Debt-for-nature swaps have gained traction recently following the U.N.'s Sustainable Development Goal to conserve and sustainably use oceans, seas, and marine resources. In 2021-2023, three sovereigns, Barbados, Belize, and Ecuador, exchanged $2.4 billion in commercial debt for new loans worth $1 billion and marine conservation commitments. Nature swaps are also reemerging in Africa, and we expect them to continue growing. S&P Global Ratings expects these transactions will become more frequent in coming years.

Debt-for-nature swaps are financial agreements to relieve a debt burden while raising capital to support local conservation activities. The bondholders or other official creditors reduce a sovereign debt stock or debt service in exchange for the issuer's--generally a government's--commitment to direct savings to conservation purposes.

Such swaps first appeared in Latin America following the 1980s debt crisis and then spread to some countries in Asia and Africa. The IMF recorded around $2.6 billion exchanged in nearly 30 sovereigns in 1987-2017--60% of it in the first decade.

Chart 1

Appetite for debt-for-nature swaps will likely extend in coming years, in light of the following factors:

Limited budget flexibility.  Sovereigns' fiscal profiles have weakened since the COVID-19 pandemic began, and governments see these kinds of transactions as a way of reducing debt pressure and obtaining additional funding, given the limited fiscal space for conservation activities.

The growing international importance of sustainability goals.   Governments need to foster conservation to mitigate climate change and achieve the U.N.'s Sustainable Development Goals; appetite for sustainable investment keeps growing. Nongovernmental organizations (NGOs) also play a key role in mobilizing funding for recent transactions.

Tight financial conditions.  Low-rated countries (in the 'B' category) are virtually cut off from international debt markets.

Determining Whether A Swap Is A Distressed Exchange

We analyze every transaction on its own merits to determine whether it constitutes a distressed debt exchange. Under our rating definitions, we view distressed debt restructurings as defaults, and debt restructurings qualify as distressed if they meet two conditions: i) the investors receive less than the original promise, and ii) should the debt restructuring not take place, there is a realistic possibility of a conventional default on the instrument over the medium term (see "S&P Global Ratings Definitions").

We view nature swaps as one type of debt restructuring. As such, we apply the very same two conditions to determine, on a case-by-case basis, whether they constitute distressed transactions.

One exception, though, is when nature swaps involve official or bilateral debt. In line with our sovereign criteria and rating definitions, we do not view it as a distressed debt restructuring when a government cancels part or all of its debt to another government or multilateral lending institution (MLI), irrespective of the purpose. Therefore, swaps for nature between two governments or a government and an MLI do not result in defaults.

All three recent nature swaps involving commercial debt met the first condition--that investors receive less than the original promise. One main objective of these swaps is that the repurchase price is below the original par in order to produce debt relief, which, from our point of view, implies that the initial creditors face a loss. The second main objective--the redirection of the debt service saved, resulting from the repurchase below par, to nature-related investments--is not a mitigating factor, in our determination.

However, for us to qualify a debt repurchase as distressed, the second condition has to be met as well, and this depends on our views on various considerations. If we think that the second condition is not met, we view the transaction as opportunistic and do not lower the issue rating or issuer credit rating to 'D' (default) or 'SD' (selective default), respectively.

We generally view issuer credit ratings as indicators of distressed transactions. According to our rating definitions, if the issuer credit rating is 'B-' or lower, the debt restructuring "would ordinarily be viewed as distressed." However, we analyze every transaction on its own merits and take into account a combination of other considerations when characterizing debt restructurings, including:

Original debt payment profile.  We look at the timing of the transaction with regard to the proximity of payments. In cases where the transaction is conducted several quarters ahead of initial maturity, we may see it as opportunistic and active debt management. On the other side, a short period between the swap and the upcoming debt repayment may signal that a conventional default could occur if the transaction did not take place.

Financing options, liquidity position, and debt pricing.  Low trading prices as the debt is approaching its maturity date generally point to the market anticipating the issuer's constrained repayment capacity--a credit feature that may be reinforced or mitigated by our assessment of the liquidity position, refinancing capacity, and alternative access to funding. In our view, market access for entities rated in the 'B' category or lower tends to be limited or uncertain.

Intention of the issuer.  Nature swaps typically involve guarantors, insurers, and NGOs that are both sensitive to nature preservation objectives and ready to secure lower interest rates and longer tenors than standard market participants--an attractive offer, from an issuer's point of view. The availability of an NGO's or MLI's guarantee and political risk insurance to enable debt placement at favorable terms, and to get those transactions a "green" label, may therefore be relevant aspects in our assessment of an issuer's opportunistic decision to go for nature swaps.

Size of the transaction.  Transaction size may also be relevant. Most swap transactions have been small relative to the issuer's total outstanding debt, thereby providing limited debt relief. By comparison, large-scale debt restructuring packages tend to be far more impactful in releasing fiscal space and restoring short- to medium-term debt sustainability for issuers.

