Embedded in Nature: Nature-Related Economic and Financial Risks and Policy Considerations

Distinctive characteristics

Instruments to promote specific investments and policy actions, usually nature conservation-oriented, and provide some debt relief (rather than comprehensive debt relief or restoring debt sustainability) on a country' external public debt (Chamon and others 2022).

Recent DNS arrangements have involved bilateral debt (Seychelles) and commercial debt (Belize, Barbados, Ecuador, Gabon). Several DNS have benefited from a political risk guarantee, provided by the US Development Finance Corporation, which has allowed them to benefit from a higher credit rating (ceteris paribus). Some DNS clauses have been standard across recent DNS (30 × 30 clause), while other conditions (including mandatory conditions related to implementing national plans) are bespoke (Standing 2023). Financial conditions Debt buyback involving the replacement of a eurobond (or of a portion of bond notes across multiple eurobonds) with blue or green bonds (with a haircut), whose proceeds are used for nature-related investments, and with additional clauses related to mandatory environment-related policy measures.

Small-scale, bespoke nature of financial arrangements, and limited potential debt reduction (excludes LICs without market access, which contain 22 percent of the world's biodiversity) (Nedopil and others 2023).

Mechanisms involved are complex and time consuming. DNS are hard to replicate, limiting the scalability potential. There are also high transaction costs (Standing 2023).

Unclear additionality. More generally, DNS do not address root causes of nature loss (Pérez-Beltràn and Landry 2023).

Limited impact on fiscal space to date (Carbon Brief 2024). Historically, DNS have not provided comprehensive debt relief or restored debt sustainability (Chamon and others 2022).

Concerns over democratic governance of marine or other natural resources, and concerns over debtor country ownership and the relative power of domestic authorities in environment-related policy choices (Standing 2023).

Long value chain of industry players and limited involvement of local stakeholders generates or perpetuates political economy challenges over use of natural resources and limits environmental impact potential.

Limited participation of indigenous peoples, local communities, and civil society in the definition and implementation of DNS (Standing 2023).

Lack of systematic monitoring, accountability, and evaluation of impacts of DNS.

Use of "tied aid" approaches favoring creditor country interests in use of freed-up resources.

Special purpose vehicles and companies used in DNS mechanisms have in some cases (for example, the Belize DNS) relied on tax havens, raising questions about tax evasion and scalability.

Loan arrangements within DNS programs have included large interest margins for participating NGOs, with unclear or unspecified use of funds.

Credit guarantees (for example, political risk guarantees) may be required for DNSs to be attractive to debtor countries, generating potential for socialization of losses (domestically or cross-border, depending on how the credit guarantees are paid for).

Risk of privatization of profits and socialization of losses if the stated environmental and debt reduction objectives of the DNS are not achieved.

Exchange rate and price stability.

Additionality principle is met (debt relief does not reduce amount of other funds provided by the creditor, and environmental measures implemented by the recipient country would not have occurred without the swap). Data must also be available to assess whether this principle is met.

Debtor country must have strong ownership of and sovereignty over its fiscal and natural resources (Paul and others 2023).

Debtor country must have the institutions and physical and informational resources to conduct high-quality impact assessments regarding conservation measures. Debtor countries should not be vulnerable to the global financial cycle, which can more than offset any improvement in debt sustainability achieved by a DNS (Standing 2023). The correlation between the relative need for ecosystem protection and sovereign debt vulnerability should be sufficiently high (Paul and others 2023).