Corporate debt restructuring in times of COVID-19: The case for Debt-for-Climate swaps

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Deforestation in Bhutan
Deforestation in Bhutan Photo: Curt Carnemark/World Bank

The strain of corporate debt looms large over the global economy. Months into the pandemic, corporate balance sheets in both advanced economies and emerging markets are more stretched than ever, with aggregate corporate debt standing at historically high levels relative to GDP. At the same time, traditional measures of debt affordability and debt sustainability are deteriorating as the global recession takes hold.  

With governments phasing out unprecedented support to business, including through extensive forbearance, we will soon witness a significant spike in corporate insolvencies across the board. This can severely undermine the green and resilient economic recovery the world needs. 

Extending Debt-for-Climate (D4C) swaps to the corporate sector may offer an avenue to address corporate debt challenges while increasing resilience to climate change and risks from biodiversity and nature loss. D4C swaps are voluntary agreements that originated in the 1980s to reduce a developing country’s debt stock or service in exchange for investment in climate-friendly programs, mostly conservation projects. Most recently, there have been proposals to scale up the instrument in the context of the COVID-related sovereign debt relief and restructuring.  

How could D4C swaps work in the context of corporate debt restructuring?  

One option would be for a government to sponsor a corporate debt restructuring fund that would buy nonperforming loans of viable firms from banks. The fund and the firms would then exchange the loans at a prearranged discount from the purchase value of the debt with a new loan to finance a permanent reduction in carbon emissions in the firm’s operations or supply chains aligned with the country’s Nationally Determined Contributions. This could be done through a sustainability linked loan (with measurable performance targets), a transition loan (supporting greening business practices) or other green instruments (such as green bonds). 

While doing so, governments should take into consideration fiscal space limitations and debt sustainability concerns, especially after the record spending of the past few months. A well-designed approach should leverage development finance and, more importantly, private finance to reduce the use of limited government financial resources to subsidize the relief component of the debt exchange. 

Bilateral and multilateral development finance institutions could support government efforts, providing mezzanine financing to the corporate restructuring fund to “buy” firms’ greenhouse gas emissions. Meanwhile, impact investors could provide senior financing to support the successful turnaround of distressed firms. 

When designing a D4C swap framework, it is important that governments set as objectives not only enabling a timely restructuring of debt and access to sufficient green financing for viable firms, but also facilitating the exit of nonviable businesses to avoid the proliferation of “zombie” firms. Identifying which firms are viable in the long run is not an easy task, however, and governments should work closely with banks―which are experienced in carrying out such assessments―to collect detailed data on firms and sectors. Moreover, given the high coordination costs involved, the proposed solution would likely apply to mid-sized and large firms only. 

Seizing the opportunity for a sustainable recovery  

This is a good moment for governments to start preparing for incoming corporate debt restructuring to relaunch growth and spur long-term productivity gains.  The scale of expected financial distress in the nonfinancial corporate sector and the unreliability of market-based solutions alone suggest that streamlining the legal framework for insolvency and creditors’ rights and corresponding enforcement mechanisms won’t be enough. Government financial support for debt restructuring and some degree of debt relief in some countries will be inevitable.  

The post-pandemic corporate debt strains, however, will occur at a time when humankind is only a few years away from avoiding catastrophic and irreversible global warming. That’s why COVID-19-related corporate debt restructuring can be an important component of economic recovery programs to advance environmentally sustainable growth policies.  

As Nobel laureate Paul Romer once famously said, “a crisis is a terrible thing to waste”. Those words resonate truer than ever today. The COVID-19 crisis is inflicting terrible human and economic costs, yet it may make it possible to address the necessary but politically difficult changes in laws, policies and institutions to save the environment we live in. Governments should leverage corporate debt restructuring to support a robust, sustainable and resilient recovery.  


Pietro Calice

Senior Financial Sector Specialist

Andrés F. Martínez

Senior Financial Sector Specialist

Fiona Stewart

Lead Financial Sector Specialist

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