Considerations in conservation finance: the debt-for-nature swap

November 9, 2022

Conservation finance is an area that has received increased attention as of late, including at this week's COP27 meetings. Following our briefing paper on finance for regenerative projects, we now turn to the topic of sovereign debt in this briefing paper, and review different mechanisms for reorienting existing obligations into capital for new projects that support sustainable development goals.

Born out of a post-war initiative to help recovering economies invest in infrastructure, sovereign debt finance was once seen as a crucial means to empower economic growth. Over time, however, many debt arrangements have led to short-term upside while saddling developing economies with unrealistic obligations over the long-term. Moreover, the COVID-19 pandemic has raised questions on the fundamental fairness of such arrangements: how can heavily-indebted countries continue to pay high interest rates to service debt that was contracted decades ago, whereas funding is urgently needed for domestic health and environmental initiatives?

In the meantime, there is also tremendous pressure on the side of lenders to requalify their loan portfolios as sustainable. While issuing green bonds under the ICMA Green Bond Principles or the EU Green Bond Standard is one option, it is difficult to ensure that some portion of the proceeds will not also go to support activities that cannot be qualified as sustainable. Moreover, complicated calculation and reporting obligations have left many issuers wary of over-committing from a risk and disclosure perspective.

There is nothing more sustainable than nature. Nature in all its breadth - ranging from people, to forests, to the mountains and the oceans. So how can both issuers and lenders reorient capital in a way that allows it to work for, and not against, nature? One opportunity in this respect is by reassessing, and restructuring, existing obligations between development banks, sovereign debtors and private banks. Debt-for-nature swaps are one way to do this.

What are some examples of debt-for-nature swaps?

There have been a number of different debt-for-nature swaps that have taken place over the years, with varying degrees of success.

In the late 1990s and early 2000s, Costa Rica undertook a series of debt-for-nature swaps that led to the creation of a number of protected areas, including the Arenal Volcano National Park. These swaps also helped to finance a number of other important conservation efforts in Costa Rica, including reforestation projects and wetland restoration.

Similarly, in 2002 Belize undertook a large debt-for-nature swap with a number of creditors that led to the creation of the Maya Mountain Marine Reserve. This protected area is now home to a number of important species, including the manatee, hawksbill turtle, and black coral. The government used the funds from the debt-for-nature swap to finance a number of other important conservation projects, including the establishment of marine protected areas and the creation of a national parks system.

One of the most notable examples is the Amazon Conservation Association's swap with the government of Bolivia, which resulted in the conservation of nearly 3 million acres of Amazon rainforest. This swap was unique in that it was the first time that a private organization had been involved in such a transaction, which allowed for a greater degree of flexibility in the terms of the agreement.

In Africa, moreover, the World Bank has worked with a number of countries on debt-for-nature swaps, including Burkina Faso, Cameroon, and Ghana. These swaps have helped to create or expand a number of protected areas, including the W National Park in Burkina Faso and the Bui National Park in Ghana. Moreover, these instruments have also helped to finance a number of other important conservation projects, such as reforestation efforts and anti-poaching patrols.

In Asia, the governments of Nepal and the Philippines have both undertaken successful debt-for-nature swaps. In Nepal, this has led to the creation of a number of protected areas, including Shey Phoksundo National Park, which is home to a number of endangered species, such as the snow leopard. And in the Philippines, a debt-for-nature swap helped to finance the expansion of Tubbataha Reef National Marine Park, which is now a UNESCO World Heritage Site.

How does a debt-for-nature swap work?

A debt-for-nature swap a type of financial transaction in which a country or organization pays off part of its debt in exchange for conserving a natural area. The idea behind these swaps is that they can provide much-needed funding for conservation efforts while also reducing the debt burden of the country or organization involved.

Debt-for-nature swaps can be structured in a number of ways. For example, a debt-for-nature swap can be part of a broader debt restructuring that also includes loan forgiveness or retiring of outstanding debt obligations. It can also include refinancing certain debt in order to simplify a country's fiscal situation and provide more favorable terms to the country, including lower interest rates or more flexible repayment terms. While the specifics will vary depending on the particular context in which the swap is used, there are a few key elements that are typically involved in these types of transactions.

First, a country or organization seeking to enter into a debt-for-nature swap will need to identify a natural area that is in need of conservation. This area may be a forest, a wetland, or some other type of natural habitat. The country or organization will then negotiate with one or more creditors to exchange part of its debt for funds that will be used to finance the conservation of the identified natural area. The amount of debt that is exchanged in a debt-for-nature swap will depend on a number of factors, including the size and location of the natural area to be conserved and the type of conservation activities that will be undertaken. In some cases, a debt-for-nature swap may involve the exchange of all or most of a country's debt obligations. In other cases, a debt-for-nature swap may only involve a small portion of a country's overall debt.

The terms of the swap will also need to be negotiated between the country or organization and its creditors. These terms will typically include a timetable for the conservation activities to be undertaken as well as milestones that need to be met in order for the debt-for-nature swap to take effect. Once the terms of the debt-for-nature swap have been negotiated, the country or organization will make payments to the creditors in exchange for the conservation funds. These payments may be made in a lump sum or they may be spread out over time. The payments may be made in local currency or in a foreign currency, depending on the terms of the agreement.

The terms of the agreements will also contain provisions that ensure the conservation funds are used for their intended purpose. For example, the agreements may require that the funds be used to finance specific conservation activities in the identified natural area. In some cases, the agreements may also require that an independent third party monitor the use of the conservation funds to ensure they are being spent as intended. In addition, customary terms providing for events of default and other remedies for creditors will also apply.

What other considerations should be taken into account?

Debt-for-nature swaps can reduce the overall debt burden of a country or organization, freeing up resources that can be used for other purposes. In addition, they can provide much-needed funding for conservation efforts, including creation or expansion of protected areas and improving stewardship of natural resources. That said, it can be difficult to negotiate these swaps, particularly when there are a large number of creditors involved. In addition, there is the risk that the funds generated by these swaps will not be used efficiently, or that the funds will have little impact on conservation efforts. Finally, there is the risk that swaps will only be used as a short-term fix for larger environmental problems. If the underlying causes of environmental degradation are not addressed, these swaps will only provide temporary relief.

These risks can be mitigated, however, through the structuring process and through implementing several transactions over time. Because the projects need to linked to an underlying environmental project, one option is for issuers to begin on a smaller scale, moving to larger projects on an incremental basis. The structure can be implemented at the municipal level for local projects, including hedging tools to mitigate some of the risks associated with debt securities (interest rates, foreign exchange risk, etc).

In any case, most restoration projects require participation of environmental practitioners and residents (either on a paid or volunteer basis) to ensure that daily and weekly actions and monitoring are undertaken. In this sense, the restoration projects can also be a useful means for communities to take an active approach in ecological restoration. That said, long-term projects covering significant ground will need to involve strong community consultation, such as through the free informed consent mechanism, as well as ensuring that appropriate training and compensation mechanisms are put in place. It is also wise to ensure that the transactions are undertaken in close coordination with the communities themselves, both through pre-implementation consultation and meetings at regular intervals. Assuming that these various considerations are taken into account, debt-for-nature swaps can be an effective tool for financing conservation efforts.

CPM