Kristina Kostial, the IMF’s deputy director, spoke at the climate resilience hub during the opening day of COP27, on the use of debt-for-nature and climate swaps to create a fiscal space for developing countries to address climate change.
Countries with large debt burdens are losing even more capital due to climate shocks, shrinking their fiscal space, she said at the event on Monday.
Whereas the public financial sector has typically treated debt vulnerability and climate vulnerability as separate financial needs, debt restructuring with imbedded climate incentives could provide some capital relief for developing economies.
This was a focus point on the first day of the implementation summit in Sharm El-Sheik, during which delegations debated the topic of innovative finance solutions for climate and development amongst other topics.
“The use of innovative financial tools and mechanisms – such as green bonds, environmental impact bonds, debt-for-climate swaps, blended finance mechanisms – can be an effective vehicle to channel funds to projects and translate NDCs [nationally determined contributions] and NAPs [national adaptation plans] into investment action plans,” the organizers explained.
Speaking at the conference on Monday, guest speaker Mahmoud Mohieldin, UN Climate Change High-Level Champion for Egypt, said: “In the time the world is suffering from the impacts of Covid-19 and the war in Ukraine, the developing countries are asked to pay the cost of the climate crisis despite the fact that they didn’t contribute to it. This makes financing climate action in the developing countries unfair, considering the increasing of countries that suffer from debt distress, according to IMF and the World Bank.”
The goal is to create an international framework of guidelines for the private sector to accelerate climate funding towards developing economies.
Growth hindered
For banks, however, the lack of bankable projects and standardized investment framework hinders growth of these types of solutions. But another obstacle is the fact that banks must interact with new stakeholders, including governments, non-governmental organizations (NGOs), local populations and multilateral development agencies.
“These transactions typically involve complex structuring aspects, but banks also need to understand demand from institutional investors,” Ramzi Issa, Credit Suisse’s head of credit investor products structuring, tells Euromoney.
It takes time and commitment to be fully engaged in innovating and being solutions oriented
“Debt-for-nature swaps involve a number of stakeholders that we wouldn’t usually see in financial transactions,” he adds. This can be more time-consuming for banks, which first need to understand the ‘why’ behind each stakeholder’s perspective and think creatively about the ‘how’ to execute and achieve objectives within a structure that works as an investable solution for institutional clients.
“It takes time and commitment to be fully engaged in innovating and being solutions oriented,” says Issa.
As with any transaction, the risks are contextual. “We need to ensure that the project has been through a thorough due-diligence process to achieve the desired and credible outcomes,” he adds.
Climate finance solutions require more efforts to be made by banks on the integration of climate measures as part of the credit risk assessment and due-diligence process, so that these types of new solutions that come to market can reduce the funding gap.
The mobilization of the $100 billion per year by 2020 – pledged in 2009 – has not been successful. According to OECD, $83 billion were channelled to developing countries in 2020, with only 14% originating from the private sector.
Still, there have been some noteworthy debt-for-nature swap deals this year, including a sovereign blue bond issuance by Barbados in September, and by Belize in 2021.
As governments recognize that these deals – which have the twin benefit of addressing debt vulnerability as well as climate vulnerability – can be implemented in practice, investor appetite will follow.
