Behind the Scenes of Debt-for-Nature Swaps

Financial Innovation for Good: Part 3

Editor’s Note: Many non-profit organizations are pursuing financial innovation. Their goals include raising additional, low-cost capital (beyond donations) and engaging new partners so that they can do more good work. We enthusiastically support these efforts and are actively discussing such opportunities with various organizations. This series summarizes key lessons. Catch up with Part 1: First Things First and Part 2: Follow the Money. 

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There’s a lot of buzz around debt-for-nature swaps these days, which is great. We are strongly in favor of all new tools that can scale and accelerate environmental progress. And we think it's smart for NGOs to diversify their funding sources beyond traditional philanthropy. 

But, some Finance Ministers mentioned to me recently that there is some overzealousness underway. They say NGOs are sometimes pitching these projects when they don’t really make sense for the target country. I can see why this might happen. NGOs want to accomplish more, so they pursue all promising avenues. But they should be careful — we don’t want to see NGO credibility or this innovative deal structure undermined. 

I was fortunate to engage directly in these matters back when I was leading The Nature Conservancy (“TNC”). I thought now would be a good time to step back and think about the best ways to do more with debt swaps.

Origin Story 

This current round of innovation started with a deal for the Seychelles in 2018. Our team at TNC came up with the great idea of using a debt-for-nature swap (or “debt conversion”) to fund marine conservation. 

Debt conversions are deals where a country repurchases some of its sovereign debt (often when it is trading at a discount) with the proceeds of a lower-cost, new debt offering that benefits from credit enhancement. The country uses much of the savings to fund ambitious and capital-intensive sustainability initiatives. 

These deals have a lot of moving pieces. If you want to know exactly how the various players work together to make the deal happen, see this great case study by TNC of the organization’s recent debt swap for Belize. 

When the team first told me about the Seychelles opportunity, I remember thinking, “Wow. This is the best deal structure I’ve ever seen for conservation projects. First, the swap creates significant economic windfalls to pay for conservation. And second, the governance provisions improve the likelihood that the project’s milestones will be achieved on schedule.”

Pushing Further 

At TNC we decided to go all in. We wanted to do as many deals like this as possible.

We recognized right away that complex deals like this are expensive to execute. We needed various types of expertise on the team — finance, conservation science, government affairs and more. Such experts have to be paid. So we decided if we’re going to do this, we would do it right. Not on a shoestring budget. We wanted a fully qualified team to do this work at the highest level over an extended period of time. We set a big fundraising goal of $40 million to invest solely in building out a dedicated team that would be in place for years. 

Then we got some good news. 

We were invited to submit our debt swap plans to be selected as a TED Audacious Project. There was only one catch. 

TED told us if we didn’t raise a substantial portion of the $40 million before the time winners were selected, we wouldn’t be among them. 

That’s when I really had to dig in and get to work. I reached out to some of our best, most loyal, and — in my view — most long-term-minded donors. 

To their credit, they answered the call. They realized that such donations — to directly fund the staff who would be leading such highly leveraged projects — would produce a very high return on their donations. The donors stepped up and in a matter of weeks we raised over $23 million and our project was selected as an Audacious Project winner. We couldn’t have asked for a better launch.  

TNC went on to lead three more debt swap deals over the next several years, in Belize, Ecuador, and Barbados. Pew followed the example and led one for Gabon. All of the deals benefited from crucial credit enhancement from the DFC, IDB, and even TNC itself.  

The deals are getting much bigger too — Ecuador achieved a projected debt service reduction of some $1.5 billion over 19 years.

Picking Projects 

Identifying where debt swaps will likely work best is an important first topic to address. 

TNC has focused its debt swaps efforts to date on marine conservation. The fit is good. To pull off one of these ambitious projects, many stakeholders — all with their own interests — need to get on board. Marine conservation projects are the kind of ambitious, capital-intensive, science-based, and economy-aligned opportunity that bring people together. 

Next you need to consider the country’s incentives. 

