Singapore - ESG And Responsible Project Financing: A Primer On The Equator Principles 4.

Legal News & Analysis - Asia Pacific - Singapore - Regulatory & Compliance

29 January, 2020

 

Version 4 (“EP4”) of the Equator Principles (“EP”) was adopted by the Equator Principle Association (“EPA”) at its annual meeting in Singapore on 18 November 2019; and on the same date, DBS Bank became the 101st financial institution worldwide and the first financial institution headquartered in Southeast Asia to adopt the EP. What are the EP and how do they contribute to sustainable development? What does it mean for banks who adopt them and for their clients?

 

Introduction

 

The EP are a set of voluntary risk management framework which professes to be “financial industry benchmark standards for determining, assessing, and managing the environmental and social risks in projects”.1 It was originally adopted in 2003 by 10 financial institutions in response to rising concerns by non-governmental organisations that the space created by the withdrawal of the International Monetary Fund (“IMF”) from international project finance was being filled by private investors which, unlike the IMF, did not impose environmental and social standards on projects in developing countries. The EP are currently in their version 3; EP4 takes effect on 1 July 2020 and the EPA will in due course release associated guidance to support relevant stakeholders in the implementation of the Principles. This client update focuses on EP4.

 

Signatory financial institutions of the EP, known as Equator Principles Financial Institutions (“EPFI”), have to ensure that the projects2 they finance and advise on “are developed in a manner that is socially responsible and reflect sound environmental management practices.”3 They believe that “negative impacts on [p]roject-affected ecosystems, communities, and the climate should be avoided where possible. If these impacts are unavoidable they should be minimised and mitigated, and where residual impacts remain, clients should provide remedy for human rights impacts or offset environmental impacts as appropriate.”4 EPFIs also commit in the Preamble of the EP to respect human rights5 in line with the United Nations Guiding Principles on Business and Human Rights (“UNGP”) by carrying out human rights due diligence; support the objectives of the 2015 Paris Agreement and recognise that EPFIs have a role to play in improving the availability of climate-related information when assessing the potential transition and physical risks of projects financed under the EP;6 and support conservation.7 They will not provide project finance, project-related corporate loans to projects or project-related refinance and project- related acquisition finance to projects, which do not comply with the relevant EP requirements.8

 

The EP explicitly provide that they do not create any rights in, or liability to, any person, public or private. Where there is a clear conflict between applicable laws and regulations and requirements set out in the EP, the laws and regulations of the relevant host country prevail.9

 

Scope

 

EP4 applies to an EPFI’s —


(a) Project finance advisory services10 where total project capital costs are at least US$ 10 million; 

 

(b)  Project finance11 with total project capital costs of at least US$ 10 million;

 

(c)  Project-related capital loans12 where the majority of the loan is related to a project which the clients has effective operation control, the total aggregate loan amount and the EPFI’s individual commitment are each at least US$ 50 million, and the loan tenor is at least two years;

 

(d)  Bridge loans of less than two years that are intended to be refinanced by project finance or project-related corporate loan that is anticipated to meet the foregoing criteria; and

 

(e)  Project-related refinance 13 and project-related acquisition finance 14 where the underlying project was financed in accordance with the EP framework, there has been no material change in the scale or scope of the project, and project completion has not yet occurred at the time of the signing of the facility or loan agreement.

 

EPFIs acknowledge that they may have broader responsibilities for identifying and managing adverse environmental and social risks and impacts and respecting human rights for financial products outside the scope of the EP, and at their discretion may utilise the EP framework for financial products that fall outside the scope.15

 

Approach

 

The EPFI must only provide project finance and project-related corporate loans to projects that meet the relevant requirements of the EP. For refinance and acquisition finance, the EPFI must take reasonable measures to ensure that all existing EP environmental and social obligations relating to the underlying project continue to be included in new financing documentation. For advisory services and bridge loans, the EPFI must request that the client confirms its intention to adhere to the EP requirements when subsequently seeking long term financing.

 

Information Sharing

 

Subject to business confidentiality and applicable laws, mandated EPFIs must share appropriate environmental and social information other than competitively sensitive information with other mandated EPFIs for the purpose of achieving consistent application of the EP.

