Proposed revisions to the Equator Principles 3 include human rights, social risk, and climate change.

By James Barrett, Paul A. Davies, Joel H. Mack, and Michael D. Green

The Equator Principles Association (EP Association) recently released the draft text of the Equator Principles (EPs) version 4 (EP4). The EP Association intend the draft text to form the basis for a formal round of public consultation, led by Business for Social Responsibility™. The review of EP3 and proposed development of EP4 was originally announced in late 2017. Prior to publication of the draft EP4, environmental consultants, ERM, conducted a preliminary round of stakeholder consultation, and the results can be viewed here.

EP Association and EPs

The EP Association is the unincorporated association of member EP Financial Institutions (EPFIs). Almost 100 financial institutions across 37 countries are members, including ABN Amro, Standard Chartered plc, the Royal Bank of Scotland, Citigroup, and the Commonwealth Bank of Australia. The object of the EPFIs is to manage, administer, and develop the EPs.

The EPs form a risk management framework that determines, assesses, and manages environmental and social risk in Projects. The EPs are primarily intended to provide a minimum standard for due diligence and monitoring to support responsible risk decision-making. The EPs have global application and apply to all industry sectors. The EPs apply specifically to the following four financial products:

  • Project Finance Advisory Services
  • Project Finance
  • Project-related Corporate Loans
  • Bridge Loans

The EPFIs commit to implementing the EPs in environmental and social policies, procedures, and standards, and will not provide funding to Projects in which the client will not comply with the EPs.

The EPs divide Projects into three categories:

  • Category A – Projects with potential significant adverse environmental and social risks and/or impacts that are diverse, irreversible, or unprecedented
  • Category B – Projects with 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
  • Category C – Projects with minimal or no adverse environmental and social risks and/or impacts

Proposed Changes Between EP3 and EP4

The proposed changes include updates in four key areas:

  1. Scope and applicability of EPs
  2. Applicable standards in designated versus non-designated countries
  3. Human rights and social risk
  4. Climate change

Scope and Applicability of EPs

EP4’s scope of applicability would remain Project-related. The total threshold for Project-Related Corporate Loans would be reduced from US$100 million in EP3, to US$50 million in EP4, making smaller Projects EP-eligible.

EP4 would add an additional financial product category, being Project-related Refinancing and Project-related Acquisition Financing, that would expand the scope of the EPs. A Project-related Refinancing and Project-related Acquisition Financing would apply if re-financing or acquisition finance is put in place in which all of the following circumstances are met:

  • The underlying Project is the subject of existing finance in accordance with the EPs
  • The scale or scope of the Project has not materially changed
  • The Project is not yet completed

Applicable Standards in Designated versus Non-Designated Countries

The EPs define “Designated Countries” as “countries deemed to have robust environmental and social governance, legislation systems and institutional capacity designed to protect their people and the natural environment.” The Designated Countries list can be found here. “Non-Designated Countries” are countries not found on the Designated Countries list.

Under EP3, Projects located in Designated Countries would be deemed to satisfy the EPs in relation to compliance, environmental & social impact assessment, stakeholder engagement, and grievance mechanisms — such that Project review would be focused on compliance with host country laws. EP4 would retain the Designated Countries list, but clarify that the relevant EPFI will evaluate specific Project-related risks to determine if, in addition to host country laws, International Finance Corporation (IFC) Performance Standards could be applied to address those risks.

EP4 would also require that the EPFI’s due diligence includes a review of how each Category A and Category B Project meets each of the EPs. As such, the proposed EP4 would expand the scope of review significantly with respect to Projects located in Designated Countries (including, for example, the United States).

Human Rights and Social Risk

EP4’s Preamble has been expanded, and would include a statement that EPFIs would fulfil their responsibilities in respect of human rights in line with the United Nations Guiding Principles on Business and Human Rights (UNGPs).

Under the proposed EP4, Principle 2 (environmental and social assessment) would be revised to mandate that an assessment of potential adverse human rights impacts be included as part of a Project’s Environmental and Social Impact Assessment (or other assessment).

