(Bloomberg) -- At the outer edge of the ESG debt market, an unregulated but growing form of finance has some industry experts sounding the alarm.

Their concern centers on market practice evolving around blue bonds when they’re used in debt relief programs. Conceptually similar to green bonds, the blue variant is supposed to direct its proceeds toward marine protection. The biggest case to date is a deal for Belize, where Credit Suisse Group AG issued blue bonds to finance the country’s debt-for-nature swap set up by the Nature Conservancy in late 2021.

But analysts at Barclays Plc recently took a closer look and arrived at the conclusion that such deals come with a “real risk of greenwashing.”

“We are concerned about the use of the term ‘blue bonds’ in aspects of debt-for-nature transactions,” Charlotte Edwards, head of ESG debt-markets research at Barclays in London, said in an interview. “Blue bonds are a type of green bond, and the point of a green bond is that 100% of the proceeds that are raised are spent on environmental projects.”

In the Belize deal, the country repurchased $553 million of debt at a discount, which was ultimately financed using $364 million of blue bonds issued by Credit Suisse. Around $24 million of that was allocated to a marine conservation fund and the bulk of the rest was used to repurchase the debt. Belize also has committed to spend a further $84 million to protect its aquatic life over the coming two decades using the savings generated from the deal.

A spokesperson for Credit Suisse declined to comment. A spokesperson for TNC didn’t comment in time for this story. Representatives for Belize have said the government was “completely transparent with the transaction” and stress the benefits from the deal both to the country’s finances and its marine life.

What Bloomberg Intelligence Says...

“To call a bond ‘green’ or ‘blue,’ 90% or higher should be allocated towards the green projects or in this case, blue projects. The regulations still aren’t there yet to really hold too many issuers accountable for some of these issues, so I think it’s still up for debate whether there is a potential legal issue. But there’s definitely a reputational one.”

——Christopher Ratti, senior ESG credit analyst at Bloomberg Intelligence. 

The wider market for so-called debt-for-nature-swaps has the potential to grow to somewhere between $800 billion and $2 trillion, depending on who’s providing the estimates. A flurry of deals in the 1980s and 1990s was followed by a hiatus in the 2000s. But debt-for-nature swaps are now making a comeback, and Barclays reckons the Belize deal may become precedent-setting, with other nations like Gabon exploring similar arrangements involving private creditors.

Felix Biedermann, a partner at law firm Simmons & Simmons who specializes in debt capital markets and bank regulations, said a blue bond that doesn’t follow a 100% use-of-proceeds principle is “defensible from a legal perspective,” provided the issuer is transparent. 

“But the legal perspective in these instances doesn’t matter too much,” he said in an interview. “You can damage your reputation severely without stepping over the legal red line.” Transparency “is the only mitigant to risks involved in the ESG space,” he said.

“This is where it will crack in this market because not everything that may be possible from a legal perspective may be advisable, because this is a very sensitive topic and a very sensitive market,” Biedermann said. 

The International Capital Market Association, which sets voluntary guidelines for global bond issuance, is in the process of drafting “global guidance on blue bonds” together with International Finance Corporation. In the IFC’s existing guidelines for blue finance, it says blue bonds are instruments with proceeds exclusively destined for marine-protection projects. 

“Blue finance, including blue bonds, isn’t just a clever accounting mechanism,” an IFC spokesperson said by email. It’s “something that can effect meaningful change for our oceans and marine ecosystems.”

At least one investor in the Belize deal is treating the bond with caution in its own reporting.

Alecta AB, a holder of the blue bonds arranged by Credit Suisse, doesn’t include the investment in its disclosures on green and social bonds. Instead, the Swedish pensions manager categorizes the bond under “other investments with social and environmental impact,” said Carina Silberg, head of governance and sustainability at Alecta. 

“It is sound to have a debate on labeling, to avoid greenwashing and to ensure confidence in the financial market,” she said.

Sean Kidney, chief executive officer of Climate Bonds Initiative, suggested that concerns around nomenclature are overblown. “I don’t really care what they call it,” he said in an interview. “What I care about is whether it is making a difference.”

At ClientEarth, which last year successfully sued the UK government for failing to live up to its net-zero pledge, climate finance lawyer Catriona Glascott said the debt financing market “does have the potential to be a huge force for good.” 

But it’s also very much a case of caveat emptor, she said. 

“In ESG debt financing, there’s certainly scope for extensive greenwashing,” she said. “The lack of rules in this space really does make it a bit of a wild west.”

(Adds comment from lawyer in 11th paragraph.)

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