Carbon markets stand out as potentially one of the most needed and effective tools to help finance the global economy’s decarbonization efforts. However, their growth trajectory has not matched expectations. There is capital available to for investment in voluntary carbon credits that can support nature or technology-based carbon reduction and removal strategies, but Karen Fang, Managing Director and Global Head of Sustainable Finance at Bank of America, identified two primary headwinds which have slowed the growth of this product.
One reason, often overlooked and under-discussed, is the scrutiny faced by investors from media, stakeholders and civil society. Investors have faced accusations of greenwashing when investing in carbon offsetting projects to net against their carbon emissions, according to Fang.
The optimism witnessed by the market in 2021 was followed by a decline, reflecting investor disenchantment. Despite their support for carbon offsetting initiatives, investors felt scrutinized and criticized, she said.
The second reason cited is the absence of global standards governing quality, reporting and end use for voluntary carbon credits. The key bottleneck is the lack of clarity on what is in line with current best practices outlined for buyers and sellers, as well as a well-respected, neutral governing body that can provide final certification for the validity of the carbon credits. “We need a global body, maybe a well-respected NGO, or MDB supported by a large group of governments to bless it,” Karen Fang said.
The world is sorting out what are best practices. “We are in a sort of analysis paralysis that dampened market growth,” she added.
Market statics show that voluntary investments are crucial in the decarbonization equation. Sectors like steel, cement, aviation, shipping and road freight will not be able to cut emissions at the speed required. They account for 25% of today’s carbon emissions and have the potential to rise 50% by 2050 Given the lack of technology available today for these sectors to decarbonize they will need to invest in carbon reduction, avoidance and removal outside of their operations, to compensate their emissions.
Leveraging existing tools while focusing on Innovation
Highly sophisticated financial instruments might not be needed to attract capital to activities such as energy transition or climate finance in Latin America. Karen Fang believes that it is more a matter of developing pipelines of investible projects coupled with effective de-risking to scale capital mobilization where it is needed.
This is the consensus reached at many of the workstreams and taskforces where executives from both the public and private sector participate, such as the World Economic Forum, Sustainable Markets Initiative, the B20, and the UN Global Investors for Sustainable Development. It is a matter of amplifying the scale of projects at the company and project levels. The problem statement is clear: “It is about how to crowd in more private sector capital, in partnership with public sector and philanthropic capital, that can be directed towards environmental and social sustainability.”
Money fails to reach sustainable projects in emerging markets due to “typical risk factors,” Karen Fang points out. These include political, credit and currency risks, which are challenging to address but do not necessarily require the introduction of extraordinary new financial instruments to mitigate them.
Latin America has things going its way. “In general, Latin America is politically stable, and some countries have a solid framework of enabling policies and legal protections for investors,” she described. The region shows good GDP growth, and is rich in natural resources and potential decarbonization opportunities.
“While currency and political risks do exist,” Karen Fang said, the region could leverage its green credentials and further establish itself as a hub for climate investments. Additionally, its substantial wealth of nature resources can be utilized, “in an inclusive and socially additive way.”
The strategy, therefore, entails amplifying company and project level initiatives on the global stage. In this endeavor, multilateral development banks and development finance institutions emerge as obvious partners, she noted.
Debt for nature swaps: the template is in place
Debt-for-nature swaps represent one of the newer tools that is addressing the debt, climate and biodiversity crisis many emerging market countries face. “This is an instrument particularly well suited for countries with a heavy debt burden, a condition that oftentimes leads to biodiversity and social crises.”
In May, 2023 Ecuador completed a $1.6 billion swap. The deal, which secured cheaper financing, is expected to generate lifetime savings of $1.12 billion. This will enable Ecuador to allocate approximately $12 million per year towards the conservation of the Galapagos Islands.
In August 2023, Bank of America, led the first-ever debt-for-nature transaction in Continental Africa to refinance $500 million of sovereign debt of the Gabonese Republic. Through political risk insurance provided by the U.S. International Development Finance Corporation, the issuance was able to receive an Aa2 investment grade rating, attracting a diverse group of investors allowing the country to extend the tenor of their debt to 15 years and lower their interest payments. Gabon is using the savings to contribute $125 million in new funding for nature and ocean conservation, supporting its commitment to protect 30% of its lands, freshwater systems and oceans by 2030.
These successful deals entail governments collaborating with multilateral banks and development finance institutions to restructure sovereign bonds, as noted by Karen Fang. In the case of Ecuador and Gabon, for example, the U.S. International Development Finance Corporation (DFC) provided political risk insurance for the restructured bonds which were subsequently placed into global capital markets. Fang emphasized the potential for greater involvement from G7 nations and its development finance arms in facilitating such deals.
Ecuador and Gabon provide the template, and the objective should now be to replicate those efforts, according to Karen Fang. Importantly, these initiatives align with the interests of advanced economies as well. “Restructuring high-interest debt while preserving nature is globally appealing,” she remarked.
“With the framework in place, plain vanilla green, blue or debt for nature bonds can be extended in several directions, to finance conservation and adaptation,” she added.
At COP 28 in Dubai, Fang noted that “conservation, prevention and adaptation are cheaper than disaster relief.”
