Faced with escalating climate and biodiversity crises, developing economies are innovating with new ways to link bond issuance with sustainability goals. This brings risks and opportunities for investors, say Liam Spillane and Emilia Matei.

Read this article to understand:

  • The drivers behind the rise in green, social and sustainability (GSS) bonds
  • How sustainability-linked bonds (SLBs) and sustainable debt swaps work
  • The key considerations for investors

Located 900km west of Ecuador in the Pacific Ocean, the Galápagos Islands host one the planet’s most important ecosystems. Giant tortoises drag their shells through volcanic dust. Sea lions and marine iguanas flit through coral reefs in the azure waters offshore.

Although the archipelago is a UNESCO World Heritage Site, it is under increasing threat from climate change and pollution. But in May 2023, the Ecuadorean government partnered with investors and multilateral organisations on an innovative scheme that could help better protect this natural paradise.

Working with The Inter-American Development Bank (IDB) and the US Development Finance Corporation (DFC), Ecuador was able to buy back $1.6 billion of government bonds and issue a new “blue bond” at a more affordable rate of interest. Some of the money saved on debt repayments – around $323 million – will be used to finance conservation efforts in the Galápagos over the next two decades, including a new marine reserve.

As a condition of the deal, the Ecuadorean government agreed to ongoing environmental and social impact assessments and to engage with local stakeholders, such as local fishing communities. Political-risk insurance from the DFC and a credit guarantee from the IDB, which ensured the new bond had an investment-grade rating, helped boost the appeal of the deal to investors.1

The rise of sustainability bonds

Ecuador’s deal, the largest “debt-for-nature swap” on record, illustrates a growing trend. While they remain niche in the context of the $110 trillion global debt market, recent years have seen a rise in the number of sustainability bonds from governments of developing economies.

When the pandemic hit, emerging markets suffered a substantial shock

“COVID-19 was a key catalyst,” says Liam Spillane, head of emerging-market debt (EMD) at Aviva Investors. “When the pandemic hit, emerging markets suffered a substantial shock as international trade flows dwindled and tourism revenues plummeted. Rising debt left these nations with less fiscal room to invest in sustainable-development projects, which led them to explore alternative financing options.”

Research from the World Resources Institute finds developing economies had to redirect funds away from climate adaptation and mitigation efforts due to pandemic-related pressures.2

The result is that the financing gap to meet the United Nations’ Sustainable Development Goals (SDGs) in poorer countries has grown 56 per cent since the pre-COVID period, to $3.9 trillion, even as the climate and biodiversity crises have become increasingly urgent.3 With global institutions looking to invest in projects aligned with the SDGs and other environmental, social and governance (ESG) objectives, there is now both a growing need for capital and an investor base willing to provide it.

All of which helps explain why green, social or sustainability (GSS) bonds, also known as thematic bonds, have become increasingly popular, with issuance rising on average 80 per cent annually since 2014 (although issuance dipped amid the market turmoil of 2022, as Figure 1 shows).4

If SLBs are backed up by action plans and KPIs to achieve sustainability targets, they can be a compelling option for issuers and investors

“There are various different forms of thematic bonds,” says Emilia Matei, ESG analyst for EMD at Aviva Investors. “They can take the form of ‘use-of-proceeds’ bonds – such as green or blue bonds issued to raise financing for specific environmental projects – sustainability-linked bonds (SLBs), whose deal terms incorporate pre-agreed sustainability key performance indicators (KPIs), and ‘debt-for-nature’ or ‘debt-for-climate’ swaps, predicated on the reduction of sovereign debt in exchange for the issuer’s investment in sustainability schemes.”

Matei points out the market has differing views on these instruments, with traditional use-of-proceeds bonds often preferred.

“As SLBs do not tend to be linked to specific projects or initiatives, it is sometimes argued they are not as powerful as use-of-proceeds bonds. We disagree: if they are backed up by action plans and KPIs to achieve sustainability targets, SLBs can be a compelling option for issuers and investors.”

