Sliced: The Case for Debt, Bowties, and Nature

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By: Sean Penrith (CEO, Gordian Knot Strategies)

Thomas Lovejoy was a renowned conservation biologist. Decked out in colorful bow ties, his soft, yet ardent voice would urge senators and scientists to consider important points when discussing the conservation of nature.

Tom was smart. He was the President of the Amazon Biodiversity Center, a Senior Fellow at the United Nations Foundation, and a university professor in the Environmental Science and Policy department at George Mason University. He was the World Bank’s chief biodiversity advisor and the lead specialist for environment for Latin America and the Caribbean as well as senior advisor to the president of the United Nations Foundation. Among other distinguished posts, from 1973 to 1987 he directed the conservation program at World Wildlife Fund-U.S., and from 1987 to 1998 he served as assistant secretary for environmental and external affairs for the Smithsonian Institution in Washington, D.C.

Tom coined the term ‘biological diversity’ and shared his gloomy prediction in 1980 that 10–20 percent of all species on earth would go extinct by the year 2020. He also developed the concept of debt-for-nature swaps (D4N). In D4N swaps, environmental groups purchase burdensome foreign debt on the secondary market at the market rate, which is considerably discounted, and then convert this debt at its face value into the local currency to purchase biologically sensitive tracts of land in the debtor nation for purposes of environmental protection. WWF’s expertise in conservation finance began with this D4N swap innovation.

Tom felt that D4N swaps were a useful mechanism to ensure developing countries avoided cutting their conservation budgets to pay off sovereign debt. In a piece for The Times, he wrote that such swaps, “would be far more than a disinterested handout to mendicants: Left untouched, the environmental problems of the third world inevitably will touch our lives by generating social and political unrest.”

The very first debt-for-nature transaction was executed between Bolivia and Conservation International in 1987. The US not-for-profit organization purchased $650,000 of Bolivia’s foreign debt in the secondary market at a discounted $100,000. Bolivia in turn agreed to allocate 3.7 million acres to dedicated conservation areas.

A 2023 World Bank report reflects the dire debt levels and trends of developing countries. In 2022, developing countries spent a record $443.5 billion to pay for their external public debt. The 75 low-income nations that are eligible for loans from the International Development Association (IDA) paid a record $88.9 billion to its creditors in 2022. These 75 nations have an unprecedented total external debt of $1.1 trillion, which is more than twice as much as it was in 2012. These countries experienced a 134% increase in their foreign debt between 2012 and 2022. This is alarming as it is greater than the 53% increase in their respective gross national income.

To be clear, increased public deficits and debt service are not always to be avoided, when done correctly. Developing countries that take on debt to cover infrastructure development lead to improved long-term economic growth, thus increasing country revenues that can service the debt. The low-income countries of Bangladesh, Kenya, Madagascar, Moldova, and Nicaragua all saw their increased deficit levels matched by investment growth. Sadly, in most cases with developing countries, the level of investment falls behind the increased deficits, leading to a distressed debt level where the risk of default is high. Chad, Mozambique, and the Republic of Congo have already fallen into debt distress.

The 2023 World Report states: “Surging interest rates have intensified debt vulnerabilities in all developing countries. In the past three years alone, there have been 18 sovereign defaults in 10 developing countries – greater than the number recorded in all of the previous two decades. Today, about 60 percent of low-income countries are at high risk of debt distress or already in it.”

D4N swaps can ideally be considered when the original creditor-debtor government relationship based on loans and interest payments is under distress due to a risk of default. Creditors sell the outstanding debt (or parts thereof) at a discount of up to 100% to an environmental trust fund. The trust fund is funded by international NGOs, donor countries, and other parties to purchase the debt. The debt-laden government – rather than paying interest to the creditor pays (discounted) interest to the trust fund. The trust fund then invests this received interest revenue in local preservation projects. Under such a structure, countries with valuable biodiversity and carbon sinks can ‘charge’ others for their conservation and the delivery of a global public good.

According to the United Nations Development Programme (UNDP), since the inception of debt-for-nature swaps, the total value of the restructured debt was $2.6 billion from 1985 to 2015. Of this, $1.2 billion was used to fund development or nature-related initiatives.

The Bridgetown Initiative, a radical initiative that aims to transform how lending is made to developing nations in the face of the climate crisis, declared, “We cannot be good at rescuing banks but bad at saving countries.”

Several signature D4N swaps have been developed. Belize’s debt for nature swap with The Nature Conservancy reduced the country’s external debt by 10% of its GDP and is helping to protect the longest coral reef in the western hemisphere. Other deals under evaluation include Gabon, Sri Lanka, Ecuador, and Cape Verde, while Lao PDR is working with the UNDP to explore a potential debt-for-nature restructure.

The Republic of Seychelles in the Western Indian Ocean defaulted on its debt in 2008 and opted for the path of a D4N swap. To protect its precious coral reef ecosystems, endangered species, and its marine tourism and fishing economy it entered into a D4N swap with the Nature Conservancy (TNC) in 2016. The deal had TNC successfully restructure the country’s $21.6 million debt to the UK, France, Belgium, and Italy by establishing the Seychelles Conservation and Climate Adaptation Trust (SeyCCAT). SeyCCAT purchased the debt from the creditor countries at a discount in return for Seychelles agreeing to service the lower-interest debt to SeyCCAT, allocate the savings to marine conservation efforts, and protect 30% of its marine area from any unregulated economic activities such as fishing and drilling.

The D4N restructure was successful. By March 2020, Seychelles had made every debt-related payment on time and completed the protection of 32% of its waters.

Since its inception, debt-for-nature swaps have been applied in over 30 countries. For all debt-for-nature swap agreements during this period, over three quarters were completed in the 1990s, and 93% were public debt-for-nature swaps.

Debt-for-nature swaps have been viewed as an innovative way to free up funds for the environment while reducing the debt burden of the borrowers. Presently however, debt swaps are viewed as a rather niche instrument in the market but offer great potential in the fight to stave off the worst effects of climate change in biodiversity-rich developing countries. In the same way we saw the evolution of the thematic bond market that began with the green bond product and that transitioned to include social and other sustainable development goals (SDGs), D4N may not be limited to climate and nature but could potentially expand to other SDG areas too.

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