Corporate "Debt-for-nature" swaps? The time is now!
Deputy Chair of the IFNC, Paul Harris, writes about how new legislation and a growing appetite for impact investing create the perfect backdrop for financial institutions to embrace the new age of sustainability and recalibrate their business models ensuring they are fit for purpose in the coming decades.
The introduction of the EU Non-Financial Reporting Directive (NFRD) next year imposes a range of obligations on companies with over five hundred employees. One of the most interesting aspects is the requirement for companies to report on the environmental impact of their activities and, furthermore, details of how they are mitigating this impact.
These provisions are being introduced at a time when 'Environmental Social and Governance' (ESG) and broader sustainability themes are rapidly ascending the corporate agenda and the attendant investor appetite for transparent, responsible investment is growing exponentially.
Taken together these two elements present the perfect backdrop for financial institutions to embrace the new age of sustainability and recalibrate their business models ensuring they are fit for purpose in the coming decades. Failure to adapt to the new business landscape will inevitably lead to contraction and demise – so even a reluctance to engage with elements of this new paradigm will send out a damning message to investors.
What are debt-for-nature swaps?
One of the ways that the financial community can engage in a meaningful way could be by entering into novel “debt-for-nature” swap transactions. Based on the structures pioneered by the World Wildlife Fund (WWF) in the 1980s, these transactions would see lending institutions enter into bilateral agreements with corporate borrowers to transfer a portion of the loaned amount to a conservation trust for deployment in projects that would repair or enhance natural capital in the country where the borrower is domiciled. Unlike the classic debt-for-nature arrangement, both the borrower and the lender would contribute capital to the conservation trust (with a greater percentage from the latter). The prospect of the conservation trust being able to secure some form of matched funding from impact investors would be good.
Where does natural capital reporting come in?
The imminent arrival of a comprehensive methodology for measurement of natural capital through the Natural Capital Coalition's Protocol means that the ‘performance’ of the conservation trust investments would be discoverable. The Protocol may also be instructive with regard to the size of the initial investment if used to determine the environmental exposures under the NFRD of the respective borrower and lender.
What's in it for financiers?
Why would this be attractive to the parties? From a borrowers perspective the overall indebtedness of the company would be reduced and the company would also be able to meet obligations under the EU Directive. The lender would be able to reduce exposure (freeing up capital to be deployed more advantageously), meet its Non-Financial Reporting obligations and gain expertise in the nascent environmental finance sphere. Both entities would reap brand and reputational dividends under the ESG banner.
What's in it for nature?
The natural capital of the ‘loan host’ country would be boosted with all the attendant macroeconomic benefits. For example, in an Irish context, enhancement of ecosystem services would be advantageous to the agri-food and tourism sectors which are the cornerstones of the economy. Perhaps, because of this value (which would move to repair and enhance rural economies) policy makers may install tax enablers around these transactions to stimulate transaction flow.
This proposal is surely worthy of consideration, particularly as it delivers a win-win-win in a sustainability context not just for now, but for future generations.