Incorporating Environmental and Social considerations into Loan Documentation – New Guidance for Equator Principles Financial Institutions

A new guidance document ‘Guidance on incorporating environmental and social considerations into project finance loan documentation” has been released which can be expected to provide Equator Principles Financial Institutions with valuable advice on how to ensure the Equator Principles are applied to the projects they finance.

The loan documentation is a key document for ensuring the project sponsor applies the Equator Principles beyond the signing of the loan agreement, right through the construction and operation, and where appropriate the decommissioning, phases of the project. 

Failure to comply with the loan covenants may prevent or delay the project sponsor being able to drawdown on the loan, or even an event of default whereby, the lenders are entitles to cancel the loan, and all monies lend are immediately payable by the borrower.

Inadequate integration of human rights law – the need for additional risk management

The risks associated with financing projects can vary significantly according to the geographical location of the project. While many projects that the banks are asked to consider financing are in compliance with national legislation and permit requirements, they may fall short of international standards and best practice. A detailed understanding of the project’s political and legal framework is required in order to judge the extent to which national requirements meet the risk management needs of international financial organisations.

Use, misuse and abuse of human rights rhetoric: the case of Serbia

National application of human rights law is one of the most important tests of its efficacy. This article examines the integration of international human rights law into Serbia’s legal system. The paper argues that the use of human rights language does not necessarily indicate the proper and correct use of human rights norms

The paper covers the following:

• an overview on the intersection of international and national law with special reference to Serbia and Montenegro
• the existing legal framework for the integration of international human rights law
• an examination of the propriety of human rights law language discourse
• a discussion on the separation of the executive and the judiciary

The paper makes the following conclusions:

• the legislative framework in Serbia favours the integration of human rights law
• despite some successes there some legislative acts and a lack of human right jurisprudence indicates that international human rights law has not been properly integrated into the legal system
• there has been a misuse of human rights law and clash between judicial and political discourse on human rights
• the inadequate training of the judiciary has led to judicial deference to the executive branch of government.

New IFC Report – Banking on Sustainability (March 2007)

A new IFC report “Banking on Sustainability,” has been released.  It provides practical examples of 14 financial institutions in 12 countries that have taken concrete steps to integrate sustainability into their policies, practices, products, and services.

“While detailing the evidence of potential benefits for banks in integrating sustainability into their business strategy, the report reveals a dramatic shift in banks’ awareness of these benefits,” said Rachel Kyte, IFC Director of Environment and Social Development.

In a 2005 IFC survey, 86 percent of 120 financial institutions interviewed reported positive changes as a result of steps they had taken to integrate social and environmental issues in their business.The report shows evidence of the potential benefits of adopting sustainability as a business strategy. It also shows a dramatic shift in banks’ awareness of these benefits. Banks can tap vast benefits by reassessing their business practices and engaging in sustainability-oriented risk management and product development.

It is notoriously difficult to quantify the financial benefits of adopting sustainable business practices, however this report demonstrates some clear business benefits from adopting and integrating environmental and social considerations into core business strategies.

Key discussions at the Ethical Finance Summit

There were some excellent discussions on the Equator Principles (EP) at the Ethical Corporation – Sustainable Finance Summit. The main hot topics were:

• The need to manage the success of the principles. The need to prevent their extension to areas other than Project Finance weakening the brand, due to insufficient leverage in such areas.
• The EP’s have lead to an unprecedented level of collaboration by Financial Institutions.
• There is a lack of mechanisms for demonstrating how the adoption of the EP’s have contributed to business performance and financial benefits, but despite this FI’s are see these issues as key to their core branding.
• There is a need for a pragmatic approach to their application, in certain situations when good project sponsors and FI’s have turned down projects with high potential environmental and social risks, the projects have been progressed by weaker parties and consequently developed more severe environmental and social problems.
• There is a need to manage expectations about what the EP’s will achieve – e.g. they have not been established to be a tool for equity.
• There has been a lack of developing market banks and a notable absence of leading French Banks adopting the EP’s.
• The need for sufficient lead in times to review Finance deals to avoid situations where problems are picked up too late on a project to enable compliance.
• Some banks are striving to be leaders in sustainability, while others believe the EP’s have created a level playing field.

Sustainable Finance Summit 2006

I will be attending this event at the end of November, and I hope to see all those of you who are interested in this topic there. This will be a key event for all practitioners in this area, and will provide an excellent forum to share best practice. I’ll be posting feedback after the event, so if you don’t make it, come back here and catch up on what you missed.

Sustainable Finance Summit 2006

Recognition of the key role of financial institutions in stable and sustainable development has come. This leading-edge conference will show the way forward on these difficult, but essential issues. As banks go truly global, many for the first time, they are entering and whole new world of trust, risk – and opportunity – that must be well managed.

The newly revised Equator Principles now represent some 85% of global project finance , and that percentage is going up almost daily.

How banks can manage both profit and sustainability will be addressed early on by Jon Williams , a leading thinker and practitioner who is also Head of Group Sustainable Development at financial behemoth HSBC Holdings.

