The recent coup in Gabon has sent shockwaves through the financial world, particularly affecting an innovative debt-for-nature swap deal.
Just two weeks before the political turmoil, Bank of America Corp. had finalized a $500 million agreement with Gabon. The African nation had agreed to undertake marine conservation efforts in return for more favorable loan terms.
Debt-for-nature or climate swaps are deals that allow a country to restructure its debt at a lower interest rate or for longer repayment periods. And that’s in exchange for the debtor’s commitment to fund conservation or climate-related initiatives.
The Safety Net
The Gabon deal was unique because it included a political risk insurance contract from the US International Development Finance Corp. (DFC). This insurance serves as a safety net for creditors in case Gabon defaults on its loan or fails to meet its conservation commitments. It’s a key feature that attracts investors who usually steer clear of emerging markets.
Thys Louw, a portfolio manager at Ninety One, described the situation as “untested,” especially in the wake of the coup.
Soldiers in Gabon seized power following disputed presidential elections, causing a record drop in the country’s mostly junk-rated international bonds.
However, the bonds tied to the debt-for-nature swap, which are rated Aa2 by Moody’s Investors Service, have been more resilient.
Despite this, there’s a cloud of uncertainty hanging over Gabon’s ability to fulfill its end of the bargain, both in terms of debt repayment and environmental conservation.
Stakeholders are now in a frenzy, trying to gather more information about the implications of the coup. Both Bank of America and Gabon’s environment minister have remained tight-lipped, while the soldiers who took control have vaguely promised to honor all international agreements.
Bianca Shead, a spokesperson for The Nature Conservancy, emphasized the organization’s commitment to monitoring the situation closely, given Gabon’s ecological importance.
Since 2016, the organization has organized three debt-for-nature swaps which involved the Seychelles, Belize and Barbados. For these deals, the organization had converted over $500 million of debt into $230 million of money for conservation.
Before the Gabon deal, Credit Suisse was the dominant player in the debt-for-nature swap market. Now, other global banks like HSBC and Citigroup are showing interest, with analysts estimating the market’s potential to reach $800 billion.
However, these deals are not without their critics. Questions have been raised about whether they truly meet the “blue” label standards for marine conservation.
A Wake-up Call
Sebastian Espinosa, managing director at White Oak Advisory, called the coup a wake-up call for the industry. He cautioned that countries with unstable political or economic landscapes might not be reliable partners for long-term environmental commitments.
Gabon had announced plans to enter the debt-for-nature market in October last year.
Apart from the African nation, many other developing countries have expressed their intent to also enter the market. For instance, the island nation of Cabo Verde has plans to do a debt-for-climate swap. Colombia also considered this kind of climate financing in exchange for protecting its Amazon rainforest.
At the COP27 summit, several others have shown interest in supporting climate swaps, including Gambia, Pakistan, and Kenya.
However the emerging market for debt-for-climate swaps is a niche because of the high transaction costs involved. Plus, there’s a need to closely monitor the projects and debtors must have a long-term commitment to the scheme.
Gabon’s first coupon payment is due on February 1, and if missed, it could activate the DFC insurance, subject to arbitration. As seen in the nation’s bond prospectus, the DFC “will insure 100% of a loss”, which is around $522 million. This coverage includes the full amount of principal and interest.
In conclusion, the coup in Gabon serves as a stark reminder of the risks involved in innovative financial instruments like debt-for-nature swaps. It underscores the need for investors and stakeholders to conduct thorough risk assessments and due diligence before diving into such deals.
With billions of dollars and crucial environmental commitments at stake, the Gabon situation could very well be a watershed moment for the emerging debt-for-nature swap market.