“If the misery of the poor is caused not by the laws of nature, but by our institutions, great is the sin.” Ch. Darwin
Globally, many countries face severe debt distress. Increasing vulnerabilities posed by climate change and poverty, require countries to come up with innovative solutions to strengthen public finances, improve accountability and transparency, and adopt sustainable development pathways. Ecuador’s recent debt-swap is explored as a poster child example of ill designed novel policy approaches. Knowledge generated from this policy brief holds lessons for other countries and the international community, as well as private actors seeking to avoid reputational risks.
II. The deal: structure
On May 9, 2023, Ecuador announced a debt swap with the aim to improve the prospects for marine protection in Galapagos. This operation follows the trend initiated in 2018 by Seychelles and followed by Belize (2021) and Barbados (2022). The debt swap will extend the term structure of 1% of Ecuador’s public debt and support fiscal savings over the medium term on a net present value (NPV) basis, while generating a lucrative business opportunity for those who structure and ensure the deal. This deal has been presented as a breakthrough, given the apparent level of savings for Ecuador in the debt buy-back operation, but when looking at the details, the scheme still raises important concerns.
Similarly to the previous operations in Belize and Barbados, the debt swap involves a buy-back of sovereign bonds that were being traded at a significant discount (distressed debt), the issuance of a new so-called blue bond guaranteed by a public institution (IADB and US DFC) and in this case a pool of private insurance companies, the creation of a Special Purpose Vehicle (SPV) and the intermediation of a series of private financial and investment corporations that facilitate, structure and guide the deals (See Figure 1).
As mentioned, the deal encompasses the financial close of a US$656 million Galapagos marine conservation-linked bond with an unknown framework of issuance (The bond). The deal is structured by a private-led for-profit special purpose vehicle (the SPV), GPS Blue Financing Designated Activity Company, established in Ireland. The SPV financed the deal by issuing US$656 million in bonds (i.e., GPS BLUE FINANCING) in a sale arranged and underwritten by Credit Suisse, a private bank. The bond was used to finance a debt buy-back, exchanging US$1.6 billion of Ecuador’s international bonds for an $656 million impact loan maturing in 2041 (the loan). The SPV does that by using bond proceeds to buy back 2.4% of the government’s stock of sovereign debt (5.5% of external commercial debt). Taking advantage of the current political turmoil and instability of the country, under the cash tender offer to existing bondholders conducted by Credit Suisse, US$ 1 billion face value of Ecuador’s 2035 bond were bought at a price of 38.5 cents on the dollar, US$202 million of a 2030 note at 53.25 cents on the dollar and US$420 million of a 2040 bond at 35.5 cents on the dollar. Total debt savings amounts to US$1.1 billion (42% nominal value / 40.5% NPV) through reduced debt service costs.
Under the deal, the SPV lent the proceeds of the blue bond sale (US$656 million) to Ecuador, under partially known conditions. Under the transaction, Ecuador, as borrower, entered into a fixed-rate term facility with SVP, as lender, and The Bank of New York Mellon (BNYM), as facility agent, maturing in 2041, with a 7-year grace period for principal repayments. The payments to be made under the term facility by Ecuador to the SVP are used as reference for the separate payments to be made in turn by the SVP, in its separate capacity as issuer, under the blue bonds.
All of which is requisite upon Ecuador facilitating a private-led conservation programme in the Galapagos Islands. In fact, a core feature of the transaction, the Ministry of Environment, Water and Ecological Transition and the Ministry of Production, Foreign Trade, Investments and Fisheries of the Republic of Ecuador undertook to comply with or achieve certain sustainability commitments by agreed deadlines. These sustainability commitments relate to the management and conservation of the marine reserve surrounding the Galápagos and the growth of the natural capital of the Galápagos Islands and their marine ecosystems.