 

Principles

 

Principle 2 — Determining Risks and Impacts

 

The EPFI must require the client to conduct an appropriate assessment process to the EPFI’s satisfaction, to address the relevant environmental and social risks and scale of impacts of the proposed project. The assessment documentation should propose measures to minimise, mitigate;16 and in respect of the residual risks and impacts, compensate, offset, or remedy in a relevant and appropriate manner for risks and impacts to workers, affected communities,17 and the environment.18

 

For all Category A and, as appropriate, Category B projects,19 the assessment documentation must include an environmental and social impact assessment (“ESIA”), a comprehensive document of a project’s potential 

environmental and social risks and impacts in its area of influence. For other projects, a limited or focussed environmental or social assessment may suffice. An assessment and the assessment documentation must include assessments of potential adverse human rights impacts and climate change risks.

 

The client should refer to the UNGP when assessing human rights risks and impacts, and a climate change risk assessment should be aligned to the climate physical risk20 and climate transition risk21 categories of the Task Force on Climate-related Financial Disclosures (“TCFD”). An overview of a climate risk assessment is found in Annex A of EP4. Amongst other things, the overview suggests that an assessment should consider the Project’s compatibility with the host country’s national climate commitments, as appropriate; the EP however do not require that the EPFI only finances a project if it is compatible with such national commitments.

Principle 3 — Review of Assessment Process and Risks and Impacts

 

The assessment process should, in the first instance, comply with relevant host country laws that pertain to environmental and social issues. The EPFI’s due diligence must also include for all Category A and B projects, review and confirmation by the EPFI of how the project and transaction meet each of the Principles. In addition, the EPFI must, with support from the independent environmental and social, where applicable (see Principle 7), evaluate the project’s compliance or justified deviation from the applicable standards.

 

These standards vary depending on whether the host country is a designated or non-designated country, and in most instances, designated countries are OECD members and World Bank high income countries.

 

For projects in non-designated countries, the applicable standard refers to the applicable IFC Performance Standards on Environmental and Social Sustainability22 and the World Bank Group’s Environmental, Health and Safety Guidelines.23

 

For projects in designated countries, the applicable standard is the relevant host country’s laws pertaining to environmental and social issues. The EPFI must also consider for all Category A and, as appropriate, Category B projects in designated countries, with the support of the independent environmental and social consultant, whether one or more IFC Performance Standards could be used to address the specific risks for such projects.

 

Presumably, the underlying thinking for applying different standards to designated and non-designated countries is that while the legislation system and institutional capacity in non-designated countries generally fall short of applicable IFC Performance Standards, those of designated countries are at least as good as those of the Performance Standards. The application of separate standards for designated and non-designated countries was criticised24 amidst concerns and mass protests related to projects hosted in designated countries, such as the high-profile Dakota Access pipeline project in the United States, and the explicit additional requirement to 

consider specific risks for projects in designated countries was added to the standard for designated countries to address these criticisms.

 

Principle 4 — Management of Risks and Impacts

 

For all Category A and B projects, the EPFI must require the client to develop and/or maintain an environmental and social management system (“ESMS”),25 comprising policy, identification of risks and impacts, management programmes, organisation capacity and competency, emergency preparedness and response, stakeholder engagement, and monitoring and review. The client must also prepare an environmental and social management plan (“ESMP”)26 to address issues raised in the assessment process and incorporate actions required to comply with the applicable standards. Where the applicable standards are not met to the EPFI’s satisfaction, the client and the EPFI must agree to an Equator Principles Action Plan (“EPAP”)27 to outline gaps and commitments to meet the EPFI’s requirements in line with the applicable standards.

 

Principle 5 — Stakeholder Engagement

 

For all Category A and B projects, the EPFI must require the client to demonstrate effective stakeholder engagement with affected communities, workers, and where relevant, other stakeholders in a structured and culturally appropriate manner. 28 For projects with potentially significant adverse impacts on affected communities, the client must conduct an informed consultation and participation process. 29 To facilitate stakeholder engagement, the client must make the appropriate assessment documentation readily available to the stakeholders in the local language and in a culturally appropriate manner. The client must take account of and document the results of the stakeholder engagement process.

