EU considers debt swaps for climate projects

IFR 2402 - 25 Sep 2021 - 01 Oct 2021
6 min read
Americas, EMEA, Asia
Christopher Spink

The European Union is considering a plan to grant sovereigns in emerging markets relief from some of their bilateral debts in return for them investing the amount consequently freed up in projects to mitigate the impact of climate change.

The debt relief proposal is the latest in a string of financial measures being put forward ahead of November’s United Nations COP26 meeting in Glasgow. Others include a plan by South Africa to forgive US$10bn of debts of its state energy company Eskom if it stops using coal-powered plants.

Lazard has produced a paper for the European Commission that will outline the EU plan. It is due to be released this week to form the basis of discussions among member states before the Glasgow conference, with a view to possibly reaching an agreed EU position over the next month.

The EC told IFR that it supported the G20's current debt relief initiatives and said the contribution to the IMF's catastrophe containment and relief trust was "the EU’s financial contribution to multilateral effort for debt relief in low-income countries". However, it has indicated it wants to contribute further.

Earlier this month, European Commission president Ursula von der Leyen said the EU would commit an additional one-off amount of €4bn for climate finance, on top of US$25bn a year it already pledges as part of the UN target of US$100bn a year, which is currently unmet.

“While every country has a responsibility, major economies do have a special duty to the least developed and most vulnerable countries. Climate finance is essential for them – both for mitigation and adaptation,” she said in a speech at the European parliament in Strasbourg.

In a recent note Fitch said: “Financing incentives could play a key role in resolving the emerging market biodiversity-debt nexus and could be supported by wider trends towards multilateral and bilateral debt relief and growth in demand for impact investments.”

There have been doubts that an international agreement on the financial aspects of climate change mitigation will be possible at Glasgow. UK Prime Minister Boris Johnson has said there was only a six out of 10 chance of getting a deal.

However, hopes have been raised over the last week at the United Nations general assembly, with even China pledging to stop financing new coal-based power projects overseas. Details on this pledge by the world’s biggest consumer of coal are awaited.

Currently, 44 coal projects costing US$50bn are earmarked for investment from Chinese lenders, according to Global Energy Monitor. It is not clear if some are Eskom plants. South Africa’s plans to swap debt liabilities for pledges to use cleaner fuel may pay off, say some experts, as long as they are part of wider debt sustainability policies.

Lee Buchheit, an experienced sovereign debt adviser who as a partner at law firm Cleary Gottlieb advised Greece on its €200bn restructuring in 2012, said using debt relief as a carrot to encourage climate change mitigation policies could prove fruitful.

“In a sovereign debt restructuring, creditors know they will be asked for debt relief. The only questions are how and how much. If a portion of that debt relief can be channelled back into the debtor country by funding an environmental conservation project, everyone wins,” he said.

“The sovereign debtor gets debt relief and inward investment into its economy. The creditors improve the sovereign's debt dynamics and thereby enhance the collectability of the balance of their claim. The planet gets to breathe a bit more freely.”

Buchheit has been advising Belize on its proposal to buy back its one outstanding bond issue, a US$533m 4.398% note offering due 2034, at a 45% discount with a promise that in return it will commit US$23.4m to a major marine conservation project off the country’s Caribbean coastline (see Emerging Markets).

“Many institutional creditors complain about the lack of opportunities to demonstrate their commitment to ESG objectives. The Belize innovation is an attempt to harness that sentiment,” he said.

David McNeil, a director at Fitch Ratings, agreed. saying: “Despite growing investor interest in addressing biodiversity risks, mechanisms to influence behaviour of state and non-state actors are often limited. However, the emergence of new asset classes that tie sovereign debt financing costs to biodiversity outcomes could help address the dual challenges of nature loss and emerging market debt.”

McNeil said progress had also been made by the EU in particular on linking finance pledges to countries if tropical deforestation was arrested, citing a project in Ivory Coast and Ghana backed by EU money.

Buchheit is less hopeful that a more wide-ranging agreement would be achieved at COP26 but suggested one way to help do this would be to encourage private sector money to support initiatives by the official sector.

“The global climate change agenda will require a staggering amount of money. It cannot all come from the official sector. The official sector players should be looking closely at mechanisms by which private capital can be enlisted as part of this effort,” he said.

Shamaila Khan, head of emerging market debt strategies at AllianceBernstein, said it was hard for private sector investors unilaterally to offer debt relief since that went against their fiduciary duty to clients.

“It is important for bilateral lenders to give debt concessions on climate issues. But issuers will have to be downgraded if such debt forgiveness happens,” she said at a recent Institute of International Finance panel.

“It is harder for the private sector to give debt relief as it might affect issuers coming to the market again in the future. But private creditors will always give debt relief if it is a question of debt sustainability.”