In recent years, conservation organizations such as Conservation International (CI) have been actively engaged in creative financial engineering techniques to raise funds for biodiversity conservation programs throughout the world. The opportunities afforded by programs to restructure sovereign debt owed to private commercial banks, along with public debt restructuring programs supported by inter-governmental debt reduction initiatives have increased the momentum and sophistication of these creative financial techniques. The latest innovation in conservation finance has been the creation of offshore dollar-funded trusts to endow national parks. At the urging of U.S.-based and other non-profit conservation organizations, the recently established Global Environmental Facility (GEF), and certain bilateral donors, have begun to experiment with using trust funds as a tool to provide for long term biodiversity conservation.
I. Debt for Nature Swaps Involving Commercial Bank Debt
One popular technique is the Debt for Nature Swap. The concept of this transaction is as follows: A conservation group such as CI wants to mobilize funding for large-scale and long-term conservation efforts around sites of unique and remarkable biodiversity in countries throughout the world. The organization purchases debt owed to a private commercial bank by a subject country's government at a discount from face value. In many cases this debt is held by the commercial bank in its trading portfolio. A lot of this debt has been securitized in recent years into a bond rather than a loan, carrying a coupon rate of interest and with a fixed redemption date and amount. This occurred in the 1980's under the terms of the Brady Plan for restructuring of LDC debt.
The banks buy and sell these bonds among themselves or carry it in their inventory. Because the country whose debt has been securitized may not have a good track record paying its international debt obligations, the bonds may trade at a major discount to face value. In turn, this enables the organization to purchase the bonds at a discount from the commercial bank or broker selling them. Depending on the country involved, the discount can be substantial.
The purchasing organization then legally cancels the debt obligation owed by the host country government, in return for that government issuing local currency or securities domestically within the host country at a greater equivalent value than the discounted value at which the bonds were originally purchased. This local currency, or in the case of the bonds, the income therefrom, is used to fund the operations of the organization in that country. In some (but not all) cases, the value of the local currency or bonds issued will be equal to the full par value of the bonds purchased by the organization from the commercial bank. The difference between the discounted price paid on the secondary market and the higher amount redeemed in local currency is the "conservation premium" awarded by the country in benefit of the conservation program approved.
For example, CI may wish to fund conservation programs in Mexico. It purchases Mexican Brady Bonds (Discount Bonds) from Citibank in New York, paying $US 750,000 for $1 million of debt (i.e. supposing the debt trades at about a 25% discount from face value). Under a pre-negotiated debt conversion accord, CI then goes to the Ministry of Finance in Mexico and cancels the debt in exchange for the issue of the equivalent of $US 1 million worth of Mexican pesos to CI's affiliate in Mexico, to fund biodiversity conservation projects jointly developed and approved by Government and local non-governmental organizations there.
All parties benefit from the transaction. Citibank, the seller of the bonds, disposes of debt it no longer wishes to carry on its books, and earns fees and commissions through its trading activities. CI benefits because it has available $1 million worth of local currency to fund biodiversity conservation programs for which it has raised $750,000 (in effect a "conservation match" of $250,000). …