When Mia Mottley, the Prime Minister of Barbados, gave a speech on the impacts of climate change at COP26 in Glasgow, she said “failure to provide critical finance is measured in lives”. Akin to canaries in the coalmine, many small developing states are at the frontlines facing the harsh realities of climate disasters – hurricanes, sea level rise, drought, coastal erosion – and without solutions, these communities face an existential crisis in both humanitarian and economic terms.
Beyond the human cost, many tens to several hundred percent of annual GDP can be lost in hours during a climate catastrophe, and it takes years for affected countries to catch up with their lost growth, for households and communities to rebuild, and for individuals to reclaim their livelihoods.
Coastal and island nations have a particular economic reliance on valuable natural assets, which form the backbone of their growing blue economies and flourishing tourism industries. Based on their geographic location, these states have a higher exposure to the damaging effects of climate change, and often face unsustainable debt loads, requiring them to focus on catching up economically, leaving few funds to proactively invest in adaptation to climate change or to conserve and revitalise their natural assets. For Belize, ocean conservation is crucial to the country, with 40% of the economic output coming from tourism, and one in every 10 workers employed in the fishing sector ensuring national food security.1
At the end of 2020, Belize was struggling to service its public debt, which reached US$2.1 billion2. This was around the same time Belize suffered major flooding in the aftermath of Hurricane Eta, while also battling the COVID-19 pandemic. Belize faced an overwhelming challenge. The country needed swift resources for disaster response while still meeting their debt servicing obligations. This is a recurring problem in many developing states that need to reduce their debt burden and invest in their own economies to achieve sustainable development yet are also responsible for carving out a portion of the public budget to manage the aftermath of climate-driven catastrophes. Oftentimes, the sums simply don’t add up, and either debt servicing falls behind or an inadequate response and recovery programme is mounted. Either way, the long-term consequences compound towards catastrophe.
To-date, there have only been partial solutions implemented across Caribbean islands to provide a temporary break from debt servicing in the aftermath of natural disaster impacts. The so-called “Hurricane Clause” was introduced to create breathing space for countries like Belize, designed to lock-in pre-agreed payment deferment covering the crucial period following a natural disaster event, when financing needs are high, revenue is low, and new sources of funding are limited. While deferring payments relieves the immediate needs, it does so at the cost of reducing debt sustainability. WTW sought to find a solution that went further – a risk transfer product that would provide insurance protection to step in and cover regular debt servicing needs after severe hurricane events.
The solution found a launchpad in the form of the Blue Bond for Ocean Conservation debt restructuring effort for Belize which was announced to great fanfare in Glasgow at COP26. The NatureVest team at The Nature Conservancy (TNC) set up the Belize Blue Investment Corporation (BZBIC) - this entity purchased all of Belize’s privately held sovereign debt (over $500 million) via issuance of a blue bond purchased by investors via Credit Suisse. Wrapped into the debt servicing payments that Belize makes on a semi-annual basis across the 20-year term of the bond is the premium for a parametric insurance policy – a catastrophe or “cat” wrapper – designed by leveraging innovative risk analytics and placed by WTW who worked hard to find the best price for Belize in an increasingly competitive marketplace of (re)insurers keen to take on risk via parametric instruments in a development and/or environmental conservation context.
As climate-related natural hazards increase in scale and frequency, the cat wrapper represents a game changing solution for enhancing the financial resilience of island and coastal nations.”Dr Simon Young | Senior Director, WTW Climate and Resilience Hub
How does it work? In the event of a hurricane that meets the parametric trigger criteria, which WTW designed to occur for events likely to do damage that is the equivalent of around 20% (or more) of GDP, the next semi-annual debt servicing payment that the Government of Belize must pay to the BZBIC is waived. The trigger mechanism successfully distinguishes the four largest historical climate catastrophes affecting Belize, and includes not only severe hurricanes, but also multiple hurricanes in the same season as well as particularly wet hurricanes. The waived payment is instead made via the parametric insurance pay-out from Munich Re, the insurer. In this way, the loan terms and duration remain fully intact, while the Government of Belize is free to focus their resources on disaster response and economic recovery for at least six months and up to 12 months.
The blue bond, protected by the cat wrapper (as well as by political risk insurance provided by the US Development Finance Corp.), will unlock around US$180 million over the next 20 years to fund environmental conservation commitments of the Government of Belize. Specifically, Belize has promised to spend roughly $4 million a year for conservation and to capitalize an endowment fund that is expected to grow to over $90 million by 20413. Much of this critical finance will help to build the resilience of the Mesoamerican Reef, which protects much of Belize’s coastline, and whose service underpin much of the country’s economic activity, including the fisheries and tourism sectors. Overall, this debt restructuring with the featured cat wrapper enabled Belize to restructure approximately US$553 million of external commercial debt - an amount that represents 30% of the country’s GDP.
The bespoke parametric solution demonstrates how de-risking debt structures from climate impacts can lower the cost of capital and improve sovereign credit ratings.”Sarah Conway | Director/Team Leader (Ecosystem Resilience), WTW Climate and Resilience Hub
WTW created the world’s first sovereign debt “catastrophe wrapper” for this transaction, which provides insurance protection to cover Belize’s loan repayments after hurricane events. Using innovative risk analytics to underpin this bespoke parametric structure, WTW has demonstrated how the tools and techniques of insurance can be turned to support Environmental, Social and Governance objectives as well as further the conservation goals of developing states. The wrapper around the 20-year sovereign debt structure also strengthens Belize’s financial sustainability and resilience to climate shocks which have previously triggered credit rating downgrades that have exacerbated economic hardship.
A crucial challenge in the climate battle is ensuring that developing countries can afford to implement the policies that will make their countries more resilient to the effects of climate change and contribute to reducing emissions. With climate change putting indebted sovereigns even more at risk to events which will stress economies and test creditworthiness, the Belize Blue Bond for Ocean Conservation demonstrates a new paradigm. Not only can debt refinancing unlock capital for investments in protecting ecosystems so that they can continue to provide critical services to underpin the economy and protect coastal communities, but new insurance tools can successfully de-risk the transactions from climate disasters, protecting both the bond investors and the citizens of Belize.
1 Stubbington, Tommy. Financial Time 2021 https://www.ft.com