Figure 1: GSS bonds from EM sovereigns, 2016-2022 (US$ billion)

GSS bonds from EM sovereigns

Source: World Bank, 2022.5

EM innovation

While developed-market governments and companies still dominate this market (see “Everybody wants one: Are sustainable bonds the new smartphones?”), several EM sovereigns have successfully issued GSS bonds. And they are exploring options beyond traditional green bonds as they aim to tailor debt issuance to their own circumstances.6

In 2021, Benin issued a 14-year, €500 million Eurobond to raise financing for social and environmental projects explicitly aligned with the SDGs. The West African nation reports annually on its use of the proceeds, which have been allocated to initiatives ranging from new infrastructure to boost drinking-water supplies to the provision of free malaria treatments to poorer citizens.7

Other, larger EM issuers are experimenting with SLBs. Take Chile, which has issued $33 billion in GSS bonds since 2019 and last year developed a new SLB framework under which issuance can be linked to environmental and social outcomes.8

In March 2022, Chile issued a $2 billion SLB with a maturity of 20 years. The bond had two KPIs: the country pledged to emit no more than 95 metric tonnes of carbon dioxide by 2030 – making it the first nation to link its sovereign-debt programme to its Nationally Defined Contributions to the Paris Agreement goals – and ensure 60 per cent of its electricity production comes from renewable sources by 2032. If either target is missed, the bond’s coupon will rise by 12.5 basis points (bps); if both are missed, the coupon will rise by 25bps.9

Elsewhere in Latin America, Uruguay issued a $1.5 billion, 12-year SLB in October 2022. The bond’s KPIs were linked to the two principal elements of the country’s sovereign SLB framework – reducing the intensity of Uruguay’s greenhouse-gas emissions relative to GDP and protecting its native forests as measured by total land area.10 The government’s progress against these metrics will be assessed from 2025; as with the Chilean bonds, a step-up in the coupon will result if it fails to hit its targets. Uruguay will pay an extra 15bps penalty for each target it misses, but it will also receive a 15bps discount if it exceeds its targets by a specified amount.11

We actively engaged with Uruguay’s debt management department and climate specialists

Both deals were around four times oversubscribed, with investors – including Aviva Investors, which participated in both issuances – attracted by the clearly defined KPIs and the way the deals were embedded in robust fiscal and climate-transition frameworks.

“In Uruguay’s case, our EMD team actively engaged with the country’s debt management department and climate specialists to understand the ambitiousness of the targets embedded in the SLB framework, and to offer our thoughts on the bond’s valuation,” says Matei.

Figure 2: EM sovereign GSS bonds by issuer, 2022 (US$ billion)

Source: World Bank, 2022.12

Debt swaps

Other, more complex, deal structures, which combine elements of use-of-proceeds bonds, SLBs and debt swaps, are also being explored by smaller, more indebted EM issuers.

The Seychelles led the way in 2016, when the island nation worked with the World Bank and environmental non-profit The Nature Conservancy (TNC) to restructure debt owed to Paris Club creditors and raise $15 million via a new blue bond for marine conservation.13 Over the following five years, the government was able to use the proceeds to fund the creation of new protected zones where fishing and oil exploration are outlawed – these areas now cover 86 million acres, around 30 per cent of the country’s entire marine territory (up from 0.04 per cent in 2015).14 This created a precedent for a 2021 transaction in Belize, which both restructured the county’s outstanding debt and raised capital for conservation on the basis of pre-agreed KPIs.15

Debt-for-nature swaps are attracting growing interest from investors and multilateral sponsors

Debt-for-nature swaps are often touted as a “win-win”, offering a way to reduce poorer countries’ debt burdens, reduce risks to financial stability and free up capital for vital sustainability projects. As a result, they are attracting growing interest from investors and multilateral sponsors, including the US government and International Monetary Fund (IMF).

