Innovative financing of the sustainable development goals in the countries of the Western Balkans

Igor Lukšić; Bojana Bošković; Aleksandra Novikova; Rastislav Vrbensky

doi:10.1186/s13705-022-00340-w

Innovative financing of the sustainable development goals in the countries of the Western Balkans

Lukšić, Igor; Bošković, Bojana; Novikova, Aleksandra; Vrbensky, Rastislav 2022-02-22 00:00:00 Background: This paper is related to the current stage of development in the Western Balkans. Despite becom- ing growing instruments to finance sustainable green development, debt swaps and social or sustainability bonds are relative novelties in this region. At the same time, the development needs are huge, especially in the light of the COVID-19 aftermath. Results: The review of both historic financial instruments, such as the debt for nature swaps, and more recent ones, such as sustainability bonds in its variations, highlight the potential for use in developing countries. The relatively recent case from Montenegro and the recent issuance of the green bond in Serbia showcase the possibilities. The focus of this paper is an analysis of the public debt position of Western Balkan countries. The growing level of public debt over the past decade points to a lack of adequate interventions and a relatively imminent need for fiscal consoli- dation. The research suggests that environmental, social, governance/sustainability-linked bonds and debt-for-climate swap investments as innovative financial instruments that hold promise in leveraging additional finance to support the sustainability goals of the six countries of the Western Balkans. This influx of capital would be particularly advanta- geous, given their needs relative to EU accession and their economic and structural challenges. The recommenda- tions for policymakers are derived based on the history and features of green bonds as well as debt-for-nature swaps and their diverse underlying mechanisms which are adaptable to the respective countries. Conclusions: The related countries would benefit from exploring more innovative approaches to finance sustainable societies. In close cooperation with the EU and taking the European Green Deal into consideration, it is recommended that the six countries of the Western Balkans design financing mechanisms that will bring increased transparency to the different policies and more accountability for their implementation. Applying the recommended modality may help keep the problem of the public debt at bay, while additional funds may support implementation of structural reforms. Keywords: Sustainable/environmental social governance [ESG] finance, Green bonds, Debt swaps, Climate finance, Public debt Background The adoption of the seventeen sustainable develop - ment goals (SDGs) in 2015 by the UN General Assembly marked the beginning of a new era for global policy coor- dination. Following the Millennium Development Goals *Correspondence: igor.luksic@icloud.com; igor.luksic@udg.edu.me 1 (MDGs), adopted in 2000, the Sustainable Development University of Donja Gorica, Oktoih 1, Podgorica, Montenegro Full list of author information is available at the end of the article © The Author(s) 2022. Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. The images or other third party material in this article are included in the article’s Creative Commons licence, unless indicated otherwise in a credit line to the material. If material is not included in the article’s Creative Commons licence and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder. To view a copy of this licence, visit http:// creat iveco mmons. org/ licen ses/ by/4. 0/. The Creative Commons Public Domain Dedication waiver (http:// creat iveco mmons. org/ publi cdoma in/ zero/1. 0/) applies to the data made available in this article, unless otherwise stated in a credit line to the data. Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 2 of 19 Goals, or UN 2030 Agenda, became the anchor agenda bonds, SDG lending certificates and rediscounting poli - for all stakeholders. cies. High external debt burdens further hamper many As illustrated in a number of studies, the first global developing countries in accessing finance and setting policy agenda was only partially met. For example, only their economies on a sustainable path. 20% and 7% of low- and middle-income countries were However, expectations that blended finance can bridge on track to meet child and maternal mortality fast-track the SDG financing gap and mobilize private investment targets [1]. Despite the fact that MDGs have not fully in SDGs at scale are currently unrealistic. Each $1 of been met and mostly focused on less developed coun- MDB and DFI invested mobilizes, on average, $0.75 of tries, it was decided that the time was right to move to private finance for developing countries. Blended finance the next global policy level. The United Nations (UN), may tip the balance, but it will likely not be effective if individual countries, corporations, multilateral financial the economic fundamentals are not in place. Therefore, institutions and everyday people across the globe and the push for blended finance should not divert the atten - most affected by the success or failure of the goals, came tion from the need for grants to boost local investment together to set the priority and direction for the SDGs. environments. Donors, therefore, need to think carefully Although academic literature on SDG financing and its about the allocation of ODA and the risks and trade-offs challenges appears substantially limited [2], the imple- of investing ODA in blended finance [8]. There is also mentation of the UN 2030 Agenda is evidently costly and a need to incorporate many synergies and trade-offs, according to a UN study is estimated to cost between including around financing, inherent in the goals into USD 3.3–4.5 trillion per year to fund different projects, systems models. This will help ensure that addressing development programs and various initiatives which help and financing one goal does not inadvertently impact the countries achieve these ambitious goals [3]. According ability to achieve others. Though some models are start - to the same study, developing countries face an average ing to incorporate climate impacts and land and water annual funding gap of USD 2.5 trillion. It is clear that use in their analysis, few models go beyond this scope to government-driven or multilateral aid institutions-led address the many different interactions envisioned by the support needs to be complemented by the private sec- SDGs [9]. tor and the abundant funds that are available on the In the meantime, the countries of the Western Balkans markets. The task for policymakers and private sector Six [Albania, Bosnia and Herzegovina, Kosovo, Montene- investors is, therefore, to coordinate and look for more gro, North Macedonia, and Serbia] struggle to juggle all innovative approaches. As far as the European region is the policymaking tools to achieve sustainable economic concerned, the adoption of the European Green Deal is development. In parallel, they are expected to meet a game changer which sets the stage by introducing clear benchmarks in a number of complex fields, while achiev - goals and investment needs to turn the economy around ing good grades related mostly to the rule of law, quality by 2050 [4]. public administration and economic governance to join Innovative instruments are needed to scale up inter- the EU. national finance for sustainability purposes, but only One of the aspects that will be under particular scru- limited options are available for developing and tran- tiny is the debt portfolio of the countries in question and sitional economies [5]. For instance, the largest share the possibilities to improve the current situation, given of adaptation finance was provided through grants the sustainable development requirements. This is of par - (77%), while concessional loans (17%) and blended ticular importance as it is important to address potential grant/loan and other instruments (6%) only played a that lies ahead in using more innovative means of financ - subordinate role [6]. Mitigation finance was provided ing the development policy needs. mostly through loans and blended finance instruments Given the fact that early green bonds’ attempts are [6]. From one perspective, many bi- and multilateral more than a decade old [10], this new mechanism of issu- donors report a challenge of disbursing their funds as ing green, social or sustainability bonds [including the they fail to identify fundable projects. On the other sustainability linked variation], has been gaining trac- hand, many developing countries report difficulties in tion in recent years globally. However, it still represents accessing available resources due to lack of capacity a novelty in the region of the Western Balkans, where and the inability to fulfil specific requirements estab - countries have mostly been oriented to the classic bond lished by donors or financing institutions [6 ]. Other market for the budget needs and international financial experts [7] recommend implementing a set of simple intermediary’s [IFI] project financing for other purposes. financial mechanisms to address the SDG financing The reliance on the IFI’s, at least those based in Europe gap quickly and at a transformative scale. These mecha - and the World Bank group, has spurred the implemen- nisms include, inter alia, the issuing of sovereign green tation of certain standards which have steered countries L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 3 of 19 towards indirectly complying with some of the principles One of the consequences of COVID-19, related to of sustainable development. this new bond market, was the slow-down of the green Debt-for-nature swaps [and swaps for other sustain- bonds against the growth of the social and sustainability ability purposes] offer another solution to avert both bonds. The social bonds hit a record with an increase of debt and sustainability challenges by providing debt relief 170% since the beginning of 2020. However, despite ris- alongside mobilizing new finance for achieving sustaina - ing corporate interest, the rapid increase in social bond bility goals. While respective designs vary, all debt swaps issuances as a response to the recent pandemic has been share the same underlying mechanism: public debt of a mainly led by IFIs and primarily multilateral develop- developing country is cancelled in exchange for invest- ment banks (MDBs) [10]. In parallel, there is an expec- ments in projects linked to nature protection within tation that there will be a need to restructure sovereign the debtor country. There have only been a few debt- debt in a number of countries for which a more innova- for-nature swaps in countries of other world regions so tive approach may be needed [12]. far, and the investigative team recorded one debt swap The Green Bonds Principles just like the Social Bonds in Montenegro, but could not identify a recent surge in Principles or the Sustainability Bonds Principles are scholarly attention. designed to promote the transparency and integrity The aim of this paper is to assess new sustainability- needed to increase capital allocation to the projects that linked bonds and debt-for-climate swaps as innovative highlight either the green or social element [or the mix]. financial instruments, promising to leverage additional These investments are thus linked to the sustainability finance into sustainability goals in the Western Bal - policy, as explained by the International Capital Markets kan Six. As a first step, an online search was conducted Association’s briefs [13, 14]. To muster more resources for published material on sustainability bonds and debt needed for the SDG financing, the best avenue to take is swaps by researchers, international institutions and to increase transparency of the financing goals and the think tanks. This also entailed the collection of reports, policy makers’ directions in the mid- to long-run. news articles, and web pages. All collected data was then Launched in 2007, with the European Investment Bank reviewed and analysed from the perspective of drawing and the World Bank, issuance of the green market bond useful recommendations for the focus countries. Second, has grown significantly. The wider bond market started we analysed relevant data related to the debt situation in to react after the first USD 1 billion green bond sold the countries and drew conclusions on the usability of within an hour of issuance by IFC in March 2013, while instruments based on our experience in policymaking in in November of the same year, corporate green bonds the region. The subsequent section outlines recommen - started to see the light. The key year was 2014 when dations for policymakers in designing future green bonds USD 37 billion worth bonds were issued, while the new and debt-for-nature swaps and applies these to national record was set in 2019 when issuance reached almost circumstances in the Western Balkan Six. This study ends USD 259 billion. The cumulative issuance since 2007 with conclusions highlighting key messages. stands at USD 754 billion across 5931 deals and 927 issu- ers, while so-called certified climate bonds reached the Green, social and sustainability bonds USD 100 billion milestone [15]. History of green, social, and sustainability bonds Normally, the projects funded are related to the climate All the new forms of the bonds are voluntary. However, change mitigation, climate change adaptation, natural the growing trend is obvious. Investors tend to identify resource conservation, biodiversity conservation, and the benefits of a particular intervention based on their pollution prevention and control, and are focused, for interest to approach markets in different ways, the new example, on energy or emissions reduction projects, sus- instrument raises the country or corporation’s visibility tainable agriculture, and green buildings. or the innovation opens new financing channels as more On the other hand, social bonds are intended to meet and more investments funds are committed to keep share various social needs. Their role is to provide capital for of their investments in the green, social or sustainability projects that contribute to socioeconomic advancement bonds [11]—or as they are more and more referred, ESG and empowerment—such as affordable housing and instruments. infrastructure, access to essential services, employment The first corporate green bond was issued in November 2013 by Vasak - ronan, a Swedish property company, followed by large corporate issuers ESG refers to Environmental, Social and Governance, an acronym repre- include SNCF, Berlin Hyp, Apple, Engie, ICBC, and Credit Agricole. See for senting a growing corporate sector’s approach to the matters related to sus- more information URL https:// www. clima tebon ds. net/ market/ expla ining- tainability.green- bonds Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 4 of 19 generation, and food security [16]. They are similar in had in place processes for assessing environmental, structure to green bonds, a particularly popular form of social and governance [ESG] risks for projects. This has, “use of proceeds” bonds [10]. Logically, the target popula- however, changed over time, with a growing number of tions include people living under the poverty line, under- green bond issuances by corporations, energy and util- educated communities, marginalized groups and so on. ity companies and governments and their agencies from All of these new instruments require vigilant reporting around the world. Notable examples include Chinese by external parties who monitor and certify accomplish- issuers, who in 2016 comprised about 40% of the overall ments which adds to their credibility and makes them green bond market, as well as Poland, which in the same potentially preferred mechanisms in addressing the mid- year became the first sovereign state to issue a green to long-term needs to meet SDG benchmarks and help bond, followed by France, which issued the largest ever decarbonize the economy while making best use of pri- and longest dated benchmark green bond, a Euro 7 bil- vate–public partnerships. However, the magnitude of the lion, 22-year benchmark bond. In 2017, while holding the need is very large. Communicating the European Green COP23 Presidency, Fiji became the first sovereign emerg - Deal in December 2019, the Commission estimated the ing market issuer of green bonds when it issued a green need for an additional EUR 260 billion per year or about bond with a value of USD 50 million [20]. 1.5% of 2018 GDP to reach energy and climate 2030 goals In the context of this paper it is worth mentioning [4]. It is obvious that the new financing mechanism needs that Serbia issued their first ever green bond in Septem - to be given a boost. ber 2021 becoming the first Western Balkans country to The current total value of outstanding green, social and do so. It issued a 1 billion USD worth green bond. The sustainability bonds is USD 1503 billion [17]. However, 7-year maturity and 1% annual coupon security is aimed as the IFC team points out in their notes; green, social at investments in the rail and subway network, sewerage, and sustainability bonds still only make up a fraction water and wastewater processing, flood protection, bio - of the overall bond market. Compared to green bonds, diversity protection, pollution prevention and control, the social bond market is still in its nascent stage. How- waste management and at providing support for energy ever, issuances have skyrocketed since the outbreak of efficiency measures and the installation of rooftop solar COVID-19 in early 2020, as social bonds have become of panels [21]. increasing interest to investors looking to achieve posi- According to [22], the global green bond market in tive social outcomes together with a financial return [10]. 