the finance tool making a comeback

In 2023, Ecuador struck an unusual deal. Instead of simply paying back its debts, it refinanced part of them on better terms and promised to spend the savings protecting the Galápagos Islands.

This type of transaction, known as a debt-for-nature swap, is often described as a “win-win”: lower debt costs for governments, and long-term funding for some of the world’s most fragile ecosystems.

Debt-for-nature swap transactions offer a range of benefits. Countries facing heavy debt burdens can reduce their liabilities, while bondholders are able to offload risky assets. At the same time, the financial saving is redirected into environmental projects, supporting vulnerable ecosystems.

These deals have been around since the late 1980s. Early swaps were typically small and led by environmental charities, which bought distressed debt cheaply and converted it into local funding for conservation. Through the late 1980s and early ’90s, there was a wave of enthusiasm for such deals, particularly in Latin America and Africa.

Read more: Your essential guide to climate finance

That enthusiasm faded in the 2000s, as large-scale debt relief programmes reduced both the availability of distressed debt and the need for swaps. But in recent years, interest has returned. With banks now involved, today’s swaps can be far larger and more complex. Ecuador’s 2023 deal involved US$1.6 billion (£1.2 billion) of debt.

Since 1989, 169 debt-for-nature swap deals have been agreed, involving US$8 billion of debt being converted to fund environmental initiatives. But despite their appeal, they have not been universally popular.

Africa and Latin America have dominated these deals. By contrast, Asia has lagged behind, comprising just 13% of total global swaps. That’s surprising at first glance. Asia has an abundance of viable environmental projects, from vast biodiverse tropical forests in Malaysia to the carbon-storing mangroves of Indonesia and the threatened coral reefs in the Maldives.

So why have Asian economies not embraced debt-for-nature swaps?

During the peak of these swaps, many Asian economies had relatively little debt held in international markets, leaving less available to restructure. Borrowing was also comparatively cheap, reducing the incentive to pursue swaps.

Without a large amount of distressed, tradable debt, the financial mechanics that made swaps attractive and logistically viable in other regions were largely absent in Asia.

There were also political and institutional factors. Debt-for-nature swaps often involve foreign charities, foreign governments or international investors that influence how environmental funds are used within the country in question. In parts of Asia, concerns about sovereignty and external interference have made governments more cautious about such arrangements.

But today, that picture is changing. Across Asia, debt levels have risen sharply, particularly after the COVID pandemic. At the same time, more governments are borrowing through international bond markets, meaning a larger share of their debt is now held by private investors – and can, in principle, be bought back or restructured.

Potential candidates include Indonesia, Laos, Mongolia and the Maldives, where growing debt pressures combined with significant environmental assets provide the core ingredients required to justify effective swaps.

Despite the resurgence in interest in debt-for-nature swaps, even the largest deals often only address a small share of total debt.

The latest structures can be complex and costly to arrange. There are also concerns about both national sovereignty and impinging on the rights of local communities, whose lives are often most affected by the transaction.

By trying to explicitly link debt relief to environmental outcomes, well-designed swaps can create dedicated, long-term funding streams for conservation. This can help protect ecosystems that support livelihoods, store carbon and buffer communities against climate-related consequences such as storms and rising sea levels.

As climate change accelerates and debt burdens rise, countries – including across Asia – are being squeezed between repaying creditors and protecting their future. Debt-for-nature swaps won’t solve either problem alone, but they can offer one of the few ways to tackle both issues at once.

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Alex Dryden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.