Among those speakers will be:

F&C Investments * The Co-operative Bank * Standard Chartered * FTSE * Barclays * ABN AMRO * HSBC Holdings * UBS Investment Bank * Wall Street Journal * Financial Times * KLD Research & Analytics * Henderson Global Investors

 

IFC Launches Lessons of Experience on BTC and Chad-Cameroon Pipeline Projects

The International Finance Corporation (IFC) has launched two new Lessons of Experience publications on “The BTC Pipeline Project” and “External Monitoring of the Chad-Cameroon Pipeline Project.” The publications provide key environmental and social lessons and good practices for the benefit of staff, clients, and the wider private sector.

The sharing of project experience is an exemplary approach to risk management, it is excellent to see the IFC sharing their findings and contributing to the development of Good Practice in this way.

The Baku-Tbilisi-Ceyhan (BTC) Pipeline Project:
The BTC pipeline is 1,760km long and runs from Azerbaijan through Georgia to the Mediterranean coast of Turkey. At the time of its commencement, BTC was the largest crossborder infrastructure construction project in the world. The project faced a wide variety of complex and often difficult environmental and social challenges. Financing was agreed in February 2004 after more than two years of appraisal of the potential environmental and social impacts. Construction was completed in late 2005 and export from the new terminal in Ceyhan commenced in June 2006.
While it is impossible to capture all the challenges and complexities encountered during the design and construction phase of the BTC project, this publication focuses on six thematic areas where environmental and social lessons learned were thought to be most valuable and applicable to other IFC-financed projects.

External Monitoring of the Chad-Cameroon Pipeline Project
The Chad-Cameroon pipeline project is a US$3.5 billion development of an oil field in Chad by a consortium headed by ExxonMobil, and a 1,070 km long pipeline extending through Chad and Cameroon to the Atlantic coast. The External Compliance Monitoring Group (ECMG), funded and logistically supported by the Consortium, serves as the team responsible for auditing the implementation of the Consortium’s environmental and social commitments for this project. “External Monitoring of the Chad-Cameroon Pipeline Project: Lessons of Experience” provides lenders and project sponsors with an understanding of the business case for employing an external monitor, as well practical advice regarding the major steps and key issues for designing, implementing, and operating an external monitoring mechanism for complex projects. To highlight the practical challenges and value of the external monitoring mechanism, the publication draws illustrative examples from the experiences of IFC during the Chad-Cameroon pipeline Project.
PDF files can be downloaded at: http://www.ifc.org/enviropublications

Financial sector responsibility: The state of the art

The report discusses how greater transparency in implementing the Equator Principles can enable NGO’s to provide a fuller regulatory role, of this voluntary approach to Social and Environmental risk management.

The improved dialogue between NGOs and Financial Institutions that have been brought about through intitatives such as the Equator Principles.

The growing need to recognise that employees awareness of their personal accountability if growing, and employees are increasingly unprepared to compromise their ethics and standards in the workplace.

This special report is designed to offer the reader insights into how major institutions are responding to the sustainable development agenda. Also covered are increased expectations on business transparency and the role of regulators.

An interesting Case study discussed in the Report is the Baku-Tbilisi-Ceyhan (BTC) pipeline – which is now transporting oil from the Caspian Sea to the Mediterranean.

The $4 billion project showed how difficult it can be to address the social impacts of large infrastructure projects, such as the resettlement of local people and their compensation.
In Turkey, 300 villages were cleared during the building of the pipeline. Compensating villagers involved negotiating complex local laws – one piece of land was owned by 800 different people – and the fact that 70% of affected land owners had no legal right to compensation.
BP managed to compensate all land owners, but still there were disputes over what villagers were entitled to – for example, whether corn compensation was to be calculated at cost or market value, and over three years or just one. These disputes show how messy project finance can be on the ground.

The free PDF version of Ethical Corporation’s special 44-page report, Financial sector responsibility: The state of the art, is available to download at: www.ethicalcorp.com/fsr/

The Equator Principles bring shareholder value, but the limits of the approach must also be recognised

With campaign groups putting increasing pressure on Equator Principle (EP) banks to take responsibility for the environmental and social risks of the projects they finance, there is a need to recognise the limitations that financial institutions (FI’s) face when implementing due diligence approaches.

In general it is certainly not a lack of commitment on the part of EP banks to managing these risks that causes the difficulties, and the vast majority have made an impressive effort in this area. A key factor is the limited ability of FI’ to influence project sponsors, and as the project progresses, to influence other parties such as construction contractors and workers. The main ways FI’s can exert their influence is either by refusing to finance the project, or by writing covenants in to the loan agreement that must be met prior to each draw down of the loan.

This is not to say that project sponsors are the weak link in the environmental and social risk management process, but there is a need to recognise that the maturity of sponsors varies considerably, with some demonstrating a far better understanding of the potential risks and recognition of the need for robust management approaches than others.

