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Articles: Strategy for Financing Action on Adaptation in Small Island Developing States (SIDS) via Debt-for-Climate Swaps: a Global Approach

Contributed by YokweOnline on Jul 05, 2012 - 09:30 AM

 “Debt conversions for climate change adaptation: such innovative financing mechanisms could support the neediest countries to generate additional resources for climate change adaptation.”

UNDP Discussion Paper “Achieving Debt Sustainability and the MDGs in SIDS”

The Problem

There is a growing debt crisis within the world’s Small Island Developing States (SIDS).  As efforts are taken to accelerate progress towards the Millennium Development Goals (MDG) over the next five years, the extent to which critically high public debt levels may pose serious challenges to sustainable economic and social development, poverty reduction, adaptation to climate change, and human development programs in SIDS is of serious concern.  Of note:

    SIDS have limited access to comprehensive debt relief as they are not considered poor and/or severely indebted enough;
    Over the past decade, Overseas Development Assistance to SIDS has decreased significantly requiring SIDS to borrow more from commercial sources at higher interest rates;
    SIDS GDP growth in 2010 was just 1.7% on average compared to 6.3% for developing countries as a whole, meaning that SIDS will have a difficult time to “grow-out” of their debt;
    Public debt ratios in SIDS increased by on average 9% of GDP between 2007 and 2010 with the recent concurrent food-fuel-financial crises, an issue that will only be compounded as SIDS are projected to recover from the recent crises more slowly than other developing countries;
    In 2009, fourteen SIDS registered public debt to GDP ratios in excess of 60%, with eight SIDS, mostly in the Caribbean; registered debt to GDP levels in excess of 100% with St. Kitts and Nevis registering one of the highest in the world at 192%.
    Finally, for many SIDS (Belize and Grenada for example), a not insignificant portion of the debt is related to recovery costs from hurricanes and other natural disasters – events that are expected to occur on a more regular basis due to global climate change.

The issue of high levels of debt in some small island developing states has so far been largely unaddressed by the international policy community. The approach taken so far has relied almost exclusively on small island developing states to resolve their indebtedness problems themselves, mainly through fiscal retrenchment, increased taxation and seeking debt restructuring with individual creditors on an ad-hoc basis. This approach however has not been sufficient.

In 2010 alone, four SIDS restructured portions of their domestic, bilateral and private external debt (Antigua and Barbuda, Jamaica, the Seychelles and the Solomon Islands). In total, over the last three decades 16 SIDS have concluded more than 49 separate debt restructuring operations. Yet in many cases, debt problems persist.

The Solution

A global approach for providing debt relief to SIDS via a multi-year commitment of US$500 million to conclude upwards of US$1 billion of commercial and/or bi-lateral debt for climate adaptation in marine ecosystems swaps will translate into at least US$1.35 billion of activity over 20 years:

        US$250-$500 million in immediate debt relief (at 33%-50% discount on the debt)
        US$550 million to fund climate adaptation in marine ecosystems activities over 20 years
        US$550 million to capitalize endowments for the countries to fund climate adaptation in marine ecosystem activities into perpetuity (after cash flow from the new notes ends), which will translates into $27.5 million/year (5% payout) of dedicated funding thereafter

The activities funded could include:

        Expand and secure marine protected areas to at least 20% of near shore marine systems, with at least 5% of near shore marine systems as “no take” areas
        Develop and/or improve coastal zone management, marine, and fisheries policies and regulations, including a robust adaptation to climate change component
        Coral and mangrove restoration projects
        Provide alternative livelihoods for affected users
        Improve social resiliency to climate change

These activities are closely tied to the “blue economy” with SIDS specifically calling for the upcoming Rio+20 meeting to provide support for sustainable ocean development, adaptation to climate change, and protection of marine resources.  This concept melds MDG, climate adaptation, and biodiversity goals, as it addresses debt reduction, food security (improved management of fisheries), management of marine and coastal ecosystems, and adaptation to climate change in marine ecosystems.  As well, debt relief will free up fiscal space allowing for increased government investment in other areas (such as other coastal climate adaptation activities for example).

Financial & Governance Structure

Debt swap proceeds will be managed by national-level Conservation and Climate Adaptation Trusts (CCAT), with majority non-government boards.  These public-private partnerships will hold the new (or existing swapped) notes concluded via the debt swaps.  Over the past three years, the Conservancy has been working with eight Caribbean countries to create draft model legislation to establish these CCATs. Currently, the Conservancy is working closely with the countries to finalize the legislation in each country and develop action plans to pass the legislation to create these CCATs.  Further funding is available to assist with initial start-up of each CCAT, including funding for initial operations, board training, public outreach, local counsel review of draft legislation, and stakeholder training on how to access the CCAT funds.

Climate Adaptation Funding Sources

At the Copenhagen United Nations Framework Convention on Climate Change (UNFCCC) Conference of the Parties in 2009, Europe committed €2.4 billion (approx. US$3.12 billion) annually from 2010-2012, for both adaptation and mitigation projects globally. Furthermore at Copenhagen, Australia committed Aus$700 million and the US committed over US$1 billion.  At the Cancun UNFCCC COP in 2010, the developed world recommitted to a target of US$100 billion a year by 2020 for climate adaptation and mitigation funding.  This clearly demonstrates that the funding pipeline for climate adaptation projects will continue to grow over time.

