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The Super Cool Belize "Debt for Coral Reefs" Restructuring

posted by Mitu Gulati

This blog post draws on ideas developed with Ugo Panizza (Professor of International Economics, Graduate Institute) that form part of a paper we are working on. I am to blame for any errors though. 

In 2020, the stock of public debt in debt in developing and emerging market economies surpassed $19 trillion and reached 63% of the group’s GDP (up from 55% in 2019). Such levels of debt significantly increase the risk of multiple devastating debt crises hitting the global economy at the roughly the same time; a situation not seen since the Latin American debt crisis of the 1980s. This is a scary prospect at a time when nations need to scale-up investment in climate change and sustainable growth.

The recent restructuring of Belize’s sovereign debt is an example of how a country can address a debt crisis while preserving investment that can promote sustainable growth. Hard hit by covid-19, Belize is restructuring its sovereign debt for the fifth time in two decades. So, why is this debt restructuring so exciting?

Belize has used a promise to invest a portion of its savings from the debt reduction into the protection of its environment into two elements crucial to engineering a successful debt restructuring:  (i) more debt relief than the creditors were otherwise willing to provide (roughly 5 cents on the dollar); and (ii) more creditor votes in favor of the deal (maybe as many as 30%).

Debt for nature swaps have been attempted before for countries in distress. But these swaps have almost always been arduous affairs, requiring enormous effort and yielding little reward.  For Belize, the debt relief is significant and was achieved with speed and ease. How?

As is the case with every emerging market country that borrows on the international markets, Belize uses super-majority voting provisions in its bonds. It takes a 75% vote of its creditors (in principal amount) for there to be a debt reduction that binds all of the creditors.  The typical process is that the International Monetary Fund does an analysis of how much debt relief the country needs in order to get to sustainability and then the country and creditors negotiate around that estimate. The key for the country here is to get to the 75% number with maximal relief. It is here that the Belize magic occurred.

Belize first began negotiations with a set of the more amenable creditors. With the caveat that we are simplifying a complex negotiation, this initial group was comprised of around 50% of the creditors. As many of these the creditors saw it, Belize should have been willing to pay around 60 cents on the dollar. At this point, Belize played the coral reef card, in effect asking: How many more cents on the dollar will you give us if we put a portion of the debt reduction into preserving our coral reefs and a set of other good ESG activities?

The magic here was that many of these institutional investors had been previously asserting their commitments to ESG efforts. Belize’s hope, we suspect, was to put the investors’ feet to the fire on those assertions.  The result was -- and again, we are simplifying – another 5 cents on the dollar. No other distressed sovereign has ever gotten additional debt restructuring relief in exchange for doing environmental preservation for itself.

But the deal was not done.  The deal was dead unless another 25% of the creditors entered the deal. And many of the remaining creditors were hedge funds; hard-nosed investors who take pride in being all about the bottom line.

At this point, the second piece of magic occurred. The press got interested. There were articles in the FT, Reuters, Bloomberg, IFRE, among others, all featuring pictures of the gorgeous coral reefs that were going to be saved. Yet another Belize restructuring (remember, fifth in two decades) is not usually the type of material that superstar financial journalists such as Matt Levine talk about. A debt restructuring to help save the coral reefs though: financial press catnip.

Still, Belize didn’t have the votes yet and it was not at all clear it would get them even at 60 cents on the dollar, let alone the 55 cents.  We were ready for wait for months of tedious and acrimonious negotiations (think: Argentina). Instead, it was just a few days within which Belize didn’t just hit 75%, but got to near 85%.

How did hard-hearted lenders become coral reef loving softies? Below are a few possibilities.

First, the articles in the financial press, all excited about this innovative deal, created an atmosphere where no one wanted to be left out.  If this was the cool deal of the summer, no one wanted to be the guy who voted against it and yet was forced to go along.

Second, Belize added in a small financial incentive at the margin for the creditors who voted yes. This was but a few cents, unlikely to sway the vote of hard-hearted creditors.  But, in the context of a feel-good deal, it may have mattered.

Third, investors liked the fact that some portion of the recovery was going into a program that would help the country enhance a key natural resource that, in turn, would help future revenues and debt sustainability.  Maybe saving the coral reefs made business sense.

Bottom line: Belize managed to get more votes and a higher financial recovery by making credible promises to do more for the environment. Question is whether this magic can be reproduced for the other countries that are potentially next in line given how hard they have been hit by covid-19 (Sri Lanka? Maldives?). The Belize deal, involved a single bond, was small ($525 million), and The Nature Conservancy is funding a full buyback. That structure might be hard to reproduce for a country with multiple bond issues. The said, the need for serious conservation projects in places like the Maldives and Sri Lanka is as urgent as it gets.

What about other countries that are in desperate need of restructuring assistance like Lebanon and Ethiopia?  We are less optimistic here.  Given their track record and current political situation, it is hard to see how either of these nations makes a credible commitment to do enhanced environmental preservation or something similar on the social or governance fronts in exchange for debt relief.  We also hear through the rumor mill that Ecuador tried something similar in its recent restructuring and investors did not bite.

Note: The deal is not yet done. The Nature Conservancy, now that the creditor votes are in, still has to raise the necessary funds on the debt market to pay for the buyback (the "blue bond" issue).  This is another interesting part of the deal that deserves attention in and of itself for those of us who think this deal structure might be worth reproducing. More on that later though.

Comments

While this restructuring is appealing on the surface, it is not clear to me (after reading what I can find in the press) what this means for the investment industry. The 5 cents is huge and certainly worth more than the short-term PR benefit. I am curious as to what this means with respect to the fiduciary obligation and governance mechanism of the investing firms. I was also disappointed to see so little discussion of TNC's role and the terms of the deal. In order for this to be a replicable tool, incentives need to be aligned all around.

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