While FI’s and their advisors can help project sponsors to understand how to manage risks effectively, the onus remains on the sponsor to follow the guidelines and implement the recommended measures at the appropriate time.

Extracts from The Banker

Equator Principles
Oliver Balch reports on how environmental activists and bankers are entering a new era of understanding through the Equator Principles.

Shareholder value
Banks are increasingly conforming to the view that social and environmental risks pose a threat to long-term shareholder value. “Protecting our assets in a traditional sense is risk management and protecting shareholder returns,” explains Andre Abadie, head of sustainable business advisory at ABN AMRO. “So if we are financing potentially socially and environmentally egregious projects in far flung corners of the world, then we also have the commitment to ensure that the social and environmental footprint of those projects is well managed.”

Limits of Environmental and Social Due Diligence

But the scope of non-financial due diligence has its natural limits. The financier needs to know the end purpose of the loan if it is to assess the environmental impact of its lending activities.

“If you’re advancing a corporate loan to a large company that is not being used specifically for a project, it is not going to be reasonable or practical to get that [environmental] information across all the projects that the company might be working on,” says Jon Williams, head of group sustainable development at HSBC in London.

Naturally, for some corporate or government loans, banks will be aware of a loan’s end use. The same is true for certain debt securities placements and underwritings, equity transactions and letters of credit. But one area where banks certainly have prior knowledge is, by definition, project finance. Consequently, this is where the banking industry has channelled the bulk of its efforts to date.

Extraneous limitations on due diligence
External, not internal, reasons limit banks’ environmental due-diligence efforts, many risk specialists argue. Short of calling in its loan, a bank’s influence over a project sponsor depends largely on delicate client management. The revised Equator Principles aim to add an extra safeguard by covenanting certain environmental commitments up front. They also require all high-risk projects to be assessed independently throughout the lifetime of a loan. Experience has shown that a bank’s ability to influence other actors can be even more limited than with their clients.

Chris Bray, head of environmental risk at Barclays, believes the Principles have sent a clear message that social and environmental issues represent mainstream business risks. More than that, the principles have shown banks their main environmental impacts derive from how they use their money. As Mr Bray puts it: “Equator has fairly and squarely put lending centre-stage.

HSBC’s approach
In the past three years, the UK-based bank has adopted a raft of environment-related policies and procedures. The list includes specific guidelines on dangerous chemicals, freshwater infrastructure and forest products. In May 2005, HSBC became the first major private bank to put its name to the World Commission on Dams. Within the next 12 months, it plans to add an extractive industry policy to its growing catalogue of green tape. Underpinning what HSBC terms its “restricted appetite” for environmentally sensitive transactions lies its environmental risk standard. Launched in 2002, the standard is designed to minimise the environmental, credit and reputational risk associated with the bank’s investments. Most of the procedural steps are straightforward. HSBC’s due-diligence register, for example, now features environmental impact assessments and reviews by external auditors.

IFC Board Approves new Environmental and Social Standards

 

IFC Board Approves new Environmental and Social Standards on February 21, 2006. The Equator Principles are expected to be revised in light of these new standards

Environment & Social Development Department

Washington D.C., February 21, 2006 – The Board of Directors of the International Finance Corporation (IFC) adopted today new environmental and social standards for the organization. The new standards build upon the environmental and social requirements that IFC currently applies to private sector projects it finances in the developing world. A new policy on disclosure, adopted at the same time, will increase transparency requirements.

The main benfits of the new standards are:

1. New requirements for community health, safety, and security; labor conditions; pollution prevention and abatement; integrated social and environmental assessments; and management systems.

2. Stronger requirements for community engagement and consultation; biodiversity protection; community and worker grievance mechanisms; use of security forces; greenhouse gas monitoring; and greater disclosure of information to the public by IFC and client companies.

3. New outcomes-based approach, which requires client companies to have in place effective management systems that allow them to handle social and environmental risks as an integral part of their basic operations and business model.

Lars Thunell, IFC’s Executive Vice President said:

“The new IFC standards are stronger, better, and more comprehensive than those of any other international finance institution working with the private sector. We aim, with these new policies, to increase the development impact of projects in which we invest. We also seek to give companies operating projects in emerging markets the capacity to manage fully their environmental and social risks and to compete better in a global economy.”

In approving the new set of standards, IFC’s Board requested some refinement of the language. Accordingly, the final version of the Performance Standards and Disclosure Policy will be issued as a complete text in the coming weeks. For more information, visit http://www.ifc.org.

Banks reduce risk by adopting Equator Principles

Financial Institutions are taking stronger measures to reduce their reputational risks. 

36 Banks, Export Credit Agencies and other organisations have now signed up to the “Equator Principles“, an industry approach for financial institutions in determining, assessing and managing environmental & social risk in project financing.

By adopting the principles the banks confirm that “They will not provide loans directly to projects where the borrower will not or is unable to comply with our environmental and social policies and processes.”

The Principles are based on World Bank and IFC Pollution Prevention and Abatement Guidelines.