The universe of countries that have funded debt swaps includes Australia, Germany, US, France, Italy, Norway, Switzerland, and Spain (with a Latin America focus).  Overlaying this information with those countries that have pledged significant funding to climate adaptation along with historical funding of projects in the Caribbean, Pacific, and Indian Oceans indicates a focus on the following potential donor countries: Australia, France, Germany, the Netherlands, Norway, Switzerland, the United Kingdom, and the United States.

There also appears to be room for significant funding from private foundations, as two foundations have already pledged US$15 million towards a potential Belize debt for climate adaptation in marine ecosystems swap.

Finally, given the fact that much of the debt is commercial debt, which trades at huge discounts (anywhere from 50 to 85% discount), there is an opportunity to bring private capital into these swaps.  These social impact and/or venture philanthropists could earn a return on their investment, while funding important adaptation to climate change work in Small Island Developing States.  In fact, the goal of this project will be to bring in at least 50% of the funding as private investment capital, matched 1:1 with grant funding from public and private sources.

Why Debt for Nature Swaps?

Debt-for-development (nature, health, education, etc) swaps are not new. The first was undertaken in 1987. By 2007, it was estimated that these financial techniques had resulted in the cancellation of US$5.7 billion of debt and the application of US$3.6 billion to development projects.  There are a number of advantages for debt for nature swaps, including 1) donors can leverage their funds to fund more conservation activities then giving direct grant; and 2) for the debtor countries, it is a mechanism for them to reduce foreign currency debt and replace with local currency (or combination local and foreign currency) debt to fund worthy projects in the country.

The Nature Conservancy’s Experience & Role

From 1988 to 1992, The Nature Conservancy participated in a number of commercial debt-for-nature swaps totaling $50 million in face value which generated $30 million in funds for conservation.  Since 2001, TNC has participated in 11 of 17 Tropical Forest Conservation Act (TFCA) deals concluded by the US Treasury, investing $14 million to purchase over $210 million (face value) of debt.  Other NGO investors (Conservation International, WWF) invested $8 million with TNC, which together leveraged another $120 million in TFCA funds to purchase this debt.  These debt swaps resulted in over $265 million (principal and interest payments) in new funding for forest conservation.

The Conservancy has the opportunity to play a significant role as the broker of these deals.  As previously mentioned, TNC is currently negotiating and raising the funds for the proposed US$130 million debt for adaptation to climate change in marine ecosystems swap in Belize, which has served as the model for this scaled up concept.  Furthermore, TNC has a strong relationship with Ministry of Finance staff in all of the Caribbean countries identified as potential debt swap recipients due its work with these countries in developing and implementing the Caribbean Challenge.

Risks and Risk Mitigation

Obviously, the biggest risk is that of default on the new promissory notes created through the debt for adaptation swaps.  Prior to addressing risk mitigation strategies, it is worth noting that to date (some 25 years of debt for development swaps), no country has ever defaulted on a debt swap –  and with good reason, a country would be defaulting on itself, as all of the proceeds of the debt swap fund worthy projects in the country.

The primary method of mitigating the default risk is via the legal agreements and new promissory notes created to facilitate the debt swap. Within these agreements, it will be stipulated that if the government defaults on the new promissory notes any debt relief provided through the swap will immediately be reinstated, with deferred interest also added to the debt.   Furthermore, if possible (i.e. for those countries not under IMF programs), the new promissory note will be placed in first position for repayment under default.

Debt Swap Participants & Initial Focus

The US$500 million goal would be split evenly between Caribbean, Pacific/Indian Ocean SIDS, with a focus on those countries that have already made 20% (or more) marine protection commitments under the Caribbean Challenge Initiative, Micronesian Challenge, Coral Triangle Initiative and the West Indian Ocean Coastal Challenge.

On the Caribbean side, the US$250 million could fund debt for climate adaptation for marine ecosystem swaps in the following countries: Belize, Jamaica, Antigua & Barbuda, Grenada, St. Kitts & Nevis, St. Lucia, St. Vincent & the Grenadines, and the Dominican Republic.  On the Pacific/Indian Ocean side the US$250 million would fund debt for climate adaptation for marine ecosystem swaps in the following countries: Papua New Guinea, Solomon Islands, Seychelles, Maldives, Marshall Islands, and Palau. The initial focus of the work will be on the Caribbean, given the 14 year relationship that the project lead has with Caribbean governments and the enabling conditions in place for the concept to succeed.

Activities to Date

Discussions have been underway for nearly two years with Belize to conclude a US$130 million debt for adaptation to climate change in marine ecosystems swap.  A detailed proposal has been developed, with both local and global TNC staff participating in these negotiations.  Over the past year, the following activities have been completed:

• Presentation of the concept to Ministry of Finance staff in various Caribbean countries, including Antigua & Barbuda, Grenada, St. Vincent & Grenadines, and the Dominican Republic.

• Presentations to Donor country agencies in Germany, France and the European Commission.

• Presentations to Donor country UN Missions, including Australia, Netherlands, and France.

• Development of Debt for Adaptation Swap concept briefs between TNC and Antigua & Barbuda

• Supporting the Government of the Seychelles in briefing key SIDS Missions in New York City, including, Grenada, Belize, Solomon Islands, and the Maldives.

• Facilitating a dinner during the Durban UNFCCC meeting, co-hosted by the Governments of Seychelles and Grenada, bringing together key SIDS and Donor countries to discuss this concept, including Australia, Germany, the US, the European Commission, the Maldives, and Belize.

- Robert Weary, Director, Conservation Finance, Caribbean Program, The Nature Conservancy

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