First among these are the economic gains. To the extent that debt is repurchased at a discount, there's an absolute reduction in debt level. In the case of Belize, they were able to repurchase debt at about 55 cents to the dollar. In other words, they eliminated almost half their debt. 

Further, to the extent the credit enhancement is provided by a party with a significantly better credit rating (which has been the case so far) the new debt has a much lower interest rate. That also provides significant savings. 

These two factors together — the reduction in debt and the reduction in interest rate — are what create the financial savings that pay for the conservation. 

But there are other financial benefits as well. Debt swaps allow for maturities to be smoothed out and extended, which can be positive for the country. And they allow the countries to gain new investors through the refinancing and by taking advantage of the positive attention bestowed upon the country for undertaking a really ambitious conservation effort.

A secondary benefit is the strong governance that disburses the funding of the debt swap savings over time. An offshore trust is created that releases the funds per a schedule contingent on the country's ability to meet the milestones for the program. 

That kind of transparency and accountability is not always available with philanthropically funded conservation. It not only helps to ensure the success of the program but also gives confidence to capital providers. Indeed, an important opportunity now is to imagine how this governance structure can be used in ways beyond debt swaps.

Bringing in More Actors 

NGO leaders tell me that they want to lead on the innovation front.  If I was in their shoes, I would try to organize deals in ways to get more players in the game of funding environmental solutions. Here are some ideas:

Philanthropy:

In the case of the Seychelles, we experienced an interesting wrinkle — perhaps even a fortuitous one. As the first transaction of its kind, it took a long period of time before it was ready for signing. And over that period, the Seychelles’s credit improved quite a bit. That was obviously a good thing for the Seychelles, but it meant that their debt traded up in the market and we lost most of the discount we had counted on. 

At that stage, we turned once again to some of TNC most supportive donors. They contributed philanthropic capital to make up some of the difference. (Donors included the Leonardo DiCaprio Foundation which added some glamour and PR buzz). 

Looking forward, maybe philanthropy and other forms of below-market rate capital should play a bigger role in debt swaps. The world faces a huge challenge: there is broad agreement that developed countries need to provide huge amounts of capital to lower- and middle-income countries in order to fund the energy transition, biodiversity conservation, and climate adaptation. But the money is not really flowing. Debt swaps could provide a structure to accelerate investments.  Philanthropy, foreign aid, and impact capital could be in the mix.

Credit Enhancement:

One way to get more deals happening would be to get more players in the business of credit enhancement. Three of the recent debt swaps benefitted from credit enhancement through the DFC — an agency of the US federal government. Let’s encourage other developed countries  to follow the US example.

The Inter-American Development Bank has been in on the credit-enhancement action too. Let’s hope other multilateral development organizations will do the same. (It’s good to see them talking about doing just that).

Other strong creditors can engage too. I was really proud to see TNC courageously put its very strong balance sheet to work in supporting the Barbados debt swap. Other non-profits with strong balance sheets — including foundations — could do this too.

And private sector players should consider stepping up and doing the same in connection with their nature-based carbon removal, net-zero, ESG and philanthropic efforts.

What to Fund:

As noted, the recent debt swaps were all organized to fund marine conservation. This focus makes sense —  marine conservation benefits the economy, local communities, and sustainability outcomes. They are also the kind of capital-intensive and investment-oriented projects that motivate the financial community. And, importantly, they match well with the expertise of the lead NGOs.

But that doesn’t mean that debt swaps can’t be used in other areas such as land and forest conservation, the clean energy transition, biodiversity, health programs, the refugee crisis, and more. This is a great place for NGOs to exercise their creativity — but in a smart way. 

The same factors that made marine conservation deals attractive to the country, capital providers, and credit enhancement providers should apply to other areas. These projects need to be places where significant amounts of capital can be invested in ways that will produce multiple wins for the economy, community members, and nature. 

I’m optimistic about the path forward here and feel privileged to have played a role in some of the past successes. 

And of course if you’re representing an organization or country thinking of getting involved, please let us know if we can help. 

Onward,