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

Featured Sponsor

Store	Link	Sample Product
UK Artful Impressions	Premiere Etsy Store

The UK’s largest asset manager, Legal & General, backed a historic Ecuadorian debt deal, in a sign of growing investor interest in swaps that reduce countries’ interest payments while raising money for conservation. ‘environment.

A unit of Legal and general investment management it raised $250 million of the record-breaking Galápagos deal in May – the largest so-called debt swap by nature – making it the biggest key investor in the deal, he told the Financial Times.

The transaction allows it Ecuador to exchange $1.63 billion of dollar-denominated bonds for a $656 million loan at much lower repayment rates, under the condition that the country devotes some of the money it has saved to environmental conservation.

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

Debt swaps by nature have traditionally been brokered by governments and non-governmental organizations, but Credit Suisse – which began arranging this transaction before its recent purchase by UBS – structured swaps for Belize in 2021 and Barbados last year. , valued at $364 million and $146.5 million, respectively.

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

“Part of our plan . . . it’s that we’re in debt-by-nature exchanges like this all over the world. It could become a pretty significant part of our strategy as long as the risks build up.”

Ecuador’s deal will save the Andean nation $1.13 billion in reduced debt-service costs, according to Credit Suisse, while Ecuador will spend $323 million 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 a marine conservation endowment.

A credit guarantee from the Inter-American Development Bank and insurance from the US International Development Finance Corporation that protects against disruption related to government interference or political violence keep the risk low, Harper added.

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

“You may be wondering why a retirement fund would want to invest in an asset class like this,” Harper said. “We are asked internally, are we just lending money to a sovereign to restructure debt?”

However, Moody’s gave the new debt an Aa2 provisional investment grade credit rating – the third highest – and 16 grades above Ecuador’s Caa3 junk rating. Ecuador’s sovereign bonds yield about 22%, while the new bond, which will last until 2041, has a 5.6% coupon. There is a seven year grace period on principal refunds.

In Ecuador – where the Galápagos Islands are a symbol of national pride – the news was met with headlines that briefly competed with a political crisis in which the president called a snap election after facing impeachment charges. “Our currency is biodiversity,” Ecuadorian foreign minister Gustavo Manrique, who worked on the deal while formerly minister of the environment, told the FT.

Most, but not all, Ecuadorian bonds have been placed, mainly with pension funds, insurance companies and asset managers. A number of other countries are eager to make such deals and hope interest in Ecuador’s deal signals growing investor demand.

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

Arosemena said the government was pursuing a debt-for-nature swap involving corridors in the Amazon rainforest. Such a deal would involve “keeping oil in the ground in certain areas and monetizing that action for conservation,” she said.

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

But some remain skeptical of the benefits of such deals. Credit Suisse’s new owner, UBS, has yet to contribute to the biodiversity-themed debt experiment spearheaded by its former rival.

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

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

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

Critics also point out that only a fraction of the savings from debt service is channeled towards retention in this type of arrangement.

“My main concern is that the numbers suggest a significant transfer of marine conservation assets, when in reality those sums are relatively small on an annualized basis,” said Graham Stock, senior emerging markets sovereign strategist at RBC BlueBay Asset Management.

Climate capital

Where climate change meets business, markets and politics. Explore the coverage of the FT here.

Are you curious about the FT’s environmental sustainability commitments? Learn more about our science goals here