In 2022, the IMF published a working paper outlining its plans. It referenced the Belize deal and argued similar debt swaps could help poorer countries on the frontlines of the climate crisis – although it stressed they are “unlikely to provide a universal solution for countries struggling with debt or confronting climate change or nature loss” and must be scaled up dramatically to make a substantial difference.16

Research published by the French central bank in February 2023 questioned the efficacy of debt swaps in many cases, pointing to typically prolonged negotiations between different stakeholders, deal complexity (and consequently high transaction costs) and difficulties in measuring KPIs, especially when related to biodiversity. It also cited the risk countries may effectively be yielding sovereignty to creditors when the latter are given too much sway over fiscal and environmental priorities.17

Despite these challenges, an increasing number of countries see debt swaps as a way to achieve interlinked economic and environmental objectives. In the same month as Ecuador sealed its debt-for-nature swap to protect the Galápagos, Gabon reportedly agreed a $500 million deal that will see TNC buy its outstanding Eurobonds and sell them back to the West African nation at a longer maturity and lower rate of interest. The $5 million saved annually on repayments will be used to invest in coastal conservation schemes.18

Investment implications

Spillane and Matei say new deal structures that broaden the toolkit available to EM countries to issue and manage debt and invest in important sustainability initiatives are welcome. With greater choice comes more scope for countries to tailor debt issuance to their needs, and with it, more choice for investors with their own ESG priorities.

But they point to key principles for investors to consider when assessing GSS bonds from EM sovereign issuers. First and foremost, bonds with sustainability characteristics should be embedded within fiscally prudent and clearly delineated debt frameworks from the issuing governments, as was the case with Chile’s and Uruguay’s SLBs. This is especially important at a time of macroeconomic uncertainty and rising interest rates.

GSS bonds will form part of the financing toolkit for EM issuers and we are committed to working with those issuers

“There is no doubt in our minds that GSS bonds will form part of the financing toolkit for EM issuers and we are committed to working with those issuers to support credible climate transition objectives,” says Spillane. “However, the requirement for fiscal coherence takes on even greater significance for some issuers in a world of higher interest rates.”

To ensure better standards in all areas of the GSS market, issuers should comply with the voluntary principles set out by the Climate Bonds Initiative and the International Capital Market Association (ICMA). The ICMA’s SLB principles stipulate KPIs should be material, relevant and measurable.19

The ICMA principles also emphasise KPIs should be externally verifiable. Because there is limited historical data on the performance of SLBs and other GSS bonds, it is unclear how a country’s failure to meet its targets would affect market appetite for a bond or the reputation of the issuer. This makes transparency based on independent reporting and verification all the more important.

The coupon step-up should also be meaningful. Such is the demand for SLBs that they sometimes command a “greenium” – a discount for the issuer compared with a conventional bond. Academic research from the Swiss Finance Institute shows in some cases this saving can be larger than the potential penalty from missing the KPIs. The result is that the issuer effectively has a “free lunch”, gaining a financial benefit regardless of whether it achieves its sustainability targets.20

While debt swaps have their uses, they must be assessed on a case-by-case basis as macroeconomic instability can erode their effectiveness. The Bank of France report cited the cautionary example of Zambia, which agreed an early form of debt-for-nature swap in 1989 shortly before the steep devaluation of its currency, the kwacha. This exhausted the funds set aside for conservation and negated the purpose of the deal.21

Capacity constraints are a challenge in some emerging markets

With this in mind, greater involvement from the IMF, World Bank and other multilateral organisations would be a positive step, potentially underpinning the feasibility of individual debt-swap transactions, especially where they involve the issuance of new bonds, and enabling a broader range of investors to participate.

“Sovereign thematic bond issuances require collaboration among multiple government departments and institutions – and often external stakeholders too – to develop strong sustainable finance frameworks,” says Matei. “Capacity constraints are a challenge in some emerging markets, especially frontier markets. International financial institutions such as the World Bank can assist with capacity building.”

Engaging for positive action

Investing in sovereign GSS bonds is not the only way for investors to contribute to the achievement of social and environmental goals. Engagement with governments can help to curb damaging practices – Aviva Investors has engaged with the Brazilian government to act on deforestation, for example.22 Alignment of investment strategies with ESG factors can help mitigate climate and other material risks.

GSS bonds can offer a useful way for investors to achieve financial objectives

But when complemented by these approaches, Matei and Spillane argue GSS bonds can offer a useful way for investors to achieve financial objectives while contributing to positive environmental and social programmes, from the fragile ecosystems of the Galápagos to Uruguay’s ancient forests.

