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NatureFinance to launch support for sustainability-linked sovereign debt

© Shutterstock / William PotterPost Thumbnail

The global Sustainability-Linked Sovereign Debt Hub has been announced by development banks and NGOs at a ministerial meeting in Egypt.

  • Non-profit organisation NatureFinance has announced a Sustainability-Linked sovereign debt hub (SSDH) to help international governments adopt the structure.
  • Systemic issues fuelled by environmental crime have caused the sovereign debt markets of vulnerable countries to spiral into crises.
  • Bring multiple actors together will enable a systemic approach to systemic problems, reversing the downward spiral and opening the door to innovative financial instruments like debt for nature swaps.

The hub was announced during a ministerial meeting in Egypt, as the country prepares to host COP 27 in November 2022. The initiative hopes to leverage capital towards sustainable economic development by mobilising sovereign debt.

What is the hub, and why is it so important?

The hub will go live in November,  with The International Capital Markets Association (ICMA), World Bank, European Bank for Reconstruction and Development, Asian Infrastructure Investment Bank, Climate Bond Initiative, Nature Conservancy and Institute of International Finance to be represented on its advisory board.

It will provide a place for all those involved in sovereign sustainability-linked bonds to come together in a collaborative effort to advance the agenda for incorporating measures to promote nature’s protection within sovereign debt markets.

The SSDH has been set up to address deep systemic problems. The interconnectedness of problems such as the destruction and degradation of nature, climate change, conflict, and crippling global debt, have led to further issues including food insecurity, political unrest and economic failures.

Failure to acknowledge how these issues feed into one another presents the risk that they will continue to spiral. 

Simon Zadek, chair of NatureFinance (formerly Finance for Biodiversity) said: “today’s sovereign debt markets are not fit for purpose, as they fail to take adequate account of the sustainability risks which increasingly are having a material impact on countries’ economic growth and resilience.”

Countries that are struggling with high levels of debt, corruption and environmental crime have entered into a negative feedback loop. Their high risk ratings leave them unable to access capital, “thus leading to a downward spiral of debt defaults, debt restructuring and further nature degradation”, Zadek explained.

The SSDH initiative aims to transform this vicious cycle into a virtuous cycle by introducing risk sharing and embedding sustainability risk into practice, regulation and other rules.

According to NatureFinance, which led the hub’s creation, “sovereign bonds are the largest asset class for many institutional investors, representing almost 40% of the $100 trillion global bond market. In March 2022, Chile announced its newest initiative: a first-of-its-kind, $2 billion sustainability-linked bond offering .”

By bringing multiple actors together and providing them with technical support and other resources, the SSDH aims to promote the wider adoption of the sustainability-linked sovereign debt model launched in Chile.

Environmental crime at the root of countrys’ high risk levels

Rampant deforestation, mining, wildlife trade, is laying waste to the world’s biodiversity and carbon sinks, and financial institutions have been benefitting from the returns. 

This is largely the result of environmental crime, a global crisis which Finance for Biodiversity plans to tackle by targeting the supply chain of goods through their financial chain.

Degraded nature means greater vulnerability to extreme climate events and increased poverty levels, while environmental crime fuels corruption that enables the situation to continue growing worse.

Working together in support of nature is a win-win

The Nature Conservancy, an environmental non-profit represented on the SSDH’s advisory board, has previously transacted ‘debt-for-nature’ swaps between countries. 

This collaborative approach has achieved high conservation outcomes and reduced the country’s sovereign debt. A complicated package, it also involves complex monitoring and management in-situ.

The SSDH will provide space for financial practitioners to exchange notes, facilitating the development of increasingly innovative financial instruments with successful outcomes for both sovereign debt and nature

Sustainability linked loans more suitable for country sustainability advance

Sustainability-linked loans may be perceived as less effective in environmental outcomes than green bonds, as the rules they are bound to are much broader.

Rather than being tied to specific projects, they are aligned to a borrower’s performance against predetermined sustainability targets and reviewed against key performance indicators, external ratings and/or equivalent metrics.

The aim of this approach is to enhance a borrower’s sustainability profile on measurable terms. As such, sustainability-linked loans serve to facilitate and support environmentally and socially sustainable economic activity and growth.

According to the principles set out by the ICMA, “sustainability linked loans are any types of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) which incentivise the borrower’s achievement of ambitious, predetermined sustainability performance objectives.”

One of the SSDH’s primary objectives will be to develop a robust system for measuring, reporting and reviewing the performance of sustainability-linked loans against their performance targets.

The hub will then extend this technical outreach to countries, supporting them in implementing models based on evidenced best practices and thus providing opportunities for sustainable mobilisation of capital while reducing the burden of debt repayments.

The hub may also catalyse action towards the Leaders’ Pledge for Nature, an initiative launched at the beginning of 2021 and adopted by 93 national leaders committed to reversing biodiversity loss by 2030.

As yet, the pledge has seen little action, with few solid commitments made during the first phase of the Convention on Biodiversity (CBD) held in July 2022.

The UK and US governments have been more forthcoming in terms of putting financial value on nature, with central banks and the private finance sector also playing their part.

The SSDH could extend this trend to include global debt, taking a systemic approach to tackling systemic issues and establishing innovative financial models to reverse destructive sovereign spirals.

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