2019 grew by 51% to reach $260 billion with loan pro- There is still much progress to be made when con - ceeds primarily used in clean energy, building, and trans- sidering the regulatory framework, especially now that port sectors mainly in the EU and Asia Pacific, and North sustainable finance is becoming a part of mainstream America. By far and large, this innovative green finance discourse. The green transition in various sectors can instrument has not reached the developing countries at be significantly supported by some of these sustain - the scale and in the sectors required—where capital is ability or performance linked mechanisms. Therefore, most needed. The challenge, therefore, is to expand the it is expected that the EU will further work in this field issuance of green bonds to developing countries. One of by creating an EU Green Bond Standard [18], including the recommendations made in this respect for the gov- defining EU Taxonomy [19] with reference to the guide - ernments in developing economies is to adopt a holistic lines and disclosures. In the meantime, Climate Bonds and comprehensive policy framework that is conducive Initiative has launched Climate Bonds Standard 3.0, aim- to the inflow of sustainable investment resources, offers ing to improve the overall business environment [15]. investors protection, and is transparent. It is also criti- cal to clearly and transparently link performance indica- Examples of sustainability bonds worldwide tors with environment and sustainability. This includes Demand for green bonds is continuously increasing. developing sovereign green bonds as well as encouraging Until roughly 2012, the green bond market was domi- private enterprises to issue green bonds to fund climate nated by multilateral development banks, which already adaptation and mitigation efforts. To date, more than 90% of all new green bonds have come from issuers other than multilateral development banks. This is illustrated, for instance, by the ranking of In 2018, Danone was the first corporation to issue a social bond. The pro - ceeds (EUR 300 million) were used to fund research and development in food the largest climate bond issuers in 2019. Fannie Mae, security. However, Emmanuel Faber, chairman of the Board who long cham- the pioneer of issuing Green Mortgage-backed Securi- pioned social bonds and sustainable financing, was fired by the board when ties [MBS], remained the largest green bond issuer with shareholders became unhappy with the stagnant share price, which contra- dicts the sustainability logic of companies working for the wider benefit to 22.9bn USD issuance or 9% of the total. KfW, the German shareholders For more details, please see The Economist, Climate finance: It is state-owned development bank, was the second largest not easy being green, March 27, 2021. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 5 of 19 issuer with a total of 9bn USD worth of green bonds in There are also incentives not directly related to finan - the market with proceeds used to provide financing or cial risks such as those associated with reducing repu- co-financing to renewable energy and green building pro - tational risks and risks associated with potential future jects. They were followed by the Dutch State Treasury regulatory framework related to sustainability [29]. In Agency [DSTA] ranked as the third largest issuer with addition, the academic literature identifies additional 6.7bn USD debut green sovereign bond. incentives, associated with broader forces, such as the Another recent example of this phenomenon was the legitimacy of the organization and institutional-ori- announcement of global biopharmaceutical company ented drivers connected to operating at a societal level Pfizer about launching a $1 billion USD sustainability [30, 31]. bond offering, with the use of proceeds funding R&D and capex for the company’s COVID-19 vaccine. The 10-year Features of sustainability‑linked bonds bond was priced at 1.75%. The issue marks the second for A variation to the above-mentioned bonds is the sus- Pfizer under its Sustainability Bond Framework, follow - tainability-linked bonds [SLBs] or ESG bonds. The ing a $1.25 billion USD 2.625% 10-year offering in March proceeds of SLBs are intended for general purposes of last year. According to the company, proceeds from and due to the variability of the coupon, based on the the offering will be used to finance or refinance research accomplishment, may be further explored by the West- and development expenses related to COVID-19 vac- ern Balkan countries. During the preparation process cine research and development, capital expenditures in objectives are measured through predefined key per - connection with the manufacturing and distribution of formance indicators [KPIs] and assessed against prede- COVID-19 vaccines, and other projects of Pfizer or any fined sustainability performance targets [SPTs]. of its subsidiaries that have environmental and/or social The Sustainability-Linked Bond Principles [SLBP] benefits [23]. [14], established by ICMA, recommend that issuers publicly communicate their rationale for the selection Incentives for green bonds issuance of their KPIs [i.e., relevance, materiality], the motiva- Although to date, there has been very little academic tion for the SPTs [i.e., ambition level, consistency with work in the theory of the growth of the green bond mar- overall strategic planning and benchmarking approach], ket in the academic literature [24], some conclusions can the potential change of bond financial and/or struc - already be gleaned. In general, the financial incentives tural characteristics and the trigger events leading to for investing in green bonds are no different than for such a change, intended post issuance reporting and other asset classes. An investor has financial incentive to independent verification. The target setting exercise invest in a green bond if this bond provides some or all should be based on a combination of benchmarking the following benefits: better returns, lower risk, and bet - approaches that include the issuers’ own performance, ter diversification benefits than other comparable assets. the performance of its peers and reference to the sci- An issuer has a direct financial incentive to issue a green ence. In this process, the issuer may seek a second party bond if the green bond reduces their cost of capital and/ opinion. or improves their access to capital. The potential variation of the coupon is the most Besides incentives related to the economic perfor- common example, but it is also possible to consider mance of the investor there are incentives that are not the variation of other SLB’s financial and/or structural directly related to the financial performance of the green characteristics. bond. [25] The four types of non-financial business case What adds to the transparency and the overall cred- incentives are: operational, efficiency branding, creating ibility of this mechanism is that issuers should seek new markets, and reducing risk. Operational efficiency independent and external verification [for example lim - could be enhanced by attracting high quality employ- ited or reasonable assurance] of their performance level ees or making an impact on the productivity of employ- against each SPT for each KPI by a qualified external ees motivated by sustainability commitments [26]. The reviewer with relevant expertise, such as an auditor or branding benefits of engaging in sustainable finance an environmental consultant, at least once a year. include attracting and retaining customers or charging premium prices for products and services [27]. Creating new markets could entail developing new investment products for customers interested in sus- tainable investing and/or attracting new classes of customers to existing and new product offerings [28]. Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 6 of 19 Debt‑for‑nature swaps raised hundreds of million of dollars for environmental History of debt‑for‑nature swaps projects in the 1990s. It is estimated that between 1987 Reference [32] provide a historical review of the debt- and 1997 USD 134 million worth of debt allowed financ - for-nature swaps. According to the authors, the design ing of USD 126 million in nature conservation [37]. [38] and use of the debt swap instrument dates back to estimates the volume to total USD 163 million for the the 1990s with the first instruments taking the form period of 1987–1995 and according to OECD estimates of debt-for-equity swaps. Debt restructuring started [39], USD 1.1 billion of conservation was financed from almost immediately after World War II and accelerated debt titles of USD 3.6 billion between 1991 and 2003. when the Paris Club was founded in 1956 [33]. Com- In the months leading up to the climate summit in posed of officials from major creditor countries, the Copenhagen, Indonesia named debt swaps as a source of club would initiate the first large-scale debt relief pro - climate finance in informal UNFCCC consultations. Still, grams in the form of debt-for-equity swaps, and from debt-for-climate swaps were never declared as an offi - 1991 onwards allow debtors to convert their public debt cial climate finance instrument under the UNFCCC [39]. into local payments for social or environmental pro- Nevertheless, both the United States and Italy fulfilled jects [34]. The first debt-for-equity swap took place in parts of their fast-start-finance commitments [0.5 and Chile in 1985, where commercial debt was cancelled 11%, respectively] for 2010–2012 via debt swaps, together in exchange for creditors receiving shares in publicly contributing USD 82.5 million of the USD 30 billion fast- owned enterprises [35]. start-finance goal of the Copenhagen Accord [41]. The first debt-for-nature swaps appeared in the 1980s as a response to the worsening environmental condi- Examples of debt‑for‑nature swap reported by literature tions in developing countries. In the 1980s many coun- Debt relief linked to environmental goals or debt-for- tries particularly in Latin America increased their export nature swaps is not a new story: after World War II the volume in response to the debt and economic crisis that Paris Club comprised of major creditor countries ini- caused heightened rates of resource exploitation and tiated large-scale debt relief programs in the form of deforestation. Soon after, the first debt-for-nature swap debt-for-equity swaps, and from 1991 onwards allowed was agreed upon by Bolivia and Conservation Interna- debtors to convert their public debt into local payments tional, in which the latter bought USD 650,000 of Bolivia’s for social or environmental projects. Since then, debt-for- commercial debt at a redemption price of USD 100,000 nature swaps have raised hundreds of million of dollars from a Swiss bank. This debt was then swapped against a for the environment. commitment by the Bolivian government to spend USD A good example of this approach is the 2015 debt swap 260,000 on biodiversity conservation [35]. scheme implemented by Seychelles and a club of public The volume of debt swaps grew in the 1980s to peak and private debtors which enabled the country to cancel in 1990 and decline through the 1990s. Throughout the EUR 21.6 million in exchange for domestic investments 1980s, the secondary market of debt titles grew rapidly in protection of its unique marine ecosystem against a and debt swaps were advertised as a standard instrument specific commitment of the Government of Seychelles to of debt relief by lending agencies seeking new ways to increase marine protected area from 1 to 30% of its ter- minimize their financial losses [34]. Total swap volumes, ritorial waters [42]. including buybacks and other exchanges, peaked in Another good example was the swap between Italy 1990 at USD 27 billion, after which they declined in the and the Philippines in 2012 that entailed the cancella- 1990s. This was partly due to structural adjustments and tion of the Philippine’s public debt of EUR 2.9 million an improved economic performance of many indebted in exchange for investments in environmental protec- countries that would increase the value of their debt titles tion and poverty reduction [39]. The projects that were on the secondary market and thereby make them less in the areas of conservation, reforestation, agriculture, attractive leverage instruments for environmental groups and sustainable resource management placed a particular [35, 36]. focus on the participation of local communities. By 2019, Although debt-for-nature swaps were performed at the program is estimated to have 17,000 beneficiaries, much smaller scales than debt-for-equity swaps, they including local farmers and fishers from predominantly poor districts. 4 Features of debt swaps For more about the Paris Club please visit https:// clubd eparis. org As [32] explain, swaps are either arranged directly As a consequence, then vice president of the World Wide Fund for Nature (WWF) Thomas Lovejoy proposed a debt-for-nature swap instrument that between one debtor and one or more creditor govern- would encourage debtor countries to invest into their natural conservation ments, the basic model, or are facilitated by a third programs in exchange for debt reduction [40]. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 7 of 19 Fig. 1 Architecture of debt-for-nature swap instruments [32] party—often an international NGO tripartite model. In If debt titles are bought on the secondary market, the the latter, the NGO purchases the debt of an indebted price is determined by the credit rating, debt situation, country at a secondary market price and redeems and overall economic performance of the indebted state. the debt title with the debtor country in exchange for If, alternatively, debt titles are bought back via bilateral conservation efforts. The secondary market price ulti - agreements, no rules or restrictions on the discount rate mately depends on the probability of full debt repay- by which the initial debt is reduced exist. Having mainly ment and is consequently higher if full repayment is ranged between 0 and 50% in the past, discount rates are expected. In addition, the extent to which the outstand- negotiated between the participating governments on a ing debt service payments are already written off by the case-by-case basis. creditor government as well as the overall economic Overall, debt swaps are more feasible when creditor situation and growth projections of the debtor govern- governments are willing to sell titles at a price lower than ments play a role. Figure 1 provides an illustration of face value, because only then there is some fiscal space both models of debt-for-nature swaps. created for the debtor government. However, as bilateral After mutual agreement, expenditures of the debtor debt is predominantly held in US dollars and investments government are usually made gradually, often into a in local environmental projects are generally made in dedicated fund, and according to the original repay- local currency, preferable conditions could arise even at ment schedule of the initial debt. They can either be a discount rate of zero when scarce hard currency can be channelled directly towards environmental projects saved. or placed in a national trust fund, through which the Most debt swaps have involved bilateral public debt, interest earned on the deposited money can also be but debt swaps can also be conducted in the case of mul- used to finance environmental projects, e.g., via grants tilateral public or commercial debt. Commercial debt, to local NGOs. Such funds allow earmarking and for example, can be bought on the secondary market increase accountability as they are governed by a com- by a donor country as a form of official development mittee composed of representatives from both govern- assistance [ODA] or climate finance. Multilateral credi - ments and independent observers, such as national or tors, such as the World Bank or the IMF, cannot provide international NGOs. debt relief per se because of their legal status, but donor Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 8 of 19 Table 1 Opportunities and challenges of debt swaps for the involved parties [43] Advantages and positive outcomes for debtor country Advantages and positive outcomes for creditor country Shortfalls and challenges - Through debt relief and conversion, the overall debt burden - From a financial perspective, creditor countries’ remaining debt - If the discount rate is low or even zero, no extra budgetary room on the debtor country is lowered and the strain on the national claims increase in value through such swaps, and creditors can is provided, which leaves the overall macroeconomic situation budget is reduced recover either full or at least part of their debt and thereby avoid unaffected - Since counterpart payments into environmental projects are the accumulation of arrears. Debt swaps are particularly benefi- - If the debt swap volume is small, the positive impact on the generally made in local currency, debtor governments save cial if parts of the debt are already written off and full repayment debtor’s economic situation is negligible or might even be scarce hard currency which they can then use to establish is unlikely outweighed by the costs incurred when negotiating a swap and foreign exchange reserves - Creditors have to mobilize less additional finance to meet their setting up a trust fund - Debt relief can strengthen economic stability, improve the international climate commitments and, at the same time, can - Debtor countries must have sufficient funds to put into trust credit rating of a debtor, and attract new investments register the instrument as the provision of ODA. Since the nomi- funds, and there exists a risk of inflation if debtor governments - Environmental projects