This month, the Environmental, Social, and Governance investing movement got a hard reality check about one of its favorite financial tools. Known as debt-for-nature or climate swaps, that tool played a role in a recent coup in Gabon. The coup took place just a week after the completion of a $500 million swap agreement, illustrating the problems with these instruments, in theory and practice alike.
Climate swaps take existing debt in emerging markets and either refinance it at a lower rate or extend the terms of the loan. The emerging nations then take the money raised and use it for biodiversity protection and climate adaptation. The swaps, the origins of which date back to the 1980s, have taken on new life as environmentalists encourage developing markets to spend more on conservation.
In fact, the swaps are more popular than ever today, as large banks look to make more ESG-related deals and higher interest rates pressure emerging-market countries. On its website, the Nature Conservancy boasts that it enabled a deal that reduced Belize’s debt by 12 percent of GDP, unlocking $180 million over the next 20 years. An article in Bloomberg estimates that the market for both public and private climate-swap deals is set to exceed $800 billion. But Barclays has raised concerns that the deals, the Belize deal in particular, are not being adequately scrutinized or are examples of “greenwashing,” meaning that the money is not actually going toward conservation.
The greenwashing would not be so terrible if the money from the swaps were going somewhere useful, but Barclays argues that much of it is being deployed to pay bank fees and other intermediaries. Also, as the recent coup illustrates, these swaps can enable corruption and are often characterized by a lack of transparency. A group of 31 nonprofits recently criticized the swaps on grounds that the money raised goes directly to new domestic-conservation NGOs, some of which run annual budgets surpassing that of entire government departments and civil-society organizations.
The problems with green debt swaps go deeper than poor implementation or lack of scrutiny. Something is unseemly about European and American banks imposing their values on poorer countries that have more pressing economic needs. Emerging markets often have more practical investment projects that could alleviate poverty, promote development, and pay off for investors in both the short and long term. Investors in these markets likely have a better sense of what those markets’ priorities should be. The real danger posed by the swaps is that they create market distortions that favor politically popular Western ideas and not what best serves local markets.
The swaps often involve long-term obligations, and much can change in a few years, let alone over a few decades, in countries with corruption and other political risks. It’s unclear if the new government in Gabon will honor the climate deal and use the funds as intended, and the agreement could have wider implications for the nation’s economy. The Gabon contracts are insured for political risk, which will pay out if the country defaults or fails to use the money for conservation. Perhaps the insurance will make the market viable and bring accountability—but if the swaps also breed corruption, insuring deals will be harder in the future, making investing in emerging markets even riskier.
These bonds are well intentioned: markets can be too focused on the short term and under-value things like cleaner oceans. Still, the arguments made by climate-swap supporters don’t add up. The Nature Conservancy, for example, maintains that rich countries have a moral obligation to bankroll the swaps because they gained their wealth by polluting the planet. But to whatever extent this is true, it is not best solved by expecting emerging markets to funnel their scarce capital into conservation. A better solution: keep explicit ESG goals out of these markets, and let the markets allocate capital to the most productive places, enabling developing countries to get richer. When that happy day arrives, these once-poor countries will have the resources to devote to environmental goals as they see fit.