Barbados And Ecuador Swaps Were Opportunistic

The three debt swaps in Barbados, Belize, and Ecuador were done below the original par. The purchase price was determined by a modified Dutch auction process. Settlement prices were in general somewhat above market prices before the auction but below par, ranging between $35 and $95 per $100 of principal amount.

At the time of the debt swap negotiation, Belize's U.S. dollar bond (superbond) due 2034 was in default, which made the opportunistic analysis irrelevant. That said, the conclusion of the swap led to Belize resuming debt payments, and we raised our sovereign credit rating to 'B-' from 'SD'.

Barbados and Ecuador were rated 'B-' at the time of the swaps, making our opportunistic analysis relevant.

Barbados launched a modified Dutch auction tender offer for bondholders of two existing bonds, whereas in Ecuador, the offer and purchase were done by a private entity (Credit Suisse, on behalf of a special-purpose vehicle) that then swapped the repurchased securities for a new loan with Ecuador.

Creditworthiness for both sovereigns was relatively weak at the time of the transactions. That said, both countries had completed debt restructurings within the prior four years, making their debt service profiles more manageable. Ecuador had just completed its IMF program, which allowed access to MLI lending. Barbados had access to IMF and other MLI funding. These conditions supported our view that Ecuador and Barbados most likely would have avoided conventional defaults.

The credibility of the transactions was established by the participation of key stakeholders with well-defined policy mandates, which helped enhance the financial characteristics of the transactions.

These Swaps Focus On Nature Conservancy, Not Reducing Debt, And Have Not Led To Higher Ratings

The completion of the swap in Belize allowed us to raise the sovereign credit rating to 'B-' from 'SD'. That said, by itself, none of these swaps structurally changed the fundamentals that constrain the sovereign's creditworthiness. Belize, Barbados, and Ecuador have generally weak institutional credibility, large external imbalances, and very weak monetary flexibility.

The swaps generally reduced the governments' debt burdens, but not enough to change our assessment of those burdens or the ratings. The gross external financing needs metric generally experiences some benefit from these transactions, given debt service is reduced--though relief is channeled to climate conservation. However, sovereigns' financing needs have generally remained high at above 100% of current account receipts after these transactions, not materially improving external metrics.

Debt-for-nature exchanges are complex transactions that take months to develop. The governments that have completed these swaps generally had more limited access to external commercial markets for traditional financing because they were recently in default or due to unfavorable global market conditions. Some governments see these transactions as opportunities to gradually return to the markets and open space for traditional bond issuance.

That said, high interest rates constrained the sovereigns' capacity to tap markets and financing in the months after the debt-for-nature swap, mainly through official financing or local market issuances.

Chart 2

Fulfilling Conservation Commitments Is Key To The Future Of Nature Swaps

We expect debt-for-nature swaps will keep gaining traction and could expand to other sectors. The transactions in the past three years focused on marine conservation, but some countries have already expressed plans to use this type of transaction to improve water management or boost forest conservation.

However, even while new money raised has been labeled "blue," total funds devoted to conservation purposes are just a moderate share of the new debt. Moreover, the execution of these conservation commitments generally extends over a decade. For example, marine conservation funding in Barbados, Belize, and Ecuador was $50 million, $180 million, and $450 million, respectively, equivalent to 50%-70% of the blue bonds proceeds, and execution is expected to take 15 to 19 years.

The capability of governments to meet their long-term commitments to conservation targets remains untested. The long time frame of the environmental commitments makes them vulnerable to changes in the political cycle, and we view the institutional frameworks of Barbados, Belize, and Ecuador, for example, as credit weaknesses, reflecting limited visibility over long-term policies.

To mitigate political risk surrounding the enforcement of these conservation commitments, the conservation funds are managed by an independent entity overseen by local and international authorities. Likewise, the loans may combine financial and environmental commitments. The three contracts we analyzed contain clauses compelling the sovereign to make additional payments if there is a failure to meet sustainability commitments.

Moreover, in some cases, failure to make the regular payments and those additional ones would constitute an event of default, according to the loan agreements. Enforcement of climate contracts will be a key factor to watch in the coming years. Failure to meet such commitments may affect the evolution of debt-for-nature swaps.

We expect debt-for-nature swaps to remain more relevant for issuers with low credit ratings and limited access to markets, as higher-rated sovereigns maintain a wider range of options to tap markets and fund their own nature goals.

Related Research

• Ecuador 'B-' Ratings Affirmed On Debt-For-Nature Transaction; Outlook Remains Stable, May 12, 2023
• Barbados ‘B-/B’ Sovereign Ratings Affirmed After Debt Repurchase For Marine Conservation; Outlook Remains Stable, Sept. 23, 2022
• Belize Long-Term Foreign Currency Rating Raised To 'B-' From 'SD' On Completed Debt Exchange; Outlook Stable, Nov. 9, 2021

External Research

Chamon, Marcos, Erik Klok, Vimal Thakoor, and Jeromin Zettelmeyer. (2022) "Debt-for-Climate Swaps: Analysis, Design, and Implementation," IMF Working Paper