debt vehicles, which also started out as a vehicle primarily supported by development finance institutions.