Environment law- The Equator Principles

Environment and social issues in project financing

A number of banks, providing the bulk of loans in the project finance market, have adopted and are starting to apply a set of principles that will govern how they assess and manage risks arising from the environmental and social aspects of the projects they finance.

A large and growing number of banks have adopted the Equator Principles, committing them to assess the social and environmental impact of big projects they finance. This commitment is already affecting loan documentation still under negotiation and seems to be the cause of some confusion amongst both the lending and project development community.

What are the Equator Principles?

The Equator Principles set the framework for banks to assess the environmental and social impacts of the projects they finance. They apply to projects anywhere in the world and in any industry sector, provided the total capital cost of the project is US$50 million or more.

The principles are based on (and incorporate) a number of policies and guidelines of the World Bank's private sector lending arm, the International Finance Corporation ('IFC') and are intended to ensure that finance is provided only to projects that are developed in an environmentally and socially responsible manner. The principles are also intended to help banks document and manage their own risk exposure on these issues.

The principles have already been adopted by a number of leading banks. Adopting banks are expected to develop their own policies and procedures to implement the principles and to provide loans for projects only if they have been assessed against, and comply with, the principles. Until these policies and procedures have been developed, however, borrowers will be subjected to elements of uncertainty (see further below).

Which banks have adopted the principles?

The initial group of banks that adopted the principles on 4 June 2003 includes: ABN AMRO Bank NV, Barclays Bank plc, Citigroup Inc., Credit Lyonnais, Credit Suisse Group, HVB Group, Rabobank Group, The Royal Bank of Scotland, WestLB AG and Westpac Banking Corporation.

Since then, further banks have adopted the principles. At the time of writing, this includes: Dexia Group, Dresdner Bank, HSBC Group, ING Group, MCC SpA, Royal Bank of Canada and Standard Chartered Bank. More banks are moving towards adoption.

The IFC and adopting banks intend that the principles should become industry standard in the bank project finance market. As it is, the adopting banks are estimated to have accounted for the majority of the global project loan market by volume in 2002.

What do the Equator Principles require?

In practice, much should depend on the policies and procedures developed by the adopting banks but the general process is as follows:

Stage 1 - Screening:

Banks must screen all projects with a total capital cost of US$50 million or more and categorise them according to the significance of the likely impact of the project. Projects considered the least significant (category 'C') need no further action beyond screening. For projects considered to have greater environment/social impacts (category 'A' or 'B') the borrower will be required to prepare an environmental assessment ('EA').

Stage 2 – Environmental Assessment

The EA must address specified environmental and social issues, including sustainability, use of renewable resources, waste minimisation, efficient use of resources and energy. The EA must also address compliance with applicable laws and with applicable minimum standards under the World Bank and IFC Pollution Prevention and Abatement Guidelines.

For projects in 'low and middle income countries' (as defined by the World Bank Development Indicators Database), the EA will also have to address compliance with, or justify deviations from, applicable IFC Safeguard Policies which provide guidance on issues such as natural habitats, indigenous peoples, involuntary resettlement, dam safety, forestry, and cultural sites.

It is particularly important to note that the list and scope of issues that the principles require the EA to cover may not match whatever are the domestic legal requirements for environmental assessments in the country in which the project is to be developed. For example, the principles require wider considerations to be taken into account in an EA than UK laws would require to be considered in an environmental statement associated with a planning application.

Stage 3 – Environmental
Management Plan

For category 'A' projects and, where appropriate, category 'B' projects, the borrower will be required to prepare an environmental management plan ('EMP') which draws on the conclusions of the EA and sets out an appropriate approach to monitoring, mitigation and risk management.

Using the UK example again, since the scope of an environmental statement supporting a planning application does not have to be as wide as that required by the principles, any management plan based on that assessment may be correspondingly deficient.

Consultation and review

In respect of all category 'A' projects and as appropriate for category 'B' projects, the borrower must have consulted in a 'structured and culturally appropriate way' with affected groups and local NGOs during the planning stage. This includes consultation in respect of the EA. Both the EA and the EMP should take account of such consultations.

Again, it should be noted that the consultation requirements of the principles may not match up with consultation requirements under domestic law.

For all category 'A' projects, all EAs and EMPs must be subjected to independent expert review.

What do the Equator Principles require of a project developer?

The Equator Principles do not state who should have responsibility to produce EAs, EMPs and decommissioning plans but, in practice, the banks will require the borrower to produce these.

However, the principles do expressly require the borrower to covenant:

• to comply with the EMP in the construction and operation of the project
• to report regularly to the banks on compliance with the EMP
• where applicable, to comply with an agreed decommissioning plan.

This is largely consistent with the existing lending requirements of many banks for larger projects to be developed in countries that already have some form of environmental assessment requirement in their domestic law.

The key difference lies in the scope of the issues that must be considered in the EA and EMP under the principles as opposed to domestic law and in any additional internal policies, procedures and other related requirements developed by the adopting banks.

What difficulties are there with the Equator Principles?

Adopting banks are already requiring project developers to covenant to comply with the principles but the terms of any such covenant sought are crucial. An all-encompassing covenant to comply with the principles is inappropriate. The principles allow discretion to be exercised by the bank; something that a borrower cannot anticipate in such a covenant. Furthermore, the principles are intended to set out the framework for the banks to develop their own internal procedures, policies and guidelines for assessing projects. So, until the banks have developed those procedures, policies and guidelines, project developers are unlikely to be able to identify what compliance means for a particular bank. However, a narrower covenant, limited to the reporting and EMP compliance requirements actually set out in the principles may be acceptable.

Therefore, banks and project developer-borrowers should each bear in mind that:

• it is for the bank (and not the borrower) to assess whether a project is category 'A', 'B' or 'C'
• the bank will need to assess the adequacy of the EA (including whether the EA adequately addresses the specified environment and social issues) and it may seek some form of warranty in this regard from the borrower and/or its consultants
• there may be gaps between the requirements of the principles and any environmental assessments, environmental management plans and consultations undertaken purely for the purpose of satisfying domestic legal requirements – it is likely to be much less problematic, expensive and time consuming if the borrower anticipates the requirements of the principles when designing the project and first appointing consultants;
• for some time to come, adopting banks will still be in the process of developing their own internal policies, procedures and guidelines to implement the principles – thus, at least in the near future, they are unlikely to have adequate systems in place to be able to make the necessary assessments themselves or to have developed a suitably specific framework against which the borrower (or the borrower's consultants) can assess wider compliance; and
• in respect of any covenant that may be sought, both bank and borrower need to be clear how compliance or non-compliance will be assessed and how objective any such assessment will be.

For further information please contact Tom Bainbridge on + 44 (0)20 7367 3174 or email [email protected].