The Galapagos Islands’ record-setting debt-for-nature swap was broadly applauded as a win-win-win for Ecuador, nature, and international financiers, but now a groundswell of critical voices is pointing to problems that must be avoided as nations queue up to strike similar deals.

Last month’s Galapagos debt-for-nature swap buys back over $1.6 billion in Ecuador’s foreign debt using a $656 million loan issued through a special-purpose vehicle structured by Credit Suisse bank.

The deal eliminates the debt owing and servicing of interest payments on 1-3% of Ecuador’s foreign debt, but also results in cash flow earmarked for marine protection, made possible through the issuance of a Galapagos Marine “blue” bond.

Yet despite the obvious appeal of boosting finance for the world-famous Galapagos marine reserves while simultaneously targeting Ecuador’s debt distress, the deal has angered certain groups of stakeholders.

Some 130 organisations, academics, environmentalists, and other experts have expressed frustration with a lack of integrity and transparency of the deal, as well as concerns that foreign interests may eclipse Ecuador’s choice in policy direction.

The groups pointed out that despite headline dollar figures, a much smaller amount will be directed towards conservation, and that decision-making on the use of those flows will fall to an external private entity.

They also point to private profits and public liabilities, raising doubts over “who will really benefit from the agreement and whether the established environmental objectives will be achieved”.

THE DETAILS

Debt-for-nature swaps are agreements to forgive or restructure a portion of a nation’s foreign debt in exchange for local investments in environmental conservation measures.

The deals are generally made possible because of the discount the debt titles fetch on international markets when there is a risk of default, meaning that they can be bought at a fraction of their intended value.

Ecuador’s foreign debt currently stands at about $60 billion, and with the nation having defaulted some 11 times on its sovereign bonds – coupled with current political uncertainty – its credit rating is extremely poor and its sovereign bonds can trade at 20-40% of their face value.

This allowed international funders to step in to buy the bonds at a discount price, taking over $1.6 billion off the debt book, while costing those funders only a fraction of that.

That cost was financed through proceeds from a $656 mln blue bond issuance, purchased by the likes of international pension funds and asset managers, eager to highlight their sustainable assets.

After debt buy back, some $323 million will be left from that issuance for Galapagos marine protection, with that money tied to pre-agreed terms on conservation.

But that $656-mln also remains in Ecuador’s liability column, where the nation will need to pay back that loan in 2041, plus a healthy 5.6% interest rate flowing to blue-bond buyers.

Galapagos blue-bond buyers take on minimal risk, since the returns are guaranteed by international players, including by the Inter-American Development Bank, with political risk insurance provided by the US International Development Finance Corporation.

This backing saw the bonds graded Aa2, the third-highest long-term credit rating that Moody’s assigns with very little credit risk.

CONSERVATION TRANCHE

The relatively modest $323 mln will be spread out for annual conservation funding over 18 years, advertised as helping to fulfil desperately needed finance for the biodiversity-rich UNESCO World Heritage site, first made internationally famous by pioneering scientist Charles Darwin in 1859.

That loan will also have strings attached, with a requirement to engage an independent US-based trust to distribute $12 mln annually through 2041, and manage the additional $5.4 mln permanent endowment.

This Galapagos Life Fund – registered as a limited liability company in Delaware – will have ultimate power in carrying out the conservation initiatives.

Its board consists of 11 members, of which six are from the private sector or not-for-profits, and only five from the Ecuadorian government, meaning the government does not have majority vote.

The stakeholder group argues that the structure of the Life Fund is not transparent, providing little assurance of good management.

Even if well-intentioned, the fund could easily diverge from the local populations’ or national interests, and is likely to carry high transaction costs in operation, they said.

The example begs the question on how nature – as an increasingly recognised linchpin to human survival – will be governed and coordinated globally, and how the voices of those that live on that land will be integrated into decision making.

Beyond governance concerns, there is also a worry that the deal creates a smokescreen for the real financing needs of the islands.