Ecuador committed to make quarterly payments dedicated to conservation and linked to the debt exchange of initially US$ 4.5 million (average US$5.41 million per annum) to the SVP until 2041, which the lender has in turn committed to contribute to Galápagos Life Fund (GLF), a foreign not-for-profit endowment fund. In addition, a portion of the amounts payable under the corresponding loan agreement (US$12.05 million per annum for 18 years) will be directed to the GLF. GLF will use the proceeds to fund conservation activities through grant awards accessed via a competitive bidding process covering monitoring/surveillance, environmental education, science and economics research, and sustainable tourism development. The Board of the endowment fund is composed of 11 members out of which 6 seats represent private actors including two from Pew Bertarelli Ocean Legacy and Oceans Finance Company (Climate Fund Managers subsidiary) and representatives from local tourism and fishing industry and researchers. Remaining 5 seats are to be allocated among Ecuador’s government. The administrative costs structure of the endowment fund is unknown.
II.a. The deal breaker: the guarantee (credit enhancement)
The US government’s development bank, the International Development Finance Corporation (DFC), provided political risk insurance for US$656 million loan, while the Inter-American Development Bank (IADB) is providing
an US$85 million guarantee to cover the first six quarterly interest coupons, in the event of default, and for certain legal and operating expenses. A group of 11 private insurers is providing more than fifty percent reinsurance to facilitate the deal. Political risk coverage includes breach of arbitration award and the denial of recourse that protects the insured, SPV, BNYM and ultimately Credit Suisse, of the non-payment of an arbitral award from Ecuador. DFC will cede at least 50% of its liability to private insurers. The bond structure allows deferral of principal and interest payments for up to two years after the default of the initial payment under the Fund. This unknown-costs insurance scheme contributed to achieve Moody’s Aa2 rating – solid investment grade credit rating (i.e., 16 levels above other Ecuador’s bonds Caa3 rating). This was key to the issuance of the new blue bond under more ‘favorable’ conditions than other debt issued by Ecuador (5.4% interest rate). However, these favorable conditions do not reflect on the SPV loan to Ecuador. This is different in the DFC-insured Belize case where the blue bonds conditions were transferred to the SPV loan to Belize benefiting from a low interest rate, a 10-year grace period during which no principal is paid.
On the contrary, the loan to Ecuador carries a 11.04% rate whereas the blue bond was issued at 5.4%. This is a difference of 5.50 basis points of spread generating about US$450 million in 18 years. The 450 million are distributed between transaction costs, SPV profit and resources for conservation. The bulk of the resources goes to transaction costs.
Note: elaborated by authors using publicly available data (see BID, 2023). + Author’s calculation. Includes a small portion to be transferred from the SVP to the GLF.
III. Observed performance: Lack of Integrity
Financial integrity describes the characteristics of a financial system that operates in a clean, transparent and accountable way. In fact, illegitimate decisions by high-level officials regarding public assets and strategic resources erode public trust and may contribute to deprive present and future generations of economic opportunities. Moreover, democratic institutions are weakened as well as the capacity of countries to implement critical sustainable development agendas including just climate transition. In this context, debt conversion transparency, fiscal transparency, procurement and contract transparency, and beneficial ownership transparency are prerequisites to financial integrity. However, the observed situation of the deal shows a completely different performance where the country role is limited to act as an observer, accepting a conditional loan, covering costs of IDB guarantee, international private financial and legal advisors and ceding sovereignty.
The critical timeline of the Galapagos deal sheds light into opacity underlying the debt swap operation. The private-led proposal was officially presented in January 2021. During the UK Climate Conference in November 2021, the government announced its interest in a debt conversion deal to support the expansion of the Galapagos Marine Reserve “La Hermandad”. Climate Fund Managers (CFM) – investment firm, via its subsidiary Oceans Finance Company (OFC), and the Pew Bertarelli Ocean Legacy with technical support from Aqua Blue Investments LLC, provided the early-stage development capital and established the Galapagos Life Fund. CFM-managed emerging market infrastructure fund Climate Investor Two (CI2) facilitated high-risk investment of about $2 million to finance OFC efforts to orchestrate the deal. Dutch Fund for Climate & Development (DFCD) and the European Commission (EC) amongst others provided the risk capital via CI2’s development fund. By October 2022, the Special Purpose Vehicle has been registered in Ireland. The SVP largest shareholder is Waystone Corporate Services (Ie) Limited which is solely owned by Waystone Centralised Services (Ie) Limited under a pyramid of holding companies. It is unknown if the SVP’s control holder is at the top of the pyramid. On the other hand, by December 2022, the IDB issued the backing guarantee. The Galapagos Life Fund is established in Delaware, US to enable US-DFC coverage given the participation of US-based Aqua Blue Investments LLC.
