The Belize Sovereign Debt Restructuring
Right in time for the 2022 Annual Meetings of the International Monetary Fund and the World Bank Group, the IMF issued its Global Financial Stability Report, which, in Chapter 2 under the heading Scaling up Private Climate Finance in Emerging Market and Developing Economies: Challenges and Opportunities, discusses the significant need of economies in the Global South for financing to mitigate and adapt to climate change.
The report is a rare treasure that warrants in-depth analysis and discussion as it draws a very nuanced picture of public and private capital as the forces driving the development of a green/blue economy, conservation or the cleanup of past sins. For observers unsurprisingly, in press coverage and academic discussions, however, often only mentioned in passing, if at all, the IMF states that public and quasi-public institutions have de-risked certain financial instruments to attract private capital for, for example, conservation projects and will have to do even more of this in the future. The IMF assigns a key role to multilateral development banks and development finance institutions in containing climate change and combating its effects.
Let’s look at the 2021 restructuring of Belize’s eurobond as an example of a development finance institution de-risking financial instruments and discuss some of the implications. The remainder of this post describes the key terms of Belize’s “debt for climate swap,” explains why it was rational for eurobond holders to agree to the deal and suggests some preliminary big picture conclusions.
Situation in Belize in 2021
Belize, the home of 30% of the Mesoamerican barrier reef, one of the world’s most treasured marine areas, had already restructured its eurobond issued in 2007 three times when it approached its bondholders with a forth restructuring proposal in 2021. Among other things, the Covid-19 pandemic and natural disasters had caused Belize to default on interest payments under the eurobond. Specifically, the restructuring, also referred to as a “debt for climate swap,” had three components: a restructuring of Belize’s eurobond due 2034, a new financing and Belize’s commitment to conservation.
First Component: The Restructuring of Belize’s Eurobond
Belize’s eurobond amounted to US$552.9 million, including capitalized unpaid interest, and made up approximately 27% of its public debt in 2020. Under the terms of the restructuring, the bondholders agreed that Belize’s obligations under the eurobond would extinguish in exchange for a cash payment of approximately 55 cents on the dollar. The 45% haircut was exceptionally high by comparison to the market. In similar restructurings, bondholders often see the maturity of their bonds extended and the interest rate lowered rather than a cash payment being offered. Belize’s external bilateral and multilateral debt, which made up approximately 42% of its public debt in 2020, remained untouched under the terms of the restructuring.
Second Component: The Blue Loan
To attract the funding necessary to buy out Belize’s bondholders, The Nature Conservancy (“TNC”), an NGO based in Virginia, set up the Belize Blue Investment Company (the “BBIC”), a special purpose vehicle incorporated in Delaware, an investor-friendly jurisdiction. Credit Suisse Group AG (and/or its affiliated entities, “Credit Suisse”) lent US$364 million (“Blue Loan”) to the BBIC, which the BBIC lent on to Belize, which used the funds to buy out its bondholders and to fund a newly set up conservation trust. The parties employed a non-recourse structure, which entitles Credit Suisse to repayment only from the BBIC and not from any other assets of Belize.
The United States International Development Finance Corporation (the “DFC”), a development finance institution and agency of the United States federal government, provided political risk insurance in an amount of US$610 million to the BBIC. While the details of the insurance cover provided are not publicly available, what is typically understood under the term “political risk insurance” is, among other things, coverage against arbitral award default and denial of justice protecting the insured, here BBIC and ultimately Credit Suisse, from non-payment of an arbitral award by a host country government, here Belize. As a result of the insurance cover, the Blue Loan received an Aa2 rating by Moody’s, which is the third highest long-term credit rating Moody’s assigns to high-quality fixed income securities with very low credit risk. By way of comparison, Belize’s eurobond was rated CCC or in default.
Stakeholders publicly discussing the deal indicated that the terms of the Blue Loan were significantly more favorable to Belize than the terms of its eurobond, including a lower interest rate and a maturity date stretched out beyond 2034, the maturity date of the eurobond. According to TNC, having replaced the eurobond with the Blue Loan, Belize will save US$54 million in debt service in the five years following the restructuring.