EP3, under Principle 5, contains the requirement for Projects with adverse impacts on indigenous people to obtain the Free, Prior, and Informed Consent (FPIC) of those indigenous people with respect to the Project. EP4 seeks to sharpen the FPIC requirements — and provides two options related to FPIC for stakeholder discussion:

  • Option 1: For Projects with impacts on indigenous peoples as described in IFC Performance Standard 7, clients “are expected to engage in meaningful consultation with affected Indigenous People, with the goal of achieving their Free Prior and Informed Consent.”
    • Under this option, if the client has documented its good faith efforts to engage in meaningful consultation, but it is not clear at the time of EPFI due diligence if consent has been achieved, EPFIs should evaluate if further consultation efforts are required and whether the client has appropriate plans to mitigate and remedy potential adverse impacts. Where stakeholder engagement, including with Indigenous Peoples, is the responsibility of the host government, EPFIs expect the client to collaborate with the responsible government agency during the planning, implementation and monitoring of activities, to the extent permitted by the agencies.
  • Option 2: For Projects with impacts on indigenous peoples as described in IFC Performance Standard 7, clients “must demonstrate to the EPFI’s satisfaction, that the Free, Prior and Informed Consent of the indigenous peoples affected by the Project is obtained.”
    • Under this option, where stakeholder engagement, including with Indigenous Peoples, is the responsibility of the host government, EPFIs expect the client to collaborate with the responsible government agency during the planning, implementation and monitoring of activities, to the extent permitted by the agency, to achieve outcomes that are consistent with the objectives of this Principle (and IFC Performance Standard 7).

Climate Change

EP4 would revise the Preamble to include a recognition of EPFIs’ role in achieving targets under the 2015 Paris Agreement, and EPFIs’ responsibility to improve the availability of climate-related information, such as set out in the TCFD Recommendations (please see this prior Latham blog post).

EP4 Principle 2 would introduce the requirement of a Climate Change Risk Assessment for Category A and (as appropriate) Category B Projects, including consideration of relevant physical risks. There would be a further requirement concerning Scope 1 and Scope 2 emissions, if combined Scope 1 and Scope 2 emissions are expected to be greater than 100,000 tons of CO₂ equivalent annually. In such instance, there would be a requirement to consider the relevant transition risks and the completion of an alternatives analysis to evaluate less greenhouse gas (GHG) intensive options.

In addition, if the combined Scope 1 and Scope 2 emissions threshold is met under Principle 2, EP4 Principle 10 would introduce a requirement for all Category A and (if appropriate) Category B Projects to report publicly and annually: (i) GHG emission levels of combined Scope 1 and 2 emissions; and (ii) a GHG efficiency ratio (if applicable).

Conclusion

  • The proposed updates contained in the draft EP4 would expand the overall scope of the EPs to Project-related Refinancing and Project-related Acquisition Financing.
  • Of greater significance, the proposed changes would extend the reach of the EPs to Projects sited in Designated Countries — i.e., instead of being “deemed compliant” with the EPs (including the underlying IFC Performance Standards), Projects sited in Designated Countries would be expected to essentially satisfy all EPs (including the IFC Performance Standards), in addition to showing compliance with host country environmental and social laws and regulations.
  • In addition, the proposed updates reflect further EPFI focus on Project impacts to human rights, including most prominently impacts to Indigenous Peoples and obligations to obtain the “Free, Informed and Prior Consent” (i.e., FPIC) of Indigenous Peoples who may be adversely affected by Projects subject to the EPs. Such obligations, as noted above, would effectively be extended to Projects sited in Designated Countries, such as the United States.
  • Finally, the proposed updates to the EPs include key changes concerning climate change. The proposed inclusion of EPFIs’ responsibilities under the 2015 Paris Agreement, GHG reporting, and the provision of climate-related information in line with the TCFD Recommendations signal an appreciation of climate change factors gaining real traction in the financial industry, which will be reinforced if the EP4 proposals are adopted.

The public consultation period will run until mid-August 2019. Interested parties can provide feedback here. Following the end of the consultation period, a vote will be held on the revised EPs.

Latham & Watkins will continue to monitor developments in this area.

This post was prepared with the assistance of Martin Cassidy in the London office of Latham & Watkins.