Preparing your project for Equator Principles 4

April 2020  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2020 Issue

Since their adoption in 2003, the Equator Principles have been one of the principal frameworks for managing sustainability risk in projects by financial institutions.

In November 2019, the Equator Principles Association (EPA), representing 101 Equator Principles Financial Institutions (EPFIs) headquartered in 38 countries, released an updated fourth version of the Equator Principles (EP4) which will be effective from July 2020. In practice, mainly due to co-financing of projects by financial institutions where at least one of the lenders is likely to be a signatory to the Equator Principles, the Equator Principles are being followed more widely.

Will EP4 represent a major change in the approach to sustainability issues in projects?

On the one hand, EP4 was updated to reflect current legal and voluntary sustainability standards in the area of human rights and climate change and anticipates important developments in new areas such as biodiversity and ecosystem management. Accordingly, most financial institutions will have incorporated appropriate standards into their risk management systems. However, there are two main and a few other changes which will require specific attention of EPFIs in preparation for July 2020.

The first main development is in the area of free, prior and informed consent (FPIC) of indigenous peoples in designated countries. The second is the necessity to perform human rights impact assessments in a wider scope than performed by most EPFIs to date on all projects.

Despite existing frameworks and efforts, sustainability impacts still materialise in projects with, in some instances, loss of life, unmitigated diminution of circumstances of affected communities and harm to the environment. The underlying philosophy behind the updates of the Equator Principles is increased attention on managing sustainability risks with a view to minimising sustainability impacts.

Areas of increased attention

Scope. EPFIs will need to update their guidelines for assessing which projects fall within the scope of Equator Principles, as more projects will be in scope. The threshold for project-related corporate loans has decreased from US$100m to US$50m, in-scope project-related refinancing and project-related acquisition financing is expanded, and refinancing and upgrades of all existing projects will also fall within the scope of EP4.

Applicable standards. Currently, in relation to projects in designated countries – those identified as having strong domestic environmental and social (E&S) legislation and enforcement by a proxy of Organisation for Economic Co-operation and Development (OECD) membership and high income status – EPFIs must comply with the project host country’s law. In addition, projects in non-designated countries must comply with the IFC Performance Standards and the World Bank Group Environmental, Health and Safety Guidelines.

Even in designated countries, EPFIs should evaluate whether the International Finance Corporation (IFC) Performance Standards guidelines would be useful as guidance to address any specific risks over and above the host country’s laws. If so, EPFIs could undertake additional due diligence against additional standards relevant to the identified project-specific risks. This becomes prominent in the application of IFC Performance Standard 7 in relation to the Free Prior Informed Consent (FPIC).

Stakeholder engagement and FPIC. Principle 5 continues to require informed consultation and the participation of project-affected communities.

Where special circumstances outlined in IFC PS 7, in which FPIC is required of affected indigenous peoples are met, EPFIs will need to engage a qualified independent consultant, which may or may not be the same as the independent environmental and social consultant, to evaluate the process against IFC PS7.

If a process of good faith that meets the consultation requirements of IFC PS7 has been followed and documented, but it is not clear if FPIC has been achieved, the EPFI and the qualified independent consultant will determine whether there has been a justified deviation or whether additional corrective action will be necessary.

These requirements apply to all projects globally, including those in designated countries.

FPIC-related issues, especially in designated countries, may be complex. Consultants and advisers with relevant expertise and knowledge of the underlying legal frameworks should be engaged to deliver methodologically sound opinions and appropriate suggestions for a course of action.

The EPA will issue guidance to support relevant stakeholders to help to clarify these requirements prior to July 2020.

Human rights impact assessments. Updates to the text in EP4 expressly put human rights on an equal footing with assessing and managing environmental risks.

Every project must be assessed from a human rights perspective, and this assessment should be recorded in the environmental and social impact assessment or a different, lower level, project assessment document.

‘Human rights’ means all the rights defined in the UN Guiding Principles on Business and Human Rights (UNGPs), not only those specifically dealt with under the Principles or IFC Performance Standards. A human rights impact assessment (HRIA) should be made in accordance with principles 17-21 of the UNGPs, such methodology being specifically referenced in the updated text.

If no human rights risks or impacts are identified, the appropriate assessment documentation will still need to comprise an explanation of how the determination of the absence of human rights risks was reached, including which stakeholder groups and vulnerable populations, if present, were considered to arrive at such a conclusion.

This represents a substantive augmentation of the need to engage in full-scale HRIAs for projects. This workstream has not always been treated with the same attention and diligence as environmental risk assessments. EPFIs which do not have the appropriate level of capacity in the HRIA area should consider strengthening and potentially upskilling their staff or engaging external advisers with relevant expertise.

Climate change. Climate change risk in the form of transition and physical risk as defined in the Task Force on Climate-related Financial Disclosures (TCFD) should be included for higher risk category projects in the environmental and social risk assessment and documented in the project assessment documentation.

Biodiversity. EP4 requires EPFIs to encourage their clients to share commercially non-sensitive biodiversity data with the Global Biodiversity Information Facility (GBIF) and relevant national and global data repositories for higher risk projects. EP4 also aligns with IFC guidance on avoiding certain sites, including those identified by the Alliance for Zero Extinction and World Heritage Sites, except for cases where the project makes an express contribution to biodiversity.

Appropriate action in relation to climate change risk assessment and disclosures envisaged by the TCFD Recommendations should, to the extent not done so yet, be adopted by all EPFIs as a matter of urgency.

Getting ready

In summary, there are a few steps which EPFIs should undertake to be ready to make their projects compliant with EP4 from July 2020.

First, EPFIs will need to update their guidelines for assessing which financial products fall within the scope of Equator Principles to ensure that all in-scope products are identified and the underlying projects’ sustainability issues are monitored appropriately throughout their lifetime.

Second, EPFIs ought to dedicate time to properly understand the implications of the indigenous peoples’ FPIC requirements and consider consultants and advisers with relevant expertise and knowledge to be engaged from July 2020 onward.

Third, EPFIs should consider their capacity to perform HRIAs on all their projects and put in place either a programme of strengthening and potentially upskilling their internal staff or decide to use external advisers with relevant expertise.

Finally, EPFIs should consider how they will require and enforce the assessment by their clients of climate change physical and, where relevant, transitional risk in line with the TCFD Recommendations.

Milana Chamberlain and Ray Chartier are partners at Norton Rose Fulbright LLP. Ms Chamberlain can be contacted on +44 (0)20 7444 3810 or by email: milana.chamberlain@nortonrosefulbright.com. Mr Chartier can be contacted on +1 (403) 267 8172 or by email: ray.chartier@nortonrosefulbright.com.

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Milana Chamberlain and Ray Chartier

Norton Rose Fulbright LLP

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