Galapagos conservation costs have been estimated at a minimum of $20 mln per year, and pressure related to the areas’ extension from the current 193,000 square kilometres to a new Hermandad Marine Reserve will add additional strain – exacerbating the finance gap.

Meanwhile, illegal fishing, overfishing in the waters directly surrounding the marine protected area ­– including at times by large-scale fleets of Chinese vessels – and climate impacts are all putting the area’s biodiversity at significant risk.

EXPERTS WEIGH IN

“This swap has been billed as a breakthrough, given the apparent level of savings for Ecuador in the debt buyback operation, but when you look at the details, the scheme raises significant concerns,” Daniel Ortega Pacheco told Carbon Pulse.

Ortega who has published an opinion piece on the topic, served as Ecuador’s environment minister from 2015-16, and is currently director of the country’s Center for Public Policy Development at the ESPOL Polytechnic University.

He said that he is concerned about issues such as the transparency of the deal, noting that these are for-profit transactions, not philanthropic grants as some media articles have implied.

Meanwhile, Ecuador remains liable to pay the 6.9% interest on the loan, pay the loan principles itself, as well as make good on the conservation commitments, while giving up control of how those funds will be distributed.

“In essence, the deal means ceding control over public policy and administration of public resources,” Ortega said.

There were alternatives to this structure, Ortega pointed out, including concessional loans, or debt-restructuring backed by organisations such as the UNDP.

Ortega also highlighted the importance of managing the funds earmarked for conservation in a way consistent with international best-practices – something he said is starkly absent from the deal.

The Galapagos Life Fund will disburse money to local projects and does not appear to have any more macro-scale game plan.

During his tenure as a member of the advisory council on the Green Bond Principles – voluntary guidance established by the International Capital Market Association – Ortega helped develop rules to ensure bonds advertised for their sustainability merits actually resulted in robust environmental outcomes.

But principles related to the Galapagos blue bonds are not well defined, he said, noting that it is not clear how projects will be chosen, or if there will be any oversight or verification of outcomes.

“Using the ‘blue’ label on this bonds is measleading. This could scare impact investors away from Galapagos,” he said. “And if not done properly, it could scare investors away from this type of financial instrument in conservation areas globally.”

Instead, the expenditure programme should be realistic and transparent, narrowly-focused on a few priorities, and should demonstrate a solid pipeline of attractive projects, he said.

The administrative costs of managing the fund should also be minimised, he added, noting that foreign involvement could see these costs soar above the 5% of annual revenue recommended by expert groups such as the OECD.

Ortega said that while the government of Ecuador does not have majority rights on how the earmarked money is actually spent, there is no doubt that the administration will be ultimately blamed if things go wrong.

COMPREHENSIVE REFORM

According to some stakeholders, debt-for-nature swaps in their current form may distract attention away from more comprehensive solutions.

While a plethora of papers have been published about the growing financing needs to address biodiversity and climate-related collapse in developing countries, some 52 low- and middle-income economies are either currently in debt distress or at high risk, according to the Financing for Sustainable Development Report. 

The deals have been small-scale compared to the size of the challenge, and instead some say a new international financial architecture is needed to address the financing crises for debt, nature, and climate.

In April, UN Secretary-General Antonio Guterres joined forces with Barbadian Prime Minister Mia Mottley on the Bridgetown Initiative, calling for extensive overhaul to the world’s financial system and a hefty stimulus package.

That initiative signals a need for an immediate re-channelling of unused Special Drawing Rights through the IMF and multilateral development banks, as well as ways to offer nations support in restructuring their debt with long-term low interest rates.

It also calls for significantly scaling up new, additional, unconditional, grant-based public finance to be used towards climate and biodiversity objectives.

These issues are likely to be discussed next week in Paris at a summit organised French President Emmanuel Macron on a “New Global Finance Pact,” as well as at the annual meetings of the IMF-World Bank Group in October.

By Katherine Monahan – katherine@carbon-pulse.com

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