As leaders gather in Paris this week for a summit on tackling climate change, and how our global financial system should evolve to be part of the solution, skeptics may wonder whether most of the world’s cash-strapped countries really have the incentives and the capacity to do much. After all, even wealthy countries are struggling to address what is undoubtedly the most serious, and expensive, shared challenge of our age.
But recent initiatives in Latin America and the Caribbean and other regions provide reasons to be optimistic. Countries from Barbados to Ecuador, Jamaica and Uruguay have been working with multilateral development banks and other stakeholders to better leverage existing resources and create innovative financial instruments to address climate and nature challenges.
In today’s polarized world, the work by these countries also shows that even in an age of uncertainty, governments, civil society, the private sector and international institutions can work together and point the direction.
There are three types of innovative instruments that are increasingly being used, offering potential opportunities to standardize, reproduce, and reach the scale that the global challenge requires: debt-to-nature swaps (and also debt-to-climate/social swaps); sustainability-linked bonds (or bonds linked to other performance indicators); and climate-resilient debt clauses (or catastrophe clauses).
Consider debt swaps. They combine two urgent global needs: debt alleviation and more resources for biodiversity and climate. Take Ecuador’s announcement last month that it had concluded the largest debt-for-nature swap in history. The deal will save the country more than $1 billion, allowing it to protect natural habitats in the Galapagos Islands that inspired Charles Darwin’s theory of evolution.
Ecuador partnered with multiple international institutions and investors to do something it could not have done on its own. The country teamed up with the U.S. International Development Finance Corporation, which provided $656 million in political-risk insurance, and with the Inter-American Development Bank (IDB), which provided an $85 million guarantee. This operation is estimated to generate savings of $323 million to create the Galápagos Life Fund, which will finance conservation activities over the next 18.5 years. Finally, 11 private-sector insurers provided over 50% in reinsurance to give Ecuador’s ambitions even more credibility.
Because of all of this, Moody’s Investors Service rated Ecuador’s new bond as investment-grade, 16 notches above its sovereign-issuer rating.
Another debt swap example is a previous move by Barbados, a small island nation that thought big about how to convert its own debt. The country worked with the IDB and The Nature Conservancy, which together provided guarantees to back the swap, allowing Barbados to save resources to invest in marine conservation.
Now consider sustainability-linked bonds. Last year, Uruguay issued its first such bond, which lowers interest rates and saves the country money when it meets key environmental performance indicators – targets on gas emissions and conservation of native forests. Uruguay’s issuance attracted 188 investors from Europe, Asia, the United States and Latin America, a fifth of whom had never held Uruguayan debt. Demand totaled almost $4 billion, easily exceeding the $1.5 billion Uruguay issued.
Instruments like this are giving countries a financial incentive to invest in climate and nature action. We should be doing this around the world.
Finally, consider catastrophe or climate-resilient debt clauses. As we create more tools to help countries go green, we must also offer immediate help when they’re hit by natural disasters.
For example, in Latin America and the Caribbean alone, climate-induced extreme weather events have tripled over the past 50 years, wiping out up to 3.6% of a country’s GDP when they strike. In South America, heatwaves already cause $22 billion in annual losses and could destroy 2.5 million jobs by 2030.
In 2021, we created a product that allows governments to postpone principal payments when catastrophes strike. The Bahamas and Barbados have already activated this feature in all of their eligible loans. But given the size of the challenge, the savings are small, and we must do much more. More recently, Jamaica’s government issued ingenious catastrophe debt, with the help of the World Bank and other stakeholders, that provides more relief when a natural disaster hits. We must expand instruments like these.
Countries need help addressing the immediate and long-term consequences of climate change. Providing it will help regions such as Latin America and the Caribbean be part of the solution to our shared challenges, not just victims. That includes providing incentives to countries and partnering much more ambitiously with the private sector and other institutions. It also means that governments worldwide must consider how to maximize their provision of concessional resources to provide the right incentives for scaling up multilateral and country work.
Multilateral institutions and other stakeholders have several roles. First, to help countries plan their projects and define their targets. Second, to provide global resources to lower costs if targets are achieved. And third, to coordinate to standardize the terms and conditions of the instrument, respecting individual specificities, to increase efforts and reach the scale that the current global challenges require. Finally, we could explore the possibility of loans from our own multilateral banks also having financial incentives for reaching climate and nature targets.
And so, as leaders gather in Paris, we should encourage them to focus on these innovative financial instruments. To be sure, financial innovations are not a panacea for the climate crisis, but they show we can do more to help countries act.
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