30 November 2006
Key Points:
The revised Principles have some admirable reforms but it remains to be seen how they will work in practice and whether they will raise the standard of social and environmental management in project finance.
If you are involved in the financing of a project with a value exceeding US$10 million and the lender is an Equator Principles signatory you will need to be aware of recent significant changes to the Principles and factor these changes into your project financing arrangements.
Background
The Equator Principles are a voluntary set of guidelines (based on the policies and guidelines of the World Bank and International Finance Corporation ("IFC")) designed to assess and mitigate the impact of environmental and social risks in the project finance sector.
The Principles were first launched in June 2003 by ten of the world's largest banks (ABN AMRO Bank N.V., Barclays plc, Citigroup Inc, Credit Lyonnais, Credit Suisse First Boston, HVB Group, Rabobank Group, The Royal Bank of Scotland, WestLB AG and Westpac Banking Corporation). At that time these banks underwrote approximately a third of the global project loan syndication market (equating to approximately US$14.5 billion of loans).
The banks agreed to apply the Principles globally to project finance initiatives across all industry sectors including mining, coal, oil and gas and forestry and undertook to provide loans only to those projects whose sponsors could demonstrate their ability and willingness to meet the environmental and social benchmarks enshrined in the Principles.
By 2006, a further 31 banks had adopted the Principles, bringing the global total to 41.
These banks undertook only to provide loans directly to projects (with a capital cost of US$50 million or more) that had been categorised and screened appropriately according to the level of environmental and social risk presented by the project: category A (high risk), category B (medium risk) and category C (low risk) projects.
The first major review of the effectiveness of the Principles was conducted by the Equator Principles Financial Institutions ("EPFIs") earlier this year to address concerns raised by stakeholders and NGOs. The result was the publication of a revised set of Principles which introduce a number of significant changes for EPFIs, borrowers and financial advisers to grapple with. The Principles were adopted by the majority of participating banks on 6 July 2006.
How have the Principles changed?
Key changes include:
A lower eligibility threshold - the capital costs threshold for eligible projects has lowered from US$50 million to US$10 million. This change brings the Principles into line with a practice that has already been adopted by a number of EPFIs and reflects the fact that a project's capital cost and its social and environmental impact are not necessarily linked.
Wider scope - the Principles will now apply to project finance advisory activities and upgrades or expansions of existing projects where the additional environmental or social impacts are significant.
Higher social and environmental standards - projects in non-OECD countries and OECD countries not designated as high income will require social and environmental assessments that comply with the applicable IFC Performance Standards (previously known as the Safeguard Principles) and the applicable Industry Specific Environmental Health and Safety Guidelines ("EHS Guidelines"). Such standards provide the compliance framework for borrowers in the ongoing management of social and environmental assessment throughout the life of the investment.
Streamlined approach for high income OECD countries - the rationale is local law requirements in such countries will generally meet or exceed the IFC's Performance Standards and EHS Guidelines. Therefore, an assessment that complies with local laws is deemed to be an acceptable substitute.
Public reporting by EPFIs - each EPFI must now report on the progress and performance of the Principles' implementation on an annual basis (at a minimum) taking into account appropriate confidentiality considerations. This change addresses a common criticism of lack of transparency in how the Principles are applied by EPFIs.
Monitoring for entire loan period - for all category A and, as appropriate, category B projects, EPFIs will need to ensure the ongoing monitoring and reporting of environmental and social issues for the lifespan of the loan. This change addresses the failure of many EPFIs to monitor the progress of projects after funding had been arranged.
More robust public consultation and a grievance mechanism will be required for all category A and, as appropriate, category B projects in non-OECD countries and low income countries to ensure that consultation, disclosure and community engagement continues throughout the construction and operation phase of the project. The borrower is also obliged to establish a grievance process to facilitate resolution of concerns about the project's social and environmental performance raised by individuals or groups.
Independent review - an independent social or environmental expert will be required to review the borrower's environmental and social assessment, the action plan and the consultation process documentation for all category A and, as appropriate, category B projects to assist the EPFIs in their due diligence and assess compliance with the Principles.
Implications
It is clear that EPFIs are committed to implementing the Principles across a much larger portion of the project financing sector, both in terms of the types of projects that are eligible to be assessed and the fact that advisers as well as borrowers will now also be bound by the Principles. It is also clear that EPFIs are keen to streamline their review process for projects in high income OECD countries where rigorous social and environmental laws and permitting requirements are already in place.
An important strength of the Principles is the incorporation of social and environmental covenants into the financing documentation that binds the borrower (and cover issues such as compliance with the host country's social and environmental laws). If the borrower is in breach of its covenants, an EPFI can work with the borrower to bring it back into compliance or exercise any other remedy it considers appropriate.
Although the EPFIs have committed to implement the Principles it must be remembered that the Principles are voluntary and there is currently no legal redress for any failure by the EPFIs to comply with the Principles or ensure that they are applied consistently. The new reporting provisions therefore indicate a concerted effort by the EPFIs to introduce some objectivity and transparency into the implementation process. The independent review by external experts also potentially provides the EPFIs with a means of legal redress in cases of professional negligence or failure to discharge the terms of the contract of engagement.
The stronger focus on social issues and the new grievance mechanism for projects in non-OECD countries and low income countries to help protect community interests must be applauded. However, it remains to be seen how the other new Principles will work in practice and whether they will raise the standard of social and environmental management in project finance.