“Properly structured and managed, a growing GSS bond market could enable greater transparency, raise capital for a just climate transition, and align investors and governments on the path to a more sustainable future,” says Spillane.

Glossary: An ABC of sustainable EM debt issuance

GSS bonds: Green, social and sustainability-linked bonds, an umbrella term for a range of securities that also aim to deliver social or environmental outcomes.

Green bonds: Bonds issued to raise capital for environmental projects. These are typically “use-of-proceeds” bonds, but the term can also refer to securitisation, covered bonds and loans.

Blue bonds: Similar to green bonds, they are intended to raise capital specifically for marine projects, such as sustainable fisheries or coral-reef conservation schemes.

Sustainability-linked bonds (SLBs): Bonds whose payment terms are linked to the delivery of specified sustainability-related KPIs. They typically include a step-up in the coupon if KPIs are not met.


Debt-for-climate and debt-for-nature swaps: A form of debt renegotiation in which a portion of the debt or interest payment is forgiven in exchange for the issuer’s investment in climate mitigation or adaptation projects or biodiversity preservation schemes.


  1. “Financial close reached in largest debt conversion for marine conservation to protect the Galápagos,” U.S. International Development Finance Corporation, May 9, 2023.
  2. Natalia Alayzya and Molly Caldwell, “Financing climate action and the Covid-19 pandemic; an analysis of 17 developing countries,” World Resources Institute, November 2021.
  3. “Global outlook on financing for sustainable development 2023,” OECD, November 10, 2022.
  4. “Green, social, sustainability and sustainability-linked bonds in developing countries: How can donors support public sector issuances?”, OECD, October 2022.
  5. Farah Imrana Hussain, et al., “Sovereign green, social and sustainability bonds: Mobilizing private sector capital for emerging markets,” World Bank, November 8, 2022.
  6. “Everybody wants one: Are sustainable bonds the new smartphones?,” Aviva Investors, March 5, 2021.
  7. “Benin SDG Eurobonds: Impact report on the July 2021 inaugural issue,” July 2022.
  8. “Chile’s sustainable bond framework,” Ministry of Finance, Government of Chile, November 2020.
  9. “Fitch rates Chile's USD 2042 sustainability-linked bond 'A-'”, FitchRatings, March 8, 2022.
  10. “Uruguay issues the first bond aligned to climate change indicators for 1.5 billion dollars,” United Nations Development Programme, November 16, 2022.
  11. Dominic Webb, “More sovereign SLBs ‘on the way’ after landmark Uruguay deal,” Responsible Investor, October 24, 2022.
  12. Farah Imrana Hussain, et al., “Sovereign green, social and sustainability bonds: Mobilizing private sector capital for emerging markets,” World Bank, November 8, 2022.
  13. Julian Smith, “Wild idea,” The Nature Conservancy, August 31, 2019.
  14. Isabelle Gerretsen, “The deal that saved Seychelles’ troubled waters,” BBC, August 3, 2020.
  15. “How Belize is transforming the Caribbean,” The Nature Conservancy, November 4, 2021.
  16. Kristalina Georgieva, et al., “Swapping debt for climate or nature pledges can help fund resilience,” IMF, December 14, 2022.
  17. Paul Quentin, et al., “Debt-for-nature swaps: a two-fold solution for environmental and debt sustainability in developing countries?,” Banque de France, February 24, 2023.
  18. Natasha White, “Bank of America to lead $500 million debt swap for Gabon,” Bloomberg, May 11, 2023.
  19. “Sustainability-Linked Bond Principles: Voluntary process guidelines,” ICMA, June 2023.
  20. Julian F. Kobel and Adrien-Paul Lambillon, “Who pays for sustainability? An analysis of sustainability-linked bonds,” Swiss Finance Institute Research, Paper No. 23-07, February 8, 2023.
  21. Paul Quentin, et al., “Debt-for-nature swaps: a two-fold solution for environmental and debt sustainability in developing countries?,” Banque de France, February 24, 2023.
  22. Thomas Dillon, “Lean on me: How can bond investors influence government climate action?,” Aviva Investors, March 25, 2021.

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