Especially for developing countries in Africa, debt-for-nature swaps are great tool for sovereigns to replace expensive debt and to put increasing sovereign debt levels in check. This is a simplified & practical insight into the workings of debt-for-nature swap transactions and how they can be used as a tool by Nigeria for averting sovereign debt crises and for combating climate change.
What is a Debt-For-Nature Swap?
Debt-for-nature swaps are a form of sovereign debt re-financing transaction wherein an amount of debt owed by a sovereign is swapped, cancelled or reduced. As part of the consideration for these kinds of transactions, a sovereign will usually make some time-bound climate-related commitments to new or existing lenders.
Some Key Considerations for a Debt-for-Nature Swap Transactions
1. New Funding Sources in Debt-for-Nature Swaps
In a debt-for-nature swap transaction, a new lender usually emerges. The lender is typically but not always an international donor or non-governmental entity focused on combating climate change or sustainable development. Such new debt can be arranged from either private markets or through public markets, in the form of blue bond issuances. Blue bonds can generally be issued by banks, limited liability companies or governments.
2. Transaction Structures for Debt-for-Nature Swaps
The transaction structures for debt-for-nature swap transaction varies, influenced by factors like swaps can be structured in a variety of ways depending on a number of factors, one of which includes the perception of the creditworthiness of a sovereign. One common structure involves a debt buyback, where new lenders provide capital to a sovereign to repurchase its external or domestic debt from the secondary markets. Ecuador’s recent debt-for-nature-swap, concluded in May 2023, saw the issuance of $656 million through the issuance of marine conservation linked bonds, which was utilized to buy back up to $1.628 billion of external debt from the secondary market via a third-party tender offer.[1] Alternatively, a swap can involve a direct purchase of a sovereign’s securities from the secondary market, as seen in Bolivia’s case where the new lender acquired $650,000 of Bolivia’s foreign debt in the secondary market.
3. Haircuts are a key feature of Debt-for-Nature Swaps
Haircuts are the percentage difference between the present values of old and new instruments, discounted at the yield prevailing immediately after the exchange. In a debt-for-nature swap transaction, new lenders and sovereigns expect to be able to acquire the debt of sovereign at a discount. It is not unusual for existing creditors who do not expect to recover the full value of their investments to be willing to accept less. Existing creditors may consider selling at a discount where an issuer has a high debt to GDP ratio or where a sovereign default crisis is on the horizon.
4. Sovereign Creditors as Drivers of Debt-for-Nature Swaps
Existing sovereign creditors with a priority for addressing climate change issuance and promoting sustainable development can also be drivers of a debt-for-nature-swap transaction. For instance, under the Tropical Forest & Coral Reef Conservation Act, (TFCCA) applicable in the United States, eligible sovereigns can access some form of sovereign debt restructuring, which may be structured as debt buy back, debt reduction or debt swap, in exchange for a range of nature conservation objectives. For instance, with a debt of a debt reduction mechanism, a certain amount of a country’s debt may be forgiven and a new payment plan arranged, on the condition that interest payments are payable into a local forest conservation fund in local currency. There are now about 22 TFCCA deals with the latest being the recent $20million Debt Swap Agreement between United States & Peru to support Amazon conservation announced on September 11, 2023
5. Benefits of Debt-for-Nature Swaps for Sovereign Debtors
A sovereign can use a debt-for-nature swap to achieve a range of strategic objectives, which may include replacing expensive debt and reducing debt servicing as would be the case where a buy back or direct purchase of securities by a new lender from the secondary market is bought at a discount from existing investors. A sovereign will generally be able to negotiate better terms with new lenders towards improving its credit rating and the serviceability of its debt.
A sovereign may be able to manage its FX dependency using a debt-for-nature swap and reduce a foreign exchange dependency. A sovereign may be able to negotiate the repayment of interests with a new lender into a local climate conservation fund and in local currency
A debt-for-nature swap provides a sovereign with the opportunity to achieve a range of sustainable development goals. For instance, in its deal, the Bolivian Government agreed to set aside 3.7 million acres in three conservation areas as buffer zones.
6. Global Recognition for Debt-for-Nature Swaps
Debt-for-nature swaps are recognized by the United Nations Development Programme, the IMF and the United Nations as a crucial tool for advancing United Nation’s Sustainable Development Goals.
Final Analysis
The recent announcement of a new ministerial portfolio of marine and blue economy as well as Nigeria’s latest commitments to combating change, highlights the country’s increased attention to, and prioritisation of environmental and climate related issues. Within this context, a debt-for-nature swap, although a significantly complex transaction remains a realistic option for Nigeria in view of the progressive rise in the country’s stock of debt and foreign exchange challenges. Where properly structured, debt-for-swap transactions can be a win-win for Nigeria as the country can use such transactions to actively manage and improve it debt sustainability, whilst also generating significant environmental benefits for humankind.
[1] In the case of the debt-for-nature swap by Barbados which closed in September 2022, Barbados raised USD 146.5 million and used the amount raised to buy back USD 77.6 million face value of the 6.5% 2029 Eurobond at 92.25 cents on the dollar and repurchased USD 72.9 million of the 8% 2043 Series E domestic debt. As part of the transaction, Barbados committed to protecting up to 30%, or ~55,000 square km, of its Exclusive Economic Zone (EEZ) and Territorial Sea. In 2016, the Government of Seychelles also closed a debt-for-nature swap transaction linked to marine conservation. Under the transaction, Seychelles bought back USD21.4m of its Paris Club debt at a discounted price, financed by a low interest loan financed by new lenders.
