A heightened focus on allowing pauses in servicing debt when sovereign borrowers are hit by climate catastrophes underscores the progress on financing for low-income and vulnerable countries that is being showcased at the UN-sponsored COP28 climate conference in Dubai.
A host of countries and multilateral development banks have committed to include climate-resilient debt clauses – also known as “pause clauses” – in their lending, marking in an important development for governments on the frontline of climate change that could prevent potential sovereign defaults and costly debt restructurings.
CRDCs are increasingly being seen as a short-term liquidity support tool that could provide breathing space at times of severe climate-related or natural disasters and allow governments to respond to the needs of people affected.
Governments will be able to defer repayment of principal for up to two years if a state of emergency is declared and interest will be added at the end of that period.
“All we are asking for at this stage is that we include these clauses in all of our debt instruments,” said Barbados prime minister Mia Mottley at COP28.
CRDCs draw from the Bridgetown Initiative, which is led by Mottley and aims to create new financing instruments and reform institutions to finance climate resilience. The island nation inserted the clause when it restructured its debt in 2018 and included a CRDC in its blue bond issued as part of last year’s debt-for-nature swap that covered natural disasters and pandemics.
“If we are hit by a hurricane tomorrow, there is no country, no institution, no company that will give us the equivalent of almost 20% of GDP for two years,” Mottley said.
The UK, France, the World Bank, Inter-American Development Bank, European Investment Bank, European Bank for Reconstruction and Development and African Development Bank all pledged at the conference to include CRDCs in their lending. A total of 73 countries have called for expanded use of the clauses by 2025.
UK development minister Andrew Mitchell said he wanted to “make CRDCs go global” and be available to all countries that are vulnerable to shocks, including in Africa and Asia, and apply to a wider set of climate disasters including droughts.
UK Export Finance last year became the first export credit agency to adopt the clauses and is adding CRDCs to its new and existing arrangements with Senegal, which is the first in Africa, and Guyana. Another 10 countries are considering the offer too.
Canada said that it would follow the UK in offering CRDCs.
IDB said that it had already offered US$1.2bn of loans covered by CRDCs and the World Bank said it will start offering CRDCs in existing loans and cover all transaction costs.
AfDB, EBRD and Agence Francaise de Developpement also announced plans to integrate pause clauses in sovereign loan agreements. EBRD said that it expects that borrowers in its area of operations will be able to opt for the clause in their loan agreements by mid-2024.
“I believe this has the ability to create the space without affecting the legal relationships and the legal obligations to ensure we stay safe,” Mottley said.
Fitch said it would consider revisions to credit rating criteria for loans to ensure the use of CRDCs does not impose a burden on borrower countries.
The next step for CRDCs could be their inclusion in more eurobonds and syndicated loans. Bankers have welcomed the development, which they said could lead to more orderly outcomes as climate catastrophes become more widespread.
"In financial markets, the key thing is to take away the uncertainty of the event and the interpretation of the event on long-term debt," one banker said.
The increasing frequency and severity of extreme weather events in recent years have added prominence to work on climate adaptation and emergency responses.
CRDCs are an important development due to rising under-insurance and refusal to insure some risks in climate-vulnerable countries. That creates problems in the corporate sector and puts more pressure on stressed government finances to fund all the losses incurred.
“Why is this so important? We are increasingly seeing under-insurance and uninsurance in our markets,” Mottley said.
She described the insurance and reinsurance industries as a “problem at the heart of the global financial system” as they deal with low and medium-risk events rather than the increasing uncertainties associated with climate change and extreme weather.
”When we stop being able to insure our development of our region and our country becomes uninsurable, it becomes uninvestible, and that is the point that leads to climate migration and failed societies," she said.