Later in March 2023, the Ministry of Economy and Finance of Ecuador approved a regulatory framework for debt conversion operations that legitimates retroactively over two years of executed actions by private proponents. By April 26, Credit Suisse announced cash purchase of Ecuadorian debt bonds followed by a press release dated May 9 announcing the loan transaction settlement. On May 15, the GPS BLUE FINANCING bond is issued with nominal value of US$1,000 and maturing date on November 9, 2041. In parallel, the Ecuadorian Government is being advised by the Green Growth Institute with support from CAF Development Bank in the design of Sovereign Thematic Bond Issuance Program to be approved in early June while the Green Taxonomy and related supervisory rules are in a very early stage of consideration. There is no indication of the portfolio of projects or plans signaling the country’s priorities that the bonds issuance will contribute to achieve or whether they will contribute to the country’s long term decarbonization.
Moreover, the deal is insufficient to cover conservation funding needs and compromises strategic resources of Ecuador. Galapagos is fiscally underfinanced since 2020 with annual deficit amounting approximately to US$20 million. The deal attempts to mobilize up to US$18 million per year. The budget to support effective implementation of the Management Plan for the new “La Hermandad” Marine Reserve has been estimated around US$47.5 million during the initial five years (average US$9.5 million) to secure protection through control and surveillance. This adds to an US$11.5 million funding deficit despite the deal. Marine reserves areas under the deal cover a large portion of Ecuador continental shelf beyond 200 nautical miles under UNCLOS with known vast biodiversity. Therefore, the deal undermines sovereign rights for independent definition of conservation policies and the management of its natural resources.
III.b. Transparency issues
Through a separate document, by following the Green Bond Principles (GBP), an issuer of a use of proceeds thematic bond articulates which assets it will (re)finance with the proceeds of issue. There is no evidence to support that allegedly Galapagos blue bonds have a Bond Framework or can be considered a GBP-aligned issuance. Without these transparency credentials alongside an investment opportunity, bond buyers can be exposed to major reputational risks.
In addition, there is no evidence to determine whether Galapagos bonds are consistent with the European Green Taxonomy or climate-related disclosure requirements of the European Commission such as the Corporate Sustainability Reporting Directive and alike by the US Security Exchange Commission.
The deal has been reviewed against DFC’s 2020 Environmental and Social Policy Procedures as a financial transaction. However, as per US-DFC Public Information Summary “the downstream subprojects of the endowment fund are likely Category B and C”. In compliance with Ecuador’s law and global best-practices related to environmental due diligence such as the International Finance Corporation’s 2012 Performance Standards, these impacts must be managed consistently. However, the insurance scheme does not cover risks from hazard occurrence of downstream projects posing additional risks to bond holders. Considering that projects will be executed in the Galápagos, an existing UNESCO World Heritage Site and MAB Biosphere Site, this is not a minor exposure to risk.
