and FAB can form the basis of discussions and roadshows, while also facilitating the subsequent structuring and pricing process.

# **6.1 Practical considerations**

**State-contingent debt instruments** The structure of SLBs is reminiscent of state-contingent debt instruments (SCDIs), which share the fundamental idea to link debt service with a state variable.20 Traditionally, SCDIs were attractive to investors due to their counter-cyclical, diversification and hedging properties. They were also appealing to issuers since debt repayments are linked to the fiscal capacity and because SCDIs could broaden the country’s investor base (IMF, 2017). However, SCDIs enjoyed limited uptake due to liquidity and pricing concerns, and measurement issues such as delayed reporting.

In the current climate of sovereign debt distress and associated debt restructuring negotiations, linking debt repayments to a state variable could be worth exploring, especially for sovereigns exposed to climate change risks and environmental degradation (Volz, 2023). The benchmarked KPIs developed under the REACH framework could inform debt (re-)structuring decisions. Similar to catastrophe bonds or other disaster risk financing instruments, SLBs could thereby provide downside protection in the case of natural disasters, since the benchmarked KPIs account for external factors. At the same time, SLBs could expand governments fiscal space and aid in their mission to reach their Sustainable Development Goals (SDGs) or Nationally Determined Contributions (NDCs).

**Geospatial deforestation data** It is worth emphasizing that the viability of both evidence-based frameworks hinges on the data environment. In the application, annual data was sufficient to demonstrate the framework. However, for model validation and reliability, more granular data would be needed. For deforestation, remote-sensed satellite data is a highly promising way to provide objective, regular and reliable observations. Subannual and subnational geospatial data on land use and land cover transitions can help us understand the drivers, locations and trends in deforestation and degradation, which could in turn produce more sophisticated and effective KPIs. An SLB that targets deforestation due to cropland expansion may necessitate a different set of government entities than an SLB that targets deforestation due to urban expansion. The World Bank and the European Space Agency are currently exploring how SLBs may leverage new deforestation monitoring technologies with cloud-penetrating capabilities.

**Private capital mobilization** Multilateral development banks (MDBs) have a clear and essential role to play to mobilize private capital. The REACH framework aims at setting better performance incentives by accounting for what the issuer can be reasonably expected to achieve. The size of the step-ups or step-downs could then be scaled beyond the commonly used 25 basis points. However, while this sends strong signals about the commitment of both issuer and investor, the interest rate differentials may be difficult to stomach, especially when the market for sovereign SLBs is still nascent. MDBs can help derisk the transaction on either side through concessional finance or guarantees.21 Moreover, SPTs are often aligned with existing development operations and MDBs can provide technical assistance, capacity building and knowledge transfer to support issuers in reaching their goals. A strong coupling of incentives to performance, as in the REACH

> 20The SLBs discussed in the REACH framework could be seen as _floater_ -type SCDIs, which have a fixed principal and a variable coupon. For the SLB, the coupon would be linked to the benchmarked KPI, the state variable. 21In the context of contract theory, MDBs can help relax the participation constraints for issuers.

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