 

Indigenous Peoples

 

All projects affecting indigenous peoples must be subject to a process of informed consultation and participation, and will need to comply with the rights and protections for indigenous peoples contained in relevant national law. Further, in the special circumstances as set out in PS7 paras 13 to 17 that require the Free, Prior and Informed Consent (“FPIC”) of affected indigenous peoples,30 the EPFI must require a qualified independent consultant to evaluate the consultation process with indigenous peoples, and the outcomes of that process, against the requirements of host country laws and PS7. If a process of good faith negotiations that meets the consultation requirements of PS7 has been followed and documented, but it is not clear if FPIC has been achieved, the EPFI must determine, with supporting advice from the consultant, whether this qualifies as a justified deviation from the requirements of PS7, and whether the client should pursue additional corrective actions to meet the objectives of PS7. 

 

Principle 6 — Grievance Mechanisms

 

For all Category A and, as appropriate, Category B Projects, the EPFI must require the client, as part of the ESMS, to establish effective grievance mechanisms which are designed for use by affected communities and workers, as appropriate, to receive and facilitate resolution of concerns and grievances about the project’s environmental and social performance. The client must inform affected communities and workers about the grievance mechanisms in the course of the stakeholder engagement process.31 However, there are no requirements for EPFIs to set up their own grievance mechanisms, and neither has the EPA set up any grievance mechanism, to receive and facilitate resolution of concerns of individuals or communities affected by projects covered by the EP.32

 

Principle 7 — Independent Review

 

For all Category A and, as appropriate, Category B projects, an independent environmental and social consultant must carry out a review of the assessment process including the ESMPs, the ESMS, and the stakeholder engagement process documentation in order to assist the EPFI’s due diligence and determination of EP compliance. The consultant will also propose or opine on a suitable EPAP capable of bringing the project into compliance with the EP, or indicate whether there is a justified deviation from the applicable standards.

 

Principle 8 — Covenants

 

For project finance and project-related corporate loans, the client must covenant in the financing documentation to comply with all relevant host country environmental and social laws, regulations and permits in all material respects. For all Category A and Category B projects, the client must also covenant in the documentation to,

 

  1. (a)  Comply with the ESMPs and EPAP (where applicable), during the construction and operation of the project in all material respects;

  2. (b)  Provide periodic reports that document compliance with the ESMPs and EPAP;

  3. (c)  Provide representation of compliance with relevant local, state and host country environmental and social laws, regulations and permits; and

  4. (d)  Decommission the facilities, where applicable and appropriate, in accordance with an agreed decommissioning plan.

 

The loan documentation will also need to define the environmental and social standards applicable to the project; and spell out the conditions precedent before a request may be made for drawdown or a disbursement of a loan, and the events of default.33

 

Where a client does not comply with its environmental and social covenants, the EPFI must work with the client on remedial actions to bring the project back into compliance. If the client fails to re-establish compliance within an agreed grace period, the EPFI must reserve the right to exercise remedies, including calling an event of default, as considered appropriate.

 

For project-related refinance and project-related acquisition finance, EPFIs must take reasonable measures to ensure that all existing environmental and social obligations continue to be included in the new financing documentation.

 

Principle 9 — Independent Monitoring and Reporting

 

For project finance and project-related corporate loans involving Category A or, as appropriate, Category B projects, the EPFI will require independent monitoring and reporting by an independent environmental and social consultant. Alternatively, the EPFI must require the client to retain qualified and experienced external experts to verify its monitoring information, which will be shared with the EPFI. 

 

Principle 10 — Reporting

 

Client Reporting

 

The client must ensure that, at a minimum, a summary of the ESIA is accessible and available online and that it includes a summary of human rights and climate change risks and impacts when relevant. The client must report publicly, on an annual basis, GHG emission levels (combined Scope 1 and Scope 2 Emissions, and, if appropriate, the GHG efficiency ratio) during the operational phase for projects emitting over 100,000 tonnes of CO2 equivalent annually. The EPFI must encourage the client to share commercially non-sensitive project-specific biodiversity data with the Global Biodiversity Information Facility and relevant national and global data repositories.