III.c. Alternatives structures’ performance
Table 2 shows how different design choices could have contributed to achieving the same level of savings in external debt while preserving sovereignty plus greater level of transparency and accountability. This is not an exhaustive comparison. The purpose is to exemplify how different policy choices can demonstrate different performance. According to Ecuador Code, public officials have the ulterior responsibility to achieve fiscal sustainability while guaranteeing the execution of public policies in the short/medium/long term, in a responsible and timely manner, safeguarding the interests of present and future generations. Both a hypothetical UN-backed deal or the use of international reserves for buy-back show enhanced integrity. On governance, there is no critical need to use a SPV under a sovereign deal. As a matter of fact, there is precedent for Ecuador direct buy-back or about US$289 million in 2009. Other previous governance arrangements for managing conservation funding include the use of a Multi Donor Trust Fund administered by United Nations Development Program UNDP and the active Fondo de Inversión Ambiental Sostenible (FIAS). In both cases, governance incorporates civil society as members of the Board without prejudicing the government’s veto power. In the case of FIAS, it shows larger comparative advantage as it is registered under Ecuadorian jurisdiction and as such subject to public scrutiny and State’s oversight in the management of public funding. This is particularly important as the national laws establish that public resources “do not lose their standing as such, when they are administered by private law legal persons, corporations, foundations, civil societies, commercial companies and other private law entities, whatever the source from which proceed, including those from loans, donations and deliveries that, under any other title, are made in favor of the State or its institutions, natural or legal persons or national or international organizations“. By invoking this regulation, a previous domestic private endowment fund was liquidated in 2016.
* Observed performance of the current deal is compared to hypothetical policy designs on the grounds of expected legal, governance, integrity, and economic performance. Expectation is based on previously observed similar arrangements. Red, amber, and green indicate low, medium and high performances.
The Galapagos case reaffirms contradictory necessary and sufficient conditions for a “successful” sovereign debt swap. It requires two country-related structural factors:
i. Severe debt distress
ii. High-risk profile
Rent-seeking agents involved in debt swaps cannot be considered philanthropy. A careful system of check and balances is needed to avoid greenwashing risks.
Biodiversity is no bargaining chip. According to Ecuador’s constitutions is a strategic resource. As such, Galapagos management is not compatible with trophy assets motivating club deals. The deal is insufficient and threatens sovereignty compromising fiscal stability and a large share of the continental shelf beyond 200 nautical miles.
Alternative policy designs could have provided the same or larger debt service benefits without compromising the sovereign capacity to define development priorities.
Blended finance, special purpose vehicles, thematic bonds and other sustainable finance instruments could have some potential to contribute to achieving a country’s prioritized sustainability goals. However, there is a clear need for improved institutional arrangement, both domestically and internationally, including:
- Global regulatory framework to ensure integrity (i.e., robust governance, transparency and accountability) in the contributions by private actors including institutional investors, asset managers, advisory firms, development corporations, multilateral financing institutions and non-for-profit organizations.
- Support to developing countries for strengthening domestic regulatory frameworks in line with international best-practices to ensure effective stakeholders’ participation and oversight including disclosure rules.
- Guidance to identify and manage trade-offs and synergies between sovereignty (i.e., unconditional public policy prioritization and decision making) and fiscal relief.
A non-exclusive set of good practices can contribute to enhance legitimacy of on-going debt relief efforts:
● Transparency: identify and disclose potential conflict of interests and incentivize whistleblowers and civil society watchdogs. Alternative, publicize undeclared conflicts of interest by debt-swap actors and designated Board members of endowment funds.
● Accountability: ensuring oversight by supervisory bodies at domestic and international level to avoid reputational risk. This can include an active legal due diligence by Attorney General or Comptroller office to ensure consistency of debt conversion with national regulatory frameworks.
● Reduce transaction costs: a UN members agreed directive to multilateral development banks and international financial institutions to support member states and facilitate low-cost sustainable financing solutions and products.
● De-risking through policy development: regulators and policymakers on multiple domains need to nudge financial intermediaries towards making more sustainable and ethical investment decisions. The environmental objectives of the EU taxonomy for sustainable finance can be considered a regulatory nudge.
 Contributors: Daniel Ortega-Pacheco, Director – Center for Public Policy Development – ESPOL, served as Minister of Environment of Ecuador and is a former member of the Advisory Council of the Green Bond Principles; Iolanda Fresnillo, Policy and Advocacy Manager – Debt Justice – EURODAD; Patricia Miranda, Director of Global Advocacy and Director of the New Financial Architecture Area – LATINDADD; Rodolfo Bejarano, Finance for Development Analyst – LATINDADD and Carola Mejia – Climate Finance Analyst – LATINDADD.