benefit from freed finance that would nal value of non-concessional debt can be registered as ODA, print money to pay the agreed amount in local currency have otherwise gone towards the creditor’s budget, often bring- many creditor countries have used this instrument to boost their - Debt swaps carry the threat of crowding out other forms of ing economic and social benefits at a local level ODA numbers finance that are potentially more effective. Debt swaps should be - Grants to environmental projects or local NGOs are typically - Furthermore, creditor countries can raise their environmental additional to the already delivered ODA and not substitute other distributed via a trust fund which is set up according to original credentials by mobilizing co-financing through international channels of new aid repayment schedules. This long-term regular funding facilitates funding institutions. A debt swap that is carefully designed - Climate-relevant debt swaps have to compete with other sectors fund and, therefore, debtor’s absorption of climate finance can guarantee an adequate use of funds and carries a greater (health, education, infrastructure) for a limited amount of eligible responsibility than a single donation debt L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 9 of 19 Fig. 2 Overview of the debt to nature swap between the Paris Club and Montenegro countries could use their resources to pay off the debt program activities was the last cancellation precondi- held at such institutions. tion. Debtor financial obligation was transferred to a spe - Debt-for-climate swaps are commonly referred to as cial account of the Vodacom company, organized as the ‘win–win’ agreements, as they benefit both debtor and Joint Service and Coordination Company for Water and creditor countries. Table 1 identifies advantages and Wastewater Services for the Montenegrin Coast. It was shortfalls of debt swaps for the involved parties. established in 2005, after the Government of Montene- gro recognized the need for active work on the improve- Case study: Debt swap experience in Montenegro ment of water supply and sewerage infrastructure on the The Montenegrin case (Fig. 2) represents the basic model Montenegrin Coast. The last disbursement to the pro - swap, since it had been arranged directly between the vider of construction works was completed in October debtor and one creditor government. Total debt volume 2013 by Vodacom which was considered as the closure of of EUR 11.23 million held by the government of Ger- the swap. Figure 2 illustrates the architecture of the deal. many, i.e., the KfW bank as the Paris Club creditor was cancelled in exchange for a project in water supply and Recommendations for designing debt‑for‑nature swaps sanitation. The Government of Montenegro and the KfW References [32, 43] summarize recommendations from bank negotiated the scheme of the swap and the agree- various publications. The authors attest that environmen - ment was concluded in 2008. The agreement reached by tal and fiscal improvements can only be realized when KfW bank and the Government of Montenegro envis- debt swaps are designed carefully, as we saw from the les- aged cancellation of the debt amount conditioned by the sons-learned. There are three main success factors which fulfilment of several preconditions. The Government of ultimately determine the overall effectiveness of the Montenegro, as the debtor, was obliged to contribute an scheme. First is the need to maximize the swap’s finan - amount of EUR 5.6 million to a sewage treatment plant cial value to the debtor country to create strong politi- and sewage network in two municipalities under the Pro- cal will and national buy-in. Second, the ambition of the gram for Water Supply and Sanitation at Adriatic Coast. scheme has to be aligned with the national climate goals, Contribution was to be issued within a 1-year period and a robust monitoring and reporting framework has to from the signing of the agreement, paid into a special be put in place to ensure that its climate impacts are duly commercial bank account and available for the KfW monitored and communicated. Finally, transparent gov- inspection. Another precondition was substantial com- ernance arrangements and a well-capacitated operator of pletion of a program for water supply and sanitation con- the scheme are indispensable for the success. struction works before the end of 2012. The first recommendation to a debtor country when The final consent of the Government of Federal Repub - designing and negotiating the financial structure of a lic of Germany on the KfW report on completion of swap mechanism to maximize the financial values of such schemes: The case study was prepared based on the inputs from the Ministry of Finance of Montenegro. Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 10 of 19 • Seek to achieve a positive difference between the society participation. While some international NGOs original face value of the debt and the redemption have gathered extensive experience in facilitating debt- price so that fiscal space is created. This can be done for-nature swaps, the contribution of local or regional by either purchasing the debt title on the secondary NGOs is similarly important to provide crucial insights market or by bilaterally agreeing on applying a dis- about local conditions. count rate greater than zero with the creditor. The third recommendation is that effective implemen - • Negotiate the cancellation of the outstanding debt tation and governance structures are essential for the service payments before making counterpart pay- success of the swap mechanism. This, first of all, calls for ments to provide extra budgetary room. an establishment of a scheme operator or a selection of • Convert the outstanding debt payments into local one from existing organizations. This should be a finan - currency payments so that hard currency can be cial institution with solid fund management expertise saved. and technical capacities to implement climate projects. • Schedule payments according to the original repay- Such a combination of financial and climate expertise ment schedule so that a constant and predictable rarely exists in developing countries and often has to be stream of finance is provided. built from scratch with additional technical assistance • Reinvest the interest rate earned by the funds to pro- from international organizations. In addition, to ensure vide additional capitalization for the mechanism. oversight and provide strategic guidance, a good practice • Only conduct debt swaps if the debt volumes are is to establish a supervisory committee that is composed large enough to justify the lengthy negotiation pro- of representatives from both the debtor government and cess and high transaction costs associated with deal the creditor’s as well as international and national NGOs. structuring and implementation. The debtor government’s leading role and close involve - ment in designing and implementing a swap deal is cru- Furthermore, debt swaps and corresponding debt relief cial to ensure national ownership and longevity of the should be additional to the creditor’s ODA and not crowd programme. At the negotiation stage, highest level politi- out other ongoing investments in climate mitigation and cal support of the climate swap proposal is particularly adaptation. Second, climate-related projects, funded by important for the deal to be secured. Climate-related debt swaps, should be additional to those already funded projects should be anchored in national climate policies, in debtor countries. While it is beneficial if concrete cli - and debt swaps should be embedded in a broader debt mate objectives and measures are envisioned and some reduction strategy. infrastructure for delivering those is already established, payments originating from swap deals should not be Public debt and feasibility of instruments in Western used to legitimize cutting back governmental spending Balkans 6 in other areas. And lastly, it is essential to ensure added For the purpose of reviewing the public debt conditions finance for the debtor country through debt relief. in the Western Balkans Six [WB6] countries, the trends The second recommendation is that the design of the of debt in the 10-year period 2010–2020 was assessed. climate swap mechanism should be aligned with national Given that the entire decade has been post-crisis, follow- climate commitments. In particular, they should be fully ing the global financial crisis in 2008, it is to be expected anchored in and aligned with national climate change that each of the countries will record an exponential priorities and the objectives as communicated in the trend of public debt growth. The new COVID-19 crisis National Determined Contributions [NDCs]. period, which began in 2020 and was primarily charac- To ensure the achievement of climate and other envi- terized by a decline in GDP and an increase in public ronmental and social benefits of climate swap schemes, it debt, is expected to underscore the need to finance the is important to start with determining a baseline scenario health sector as well as economic support programs. against which progress and final outcomes are measured. What is noticeable in methodological terms is that This entails developing indicators and specific defining there is no consistency in public debt reporting meth- targets that should be set for various steps throughout the odologies of the Western Balkan countries. Each coun- implementation phase. Monitoring plans and method- try has its own approach to reporting. However, over ologies shall also be developed to enable regular progress a 10-year period, improvements in the quality and tracking, reporting and communication to all involved stakeholders and the public-at-large to enhance transpar- ency. Involvement of independent actors, such as NGOs, Is not intended, however, to execute a debt sustainability analysis as this would require separate research. has proven to facilitate trust between debtor and creditor This is especially characteristic with the treatment of guarantees. Most governments and has been crucial for encouraging civil countries publish public debt data without including guarantees. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 11 of 19 Table 2 Public debt portfolio of the Western Balkan 6 countries Montenegro North Macedonia Serbia B&H Kosovo Albania 2010 2015 2020 2010 2015 2020 2010 2015 2020 2010 2015 2020 2010 2015 2020 2010 2015 2020 GDP (mil EUR) 2104 3625 4245 7109 9072 10,766 31,546 35,740 47,156 12,969 14,618 17,322 4402 5807 6831 8933 10,448 12,710 Public debt % GDP 42 61.6 102.4 24.6 38 60.2 42.9 76 56.8 33.8 40 35 6.2 13.0 24.6 57.7 72.8 77.9 Public debt portfolio (% of total public debt) Multilateral and bilateral 46.4 27.7 13.7 49.2 25 n.a 46.6 35 37.8 66.6 70.4 68.5 n.a 49.25 33 18.9 25.7 25.6 creditor loans Eurobond 15.7 39.6 44.9 19 22.3 n.a 0 19 19 0 0 5.4 n.a 0 0 3.36 4.31 9.05 Private sector loans 9.8 18.1 32.5 13.6 n.a 0 5 0.9 0 4.13 1.85 n.a 0.45 1.4 3.03 6.38 3.07 Government securities 3.9 4.37 4.2 31.3 38.9 n.a 47.5 30.5 39.5 11 10.4 15.8 n.a 50.5 64.7 32.41 36.32 40.12 Source: Statistical Offices and Ministry of Finance websites of WB6 [Montenegro: www. mif. gov. me [Ministry of Finance], www. monst at. org [Statistical Office] both accessed April 2021 Serbia: www. javni dug. gov. rs [Public Debt Administration] accessed April 2021, North Macedonia: www. finan ce. gov. mk [Ministry of Finance], www. stat. gov. mk [Statistical Office] both accessed April 2021, Albania: www. finan cia. gov. al Ministry of Finance], www. instat. goval [Statistical Office] both accessed April 2021, Bosnia and Herzegovina: www. mft. gov. ba [Ministry of Finance], www. bhas. gov. me [Statistical Office] both accessed April 2021, Kosovo: www. mf. rks- gov. me [Ministry of Finance] www. ask. rks- gov. netf [Statistical Office] both accessed April 2021]) Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 12 of 19 coverage of reports, as well as levels of transparency, Kosovo and Albania have 30–60% of these securities in are evident. Table 2 provides an overview of the data on their portfolio speaks not only of domestic confidence, public debt, its ratio to gross domestic product [GDP], but also of the capacities of domestic banks and institu- as well as the structure of the public debt portfolio of the tional investors. WB6 countries. The fact that all countries except Kosovo and Bosnia Table 2 illustrates that the condition of WB6’s pub- and Herzegovina, and some even before 2010, had suc- lic debt at the end of 2020 ranged widely, from 24% in cessful euro-bond issues, also indicates the presence of Kosovo to 102% in Montenegro. The trend of the debt confidence of international investors. movement was continuously progressive, except in Serbia When it comes to the debt maturity, countries do not and Bosnia, which in the second part of the period, after usually publish a single average maturity figure. Data 2015, managed to reduce their share of public debt in which are mainly given refer to the maturity structure, GDP. Other countries have managed to double, and some which show that long-term securities are predomi- have tripled, their public debt in the past decade. nantly present in the portfolio. Specifically, Montenegro Five countries, except North Macedonia, have fiscal published data that the average maturity at the end of rules in place. All of them have a rule limiting debt, but 2020 was 6.9 years, while the same data for Bosnia and there are differences in the size and nature of the limit. Herzegovina for 2019 was 7.7 years. In addition, the ratio Size of the limit differs from 40% in Kosovo to 45% in of debt to fixed and variable rates in most countries is in Albania and Serbia to 60% in Montenegro and Bosnia favor of fixed or is balanced. and Herzegovina [44]. It is clear that all countries, except All of the above leads to the conclusion that the West- Bosnia and Herzegovina and Kosovo, have been violating ern Balkan 6 will have a specific challenge to manage this fiscal rule for some time. The COVID crisis is likely their public debt in this so-called traditional way. It will to further slow these countries’ ability to comply with the be particularly interesting to see how and to what extent public debt limit. The public debt of the WB6 countries the governments of these countries will know how to is predominantly external, except in Kosovo, where start- recognize and be able to introduce new borrowing ing in 2015, the situation is changing in favor of domestic instruments. debt. In addition, public debt is dominant and euroized One of the modalities recently proposed by an IMF in countries that have their own currency. researcher [45] is based on Klemperer’s Product-Mix As for the public debt portfolio, each of the countries Auction approach. This method holds auctions to over - has certain specificities, depending on the economic and come issues related to the classic sovereign debt restruc- political heritage. Those who had liabilities based on old turing negotiations. The application of an auction model foreign currency savings, restitution and unpaid pensions offers a platform that enables participants to engage have securitized them and they are present in the port- based on their preferences rather than a one-size-fits-all folio of their domestic debt. Each of the countries in its approach, which causes enormous difficulties. Such pref - portfolio has loans from multilateral and bilateral credi- erences may relate to bonds that are different in maturity tors, government securities, euro-bonds and private sec- or denominated in different currencies. tor creditors’ loans. At the beginning of the decade, multilateral and bilat- The swap scheme’s new lease on life? eral creditors’ loans were most dominant in the public In the context of the EU accession process and the debt portfolio; and, over time, their share decreased with recently revealed European Green Deal, newly shaped the exception of Bosnia and Herzegovina, where these market mechanisms for the UN2030 Agenda financing loans represented about 70% of the total portfolio. The in the form of the green, social or sustainability bonds decrease in share of these loans in most countries was in are worth considering to ascertain if new approaches are favor of the increase in share of government securities, possible. This innovation may arise from an already exist - this time with the exception of Montenegro, which has ing debt-for-nature swap, which can trace its way back changed the structure of its portfolio in such a way that to the post WWII debt restructuring and later debt-for- euro-bonds and private sector loans have become the equity instruments as explained in the literature review. most important means of financing public debt. As already shown in the case study, one of the countries Government securities involve the issuance of bonds that has used this opportunity was Montenegro in 2009. and treasury bills. The fact that North Macedonia, Serbia, More than a year. 9 11 Data for 2020 are preliminary, bearing in mind that final GDP data have not Paul Klemperer is a renowned economist who followed the trail of Nobel been published. laureates Paul Milgrom and Robert Wilson and their auction analysis. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 13 of 19 Table 3 WB6 GDP per capita in PPS The debt analysis of the WB6 countries, despite some - what different situations, clearly points out that there % of EU are many macro-fiscal challenges ahead and an innova - average in tive approach is needed. At the same time, despite having relatively reduced fiscal space for additional borrowing, EU 27 average 100 while many structural requirements lie ahead, it is obvi- Montenegro 50 ous that individual countries’ GDP, in purchasing power, Serbia 41 is still significantly lagging behind the EU average, as North Macedonia 38 Table 3 illustrates. Bosnia and Herzegovina 32 With an average score of 38 , in 2019, the year before Albania 31 the pandemic began, it is obvious how far WB6 countries Source: Eurostat https:// ec. europa. eu/ euros tat/ web/ produ cts- datas ets/ need to go, and why innovative mechanisms are needed. It is only sustainable development and a continuous posi- tive trajectory that can keep this part of the world secure On the other hand, it is evident that the EU is a will- and migration at bay. ing partner and provides a different mechanism of sup - However, prior to any concrete move, special attention port. The most important one, so-called Instrument of is required to assess the legal aspects of the use of the Pre-accession Assistance begins its third 2021–2027 above-described novel financial instruments—as some iteration. IPA serves to provide financial assistance to countries may be in differing positions. In addition, there the candidate countries to meet political and economic is a need for more in-depth analysis of the particular pub- criteria for the membership and is based on the strate- lic debt elements and their structures. This is of special gic documents which point out necessary reforms in the relevance when it comes to the possibilities of the further fields of the rule of law, fundamental rights and govern - use of the debt for nature swaps. It is, evidently, possible ance; socio-economic development; Union policies and in its most intuitive form and only in case of bilateral or acquis ; people-to-people contacts and reconciliation; official development aid. good neighbour relations and regional cooperation. Alternatively, bringing together IPA and private mar- Expanding the previous IPA II mechanism to the areas kets, while combining the swap model and new forms of of migration; security, protection of the environment and bond issuance, a more transparent process that require climate change should be considered as new features. vigilant reporting and verification, the EU may further In fact, the debate in Parliament during the first reading support countries of the Western Balkans by repaying produced amendments which, assuming Paris Agree- part of the principal debt upon the independent verifica - ment obligations, were aimed at establishing a stronger tion of how proceeds are used and whether targets have connection between the UN 2030 Agenda and IPA. been met. This approach would not be entirely new as Such an approach should result in 16% of the program there are already examples of the so-called direct budget- addressing climate impact needs of the beneficiaries. It ary support mechanism, which is executed against a set also calls for special attention to cross-border polluting of policy measures a candidate country is obligated to issues. Equally Parliament calls for the European Fund for meet. Sustainable Development Plus to complement the efforts Such an approach can be directly linked with the com- under the pre-accession programme [46, 47]. As for plementary Green Agenda for Western Balkans [49], the IPA III assistance purpose, approximately EUR 14.2 establishing a number of initiatives in different areas, billion has been proposed and enabled along with other such as climate change, clean energy transmission, smart key areas, such as rule of law, public administration and and sustainable mobility, circular economy, depopula- economic governance, putting new emphasis on environ- tion, sustainable food systems and rural areas and the ment and climate action [48], which could serve as excel- protection of biodiversity. In parallel, Western Balkan lent leverage to generate more funding from the capital countries should continue their accession process by con- markets. ducting a series of policy reviews to one day join the EU. Figure 3 presents the KPIs that are used to help measure Agreed finally in June 2021. Common term to refer to EU legislation. Instrument for Pre-accession Assistance [IPA III] [46] was established in 2017 as a contribution to the pro-active development aid related to the UN2030 expected to have generated 44bn investments based on the EUR The table lacks data for Kosovo, which if included would further drive the 4.1 billion initial contribution. [47] average score down. Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 14 of 19 Fig. 3 List of key performance indicators [50] the EU’s contribution to the achievements of the candi- mechanism and to pay for the fraction of issued green, date countries: social, sustainability bonds. Paying for that in the matu- It is noticeable that there is no mention of the Human rity year sets free additional resources in troubled state Development Index produced by the UNDP, which would budgets. Another option could be to issue a higher also be of use when tracking progress in the social sphere, amount of bonds, while the markets realize that provid- related to the education and health, in particular. ing the implementation of the policies and meeting tar- gets means that the EU would use some of the funds to Could green, social and sustainability bonds be a good fit? repay part of the bonds once they mature. Such mecha- Going back to green, social and sustainability or ESG nisms would bring further relief in the lower interest bonds in some form could prove beneficial as they have that would be paid each year, which provides additional key performance indicators and sustainable targets. financial means to implement the EU acquis. Altogether, Given that the European Commission uses different key countries could benefit from spurring economic growth performance indicators to monitor the progress coun- based on sustainable and smart development while keep- tries make, those indicators could play an important ing public debt in check. role. At the same time, the Green Agenda for the West- What precise targets and what exact portion of the ern Balkans sets off a number of initiatives that could be bonds would be repaid by the IPA III allocation would transferred into the targets, both indicators and these depend on the type of bond, given the varying levels of targets can serve as an excellent basis for transparency support the EU provides to different areas of investments. and reporting required by the markets, as it is presented Some of the initiatives may easily be turned into clear in Fig. 4. targets, some would need further work to figure out the The availability of IPA III funds completes the picture most proper indicators. As far as the initiative related to as those resources can be used for the adjusted swap the Biodiversity Action plan is concerned, the first target might be the adoption of a proper action plan followed by some key action points to be carried out. In addition, there has already been some research produced that www. hdr. undp. org L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 15 of 19 Fig. 4 Green agenda for Western Balkans initiatives could serve as useful guidance in defining a conceptual Western Balkans, explained above, which suggests that framework, such as in the example of bioenergy [51]. many structural issues need to be tackled by the national Besides this, there has to be a proper legislative analysis governments. of whether issuing new bonds would require the pass- All the WB6 countries strive to become member states ing of new legislation in the respective Western Balkan of the EU. However, that road demands the introduction countries that would enable the use of the new finan - of the very specific legislation which normally brings cial instruments in the first place, similar to what Serbia about the need to accommodate and adjust institutions, experienced, prior to the new issue [21]. requiring additional costs and more efficient and effective The work on the SDG indicators as well as the efforts public administration in the end. In addition, infrastruc- and the contribution of the UN Global Compact could ture and overall development needs remain very high, be of tremendous help in this space. This may also be a and macro-fiscal room has shrunk—given the levels of field that would benefit from further research. the public debt, in particular. Therefore, the innovative approach presented below Summary of recommendations offers a new modality of ESG bonds which is based on As illustrated throughout this paper, there are plenty of the EU process combined with the Green Agenda initia- different tools to use in developing innovative invest - tives for the Western Balkans. This new bond mechanism ment models. The option summarized below, in Fig. 5, would use some of the lessons and practicalities learned builds on the current macroeconomic situation in the from nature for debt swaps, where green investments could lead to some debt relief. Countries are still in the position to issue green bonds, such as the one Serbia recently released or pursue classic debt for nature swaps. See for details https:// unsta ts. un. org/ sdgs/ indic ators and https:// www. The new mechanism may, in fact, serve as an extension. unglo balco mpact. org Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 16 of 19 Fig. 5 Summary of recommendations on the introduction of new financial instruments in the Western Balkans Countries should be encouraged to define clear targets tool of assessment]. In some cases, it will require that based on the sustainable development policies and then new legislation be enacted to establish and implement go to the market with the transparent support of the EU these indicators. Any initiative which is measurable through the IPA funds. The logic of the IPA funds is to through additional regional mechanisms of cooperation prepare countries for the membership and is used to help is a value added as it contributes to the stability and pros- meet various benchmarks. Even the modality by which perity of the whole region. countries benefit from the direct budget support is con - ditioned by some prior action. Conclusion This new approach would bring about the synergy The promise of the EU, made in 2003, that all Western between private and public funds; introduce very trans- Balkan countries are welcome to join the EU once estab- parent targets and indicators, verifiable by independent lished criteria are met, has set most of the policy goals auditors; and use IPA funds as a powerful leverage to for these countries. However, since then, only Croatia help save some interest or principal repayment costs and joined the EU on July 1, 2013. Whereas, Montenegro thus help a country lower public debt and reinforce inter- has advanced the most in the accession process [all the national financial credibility or use the extra money for negotiating chapters are open] and Serbia following; the additional investments in the quality of public adminis- process overall seems to have slowed down. North Mac- tration or social infrastructure. Instead of chopping IPA edonia and Albania are still waiting for the real accession between different sectors it would be more transparent talks to begin, whereas Bosnia and Herzegovina and Kos- and effective to use the contribution as an additional ver - ovo seem to be nowhere near beginning. ification that proper policies are in place [it may combine In the meantime, the UN 2030 Agenda, adopted in rule of law with public administration reforms or sustain- 2015 and establishing the SDGs, and the ongoing chal- able development]. Such an approach would increase the lenges related to COVID 19 have put additional ingre- accountability of policymakers as well. dients on the table. The green transition has become an It would be crucial to develop more measurable tar- equally important policy for the respective countries dis- gets as far as the Green Agenda for the Western Balkans cussed, and along with that emerges additional social and initiatives are concerned. Other indicators which are economic challenges. Economically speaking, the situa- reported by international organizations [World Bank’s tion is complex and all the Western Balkan 6 countries Doing Business, for example, is a more straightforward are faced with significant development financing needs. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 17 of 19 Their average GDP in terms of the purchase power com - new approach to the debt sustainability offered by IMF pared to the EU average is way below 50%. While the researchers, also discussed earlier; may result in a win– average public debt stands at around 50%, this figure, win situation for all the market agents, including gov- which may seem moderate, hides the growing trend over ernments. Hopefully, this approach may unlock missing the past decade and major discrepancies amongst coun- fiscal space, which in the mid- to long-term could bring tries, such as Montenegro and Albania on one hand and about many benefits in higher levels of GDP and human Kosovo, for example, on the other. development indexes. Therefore, the complex agenda involving EU accession, infrastructure and SDG needs requires innovation in the Abbreviations SDG financing. IPA: Instrument for pre-accession assistance of the EU to the candidate This paper analyses some of the new mechanisms, such countries; ESG: Environmental, social and governance; KfW: Kreditanstalt fur Wiederaufbau; MDG: Millennium development goals; SDG: Sustainable as green, social and sustainability bonds and nature for development goals based on UN 2030 Agenda; UNFCCC: Unit ed Nations debt swaps. It is obvious that some of the main benefits of Framework Convention on Climate Change; UNDP: United Nations Develop- the new form of ESG bonds is a higher level of transpar- ment Program; WB6: Western Balkan 6 (Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, Serbia). ency and, inevitably, a higher level of accountability that comes along with it. To achieve benefits such as lower Acknowledgements interest rates of the longer maturity terms, it is important Authors would like to thank Dragan Darmanovic, former head of the Treasury in the Ministry of Finance of Montenegro for his practical insight into the debt to incorporate independent verification metrics to deter - for nature operation shown in the case study. Authors would also like to thank mine whether the various KPIs and green/social/sustain- Marija Pejovic for the English editing of the article. ability targets are met. Authors information: Igor Luksic, f. Prime Minister (2010–2012) and f. Finance Minister (2004–2010) of Montenegro, associate professor University of Donja On the other hand, nature for debt swaps is not entirely Gorica. Bojana Boskovic Ministry of Finance of Montenegro, University of new and has been in place for some decades. Out of the Donja Gorica, associate. Montenegro.Aleksandra Novikova Institute for Climate six WB countries, it seems that only Montenegro has Protection, Energy and Mobility (IKEM), Magazinstr. 15–16, 10179 Berlin, Germany, and AvantGarde Energy (AGE), Podjavorinskej 7, 811 03 Bratislava, used it successfully and that happened once at the end of Slovakia. Rastislav Vrbensky f. UN Resident Coordinator in Montenegro and f. the first decade of the twenty-first century. UNDP Deputy Regional Director for Europe and Central Asia, Visiting Lecturer Putting together ESG bonds along with nature for debt at Masaryk University. swaps in light of the EU accession plans of the Western Authors’ contributions Balkans countries can offer the basis for another layer IL developed the key recommendation of the proposed ESG bond supported of innovative financing, and this is the key recommen - by the EU IPA funds. BB analysed Western Balkans countries’ macroeconomic and macro-financial situation generating basis for the development of dation of this paper. Countries should feel encouraged the recommendation. AN provided a literary overview and the theoretical to enter the private markets—clearly stating their green background of the nature for debt swaps and RV analysed the innovative and de-carbonization development plans and define bond instruments providing examples and the basis for the recommendation development. All authors read and approved the final manuscript. policy goals that stem from the European green deal and the Green agenda for the Western Balkans which has Funding to be combined with accountability mechanisms and Not applicable. methodologies such as those which govern European Availability of data and materials Union accession talks with candidate countries. This The data sets used and/or analysed during the current study are available recommendation assumes that participating parties will at the following links:—Montenegro: www. mif. gov. me [Ministry of Finance], www. monst at. org [Statistical Office]—Serbia: www. javni dug. gov. rs [Public develop policy targets and indicators that are independ- Debt Administration], -North Macedonia: www. finan ce. gov. mk [Ministry of ent and verifiable, as the whole agenda grows more and Finance], www. stat. gov. mk [Statistical Office],—Albania: www. finan cia. gov. al more complex at each stage. [Ministry of Finance], www. instat. goval [Statistical Office],—Bosnia and Herze - govina: www. mft. gov. ba [Ministry of Finance], www. bhas. gov. me [Statistical Such an innovative approach to the markets could also Office],—Kosovo: www. mf. rks- gov. me [Ministry of Finance] www. ask. rks- gov. encourage the EU to adjust the ways pre-accession sup- net [Statistical Office]—https:// ec. europa. eu/ euros tat/ web/ produ cts- datas port is used [IPA III in particular] as those funds could ets/. be extremely useful leverage to access private markets and accelerate investment cycle by providing synergy Declarations between the huge opportunities private markets bring, Ethics approval and consent to participate with the crucial support of the public funds coming from Not applicable. the EU. 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Publisher: Springer Journals
Copyright: Copyright © The Author(s) 2022
