29 January 2025

Hedging currency risk to aid green growth

The IADB and Brazilian government's Eco Invest Programme is turning currency risk into opportunity, write Paul Horrocks, Callum Thomas, Anderson Caputo, Rafael Cavazzoni, Orlando de Souza and Mario Augusto Gouvea de Almeida

Paul Horrocks
Paul Horrocks
For borrowers in Emerging Markets and Developing Economies (EMDEs), the local currency problem is a critical barrier in accessing external financing for sustainable development. While loans in foreign currencies often carry lower interest rates, they expose borrowers to potentially devastating foreign exchange (FX) rate risks.

When local currencies plummet, so do the financial prospects of these borrowers—whether they're building a solar farm or expanding a small business.

The solution? Affordable and accessible local currency financing, a cornerstone for resilient domestic financial systems, the focus of a forthcoming OECD Report titled: Unlocking local currency financing: What role can donors, development finance institutions and Multilateral development banks play?

History offers valuable lessons in mitigating exchange rate risks, and institutions like the Inter-American Development Bank (IADB) are dusting off and reimagining old ideas.

In the early 2000s, the US Overseas Private Investment Corporation (OPIC), piloted an innovative forex liquidity facility to shield a Brazilian hydroelectric project from currency devaluation (United Nations, 2003). The mechanism created a 'floor' value for the project's cashflows, ensuring that debt obligations could still be met despite volatile exchange rates. If the real exchange rate rebounded, the facility was reimbursed.

Callum Thomas
Callum Thomas
Fast forward to today, and the IADB, in partnership with Brazil's National Treasury and with support from the UK's Foreign and Commonwealth Development Office, are updating this concept to address the modern-day local currency financing challenges.

Enter Brazil — the largest economy in Latin America and a country often synonymous with bold innovation and ambition. Recognising the urgency of systemic vulnerabilities tied to FX risks, Brazil's G20 2024 presidency has placed local currency solutions high on the development agenda.

Launched as part of its ambitious Ecological Transformation Plan, and facilitated by IADB, the Eco Invest Brasil Program represents a cutting-edge approach to solving the twin challenges of currency risk and capital mobilisation (IADB, 2024).

By linking international capital markets to local financial institutions through a "derivatives pipeline," Eco Invest Brasil lowers the cost and increases access to long-term FX hedging instruments.

Structured within Brazil's Fundo Clima, Eco Invest Brasil combines innovative financing mechanisms with a robust institutional framework to reduce the cost of capital, enhance FX liquidity for local companies, provide FX hedging and support the country's growing pipeline of green investments.

The features of the programme include four complementary credit lines, each designed to tackle different market gaps (Presidency of Brazil, 2024).

Mario Augusto Gouvea de Almeida
Mario Augusto Gouvea de Almeida
The first, a blended finance facility, introduces concessional funding in Brazilian Real through competitive bidding. Local financial institutions must prove they can mobilise significant foreign investment while hedging currency risks — a requirement that encourages market discipline while reducing volatility for borrowers.

The second line is an enhanced foreign exchange liquidity facility, modelled on previous experiences and customized to Brazil, to help companies better manage FX risk when revenues are in Real but debts are in foreign hard currencies such as US dollars or euros.

Perhaps the most innovative feature is the third line, focused on foreign exchange derivatives. By linking international capital markets to local financial institutions through a "derivatives pipeline," Eco Invest Brasil lowers the cost and increases access to long-term FX hedging instruments.

Anderson Caputo
Anderson Caputo
This will be strengthened by a Eco-Invest catalytic capital that can mitigate counterparty risk, ensuring local banks can confidently engage in the FX market.

Together, these mechanisms create the conditions for accelerated price discovery and, crucially, lower hedging costs for projects that deliver environmental and social benefits.

Finally, the fourth line focuses on fostering innovation within Brazil's green finance landscape by encouraging the development of private equity and venture capital instruments. Through targeted incentives, this line aims to catalyse investments in innovative sustainable projects and support early-stage financing, creating a robust ecosystem for scaling large-scale initiatives.

With Eco Invest Brasil, Brazil is sending a clear message: the tools to fix the local currency problem exist.

This approach not only addresses a critical market gap but also lays the foundation for Brazil's transition to a low-carbon economy.

The importance of this programme was underscored at a recent G20 event in São Paulo, where IADB President Ilan Goldfajn joined Brazil's Treasury Secretary Rogério Ceron, Minister of Environment and Climate Change Marina Silva, and Central Bank President Roberto Campos Neto to sign letters of intent aimed at attracting foreign investments while mitigating exchange rate risks.

Rafael Cavazzoni
Rafael Cavazzoni
As Goldfajn explained: "The financial innovations that the government of Brazil and the IADB are promoting have the potential to increase the level of green investments. This programme will help Brazil on its journey to ecological transformation and strengthen a more resilient, sustainable, and prosperous economy" (IADB, 2024).

Why does this matter beyond Brazil? Eco Invest Brasil offers a replicable model for EMDEs struggling with similar challenges.

The innovative use of derivatives, combined with concessional funding and liquidity mechanisms, and an integrated strategy of sustainable sovereign bond issuances, creates a framework for other countries seeking to deepen their local capital markets while attracting foreign investment. But this hinges on the effective involvement of donors and multilateral institutions.

Donors have a critical role to play — not only in providing capital for local currency financing solutions, but also in enabling the capacity-building and institutional reforms necessary to strengthen local financial systems.

Eco Invest Brasil offers a replicable model for EMDEs struggling with similar challenges

Without these efforts, the potential of programmes like Eco Invest Brasil will remain limited to a handful of well-prepared markets. Scaling these initiatives will require a coordinated push to mobilise domestic actors, align incentives, and deliver the technical assistance needed in building a resilient ecosystem where local actors can thrive.

Orlando de Souza
Orlando de Souza
Eco Invest Brasil is sending a clear message: the tools to fix the local currency problem exist. What's needed now is the commitment to deploy them at scale and the ambition to drive systemic change. For EMDEs hoping to unlock their own ecological transformations, this programme offers a glimpse of what's possible when the financial system works with, and not against, environmental sustainability.

The Eco Invest Brasil Programme features as one of the key case studies outlined in the OECD's upcoming report 'Unlocking local currency financing: What role can donors, development finance institutions and multilateral development banks play?', which will be launched at the OECD's Community of Practice on Private Finance for Sustainable Development Conference: Mobilising Private Finance Towards 2030 and Beyond. The conference, to be held in Paris over the 4 and 5 of February, in partnership with Environmental Finance, will bring together over 500 professionals from across the development finance ecosystem to exchange policy priorities and new ideas such as the ones found in the report. Scaling successful initiatives such as the Eco Invest Brasil Programme will be key moving forward.

Event agenda

Sources:

Authors:

  • Paul Horrocks is Head of Unit at OECD.
  • Callum Thomas is a Junior Policy Analyst at OECD.
  • Anderson Caputo is Head of Connectivity, Markets and Finance Division at IDB
  • Rafael Cavazzoni is Financial Markets Specialist at IDB.
  • Orlando de Souza is Financial Markets Specialist at IDB.
  • Mario Augusto Gouvea de Almeida is a Member of the Executive Committee of Eco Invest Brazil, Brazilian Treasury.

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