 

EPFI Reporting

 

The EPFI must, at least annually, report publicly on transactions that have reached financial close and on its EP implementation processes and experience. The minimum reporting requirements are set out in Annex B of EP4.

 

Concluding Remarks

 

The EP seek to facilitate the transition to sustainable development by ensuring that the environmental and social risks and impacts of large-scale projects are systematically identified and addressed at the planning, design, construction, and operation phases. EP4 has strengthened the Principles in a number of ways, including broadening the scope of financial products covered and lowering the monetary threshold for the Principles to apply to certain products; adding additional requirements to the applicable standards for the review of projects hosted in designated countries; adding requirements in relation to the FPIC of affected indigenous peoples; and adding requirements for climate change risk assessments in accordance with the TCFD recommendations. The Principles have their shortcomings and limitations, and will no doubt continue to be subject to reviews and revisions in the future.

 

Ultimately, the EP are first and foremost a risk management framework for EPFIs, but EPFIs can collectively also complement (but not replace) the role of public regulators by implementing the EP requirements. There are costs to financial institutions and their clients for implementing the EP that may render a project uncompetitive in the short term, and this may pose a barrier to financial institutions voluntarily adopting the Principles, or EPFIs implementing the EP strictly.34 However, as more financial institutions, including those in this region,35 become convinced that responsible financing contributes to their own value, the EP will only grow in relevance and impact over time. 

 

Shook Lin Bok LLP 
 

 

For further information, please contact:  
 
Liew Kai Zee, Partner, Shook Lin & Bok
kaizee.liew@shooklin.com

 

1 The Equator Principles, November 2019, <https://equator-principles.com/wp-content/uploads/2019/11/The-Equator-Principles-November- 2019.pdf>.
2 The EP’s glossary of terms explains that a project is a development in any sector at an identified location, and includes an expansion or upgrade of an existing operation.

3 EP4, Preamble para 2.
4 EP4, Preamble para 2.
5 The EP’s glossary of terms describes human rights as those rights described in international standards aimed at securing dignity and equality for all; and as a minimum are those expressed in the Universal Declaration of Human Rights, the International Covenant on Civil and Political Rights and the International Covenant on Economic, Social and Cultural Rights and the principles concerning fundamental rights set out in the International Labour Organisation’s Declaration on Fundamental Principles and Rights at Work.
6 The EPFIs make no mention of their role in aligning their financing of projects to the objectives of the Paris Agreement, but instead focus only on their role in improving the availability of climate-related information.
7 EP4, Preamble para 2.
8 EP4, Preamble para 3.
9 EP4, Disclaimer.
10 The EP4’s glossary of terms refers to “project-related advisory services” as the provision of advice on the potential financing of a development where one of the options may be project finance. 

11 The EP4’s glossary of terms refers to “project finance” as a method of financing in which the lender looks primarily to the revenues generated by a project, both as the source of repayment and as security for the exposure.
12 The EP4’s glossary of terms refers to “project-related corporate loans” as corporate loans made to business entities related to a project where the lender looks primarily to the revenues generated by the project as the source of repayment and where security exists in the form of a corporate or parent company guarantee; or the documentation for the loan indicates that the majority of the proceeds of the total loan are directed to the project.

13 This is a new addition to the scope of the EP.
14 This is a new addition to the scope of the EP. The EP4’s glossary of terms refers to “project-related acquisition financing” as the acquisition of a project or a project company which exclusively owns, or has a majority shareholding in a project, and over which the client has effective (whether direct or indirect) operational control.
15 EP4, Preamble para 4.
16 Principle 2 does not appear to require that the assessment documentation to propose measures to avoid environmental and social risks and impacts. However, given the EPFIs’ stated belief in para 2 of the EP4 Preamble that negative impacts on project-affected ecosystems, communities, and the climate should be avoided where possible, the proposal of measures to minimise risks and impacts may arguably include measures to avoid such risks and impacts where possible.
17 The EP4’s glossary of terms refers to “affected communities” as local communities within the project's area of influence, directly affected by the project.
18 Projects are categorised according to the magnitude of potential environmental and social risks and impacts, as set out in Principle 1.
19 According to Principle 1, Category A projects have potential significant adverse environmental and social risks and/or impacts that are diverse, irreversible or unprecedented; Category B projects have potential limited adverse environmental and social risks and/or impacts that 