eISSN: 2192-0567
DOI: 10.1186/s13705-022-00340-w
Publisher site: See Article on Publisher Site

Abstract

Background: This paper is related to the current stage of development in the Western Balkans. Despite becom- ing growing instruments to finance sustainable green development, debt swaps and social or sustainability bonds are relative novelties in this region. At the same time, the development needs are huge, especially in the light of the COVID-19 aftermath. Results: The review of both historic financial instruments, such as the debt for nature swaps, and more recent ones, such as sustainability bonds in its variations, highlight the potential for use in developing countries. The relatively recent case from Montenegro and the recent issuance of the green bond in Serbia showcase the possibilities. The focus of this paper is an analysis of the public debt position of Western Balkan countries. The growing level of public debt over the past decade points to a lack of adequate interventions and a relatively imminent need for fiscal consoli- dation. The research suggests that environmental, social, governance/sustainability-linked bonds and debt-for-climate swap investments as innovative financial instruments that hold promise in leveraging additional finance to support the sustainability goals of the six countries of the Western Balkans. This influx of capital would be particularly advanta- geous, given their needs relative to EU accession and their economic and structural challenges. The recommenda- tions for policymakers are derived based on the history and features of green bonds as well as debt-for-nature swaps and their diverse underlying mechanisms which are adaptable to the respective countries. Conclusions: The related countries would benefit from exploring more innovative approaches to finance sustainable societies. In close cooperation with the EU and taking the European Green Deal into consideration, it is recommended that the six countries of the Western Balkans design financing mechanisms that will bring increased transparency to the different policies and more accountability for their implementation. Applying the recommended modality may help keep the problem of the public debt at bay, while additional funds may support implementation of structural reforms. Keywords: Sustainable/environmental social governance [ESG] finance, Green bonds, Debt swaps, Climate finance, Public debt Background The adoption of the seventeen sustainable develop - ment goals (SDGs) in 2015 by the UN General Assembly marked the beginning of a new era for global policy coor- dination. Following the Millennium Development Goals *Correspondence: igor.luksic@icloud.com; igor.luksic@udg.edu.me 1 (MDGs), adopted in 2000, the Sustainable Development University of Donja Gorica, Oktoih 1, Podgorica, Montenegro Full list of author information is available at the end of the article © The Author(s) 2022. Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. The images or other third party material in this article are included in the article’s Creative Commons licence, unless indicated otherwise in a credit line to the material. If material is not included in the article’s Creative Commons licence and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder. To view a copy of this licence, visit http:// creat iveco mmons. org/ licen ses/ by/4. 0/. The Creative Commons Public Domain Dedication waiver (http:// creat iveco mmons. org/ publi cdoma in/ zero/1. 0/) applies to the data made available in this article, unless otherwise stated in a credit line to the data. Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 2 of 19 Goals, or UN 2030 Agenda, became the anchor agenda bonds, SDG lending certificates and rediscounting poli - for all stakeholders. cies. High external debt burdens further hamper many As illustrated in a number of studies, the first global developing countries in accessing finance and setting policy agenda was only partially met. For example, only their economies on a sustainable path. 20% and 7% of low- and middle-income countries were However, expectations that blended finance can bridge on track to meet child and maternal mortality fast-track the SDG financing gap and mobilize private investment targets [1]. Despite the fact that MDGs have not fully in SDGs at scale are currently unrealistic. Each $1 of been met and mostly focused on less developed coun- MDB and DFI invested mobilizes, on average, $0.75 of tries, it was decided that the time was right to move to private finance for developing countries. Blended finance the next global policy level. The United Nations (UN), may tip the balance, but it will likely not be effective if individual countries, corporations, multilateral financial the economic fundamentals are not in place. Therefore, institutions and everyday people across the globe and the push for blended finance should not divert the atten - most affected by the success or failure of the goals, came tion from the need for grants to boost local investment together to set the priority and direction for the SDGs. environments. Donors, therefore, need to think carefully Although academic literature on SDG financing and its about the allocation of ODA and the risks and trade-offs challenges appears substantially limited [2], the imple- of investing ODA in blended finance [8]. There is also mentation of the UN 2030 Agenda is evidently costly and a need to incorporate many synergies and trade-offs, according to a UN study is estimated to cost between including around financing, inherent in the goals into USD 3.3–4.5 trillion per year to fund different projects, systems models. This will help ensure that addressing development programs and various initiatives which help and financing one goal does not inadvertently impact the countries achieve these ambitious goals [3]. According ability to achieve others. Though some models are start - to the same study, developing countries face an average ing to incorporate climate impacts and land and water annual funding gap of USD 2.5 trillion. It is clear that use in their analysis, few models go beyond this scope to government-driven or multilateral aid institutions-led address the many different interactions envisioned by the support needs to be complemented by the private sec- SDGs [9]. tor and the abundant funds that are available on the In the meantime, the countries of the Western Balkans markets. The task for policymakers and private sector Six [Albania, Bosnia and Herzegovina, Kosovo, Montene- investors is, therefore, to coordinate and look for more gro, North Macedonia, and Serbia] struggle to juggle all innovative approaches. As far as the European region is the policymaking tools to achieve sustainable economic concerned, the adoption of the European Green Deal is development. In parallel, they are expected to meet a game changer which sets the stage by introducing clear benchmarks in a number of complex fields, while achiev - goals and investment needs to turn the economy around ing good grades related mostly to the rule of law, quality by 2050 [4]. public administration and economic governance to join Innovative instruments are needed to scale up inter- the EU. national finance for sustainability purposes, but only One of the aspects that will be under particular scru- limited options are available for developing and tran- tiny is the debt portfolio of the countries in question and sitional economies [5]. For instance, the largest share the possibilities to improve the current situation, given of adaptation finance was provided through grants the sustainable development requirements. This is of par - (77%), while concessional loans (17%) and blended ticular importance as it is important to address potential grant/loan and other instruments (6%) only played a that lies ahead in using more innovative means of financ - subordinate role [6]. Mitigation finance was provided ing the development policy needs. mostly through loans and blended finance instruments Given the fact that early green bonds’ attempts are [6]. From one perspective, many bi- and multilateral more than a decade old [10], this new mechanism of issu- donors report a challenge of disbursing their funds as ing green, social or sustainability bonds [including the they fail to identify fundable projects. On the other sustainability linked variation], has been gaining trac- hand, many developing countries report difficulties in tion in recent years globally. However, it still represents accessing available resources due to lack of capacity a novelty in the region of the Western Balkans, where and the inability to fulfil specific requirements estab - countries have mostly been oriented to the classic bond lished by donors or financing institutions [6 ]. Other market for the budget needs and international financial experts [7] recommend implementing a set of simple intermediary’s [IFI] project financing for other purposes. financial mechanisms to address the SDG financing The reliance on the IFI’s, at least those based in Europe gap quickly and at a transformative scale. These mecha - and the World Bank group, has spurred the implemen- nisms include, inter alia, the issuing of sovereign green tation of certain standards which have steered countries L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 3 of 19 towards indirectly complying with some of the principles One of the consequences of COVID-19, related to of sustainable development. this new bond market, was the slow-down of the green Debt-for-nature swaps [and swaps for other sustain- bonds against the growth of the social and sustainability ability purposes] offer another solution to avert both bonds. The social bonds hit a record with an increase of debt and sustainability challenges by providing debt relief 170% since the beginning of 2020. However, despite ris- alongside mobilizing new finance for achieving sustaina - ing corporate interest, the rapid increase in social bond bility goals. While respective designs vary, all debt swaps issuances as a response to the recent pandemic has been share the same underlying mechanism: public debt of a mainly led by IFIs and primarily multilateral develop- developing country is cancelled in exchange for invest- ment banks (MDBs) [10]. In parallel, there is an expec- ments in projects linked to nature protection within tation that there will be a need to restructure sovereign the debtor country. There have only been a few debt- debt in a number of countries for which a more innova- for-nature swaps in countries of other world regions so tive approach may be needed [12]. far, and the investigative team recorded one debt swap The Green Bonds Principles just like the Social Bonds in Montenegro, but could not identify a recent surge in Principles or the Sustainability Bonds Principles are scholarly attention. designed to promote the transparency and integrity The aim of this paper is to assess new sustainability- needed to increase capital allocation to the projects that linked bonds and debt-for-climate swaps as innovative highlight either the green or social element [or the mix]. financial instruments, promising to leverage additional These investments are thus linked to the sustainability finance into sustainability goals in the Western Bal - policy, as explained by the International Capital Markets kan Six. As a first step, an online search was conducted Association’s briefs [13, 14]. To muster more resources for published material on sustainability bonds and debt needed for the SDG financing, the best avenue to take is swaps by researchers, international institutions and to increase transparency of the financing goals and the think tanks. This also entailed the collection of reports, policy makers’ directions in the mid- to long-run. news articles, and web pages. All collected data was then Launched in 2007, with the European Investment Bank reviewed and analysed from the perspective of drawing and the World Bank, issuance of the green market bond useful recommendations for the focus countries. Second, has grown significantly. The wider bond market started we analysed relevant data related to the debt situation in to react after the first USD 1 billion green bond sold the countries and drew conclusions on the usability of within an hour of issuance by IFC in March 2013, while instruments based on our experience in policymaking in in November of the same year, corporate green bonds the region. The subsequent section outlines recommen - started to see the light. The key year was 2014 when dations for policymakers in designing future green bonds USD 37 billion worth bonds were issued, while the new and debt-for-nature swaps and applies these to national record was set in 2019 when issuance reached almost circumstances in the Western Balkan Six. This study ends USD 259 billion. The cumulative issuance since 2007 with conclusions highlighting key messages. stands at USD 754 billion across 5931 deals and 927 issu- ers, while so-called certified climate bonds reached the Green, social and sustainability bonds USD 100 billion milestone [15]. History of green, social, and sustainability bonds Normally, the projects funded are related to the climate All the new forms of the bonds are voluntary. However, change mitigation, climate change adaptation, natural the growing trend is obvious. Investors tend to identify resource conservation, biodiversity conservation, and the benefits of a particular intervention based on their pollution prevention and control, and are focused, for interest to approach markets in different ways, the new example, on energy or emissions reduction projects, sus- instrument raises the country or corporation’s visibility tainable agriculture, and green buildings. or the innovation opens new financing channels as more On the other hand, social bonds are intended to meet and more investments funds are committed to keep share various social needs. Their role is to provide capital for of their investments in the green, social or sustainability projects that contribute to socioeconomic advancement bonds [11]—or as they are more and more referred, ESG and empowerment—such as affordable housing and instruments. infrastructure, access to essential services, employment The first corporate green bond was issued in November 2013 by Vasak - ronan, a Swedish property company, followed by large corporate issuers ESG refers to Environmental, Social and Governance, an acronym repre- include SNCF, Berlin Hyp, Apple, Engie, ICBC, and Credit Agricole. See for senting a growing corporate sector’s approach to the matters related to sus- more information URL https:// www. clima tebon ds. net/ market/ expla ining- tainability.green- bonds Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 4 of 19 generation, and food security [16]. They are similar in had in place processes for assessing environmental, structure to green bonds, a particularly popular form of social and governance [ESG] risks for projects. This has, “use of proceeds” bonds [10]. Logically, the target popula- however, changed over time, with a growing number of tions include people living under the poverty line, under- green bond issuances by corporations, energy and util- educated communities, marginalized groups and so on. ity companies and governments and their agencies from All of these new instruments require vigilant reporting around the world. Notable examples include Chinese by external parties who monitor and certify accomplish- issuers, who in 2016 comprised about 40% of the overall ments which adds to their credibility and makes them green bond market, as well as Poland, which in the same potentially preferred mechanisms in addressing the mid- year became the first sovereign state to issue a green to long-term needs to meet SDG benchmarks and help bond, followed by France, which issued the largest ever decarbonize the economy while making best use of pri- and longest dated benchmark green bond, a Euro 7 bil- vate–public partnerships. However, the magnitude of the lion, 22-year benchmark bond. In 2017, while holding the need is very large. Communicating the European Green COP23 Presidency, Fiji became the first sovereign emerg - Deal in December 2019, the Commission estimated the ing market issuer of green bonds when it issued a green need for an additional EUR 260 billion per year or about bond with a value of USD 50 million [20]. 1.5% of 2018 GDP to reach energy and climate 2030 goals In the context of this paper it is worth mentioning [4]. It is obvious that the new financing mechanism needs that Serbia issued their first ever green bond in Septem - to be given a boost. ber 2021 becoming the first Western Balkans country to The current total value of outstanding green, social and do so. It issued a 1 billion USD worth green bond. The sustainability bonds is USD 1503 billion [17]. However, 7-year maturity and 1% annual coupon security is aimed as the IFC team points out in their notes; green, social at investments in the rail and subway network, sewerage, and sustainability bonds still only make up a fraction water and wastewater processing, flood protection, bio - of the overall bond market. Compared to green bonds, diversity protection, pollution prevention and control, the social bond market is still in its nascent stage. How- waste management and at providing support for energy ever, issuances have skyrocketed since the outbreak of efficiency measures and the installation of rooftop solar COVID-19 in early 2020, as social bonds have become of panels [21]. increasing interest to investors looking to achieve posi- According to [22], the global green bond market in tive social outcomes together with a financial return [10]. 