Third Component: Conservation
Belize also entered into a conservation agreement pursuant to which it is obligated to work with TNC and local stakeholders, such as, for example, fishing associations and tourism boards, to develop a marine spatial plan pursuant to which 30% of Belize’s land and sea shall be under some form of conservation by 2030 and to set up a conservation trust. Having replaced its eurobond with the Blue Loan, Belize has the fiscal space to fund the conservation trust with the equivalent of U.S.$ 4.5 million p.a. (to be paid in local currency). The mandate of the conservation trust will include, for example, coral reef protection, mangrove rehabilitation, improvement of the management of fisheries, treatment of wastewater or the hiring and training of guards for the conservation areas. To comply with its mandate, the conservation trust will fund local projects dedicated to these causes. TNC will support the conservation trust in its work on an ongoing basis.
The Blue Loan and the conservation agreement are linked through a cross-default clause. If Belize defaults on its obligation under the conservation agreement, it will automatically also enter into default on the Blue Loan, and Credit Suisse will, under certain conditions, be able to accelerate the Blue Loan. The cross-default clause incentivizes Belize to comply with the conservation agreement.
A Chain of Conditions Linked the Three Components of Belize’s “Debt for Climate Swap”
A chain of conditions linked the three components of Belize’s “debt for climate swap.” Specifically, the restructuring of the eurobond was conditional, among other things, upon the consent of 75% of the bondholders, which was received in mid-September of 2021. The bondholders’ consent to the 45% haircut was conditional upon Belize obtaining the funds of the Blue Loan and using part of the funds to prefund a conservation endowment account with US$23.4 million that were to be dispersed to the conservation trust once it had been set up. Similarly, the Blue Loan was conditioned upon Belize entering the conservation agreement.
If any of these conditions had not been met, or not been met on time, Belize’s “debt for climate swap” would have likely fallen through. The chain of conditions put the stakeholders on a tight negotiation schedule and made the transaction a very complex endeavor. In essence, once an agreement in principal with the bondholders was struck, the bondholders’ consents to the restructuring had to be solicited in a public consent solicitation process and their bonds had to be tendered in a publicly launched and announced tender offer. In the meantime, the Blue Loan was negotiated, including the political risk insurance cover by the DFC while, at the same time, the conservation agreement was negotiated and documented with the input from the TNC.
Why did Bondholders Participate in the Deal?
Unsurprisingly, approximately 84.3% of the bondholders, among them renown emerging markets and sovereign debt investors like Greylock Capital Management, LLC, Aberdeen Standard Investments, Grantham Mayo van Otterloo & Co LLC and Vontobel Asset Management, consented to the restructuring of Belize’s eurobond. In addition to Belize’s commitment to conservation, there were at least four “conventional” economic reasons for the bondholders to consent to the debt restructuring of Belize’s eurobond.
First, for much of the first half of 2021, Belize’s eurobond traded at approximately 40 cents on the dollar and only when an agreement in principal on the restructuring among the principal stakeholders became more likely, its market value increased but never rose to 55 cents on the dollar as offered to bondholders in the restructuring. This makes the restructuring a bargain for the bondholders.
Second, the IMF’s latest debt sustainability analysis made clear that Belize’s fiscal position has been and continues to be extremely fragile—even with the breathing room granted by the “debt for climate swap.” In the past, approximately 40% of Belize’s GDP was generated by tourism, revenue that is highly dependent on the recovery from the pandemic. Belize is particularly exposed to exchange rate shocks since 69% of its debt is denominated in foreign currency, as well as to natural disaster and climate change related risks given, for example, its hurricane-prone geographic location. The IMF’s baseline assumption, an adjustment of the primary balance from -8.4% of GDP to 0.8% of GDP, requires drastic fiscal consolidation and structural reforms as well as debt restructuring, which may not be politically acceptable to Belize’s electorate. Against this background and taking into account that Belize has restructured its debt four times since the early 2000s, a further restructuring of the country’s debt does not seem completely unlikely and bondholder may have considered themselves lucky that they were bought out as part of the “debt for climate swap.”
Third, cash is king! In similar restructurings, bondholders saw the maturity of their bonds extended and interest rates lowered rather than a cash payment. The value of any dollar received today is greater than the value of any dollar expected to be received tomorrow. So no wonder that bondholders were up for the deal.
