Barclays Warns of Greenwashing Risk in ESG Debt-Swap Market

As emerging-market countries explore the option of debt relief in exchange for commitments to preserve nature, researchers at Barclays Plc say that some of the labeling smacks of greenwashing.

According to Barclays analysts Charlotte Edwards and Maggie O’Neal, heavily indebted countries can reduce debt and interest burdens by directing resources towards conservation projects that support overarching nature-related goals. However, the analysts note that tackling debt burdens and climate goals together is not always ideal.

According to Edwards and O'Neal, there is evidence that the amount of money that goes toward the nature conservation goal attached to such deals is only a small fraction of the transaction size. This means that the products are "misleading" in their packaging.

The market for debt-for-nature swaps is potentially huge, with estimates suggesting that it could be worth over $800 billion. However, some analysts are now calling for greater scrutiny of such deals, in order to ensure that they are truly effective.

After lying dormant for more than two decades, the debt-for-nature-swaps market has enjoyed a revival as the finance industry explores all forms of environmental, social and governance strategies to boost ESG metrics. Such programs also offer debt relief to countries that are both poor and disproportionately exposed to the ravages of climate change.

This revival is due in part to the increasing awareness of the importance of ESG metrics, as well as the need for debt relief in developing countries. These programs offer a win-win solution for all involved, and it is hoped that they will continue to grow in popularity in the years to come.

Belize has recently restructured $553 million of debt in exchange for pledges on marine conservation. This type of arrangement, led by private investors without the involvement of the group of government creditors known as the Paris Club, is likely to become more common given the "heavy debt burdens and the shared global interest in sustainability," Edwards and O'Neal said.

However, the researchers noted that "allocations to environmental projects can fall well short of amounts saved in debt repayments." They added that "there is also a real risk of greenwashing, especially if funds to repurchase debt are supplied by a third-party funding itself via ESG-labeled bonds."

According to Barclays, a key issue that is often overlooked in reports examining such deals is the amount of money actually channeled into environmental projects.

According to Edwards, environmental funds typically make up only a small portion of the total deal size. In the case of Belize, for example, only $84 million of the $553 million deal was actually allocated to marine conservation, while $86 million went to intermediaries and service providers such as re-insurers, advisers, and credit providers, Bloomberg News reported. In addition, Belize originally disclosed that it would set aside $10 million to help cover the closing costs for the transaction.

This raises questions about the impact of these deals, particularly when each additional party taking a cut from the proceeds. Edwards and O'Neal said that this could have a negative impact on the overall transaction.

We're concerned about transactions where a third-party entity issues bonds labeled as blue, and the proceeds are used as a loan to a debtor government to repurchase debt.

Environmental and debt justice advocates have raised numerous concerns about debt-for-nature swaps. Last month, a group of 31 nonprofits criticized these arrangements for locking public funds into conservation organizations, potentially at the cost of other societal needs including health care and education. There is also a worry that the swaps may jeopardize wider and lasting reforms to debt management.

‍“The risks and pitfalls of turning to financial markets to fund marine conservation are being ignored,” the group said.

Issuers of green bonds are supposed to direct all of the proceeds into environmental projects. However, in some cases the proceeds of these bonds are used to purchase other bonds, only a small portion of which may be used for nature projects.

The end result is that the label is "misleading, possibly making concerns over the quality of the ESG-labeled market worse," Edwards and O'Neal said.