are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures; and Category C projects have minimal or no adverse environmental and social risks and/or impacts.
20 The relevant climate change physical risk assessment must be considered for all Category A and, as appropriate, Category B projects.
21 For projects where the combined Scope 1 and Scope 3 emissions are expected to exceed 100,000 tonnes of CO2 equivalent, consideration must be given to the relevant climate transition risks, and an ‘alternatives analysis’ which evaluates the technical and financial feasibility of lower greenhouse gas intensive alternatives must be completed. Details of the requirements of such an analysis can be found in Annex A of EP4.

22 The Performance Standards are used to define IFC clients' responsibilities for managing their environmental and social risks, and cover generally, risk assessment and management (“PS1”); and more specifically,

  1. (a)  labour and working conditions (“PS2”);

  2. (b)  resourceefficiencyandpollutionprevention(“PS3”);

  3. (c)  community health, safety, and security Performance (“PS4”);

  4. (d)  landacquisitionandinvoluntaryresettlement(PS5);

  5. (e)  biodiversity conservation and sustainable management of living natural resources (PS6);

  6. (f)  indigenous peoples (“PS7”); and

  7. (g)  culturalheritage(PS8).

7 EP4, Preamble para 2.
8 EP4, Preamble para 3.
9 EP4, Disclaimer.
10 The EP4’s glossary of terms refers to “project-related advisory services” as the provision of advice on the potential financing of a development where one of the options may be project finance.

11 The EP4’s glossary of terms refers to “project finance” as a method of financing in which the lender looks primarily to the revenues generated by a project, both as the source of repayment and as security for the exposure.
12 The EP4’s glossary of terms refers to “project-related corporate loans” as corporate loans made to business entities related to a project where the lender looks primarily to the revenues generated by the project as the source of repayment and where security exists in the form of a corporate or parent company guarantee; or the documentation for the loan indicates that the majority of the proceeds of the total loan are directed to the project.

13 This is a new addition to the scope of the EP.
14 This is a new addition to the scope of the EP. The EP4’s glossary of terms refers to “project-related acquisition financing” as the acquisition of a project or a project company which exclusively owns, or has a majority shareholding in a project, and over which the client has effective (whether direct or indirect) operational control.
15 EP4, Preamble para 4.
16 Principle 2 does not appear to require that the assessment documentation to propose measures to avoid environmental and social risks and impacts. However, given the EPFIs’ stated belief in para 2 of the EP4 Preamble that negative impacts on project-affected ecosystems, communities, and the climate should be avoided where possible, the proposal of measures to minimise risks and impacts may arguably include measures to avoid such risks and impacts where possible.
17 The EP4’s glossary of terms refers to “affected communities” as local communities within the project's area of influence, directly affected by the project.
18 Projects are categorised according to the magnitude of potential environmental and social risks and impacts, as set out in Principle 1.
19 According to Principle 1, Category A projects have potential significant adverse environmental and social risks and/or impacts that are diverse, irreversible or unprecedented; Category B projects have potential limited adverse environmental and social risks and/or impacts that 

are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures; and Category C projects have minimal or no adverse environmental and social risks and/or impacts.
20 The relevant climate change physical risk assessment must be considered for all Category A and, as appropriate, Category B projects.
21 For projects where the combined Scope 1 and Scope 3 emissions are expected to exceed 100,000 tonnes of CO2 equivalent, consideration must be given to the relevant climate transition risks, and an ‘alternatives analysis’ which evaluates the technical and financial feasibility of lower greenhouse gas intensive alternatives must be completed. Details of the requirements of such an analysis can be found in Annex A of EP4.

22 The Performance Standards are used to define IFC clients' responsibilities for managing their environmental and social risks, and cover generally, risk assessment and management (“PS1”); and more specifically,

  1. (a)  labour and working conditions (“PS2”);

  2. (b)  resourceefficiencyandpollutionprevention(“PS3”);

  3. (c)  community health, safety, and security Performance (“PS4”);

  4. (d)  landacquisitionandinvoluntaryresettlement(PS5);

  5. (e)  biodiversity conservation and sustainable management of living natural resources (PS6);

  6. (f)  indigenous peoples (“PS7”); and

  7. (g)  culturalheritage(PS8).