2019 grew by 51% to reach $260 billion with loan pro- There is still much progress to be made when con - ceeds primarily used in clean energy, building, and trans- sidering the regulatory framework, especially now that port sectors mainly in the EU and Asia Pacific, and North sustainable finance is becoming a part of mainstream America. By far and large, this innovative green finance discourse. The green transition in various sectors can instrument has not reached the developing countries at be significantly supported by some of these sustain - the scale and in the sectors required—where capital is ability or performance linked mechanisms. Therefore, most needed. The challenge, therefore, is to expand the it is expected that the EU will further work in this field issuance of green bonds to developing countries. One of by creating an EU Green Bond Standard [18], including the recommendations made in this respect for the gov- defining EU Taxonomy [19] with reference to the guide - ernments in developing economies is to adopt a holistic lines and disclosures. In the meantime, Climate Bonds and comprehensive policy framework that is conducive Initiative has launched Climate Bonds Standard 3.0, aim- to the inflow of sustainable investment resources, offers ing to improve the overall business environment [15]. investors protection, and is transparent. It is also criti- cal to clearly and transparently link performance indica- Examples of sustainability bonds worldwide tors with environment and sustainability. This includes Demand for green bonds is continuously increasing. developing sovereign green bonds as well as encouraging Until roughly 2012, the green bond market was domi- private enterprises to issue green bonds to fund climate nated by multilateral development banks, which already adaptation and mitigation efforts. To date, more than 90% of all new green bonds have come from issuers other than multilateral development banks. This is illustrated, for instance, by the ranking of In 2018, Danone was the first corporation to issue a social bond. The pro - ceeds (EUR 300 million) were used to fund research and development in food the largest climate bond issuers in 2019. Fannie Mae, security. However, Emmanuel Faber, chairman of the Board who long cham- the pioneer of issuing Green Mortgage-backed Securi- pioned social bonds and sustainable financing, was fired by the board when ties [MBS], remained the largest green bond issuer with shareholders became unhappy with the stagnant share price, which contra- dicts the sustainability logic of companies working for the wider benefit to 22.9bn USD issuance or 9% of the total. KfW, the German shareholders For more details, please see The Economist, Climate finance: It is state-owned development bank, was the second largest not easy being green, March 27, 2021. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 5 of 19 issuer with a total of 9bn USD worth of green bonds in There are also incentives not directly related to finan - the market with proceeds used to provide financing or cial risks such as those associated with reducing repu- co-financing to renewable energy and green building pro - tational risks and risks associated with potential future jects. They were followed by the Dutch State Treasury regulatory framework related to sustainability [29]. In Agency [DSTA] ranked as the third largest issuer with addition, the academic literature identifies additional 6.7bn USD debut green sovereign bond. incentives, associated with broader forces, such as the Another recent example of this phenomenon was the legitimacy of the organization and institutional-ori- announcement of global biopharmaceutical company ented drivers connected to operating at a societal level Pfizer about launching a $1 billion USD sustainability [30, 31]. bond offering, with the use of proceeds funding R&D and capex for the company’s COVID-19 vaccine. The 10-year Features of sustainability‑linked bonds bond was priced at 1.75%. The issue marks the second for A variation to the above-mentioned bonds is the sus- Pfizer under its Sustainability Bond Framework, follow - tainability-linked bonds [SLBs] or ESG bonds. The ing a $1.25 billion USD 2.625% 10-year offering in March proceeds of SLBs are intended for general purposes of last year. According to the company, proceeds from and due to the variability of the coupon, based on the the offering will be used to finance or refinance research accomplishment, may be further explored by the West- and development expenses related to COVID-19 vac- ern Balkan countries. During the preparation process cine research and development, capital expenditures in objectives are measured through predefined key per - connection with the manufacturing and distribution of formance indicators [KPIs] and assessed against prede- COVID-19 vaccines, and other projects of Pfizer or any fined sustainability performance targets [SPTs]. of its subsidiaries that have environmental and/or social The Sustainability-Linked Bond Principles [SLBP] benefits [23]. [14], established by ICMA, recommend that issuers publicly communicate their rationale for the selection Incentives for green bonds issuance of their KPIs [i.e., relevance, materiality], the motiva- Although to date, there has been very little academic tion for the SPTs [i.e., ambition level, consistency with work in the theory of the growth of the green bond mar- overall strategic planning and benchmarking approach], ket in the academic literature [24], some conclusions can the potential change of bond financial and/or struc - already be gleaned. In general, the financial incentives tural characteristics and the trigger events leading to for investing in green bonds are no different than for such a change, intended post issuance reporting and other asset classes. An investor has financial incentive to independent verification. The target setting exercise invest in a green bond if this bond provides some or all should be based on a combination of benchmarking the following benefits: better returns, lower risk, and bet - approaches that include the issuers’ own performance, ter diversification benefits than other comparable assets. the performance of its peers and reference to the sci- An issuer has a direct financial incentive to issue a green ence. In this process, the issuer may seek a second party bond if the green bond reduces their cost of capital and/ opinion. or improves their access to capital. The potential variation of the coupon is the most Besides incentives related to the economic perfor- common example, but it is also possible to consider mance of the investor there are incentives that are not the variation of other SLB’s financial and/or structural directly related to the financial performance of the green characteristics. bond. [25] The four types of non-financial business case What adds to the transparency and the overall cred- incentives are: operational, efficiency branding, creating ibility of this mechanism is that issuers should seek new markets, and reducing risk. Operational efficiency independent and external verification [for example lim - could be enhanced by attracting high quality employ- ited or reasonable assurance] of their performance level ees or making an impact on the productivity of employ- against each SPT for each KPI by a qualified external ees motivated by sustainability commitments [26]. The reviewer with relevant expertise, such as an auditor or branding benefits of engaging in sustainable finance an environmental consultant, at least once a year. include attracting and retaining customers or charging premium prices for products and services [27]. Creating new markets could entail developing new investment products for customers interested in sus- tainable investing and/or attracting new classes of customers to existing and new product offerings [28]. Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 6 of 19 Debt‑for‑nature swaps raised hundreds of million of dollars for environmental History of debt‑for‑nature swaps projects in the 1990s. It is estimated that between 1987 Reference [32] provide a historical review of the debt- and 1997 USD 134 million worth of debt allowed financ - for-nature swaps. According to the authors, the design ing of USD 126 million in nature conservation [37]. [38] and use of the debt swap instrument dates back to estimates the volume to total USD 163 million for the the 1990s with the first instruments taking the form period of 1987–1995 and according to OECD estimates of debt-for-equity swaps. Debt restructuring started [39], USD 1.1 billion of conservation was financed from almost immediately after World War II and accelerated debt titles of USD 3.6 billion between 1991 and 2003. when the Paris Club was founded in 1956 [33]. Com- In the months leading up to the climate summit in posed of officials from major creditor countries, the Copenhagen, Indonesia named debt swaps as a source of club would initiate the first large-scale debt relief pro - climate finance in informal UNFCCC consultations. Still, grams in the form of debt-for-equity swaps, and from debt-for-climate swaps were never declared as an offi - 1991 onwards allow debtors to convert their public debt cial climate finance instrument under the UNFCCC [39]. into local payments for social or environmental pro- Nevertheless, both the United States and Italy fulfilled jects [34]. The first debt-for-equity swap took place in parts of their fast-start-finance commitments [0.5 and Chile in 1985, where commercial debt was cancelled 11%, respectively] for 2010–2012 via debt swaps, together in exchange for creditors receiving shares in publicly contributing USD 82.5 million of the USD 30 billion fast- owned enterprises [35]. start-finance goal of the Copenhagen Accord [41]. The first debt-for-nature swaps appeared in the 1980s as a response to the worsening environmental condi- Examples of debt‑for‑nature swap reported by literature tions in developing countries. In the 1980s many coun- Debt relief linked to environmental goals or debt-for- tries particularly in Latin America increased their export nature swaps is not a new story: after World War II the volume in response to the debt and economic crisis that Paris Club comprised of major creditor countries ini- caused heightened rates of resource exploitation and tiated large-scale debt relief programs in the form of deforestation. Soon after, the first debt-for-nature swap debt-for-equity swaps, and from 1991 onwards allowed was agreed upon by Bolivia and Conservation Interna- debtors to convert their public debt into local payments tional, in which the latter bought USD 650,000 of Bolivia’s for social or environmental projects. Since then, debt-for- commercial debt at a redemption price of USD 100,000 nature swaps have raised hundreds of million of dollars from a Swiss bank. This debt was then swapped against a for the environment. commitment by the Bolivian government to spend USD A good example of this approach is the 2015 debt swap 260,000 on biodiversity conservation [35]. scheme implemented by Seychelles and a club of public The volume of debt swaps grew in the 1980s to peak and private debtors which enabled the country to cancel in 1990 and decline through the 1990s. Throughout the EUR 21.6 million in exchange for domestic investments 1980s, the secondary market of debt titles grew rapidly in protection of its unique marine ecosystem against a and debt swaps were advertised as a standard instrument specific commitment of the Government of Seychelles to of debt relief by lending agencies seeking new ways to increase marine protected area from 1 to 30% of its ter- minimize their financial losses [34]. Total swap volumes, ritorial waters [42]. including buybacks and other exchanges, peaked in Another good example was the swap between Italy 1990 at USD 27 billion, after which they declined in the and the Philippines in 2012 that entailed the cancella- 1990s. This was partly due to structural adjustments and tion of the Philippine’s public debt of EUR 2.9 million an improved economic performance of many indebted in exchange for investments in environmental protec- countries that would increase the value of their debt titles tion and poverty reduction [39]. The projects that were on the secondary market and thereby make them less in the areas of conservation, reforestation, agriculture, attractive leverage instruments for environmental groups and sustainable resource management placed a particular [35, 36]. focus on the participation of local communities. By 2019, Although debt-for-nature swaps were performed at the program is estimated to have 17,000 beneficiaries, much smaller scales than debt-for-equity swaps, they including local farmers and fishers from predominantly poor districts. 4 Features of debt swaps For more about the Paris Club please visit https:// clubd eparis. org As [32] explain, swaps are either arranged directly As a consequence, then vice president of the World Wide Fund for Nature (WWF) Thomas Lovejoy proposed a debt-for-nature swap instrument that between one debtor and one or more creditor govern- would encourage debtor countries to invest into their natural conservation ments, the basic model, or are facilitated by a third programs in exchange for debt reduction [40]. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 7 of 19 Fig. 1 Architecture of debt-for-nature swap instruments [32] party—often an international NGO tripartite model. In If debt titles are bought on the secondary market, the the latter, the NGO purchases the debt of an indebted price is determined by the credit rating, debt situation, country at a secondary market price and redeems and overall economic performance of the indebted state. the debt title with the debtor country in exchange for If, alternatively, debt titles are bought back via bilateral conservation efforts. The secondary market price ulti - agreements, no rules or restrictions on the discount rate mately depends on the probability of full debt repay- by which the initial debt is reduced exist. Having mainly ment and is consequently higher if full repayment is ranged between 0 and 50% in the past, discount rates are expected. In addition, the extent to which the outstand- negotiated between the participating governments on a ing debt service payments are already written off by the case-by-case basis. creditor government as well as the overall economic Overall, debt swaps are more feasible when creditor situation and growth projections of the debtor govern- governments are willing to sell titles at a price lower than ments play a role. Figure 1 provides an illustration of face value, because only then there is some fiscal space both models of debt-for-nature swaps. created for the debtor government. However, as bilateral After mutual agreement, expenditures of the debtor debt is predominantly held in US dollars and investments government are usually made gradually, often into a in local environmental projects are generally made in dedicated fund, and according to the original repay- local currency, preferable conditions could arise even at ment schedule of the initial debt. They can either be a discount rate of zero when scarce hard currency can be channelled directly towards environmental projects saved. or placed in a national trust fund, through which the Most debt swaps have involved bilateral public debt, interest earned on the deposited money can also be but debt swaps can also be conducted in the case of mul- used to finance environmental projects, e.g., via grants tilateral public or commercial debt. Commercial debt, to local NGOs. Such funds allow earmarking and for example, can be bought on the secondary market increase accountability as they are governed by a com- by a donor country as a form of official development mittee composed of representatives from both govern- assistance [ODA] or climate finance. Multilateral credi - ments and independent observers, such as national or tors, such as the World Bank or the IMF, cannot provide international NGOs. debt relief per se because of their legal status, but donor Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 8 of 19 Table 1 Opportunities and challenges of debt swaps for the involved parties [43] Advantages and positive outcomes for debtor country Advantages and positive outcomes for creditor country Shortfalls and challenges - Through debt relief and conversion, the overall debt burden - From a financial perspective, creditor countries’ remaining debt - If the discount rate is low or even zero, no extra budgetary room on the debtor country is lowered and the strain on the national claims increase in value through such swaps, and creditors can is provided, which leaves the overall macroeconomic situation budget is reduced recover either full or at least part of their debt and thereby avoid unaffected - Since counterpart payments into environmental projects are the accumulation of arrears. Debt swaps are particularly benefi- - If the debt swap volume is small, the positive impact on the generally made in local currency, debtor governments save cial if parts of the debt are already written off and full repayment debtor’s economic situation is negligible or might even be scarce hard currency which they can then use to establish is unlikely outweighed by the costs incurred when negotiating a swap and foreign exchange reserves - Creditors have to mobilize less additional finance to meet their setting up a trust fund - Debt relief can strengthen economic stability, improve the international climate commitments and, at the same time, can - Debtor countries must have sufficient funds to put into trust credit rating of a debtor, and attract new investments register the instrument as the provision of ODA. Since the nomi- funds, and there exists a risk of inflation if debtor governments - Environmental projects benefit from freed finance that would nal value of non-concessional debt can be registered as ODA, print money to pay the agreed amount in local currency have otherwise gone towards the creditor’s budget, often bring- many creditor countries have used this instrument to boost their - Debt swaps carry the threat of crowding out other forms of ing economic and social benefits at a local level ODA numbers finance that are potentially more effective. Debt swaps should be - Grants to environmental projects or local NGOs are typically - Furthermore, creditor countries can raise their environmental additional to the already delivered ODA and not substitute other distributed via a trust fund which is set up according to original credentials by mobilizing co-financing through international channels of new aid repayment schedules. This long-term regular funding facilitates funding institutions. A debt swap that is carefully designed - Climate-relevant debt swaps have to compete with other sectors fund and, therefore, debtor’s absorption of climate finance can guarantee an adequate use of funds and carries a greater (health, education, infrastructure) for a limited amount of eligible responsibility than a single donation debt L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 9 of 19 Fig. 2 Overview of the debt to nature swap between the Paris Club and Montenegro countries could use their resources to pay off the debt program activities was the last cancellation precondi- held at such institutions. tion. Debtor financial obligation was transferred to a spe - Debt-for-climate swaps are commonly referred to as cial account of the Vodacom company, organized as the ‘win–win’ agreements, as they benefit both debtor and Joint Service and Coordination Company for Water and creditor countries. Table 1 identifies advantages and Wastewater Services for the Montenegrin Coast. It was shortfalls of debt swaps for the involved parties. established in 2005, after the Government of Montene- gro recognized the need for active work on the improve- Case study: Debt swap experience in Montenegro ment of water supply and sewerage infrastructure on the The Montenegrin case (Fig. 2) represents the basic model Montenegrin Coast. The last disbursement to the pro - swap, since it had been arranged directly between the vider of construction works was completed in October debtor and one creditor government. Total debt volume 2013 by Vodacom which was considered as the closure of of EUR 11.23 million held by the government of Ger- the swap. Figure 2 illustrates the architecture of the deal. many, i.e., the KfW bank as the Paris Club creditor was cancelled in exchange for a project in water supply and Recommendations for designing debt‑for‑nature swaps sanitation. The Government of Montenegro and the KfW References [32, 43] summarize recommendations from bank negotiated the scheme of the swap and the agree- various publications. The authors attest that environmen - ment was concluded in 2008. The agreement reached by tal and fiscal improvements can only be realized when KfW bank and the Government of Montenegro envis- debt swaps are designed carefully, as we saw from the les- aged cancellation of the debt amount conditioned by the sons-learned. There are three main success factors which fulfilment of several preconditions. The Government of ultimately determine the overall effectiveness of the Montenegro, as the debtor, was obliged to contribute an scheme. First is the need to maximize the swap’s finan - amount of EUR 5.6 million to a sewage treatment plant cial value to the debtor country to create strong politi- and sewage network in two municipalities under the Pro- cal will and national buy-in. Second, the ambition of the gram for Water Supply and Sanitation at Adriatic Coast. scheme has to be aligned with the national climate goals, Contribution was to be issued within a 1-year period and a robust monitoring and reporting framework has to from the signing of the agreement, paid into a special be put in place to ensure that its climate impacts are duly commercial bank account and available for the KfW monitored and communicated. Finally, transparent gov- inspection. Another precondition was substantial com- ernance arrangements and a well-capacitated operator of pletion of a program for water supply and sanitation con- the scheme are indispensable for the success. struction works before the end of 2012. The first recommendation to a debtor country when The final consent of the Government of Federal Repub - designing and negotiating the financial structure of a lic of Germany on the KfW report on completion of swap mechanism to maximize the financial values of such schemes: The case study was prepared based on the inputs from the Ministry of Finance of Montenegro. Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 10 of 19 • Seek to achieve a positive difference between the society participation. While some international NGOs original face value of the debt and the redemption have gathered extensive experience in facilitating debt- price so that fiscal space is created. This can be done for-nature swaps, the contribution of local or regional by either purchasing the debt title on the secondary NGOs is similarly important to provide crucial insights market or by bilaterally agreeing on applying a dis- about local conditions. count rate greater than zero with the creditor. The third recommendation is that effective implemen - • Negotiate the cancellation of the outstanding debt tation and governance structures are essential for the service payments before making counterpart pay- success of the swap mechanism. This, first of all, calls for ments to provide extra budgetary room. an establishment of a scheme operator or a selection of • Convert the outstanding debt payments into local one from existing organizations. This should be a finan - currency payments so that hard currency can be cial institution with solid fund management expertise saved. and technical capacities to implement climate projects. • Schedule payments according to the original repay- Such a combination of financial and climate expertise ment schedule so that a constant and predictable rarely exists in developing countries and often has to be stream of finance is provided. built from scratch with additional technical assistance • Reinvest the interest rate earned by the funds to pro- from international organizations. In addition, to ensure vide additional capitalization for the mechanism. oversight and provide strategic guidance, a good practice • Only conduct debt swaps if the debt volumes are is to establish a supervisory committee that is composed large enough to justify the lengthy negotiation pro- of representatives from both the debtor government and cess and high transaction costs associated with deal the creditor’s as well as international and national NGOs. structuring and implementation. The debtor government’s leading role and close involve - ment in designing and implementing a swap deal is cru- Furthermore, debt swaps and corresponding debt relief cial to ensure national ownership and longevity of the should be additional to the creditor’s ODA and not crowd programme. At the negotiation stage, highest level politi- out other ongoing investments in climate mitigation and cal support of the climate swap proposal is particularly adaptation. Second, climate-related projects, funded by important for the deal to be secured. Climate-related debt swaps, should be additional to those already funded projects should be anchored in national climate policies, in debtor countries. While it is beneficial if concrete cli - and debt swaps should be embedded in a broader debt mate objectives and measures are envisioned and some reduction strategy. infrastructure for delivering those is already established, payments originating from swap deals should not be Public debt and feasibility of instruments in Western used to legitimize cutting back governmental spending Balkans 6 in other areas. And lastly, it is essential to ensure added For the purpose of reviewing the public debt conditions finance for the debtor country through debt relief. in the Western Balkans Six [WB6] countries, the trends The second recommendation is that the design of the of debt in the 10-year period 2010–2020 was assessed. climate swap mechanism should be aligned with national Given that the entire decade has been post-crisis, follow- climate commitments. In particular, they should be fully ing the global financial crisis in 2008, it is to be expected anchored in and aligned with national climate change that each of the countries will record an exponential priorities and the objectives as communicated in the trend of public debt growth. The new COVID-19 crisis National Determined Contributions [NDCs]. period, which began in 2020 and was primarily charac- To ensure the achievement of climate and other envi- terized by a decline in GDP and an increase in public ronmental and social benefits of climate swap schemes, it debt, is expected to underscore the need to finance the is important to start with determining a baseline scenario health sector as well as economic support programs. against which progress and final outcomes are measured. What is noticeable in methodological terms is that This entails developing indicators and specific defining there is no consistency in public debt reporting meth- targets that should be set for various steps throughout the odologies of the Western Balkan countries. Each coun- implementation phase. Monitoring plans and method- try has its own approach to reporting. However, over ologies shall also be developed to enable regular progress a 10-year period, improvements in the quality and tracking, reporting and communication to all involved stakeholders and the public-at-large to enhance transpar- ency. Involvement of independent actors, such as NGOs, Is not intended, however, to execute a debt sustainability analysis as this would require separate research. has proven to facilitate trust between debtor and creditor This is especially characteristic with the treatment of guarantees. Most governments and has been crucial for encouraging civil countries publish public debt data without including guarantees. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 11 of 19 Table 2 Public debt portfolio of the Western Balkan 6 countries Montenegro North Macedonia Serbia B&H Kosovo Albania 2010 2015 2020 2010 2015 2020 2010 2015 2020 2010 2015 2020 2010 2015 2020 2010 2015 2020 GDP (mil EUR) 2104 3625 4245 7109 9072 10,766 31,546 35,740 47,156 12,969 14,618 17,322 4402 5807 6831 8933 10,448 12,710 Public debt % GDP 42 61.6 102.4 24.6 38 60.2 42.9 76 56.8 33.8 40 35 6.2 13.0 24.6 57.7 72.8 77.9 Public debt portfolio (% of total public debt) Multilateral and bilateral 46.4 27.7 13.7 49.2 25 n.a 46.6 35 37.8 66.6 70.4 68.5 n.a 49.25 33 18.9 25.7 25.6 creditor loans Eurobond 15.7 39.6 44.9 19 22.3 n.a 0 19 19 0 0 5.4 n.a 0 0 3.36 4.31 9.05 Private sector loans 9.8 18.1 32.5 13.6 n.a 0 5 0.9 0 4.13 1.85 n.a 0.45 1.4 3.03 6.38 3.07 Government securities 3.9 4.37 4.2 31.3 38.9 n.a 47.5 30.5 39.5 11 10.4 15.8 n.a 50.5 64.7 32.41 36.32 40.12 Source: Statistical Offices and Ministry of Finance websites of WB6 [Montenegro: www. mif. gov. me [Ministry of Finance], www. monst at. org [Statistical Office] both accessed April 2021 Serbia: www. javni dug. gov. rs [Public Debt Administration] accessed April 2021, North Macedonia: www. finan ce. gov. mk [Ministry of Finance], www. stat. gov. mk [Statistical Office] both accessed April 2021, Albania: www. finan cia. gov. al Ministry of Finance], www. instat. goval [Statistical Office] both accessed April 2021, Bosnia and Herzegovina: www. mft. gov. ba [Ministry of Finance], www. bhas. gov. me [Statistical Office] both accessed April 2021, Kosovo: www. mf. rks- gov. me [Ministry of Finance] www. ask. rks- gov. netf [Statistical Office] both accessed April 2021]) Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 12 of 19 coverage of reports, as well as levels of transparency, Kosovo and Albania have 30–60% of these securities in are evident. Table 2 provides an overview of the data on their portfolio speaks not only of domestic confidence, public debt, its ratio to gross domestic product [GDP], but also of the capacities of domestic banks and institu- as well as the structure of the public debt portfolio of the tional investors. WB6 countries. The fact that all countries except Kosovo and Bosnia Table 2 illustrates that the condition of WB6’s pub- and Herzegovina, and some even before 2010, had suc- lic debt at the end of 2020 ranged widely, from 24% in cessful euro-bond issues, also indicates the presence of Kosovo to 102% in Montenegro. The trend of the debt confidence of international investors. movement was continuously progressive, except in Serbia When it comes to the debt maturity, countries do not and Bosnia, which in the second part of the period, after usually publish a single average maturity figure. Data 2015, managed to reduce their share of public debt in which are mainly given refer to the maturity structure, GDP. Other countries have managed to double, and some which show that long-term securities are predomi- have tripled, their public debt in the past decade. nantly present in the portfolio. Specifically, Montenegro Five countries, except North Macedonia, have fiscal published data that the average maturity at the end of rules in place. All of them have a rule limiting debt, but 2020 was 6.9 years, while the same data for Bosnia and there are differences in the size and nature of the limit. Herzegovina for 2019 was 7.7 years. In addition, the ratio Size of the limit differs from 40% in Kosovo to 45% in of debt to fixed and variable rates in most countries is in Albania and Serbia to 60% in Montenegro and Bosnia favor of fixed or is balanced. and Herzegovina [44]. It is clear that all countries, except All of the above leads to the conclusion that the West- Bosnia and Herzegovina and Kosovo, have been violating ern Balkan 6 will have a specific challenge to manage this fiscal rule for some time. The COVID crisis is likely their public debt in this so-called traditional way. It will to further slow these countries’ ability to comply with the be particularly interesting to see how and to what extent public debt limit. The public debt of the WB6 countries the governments of these countries will know how to is predominantly external, except in Kosovo, where start- recognize and be able to introduce new borrowing ing in 2015, the situation is changing in favor of domestic instruments. debt. In addition, public debt is dominant and euroized One of the modalities recently proposed by an IMF in countries that have their own currency. researcher [45] is based on Klemperer’s Product-Mix As for the public debt portfolio, each of the countries Auction approach. This method holds auctions to over - has certain specificities, depending on the economic and come issues related to the classic sovereign debt restruc- political heritage. Those who had liabilities based on old turing negotiations. The application of an auction model foreign currency savings, restitution and unpaid pensions offers a platform that enables participants to engage have securitized them and they are present in the port- based on their preferences rather than a one-size-fits-all folio of their domestic debt. Each of the countries in its approach, which causes enormous difficulties. Such pref - portfolio has loans from multilateral and bilateral credi- erences may relate to bonds that are different in maturity tors, government securities, euro-bonds and private sec- or denominated in different currencies. tor creditors’ loans. At the beginning of the decade, multilateral and bilat- The swap scheme’s new lease on life? eral creditors’ loans were most dominant in the public In the context of the EU accession process and the debt portfolio; and, over time, their share decreased with recently revealed European Green Deal, newly shaped the exception of Bosnia and Herzegovina, where these market mechanisms for the UN2030 Agenda financing loans represented about 70% of the total portfolio. The in the form of the green, social or sustainability bonds decrease in share of these loans in most countries was in are worth considering to ascertain if new approaches are favor of the increase in share of government securities, possible. This innovation may arise from an already exist - this time with the exception of Montenegro, which has ing debt-for-nature swap, which can trace its way back changed the structure of its portfolio in such a way that to the post WWII debt restructuring and later debt-for- euro-bonds and private sector loans have become the equity instruments as explained in the literature review. most important means of financing public debt. As already shown in the case study, one of the countries Government securities involve the issuance of bonds that has used this opportunity was Montenegro in 2009. and treasury bills. The fact that North Macedonia, Serbia, More than a year. 9 11 Data for 2020 are preliminary, bearing in mind that final GDP data have not Paul Klemperer is a renowned economist who followed the trail of Nobel been published. laureates Paul Milgrom and Robert Wilson and their auction analysis. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 13 of 19 Table 3 WB6 GDP per capita in PPS The debt analysis of the WB6 countries, despite some - what different situations, clearly points out that there % of EU are many macro-fiscal challenges ahead and an innova - average in tive approach is needed. At the same time, despite having relatively reduced fiscal space for additional borrowing, EU 27 average 100 while many structural requirements lie ahead, it is obvi- Montenegro 50 ous that individual countries’ GDP, in purchasing power, Serbia 41 is still significantly lagging behind the EU average, as North Macedonia 38 Table 3 illustrates. Bosnia and Herzegovina 32 With an average score of 38 , in 2019, the year before Albania 31 the pandemic began, it is obvious how far WB6 countries Source: Eurostat https:// ec. europa. eu/ euros tat/ web/ produ cts- datas ets/ need to go, and why innovative mechanisms are needed. It is only sustainable development and a continuous posi- tive trajectory that can keep this part of the world secure On the other hand, it is evident that the EU is a will- and migration at bay. ing partner and provides a different mechanism of sup - However, prior to any concrete move, special attention port. The most important one, so-called Instrument of is required to assess the legal aspects of the use of the Pre-accession Assistance begins its third 2021–2027 above-described novel financial instruments—as some iteration. IPA serves to provide financial assistance to countries may be in differing positions. In addition, there the candidate countries to meet political and economic is a need for more in-depth analysis of the particular pub- criteria for the membership and is based on the strate- lic debt elements and their structures. This is of special gic documents which point out necessary reforms in the relevance when it comes to the possibilities of the further fields of the rule of law, fundamental rights and govern - use of the debt for nature swaps. It is, evidently, possible ance; socio-economic development; Union policies and in its most intuitive form and only in case of bilateral or acquis ; people-to-people contacts and reconciliation; official development aid. good neighbour relations and regional cooperation. Alternatively, bringing together IPA and private mar- Expanding the previous IPA II mechanism to the areas kets, while combining the swap model and new forms of of migration; security, protection of the environment and bond issuance, a more transparent process that require climate change should be considered as new features. vigilant reporting and verification, the EU may further In fact, the debate in Parliament during the first reading support countries of the Western Balkans by repaying produced amendments which, assuming Paris Agree- part of the principal debt upon the independent verifica - ment obligations, were aimed at establishing a stronger tion of how proceeds are used and whether targets have connection between the UN 2030 Agenda and IPA. been met. This approach would not be entirely new as Such an approach should result in 16% of the program there are already examples of the so-called direct budget- addressing climate impact needs of the beneficiaries. It ary support mechanism, which is executed against a set also calls for special attention to cross-border polluting of policy measures a candidate country is obligated to issues. Equally Parliament calls for the European Fund for meet. Sustainable Development Plus to complement the efforts Such an approach can be directly linked with the com- under the pre-accession programme [46, 47]. As for plementary Green Agenda for Western Balkans [49], the IPA III assistance purpose, approximately EUR 14.2 establishing a number of initiatives in different areas, billion has been proposed and enabled along with other such as climate change, clean energy transmission, smart key areas, such as rule of law, public administration and and sustainable mobility, circular economy, depopula- economic governance, putting new emphasis on environ- tion, sustainable food systems and rural areas and the ment and climate action [48], which could serve as excel- protection of biodiversity. In parallel, Western Balkan lent leverage to generate more funding from the capital countries should continue their accession process by con- markets. ducting a series of policy reviews to one day join the EU. Figure 3 presents the KPIs that are used to help measure Agreed finally in June 2021. Common term to refer to EU legislation. Instrument for Pre-accession Assistance [IPA III] [46] was established in 2017 as a contribution to the pro-active development aid related to the UN2030 expected to have generated 44bn investments based on the EUR The table lacks data for Kosovo, which if included would further drive the 4.1 billion initial contribution. [47] average score down. Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 14 of 19 Fig. 3 List of key performance indicators [50] the EU’s contribution to the achievements of the candi- mechanism and to pay for the fraction of issued green, date countries: social, sustainability bonds. Paying for that in the matu- It is noticeable that there is no mention of the Human rity year sets free additional resources in troubled state Development Index produced by the UNDP, which would budgets. Another option could be to issue a higher also be of use when tracking progress in the social sphere, amount of bonds, while the markets realize that provid- related to the education and health, in particular. ing the implementation of the policies and meeting tar- gets means that the EU would use some of the funds to Could green, social and sustainability bonds be a good fit? repay part of the bonds once they mature. Such mecha- Going back to green, social and sustainability or ESG nisms would bring further relief in the lower interest bonds in some form could prove beneficial as they have that would be paid each year, which provides additional key performance indicators and sustainable targets. financial means to implement the EU acquis. Altogether, Given that the European Commission uses different key countries could benefit from spurring economic growth performance indicators to monitor the progress coun- based on sustainable and smart development while keep- tries make, those indicators could play an important ing public debt in check. role. At the same time, the Green Agenda for the West- What precise targets and what exact portion of the ern Balkans sets off a number of initiatives that could be bonds would be repaid by the IPA III allocation would transferred into the targets, both indicators and these depend on the type of bond, given the varying levels of targets can serve as an excellent basis for transparency support the EU provides to different areas of investments. and reporting required by the markets, as it is presented Some of the initiatives may easily be turned into clear in Fig. 4. targets, some would need further work to figure out the The availability of IPA III funds completes the picture most proper indicators. As far as the initiative related to as those resources can be used for the adjusted swap the Biodiversity Action plan is concerned, the first target might be the adoption of a proper action plan followed by some key action points to be carried out. In addition, there has already been some research produced that www. hdr. undp. org L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 15 of 19 Fig. 4 Green agenda for Western Balkans initiatives could serve as useful guidance in defining a conceptual Western Balkans, explained above, which suggests that framework, such as in the example of bioenergy [51]. many structural issues need to be tackled by the national Besides this, there has to be a proper legislative analysis governments. of whether issuing new bonds would require the pass- All the WB6 countries strive to become member states ing of new legislation in the respective Western Balkan of the EU. However, that road demands the introduction countries that would enable the use of the new finan - of the very specific legislation which normally brings cial instruments in the first place, similar to what Serbia about the need to accommodate and adjust institutions, experienced, prior to the new issue [21]. requiring additional costs and more efficient and effective The work on the SDG indicators as well as the efforts public administration in the end. In addition, infrastruc- and the contribution of the UN Global Compact could ture and overall development needs remain very high, be of tremendous help in this space. This may also be a and macro-fiscal room has shrunk—given the levels of field that would benefit from further research. the public debt, in particular. Therefore, the innovative approach presented below Summary of recommendations offers a new modality of ESG bonds which is based on As illustrated throughout this paper, there are plenty of the EU process combined with the Green Agenda initia- different tools to use in developing innovative invest - tives for the Western Balkans. This new bond mechanism ment models. The option summarized below, in Fig. 5, would use some of the lessons and practicalities learned builds on the current macroeconomic situation in the from nature for debt swaps, where green investments could lead to some debt relief. Countries are still in the position to issue green bonds, such as the one Serbia recently released or pursue classic debt for nature swaps. See for details https:// unsta ts. un. org/ sdgs/ indic ators and https:// www. The new mechanism may, in fact, serve as an extension. unglo balco mpact. org Lukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 16 of 19 Fig. 5 Summary of recommendations on the introduction of new financial instruments in the Western Balkans Countries should be encouraged to define clear targets tool of assessment]. In some cases, it will require that based on the sustainable development policies and then new legislation be enacted to establish and implement go to the market with the transparent support of the EU these indicators. Any initiative which is measurable through the IPA funds. The logic of the IPA funds is to through additional regional mechanisms of cooperation prepare countries for the membership and is used to help is a value added as it contributes to the stability and pros- meet various benchmarks. Even the modality by which perity of the whole region. countries benefit from the direct budget support is con - ditioned by some prior action. Conclusion This new approach would bring about the synergy The promise of the EU, made in 2003, that all Western between private and public funds; introduce very trans- Balkan countries are welcome to join the EU once estab- parent targets and indicators, verifiable by independent lished criteria are met, has set most of the policy goals auditors; and use IPA funds as a powerful leverage to for these countries. However, since then, only Croatia help save some interest or principal repayment costs and joined the EU on July 1, 2013. Whereas, Montenegro thus help a country lower public debt and reinforce inter- has advanced the most in the accession process [all the national financial credibility or use the extra money for negotiating chapters are open] and Serbia following; the additional investments in the quality of public adminis- process overall seems to have slowed down. North Mac- tration or social infrastructure. Instead of chopping IPA edonia and Albania are still waiting for the real accession between different sectors it would be more transparent talks to begin, whereas Bosnia and Herzegovina and Kos- and effective to use the contribution as an additional ver - ovo seem to be nowhere near beginning. ification that proper policies are in place [it may combine In the meantime, the UN 2030 Agenda, adopted in rule of law with public administration reforms or sustain- 2015 and establishing the SDGs, and the ongoing chal- able development]. Such an approach would increase the lenges related to COVID 19 have put additional ingre- accountability of policymakers as well. dients on the table. The green transition has become an It would be crucial to develop more measurable tar- equally important policy for the respective countries dis- gets as far as the Green Agenda for the Western Balkans cussed, and along with that emerges additional social and initiatives are concerned. Other indicators which are economic challenges. Economically speaking, the situa- reported by international organizations [World Bank’s tion is complex and all the Western Balkan 6 countries Doing Business, for example, is a more straightforward are faced with significant development financing needs. L ukšić et al. Energy, Sustainability and Society (2022) 12:15 Page 17 of 19 Their average GDP in terms of the purchase power com - new approach to the debt sustainability offered by IMF pared to the EU average is way below 50%. While the researchers, also discussed earlier; may result in a win– average public debt stands at around 50%, this figure, win situation for all the market agents, including gov- which may seem moderate, hides the growing trend over ernments. Hopefully, this approach may unlock missing the past decade and major discrepancies amongst coun- fiscal space, which in the mid- to long-term could bring tries, such as Montenegro and Albania on one hand and about many benefits in higher levels of GDP and human Kosovo, for example, on the other. development indexes. Therefore, the complex agenda involving EU accession, infrastructure and SDG needs requires innovation in the Abbreviations SDG financing. IPA: Instrument for pre-accession assistance of the EU to the candidate This paper analyses some of the new mechanisms, such countries; ESG: Environmental, social and governance; KfW: Kreditanstalt fur Wiederaufbau; MDG: Millennium development goals; SDG: Sustainable as green, social and sustainability bonds and nature for development goals based on UN 2030 Agenda; UNFCCC: Unit ed Nations debt swaps. It is obvious that some of the main benefits of Framework Convention on Climate Change; UNDP: United Nations Develop- the new form of ESG bonds is a higher level of transpar- ment Program; WB6: Western Balkan 6 (Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, Serbia). ency and, inevitably, a higher level of accountability that comes along with it. To achieve benefits such as lower Acknowledgements interest rates of the longer maturity terms, it is important Authors would like to thank Dragan Darmanovic, former head of the Treasury in the Ministry of Finance of Montenegro for his practical insight into the debt to incorporate independent verification metrics to deter - for nature operation shown in the case study. Authors would also like to thank mine whether the various KPIs and green/social/sustain- Marija Pejovic for the English editing of the article. ability targets are met. Authors information: Igor Luksic, f. Prime Minister (2010–2012) and f. Finance Minister (2004–2010) of Montenegro, associate professor University of Donja On the other hand, nature for debt swaps is not entirely Gorica. Bojana Boskovic Ministry of Finance of Montenegro, University of new and has been in place for some decades. Out of the Donja Gorica, associate. Montenegro.Aleksandra Novikova Institute for Climate six WB countries, it seems that only Montenegro has Protection, Energy and Mobility (IKEM), Magazinstr. 15–16, 10179 Berlin, Germany, and AvantGarde Energy (AGE), Podjavorinskej 7, 811 03 Bratislava, used it successfully and that happened once at the end of Slovakia. Rastislav Vrbensky f. UN Resident Coordinator in Montenegro and f. the first decade of the twenty-first century. UNDP Deputy Regional Director for Europe and Central Asia, Visiting Lecturer Putting together ESG bonds along with nature for debt at Masaryk University. swaps in light of the EU accession plans of the Western Authors’ contributions Balkans countries can offer the basis for another layer IL developed the key recommendation of the proposed ESG bond supported of innovative financing, and this is the key recommen - by the EU IPA funds. BB analysed Western Balkans countries’ macroeconomic and macro-financial situation generating basis for the development of dation of this paper. Countries should feel encouraged the recommendation. AN provided a literary overview and the theoretical to enter the private markets—clearly stating their green background of the nature for debt swaps and RV analysed the innovative and de-carbonization development plans and define bond instruments providing examples and the basis for the recommendation development. All authors read and approved the final manuscript. policy goals that stem from the European green deal and the Green agenda for the Western Balkans which has Funding to be combined with accountability mechanisms and Not applicable. methodologies such as those which govern European Availability of data and materials Union accession talks with candidate countries. This The data sets used and/or analysed during the current study are available recommendation assumes that participating parties will at the following links:—Montenegro: www. mif. gov. me [Ministry of Finance], www. monst at. org [Statistical Office]—Serbia: www. javni dug. gov. rs [Public develop policy targets and indicators that are independ- Debt Administration], -North Macedonia: www. finan ce. gov. mk [Ministry of ent and verifiable, as the whole agenda grows more and Finance], www. stat. gov. mk [Statistical Office],—Albania: www. finan cia. gov. al more complex at each stage. [Ministry of Finance], www. instat. goval [Statistical Office],—Bosnia and Herze - govina: www. mft. gov. ba [Ministry of Finance], www. bhas. gov. me [Statistical Such an innovative approach to the markets could also Office],—Kosovo: www. mf. rks- gov. me [Ministry of Finance] www. ask. rks- gov. encourage the EU to adjust the ways pre-accession sup- net [Statistical Office]—https:// ec. europa. eu/ euros tat/ web/ produ cts- datas port is used [IPA III in particular] as those funds could ets/. be extremely useful leverage to access private markets and accelerate investment cycle by providing synergy Declarations between the huge opportunities private markets bring, Ethics approval and consent to participate with the crucial support of the public funds coming from Not applicable. the EU. 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Keywords: Sustainable/environmental social governance [ESG] finance; Green bonds; Debt swaps; Climate finance; Public debt

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Innovative financing of the sustainable development goals in the countries of the Western Balkans

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