Fourth, the transaction was structured, among other things, as an “exit consent,” which provided bondholders with an additional incentive to consent to the haircut. Pursuant to the “exit consent,” Belize’s offer to repurchase the outstanding bonds (term of art: tender offer) for a payment of 55 cents on the dollar was combined with the solicitation of consents to certain amendments of the indenture governing the eurobond. Such amendments would allow for the “forced repurchase” (term of art: redemption) of the eurobonds of any bondholders who had not tendered their eurobonds, for a payment of only 52 cents on the dollar, i.e. 5.5% less than under the tender offer. Anybody accepting the tender offer automatically consented to such amendments. It was impossible to accept the tender offer and, at the same time, to disagree with the amendments. Under the exit consent structure, there was an incentive for all bondholders to tender their bonds: Because bondholders did not know how many of their peers would accept the tender offer and therefore consent to the indenture amendments, they had to assume that there was a real chance that they would be forced out of their positions at 52 cents on the dollar, which would have implied a haircut of 48% rather than the more favorable 45%. In short, the assumption that not accepting the tender offer would make bondholders holdout creditors who may potentially receive payment in full after a long, protracted legal battle, was not a certainty but its probability had to be weighed. Under these circumstances, accepting the 45% haircut became a relatively lucrative option.
Why Did Credit Suisse Finance the Blue Loan?
If the bondholders were lucky to get bought out, why did Credit Suisse finance the Blue Loan? Put in simple terms, unlike the bondholders, Credit Suisse is not exposed to Belize’s default risk but to the default risk of the DFC, which is virtually zero given that the DFC is backed by the full faith and credit of the U.S. government. As a result of the political risk insurance granted by the DFC, Belize received access to a part of the global capital markets, which was previously unavailable to it and where financing is available at much more favorable conditions.
The Bottom Line: Some Preliminary Big Picture Conclusions
Here are a few thoughts on the bottom line, at this time, in no particular order.
From a technical perspective, the Belize deal is an extremely complex transaction that connects multiple parts that could each well be standalone transactions through conditionality. For all transaction parts to interlink smoothly, the sovereign, creditors, TNC, DFC, Credits Suisse as well as other stakeholders and all advisors had to work extremely hard.
TNC facilitated the “debt for climate swap,” which would likely not have been possible without TNC’s involvement. Belize’s “debt for climate swap” is part of a larger program TNC set up under the name “Blue Bonds for Ocean Conservation Program” and which was already used in the Seychelles’ sovereign debt restructuring in 2015. Under the program, a sovereign’s debt is restructured in exchange for its tailor-made commitment to protect at least 30% of is (maritime) area. Because TNC provides scientific support to the sovereign and local stakeholders in identifying goals, creating plans for conserving critical ocean areas, and establishing the policies and regulations needed for implementation, it provides credibility to the sovereign’s conservation commitment and allows for the linking of the financing arrangement and the conservation commitment through a cross-default clause. TNC also has the capacity to bring in stakeholders such as the DFC, advisory expertise and, as in the case of the Seychelles “debt for climate swap,” impact investors. Because TNC’s involvement is customary, “debt for climate swaps’” scalability is likely limited.
Belize’s restructuring led to substantial debt relief of approximately US$190 million (comparing the principal outstanding under the eurobond and the principal outstanding under the Blue Loan) and reduced the cashflow burden on Belize by significantly reducing Belize’s interest payments. However, Belize’s fiscal position likely remains fragile given that the restructuring only related to Belize’s eurobond and not to any of its other foreign debt. In addition, Belize’s revenue from tourism may be volatile (also due to the rising cost of living in many countries), the impact of climate change and/or natural disasters may increase its costs and the rising US$ may erode its ability to service its debt.
One way of interpreting the Belize sovereign debt restructuring is to understand the transaction as a gigantic risk re-distribution. In essence, Belize’s default risk was shifted from the bondholders to the DFC who insures the repayment of the Blue Loan and therefore ensures that Credit Suisse does not carry Belize’s default risk. This interpretation prompts further queries about the mandate and the motivation of the DFC and how the DFC will ultimately manage the risks it insures.
One may also find that Belize’s “debt for climate swap” illustrates that, in the capital markets, there are currently two types of investors, investors who are and who are not prepared to take on the risks related to conservation, climate change and natural disasters. Investors who are prepared to take on these risks are predominantly public actors, i.e., entities that are government backed. At least two questions follow from this: (i) How to adequately price climate risks? (ii) Is it sufficient to assume that public investment will eventually crowd in private capital or are private sector investment criteria along the lines of conventional profit maximization no longer legitimate and, if so, are there credible alternatives?
The terms of the conservation agreement and of the political risk insurance are not publicly available. Among the open question of particular interest remain, how exactly is Belize’s compliance monitored by the TNC, what amounts to a default, an event of default or a cross-default, could a newly democratically elected government withdraw from the arrangements and, if so, how would the principle of “pacta sunt servanda” be enforced?
Maria C. Schweinberger