Implementing Equator principles has enhanced role of project financing; sustainable development now key

Published: February 25, 2019 3:55:52 AM

Implementing the Equator Principles has enhanced the role of project financing; sustainable development has become key

The Equator Principles were formally launched in Washington, DC, on June 4, 2003.

By Vidya Hattangadi

The Equator Principles is a risk-management framework, adopted by financial institutions, for determining, assessing and managing environmental and social risk in project financing, and is intended to provide a minimum standard for due diligence and monitoring to support responsible risk decision-making prior to lending for projects. The Equator Principles were formally launched in Washington, DC, on June 4, 2003.

They were formed as a guideline to financial institutions before lending to infrastructure projects. Since the inception of the Equator Principles in 2003, the energy and extractives industry has been a major focus of the environmental and social risk reviews conducted by nearly 80 member banks. For example, Bank of Tokyo-Mitsubishi, a leader in project finance, put 225 projects through its Equator Principles review process between 2006 and 2012. Of these, 60% were in the mining, oil, gas and energy sectors.
Financial institutions are accountable to screening when lending to projects that are hazardous environmentally and socially. Their investment decisions increasingly include an assessment of E&S risks and impacts. This rule is not only applicable to MDBs (multilateral development banks) and international financial institutions, but also to commercial banks and private equity funds. In many developing countries, international players require compliance with both national laws and international E&S standards developed by MDBs, which are sometimes more stringent than those inscribed in national legislation.

In the 1980s, the Sardar Sarovar project, which involved construction of a dam on the Narmada river in Gujarat, got harshly criticised worldwide for its adverse environmental and social impacts. It was built to provide electricity and irrigation water to downstream regions, and the construction of this dam resulted in forced dislocation of more than 2 lakh native people living along upstream districts, without provisions of sufficient compensation or means of livelihood reinstatement. To ensure justice to the people displaced, international NGOs undertook Narmada relief campaign, due to which the financial assistance to the project, provided by the World Bank and official development assistance (ODA) of the Japanese government, got terminated.

In the late 1990s, when the world started seriously thinking about safeguarding environment and social welfare above all, multilateral development financial organisations such as the World Bank and export credit agencies of OECD member countries came up with environmental and social guidelines to properly manage environmental and social risks associated with large-scale projects. But only a handful of private financial institutions in the world were implementing environmental and social reviews before lending for projects. Therefore, environmental NGOs started demanding that private financial institutions must be held responsible for neglecting environmental and social risks; attention must be given to CSR in terms of environmental issues.

To address these demands and concerns, in October 2002, ABN AMRO and the International Finance Corporation (the IFC is in charge of private projects for the World Bank Group) invited major global financial institutions engaged in project finance activities to assemble in London with the intention to come up with environmental and social risks management guidelines for private financial institutions. As a result of this meeting, Citigroup, ABN AMRO, Barclays and WestLB, in collaboration with the IFC, created a framework for managing environmental and social risks. The Equator Principles were thus formulated in June 2003.

The founders of the Equator Principles wanted their adoption to be a globally applicable to financial institutions in the northern and southern hemispheres, and the equator seemed to represent that balance perfectly, hence were named thus.

The Equator Principles were first revised in July 2006, to align it with the IFC Performance Standards. Further revision of the IFC Performance Standards took place in 2012 and the need to strengthen environmental and social risks management resulted in the launch of the third version of the Equator Principles in June 2013. The fourth round of revision is under review and will be finalised by August 2019.

The key thematic areas of this round include social impact and human rights, climate change, designated countries and applicable standards and scope of applicability of each principle. So far, 94 financial institutions from 37 countries have officially adopted the Equator Principles, which covers the majority of international project finance debt in emerging and developed markets.

Pursuant to the finalisation of principles of EPFIs (Equator Principles Financial Institutions), the lender needs to categorise a new project according to its level of probable environmental and social risks based on the screening criteria of the IFC. The three categories are as follows:

Category A: Projects with potential significant adverse social and environmental impacts those are diverse, permanent and exceptional;

Category B: Projects with potential limited adverse social or environmental impacts, largely reversible and addressable through mitigation measures;

Category C: Projects with minimal or no social or environmental impacts. The standards have consequently been periodically updated into what is commonly known as the IFC Performance Standards on social and environmental sustainability and on the World Bank Group Environmental, Health, and Safety Guidelines.

Benefits of the Equator Principles: Borrowers don’t like banks telling them how to behave; they want their loans to be sanctioned and that’s about it. With so many monetary scams and money laundering taking place, the credibility of the global financial institutions is under heavy scrutiny today, especially in markets where social and environmental standards for business are less stringent. Another fact is that companies with little or no experience in applying mitigation measures often require additional support and advice from their lenders. Implementing the Equator Principles has enhanced the role of project financing; sustainable development has become key issue.

-The author is a management thinker and blogger

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