 A “Special Purpose Vehicle” (SPV) is a company formed for a specific purpose. SPV outsources and controls liability risks in connection with a specific project. It is an ideal tool to separate, anonymize and protect assets. Shareholders are also board members in the SPV. Board members can control the activities of the OFC as project manager. Project manager is Chairman of the Board of the SPV. SPV are known to facilitate Club Deals (off-market deals). The public is excluded. Investors realize above average returns. It requires excellent connections to close off-market transactions fast and successfully. SPV became well known given their central role in Pandora Papers and usage in tax avoidance schemes. Even when tax savings are a primary objective, SPVs are not necessarily optimal organizational structures facilitating debt swaps. Once all costs are considered, for example, in addition to legal setup costs, SPEs can reduce information quality, increase regulatory scrutiny, enhance public pressure, and result in large tax penalties (Demeré et al 2017). The deal SPV pays no Irish taxes, VAT, or duties if it qualifies under Section 110 of the Irish Taxes Consolidation Act 1997. A study published in Nature listed Ireland as one of the global Conduit OFCs which use SPVs to route funds to tax havens (Garcia-Bernardo et al 2017).
 Mukherjee 1992. https://documents1.worldbank.org/curated/en/520881468767353294/pdf/multi0page.pdf
 GPS stands for Galápagos. However, the downstream subprojects of the endowment fund are likely Category B and C which add risks to bond holders
 Hoja Infomativa – Conversión de Deuda por Naturaleza – Ecuador (Galápagos) https://www.iadb.org/document.cfm?id=EZIDB0000577-1059354427-37
 Established in 2015, CFM is a joint venture between the Dutch development bank FMO and Sanlam InfraWorks – part of the Sanlam Group of South Africa.
 https://www.un.org/depts/los/clcs_new/submissions_files/ecu90_2022/PartI.pdf http://portal.amelica.org/ameli/journal/648/6482950008/html/
 Appendix 1 of the GBP was updated to make a distinction between “Standard Green Use of Proceeds Bonds” (unsecured debt obligation) and “Secured Green Bonds” and to provide further guidance on green covered bonds, securitisations, asset-backed commercial paper, secured notes and other secured structures. https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/Green-Bond-Principles_June-2022-280622.pdf
 https://www.dfc.gov/sites/default/files/media/documents/9000104959_0.pdf https://www.finanzas.gob.ec/wp-content/uploads/downloads/2012/09/CODIGO_PLANIFICACION_FINAZAS.pdf
 For those elected to regulate the National System of Public Finance, Article 76 of the Organic Code of Planning and Public Finance, states in its first paragraph that “public resources are understood to be those defined in Article 3 of the Law on Contra / ode General of the State.” As established in article 3 of the Organic Law of the General Comptroller of the State, “for the purposes of this law, public resources shall be understood as all assets, funds, titles, shares, participations, assets, income, profits, surpluses, subsidies and all rights that belong to the State and its institutions, whatever the source from which they come, including those from loans, donations and deliveries that, under any other title, are made in favor of the State or its institutions, persons natural or legal or national or international organizations.
The first general provision of the same Code establishes that “Whatever the origin of the resources, public sector entities and organizations may not create accounts, funds or other mechanisms for managing income and expenses that are not authorized by the governing body of the System of Public Finance “.
 The International Bank for Reconstruction and Development (IBRD) Costs: i) Front-end fee: one-time fee of 0.25 per cent on the amount of the guarantee. ii) Initiation fee: one-time fee of 0.15 per cent on the amount of the guarantee or a minimum of USD 100,000. iii) Processing fee: one-time fee of up to 0.5 per cent on the amount of the guarantee, to cover the cost of out-of-pocket expenses. Iv) Guarantee fee: 0.3 per cent per annum on the disbursed and outstanding guarantee amount.
 Cai, C. (2019), ‘Nudging the financial market? A review of the nudge theory’, Accounting & Finance, 60(4), https://onlinelibrary.wiley.com/doi/10.1111/acfi.12471 Demeré et al. 2017. https://www.irs.gov/pub/irs-soi/17resconlisowsky.pdf; García-Bernardo et al. 2017 https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5524793/