For an overview of the Performance Standards, see Exhibit 3 of EP4.

23 The guidelines contain explicit performance levels and measures on environmental, health, and safety issues that are normally acceptable to the World Bank Group. They cover guidelines that are generally potentially applicable across all sectors, as well as detailed guidelines that are specific to the agribusiness and food production, chemicals, forestry, general manufacturing, infrastructure, mining, oil and gas, and power sectors. The Guidelines supplement the IFC Performance Standards, particularly PS3 (and to a lesser degree, PS1, PS2, and PS4). For an overview of the Guidelines, see Exhibit 3 of EP4.
24 See for example, the letter by 10 EPFIs to the EPA, dated 22 May 2017, <https://www.banktrack.org/download/letter_from_10_banks_to_epa_secretariat_on_designated_countries_eps/170522_letter_banks_on _designated_countries.pdf>. 

25 The EP’s glossary of terms describes an ESMS as an overarching environmental, social, health and safety management system which is designed to identify, assess and manage risks and impacts in respect to the project on an ongoing basis. It incorporates:

  1. (i)  policy;

  2. (ii)  identification of risks and impacts;

  3. (iii)  management programs;

  4. (iv)  organizational capacity and competency;

  5. (v)  emergency preparedness and response;

  6. (vi)  stakeholder engagement (that may include stakeholder analysis and planning, disclosure and dissemination of information,

    consultation and participation, grievance mechanism, and ongoing reporting to affected communities); and

  7. (vii)  monitoring and review. More information about the ESMS can be found in PS1.

26 The EP’s glossary of terms describes an ESMP as a summary of the client’s commitments to measures to address and mitigate risks and impacts identified as part of the assessment, through avoidance, minimisation, and compensation/offset. More information about the ESMP can be found in PS1.
27 According to the EP’s glossary of terms, an EPAP describes and prioritises the actions needed to address any gaps in the assessment documentation, ESMPs, ESMS, or stakeholder engagement process documentation to bring the project in line with the applicable standards as defined in the EP. More information about the ESAP can be found in PS1.

28 PS1 provides further requirements on stakeholder engagement.
29 PS1 provides further requirements on the informed consultation and participation process. 30 Principle 5 set outs four circumstances —

  1. (a)  projects with impacts on lands and natural resources subject to traditional ownership or under the customary use of indigenous peoples;

  2. (b)  projects requiring the relocation of indigenous peoples from lands and natural resources subject to traditional ownership or under customary use;

  3. (c)  projects with significant impacts on critical cultural heritage essential to the identity of indigenous peoples; and

  4. (d)  projects using their cultural heritage for commercial purposes. 

31 Grievance mechanisms must seek to resolve concerns promptly, using an understandable and transparent consultative process that is culturally appropriate, readily accessible, at no cost, and without retribution to the party that originated the issue or concern. They should also not impede access to judicial or administrative remedies. PS1 provides further requirements on the grievance mechanism.
32 See also UNGP Principles 29 and 30.

33 In this regard, it may still be useful to refer for guidance to the EPA’s Guidance for EPFIs on Incorporating Environmental and Social Considerations into Loan Documentation (2014), <https://equator-principles.com/wp- content/uploads/2017/03/ep_guidance_for_epfis_on_loan_documentation_march_2014.pdf>, issued in relation to version 3 of the EP. 

34 Even the EPA only explicitly provides for two instances for the delisting of an EPFI and removal as member of the EPA – where it has failed to report publicly on its implementation of the EP in accordance with Principle 10 and Annex B; and non-payment of the EPA annual fees. See The Equator Principles Association Governance Rules, April 2017 (v2), rules 6(g)(iii) and 18(h)(iii), <https://equator-principles.com/wp- content/uploads/2018/01/governance-rules-april-2017-v2.pdf>.

35 Of the 101 EPFIs, only 17 are headquartered in Asia, including one in Southeast Asia.