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UK fund giant L&G bets on Ecuador’s Galápagos debt experiment

The UK’s largest asset manager Legal & General has thrown its weight behind a landmark debt deal by Ecuador, in a sign of growing investor interest in swaps that shrink countries’ interest payments while raising money for environmental conservation.

A unit of Legal & General Investment Management snapped up $250mn of the record-setting Galápagos deal in May — the largest ever so-called debt-for-nature swap — making it the largest cornerstone investor in the deal, it told the Financial Times.

The transaction allows Ecuador to exchange $1.63bn of dollar-denominated bonds for a $656mn loan at much lower repayment rates, on the condition the country must put some of the money it has saved towards environmental conservation.

LGIM’s buy-in provides big-name institutional support for an experimental asset class that other developing countries around the world are expected to adopt.

Debt-for-nature swaps were traditionally brokered by governments and non-governmental organisations, but Credit Suisse — which started arranging this transaction before its recent purchase by UBS — structured swaps for Belize in 2021 and Barbados last year, worth $364mn and $146.5mn respectively.

“We like this type of transaction partly because of its inclusive capitalism [theme] and partly because of the returns,” said Jake Harper, investment manager at LGIM.

“Part of our plan . . . is that we are in debt-for-nature swaps like this throughout the world. It could become quite a significant part of our strategy as long as the risks stack up.”

Ecuador’s deal will save the Andean nation $1.13bn in reduced debt service costs, according to Credit Suisse, while Ecuador will spend $323mn on marine conservation in the Galápagos Islands over the next 18-and-a-half years. Much of it will support the new Hermandad Marine Reserve and the existing Galápagos Marine Reserve, while there will be funding for an endowment for marine conservation.

A credit guarantee provided by the Inter-American Development Bank, and insurance by the US International Development Finance Corporation protecting against upheavals linked to government interference or political violence, keep the risk low, added Harper.

Moody’s said the bonds had been sold at “deeply distressed” prices, technically making the swap a “default”.

“You might question why would a pension fund want to invest in an asset class like this,” Harper said. “We do get asked internally, are we just lending money to a sovereign to restructure debt?”

Still, Moody’s gave the new debt a provisional investment-grade Aa2 credit rating — its third-highest — and 16 notches above Ecuador’s junk Caa3 rating. Ecuador’s sovereign bonds yield about 22 per cent, while the new bond, which will run until 2041, has a 5.6 per cent coupon. There is a seven-year grace period on principal repayments.

In Ecuador — where the Galápagos Islands are a symbol of national pride — the news was met with front-page headlines that briefly competed with a political crisis in which the president has called snap elections after facing impeachment charges. “Our currency is biodiversity,” Ecuador’s foreign minister, Gustavo Manrique, who worked on the deal while previously serving as environment minister, told the FT.

Most, but not all, of the Ecuadorean bonds have been placed, primarily with pension funds, insurance companies and asset managers. A number of other countries are keen to do such deals, and are hoping that the interest in Ecuador’s deal signals growing investor demand.

Ecuador also plans to restructure more of its own debt using this mechanism. “We’re seeing different ways of capitalising on biodiversity,” Pablo Arosemena, Ecuador’s finance minister, told the FT. “We have a portfolio of various projects of this sort.”

Arosemena said the government was pursuing a debt-for-nature swap involving corridors in the Amazon rainforest. That deal would involve “keeping oil below the ground in certain zones, and monetising that action for conservation”, he said. 

Gabon, Sri Lanka and Colombia have previously also said they are considering similar deals. The Nature Conservancy, a US non-profit that worked on the Belize and Barbados deals, told the FT it was in talks with dozens of countries it considers good candidates.

But some remain sceptical of the benefits of such deals. Credit Suisse’s new owner UBS has not yet thrown its own weight behind the biodiversity-themed debt experiment spearheaded by its former rival.

“It’s clearly not a silver bullet,” said Frederic de Mariz, head of ESG at UBS in Latin America. “My main concern is how you make this scaleable, and make sure we don’t combine one topic, which is debt restructuring, and another topic, very different, this payment for nature services.” Mariz added that there was a “limited pool of money” from investors willing to give up financial returns in exchange for a nature-based return.

Farnam Bidgoli, managing director and global head of ESG solutions at HSBC, said the London-based lender was in “active conversations” about structuring its own debt-for-nature swaps, in markets where it already has relationships with government debt issuers and creditors.

But she warned that high transaction fees paid by the issuer meant the terms could be less favourable than traditional debt relief measures such as concessional loans. “From a government perspective this would not be your first option.”

Critics also point out that only some of the savings from debt servicing are funnelled towards conservation in this type of deal.

“My main concern is that the headline numbers suggest a meaningful transfer of resources for marine conservation whereas in fact those sums are relatively small on an annual basis,” said Graham Stock, senior emerging market sovereign strategist at RBC BlueBay Asset Management.

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