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  • Writer's pictureStephanie Lai

The rising popularity of Debt for Nature Schemes

by Stephanie Lai on 27/02/23



SUMMARY: Many Wall-Street banks are re-introducing a form of ESG financing, debt for nature swaps, where developing nations receive a lower debt burden from banks in exchange for promises to invest savings in environmentally-friendly areas. However, skepticism is rising around the legitimacy of this, and the likelihood of greenwashing.


Debt for nature swaps have become re-popularised among banks as they provide a solution for developing nations that are economically weak to lower their debt, which is important amidst the current global inflation. This is while also improving these developing nations’ environmentalism, which is instrumental given that many developing nations host vast biodiversity.


Debt for nature swaps are financial transactions that forgive an amount of the foreign debt of developing countries in exchange for investments in environmental projects. It has been suggested that upto 2 trillion USD of debt in developing nations can be included in debt for nature swaps, greatly alleviating the debt burden which is being exacerbated by the tumultuous economic climate. Debt for nature swaps’ popularity has been evident in numerous developing nations, many of which are known to default. This includes Belize, which has vast biodiversity in their coral reefs and rainforests, and has planned $553 million in debt for nature swaps with Credit Suisse. Other developing countries that are planning substantial debt for nature swaps include: Gabon who has proposed $700 million, Ecuador has organized for $800million in debt for nature swaps and Sri Lanka, who recently defaulted in April 2022, has signaled a $1 billion deal in a debt for nature swaps. This conveys the rising popularity of these schemes in developing nations which involve substantial sums of capital.


For developing nations

While debts are rising in developing nations and the debt for nature swaps can alleviate these financial struggles, doubts are forming about their impact on developing nations as they carry high transaction costs. Further, suspicion has arisen around the schemes since they were first introduced in the 1980s. Doubts are being raised by non governmental organizations, such as Greenpeace about debt for nature swaps to be removed from the uncertainty they bring financially, and for the domestic of the developing nations. Financial uncertainty may occur from developing nations hiding the extent of their debt in order to obtain funding. Hence if their debts continue to substantially increase despite the debt for nature swaps, these nations will be susceptible to financial challenges and a damaged reputation if they are unable to follow through in their promises to invest money into environmental projects. This is a common theme as research has found that 18,000 marine protected regions fail to reach their environmental goals due to inadequate finances. Further, many developing nations, such as Brazil, are uninviting aid from developed nations as they perceive it as a form of intervention into their sovereignty, as well as questions of the morality of such large funds going to the environment as opposed to social issues such as health care have been raised.


For banks

Banks are betting that the debt for nature swaps will be successful as they intend to use public funds to de-risk private investment and capital to finance developing nations, which are often considered risky to invest in, especially in environmental projects which often do not follow through. Further, banks are likely very keen to be involved in debt for nature swaps as they are contemporarily always seeking to have a high amount of capital invested in ESG related projects in order to meet their green investment targets. However, often the amount of capital that goes toward green investments is substantially smaller than the transaction size, suggesting that even though the sums being paid for the debt to nature swap is large, the amount invested into the environment by developing nations will likely be significantly smaller. For example from the debt for nature swap in Belize, only $84million went towards their reef out of the $553 million they received.


Banks may also be susceptible to high levels of risk from their debt for nature swaps in the instance that one of these nations defaults from their debt increasing, which may occur given the tough economic climate globally. Hence, whilst the debt for nature swap attempts to make investments in these nations less-risky, rapid inflation and economic uncertainty may put this in jeopardy. For example, Sri Lanka experiences surging inflation of 30% in April coupled with domestic unrest, causing their nation to default for the first time ever. This is as the past few years have had severe turbulence in the market from inflation and exchange rates which may impede the success of the debt write off in exchange for the investment in environmental projects.


Future

The debt for nature swap has the chance to be successful and aid nations struggling with debt financially and also environmentally strengthen biodiverse regions of the world. However, the economic uncertainty, coupled with the commonality of greenwashing and environmental malpractice suggests it may not be as successful as big banks are portraying.



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