A broader list of countries affected by natural disasters should be able to pause their debt payments, under a scheme drawn up by international financial institutions including the IMF, World Bank and private sector lenders.
Vulnerable countries will be able to add climate resilient debt clauses in to future bonds they offer on international markets, using new measures published by the International Capital Market Association. If defined trigger events occur, such as droughts, earthquakes, floods and hurricanes, nations should be able to defer payments for a maximum of two years, freeing up funds for disaster relief.
The measures, announced at the COP27 summit in Egypt on Wednesday, come in the wake of highly indebted, climate-affected countries like Pakistan struggling to keep up with their debt obligations.
The nation has been hit by unprecedented flooding since June, triggering a humanitarian crisis and causing an estimated $30bn in damages. A draft paper from the UN Development Programme in September proposed that Pakistan negotiate debt relief with its creditors.
While CRDCs have previously been included in a small number of bonds and loans, particularly in the Caribbean, efforts by the ICMA, which represents banks and investors, are an attempt to standardise the practice and make them applicable in a wider range of disaster situations and locations.
Any country could take advantage of the measures, but the ICMA said they are likely to be most suitable for “low-income countries, small island developing states, or other developing countries particularly vulnerable to the impacts of climate change”.
Leland Goss, the ICMA’s general counsel, said in a statement: “We live in a world today where countries are vulnerable to both growing debt levels and an increasing risk of climatic shocks. If sovereign borrowers can avoid default at the time of a natural catastrophe, this will benefit both affected countries but also their creditors and the global financial system that might otherwise be providing finance potentially simultaneously in multiple jurisdictions.”
The clauses were drawn up by a private sector working group, chaired by the UK Treasury, which included the IMF, World Bank, academics, as well as lenders such as banks and investment firms.
Exact arrangements for the repayment of deferred debt will be left to issuer countries and their creditors to define, but broadly, payments can either be added to the bond and repaid gradually over a set period, or they can be tagged on at the end of the life of the debt instrument where the repayment forms a lump sum on the maturity date.
The ICMA did not specify whether issuers would be subject to a price premium for inserting CRDCs in to debt issues, but it cautioned that “if there was an additional cost inherent in CRDCs then countries would need to consider carefully whether the additional benefits of increased macro-stability and liquidity during an exogenous shock outweighed any additional cost of raising financing”.
Previous attempts to incorporate private finance in disaster relief have drawn mixed results.
The World Bank’s pandemic bonds, in 2017 raised $320mn, but they were designed to pay out only if an outbreak of an infectious disease such as Ebola reached a second country and caused at least 20 deaths. Investors enjoyed high returns, but the instruments were criticised for producing small amounts to help with the Ebola crisis in central Africa.