Equator Principles Association Adopts Equator Principles 4

The final text of Principle 5 requires a consultation process between the client and the indigenous community.

By James R. Barrett, Paul A. Davies, and Michael D. Green

On 18 November 2019, the Equator Principles Association (EP Association) adopted the most recent iteration of the Equator Principles (EPs), the fourth version of the EPs that has been released since their inception in 2003 (EP4). The final content of EP4 is very similar to that of the draft text, which was published earlier this year for stakeholder consultation (see Equator Principles Association Releases Equator Principles 4 for Consultation).

EP4 will come into effect on 1 July 2020, and differs from the previous version, EP3, in significant ways. This post includes a table summarising the key differences between EP3 and EP4 (see below). Some notable changes include the following:

1. Expanded Scope. EP4 lowers the applicability threshold from US$100 million to US$50 million in relation to Project-related corporate loans. It also expands the scope of the EPs to now cover Project-related refinance and Project-related acquisition finance. Accordingly, parties can expect to see more transactions subject to the EPs.

2. Standards Applied to Projects in “Designated Countries”. For Projects sited in Designated Countries (i.e., high-income countries such as the United States), EP4 makes two major changes:

First, under EP3, Projects located in Designated Countries that comply with host-country environmental and social laws are deemed to be in compliance with the following EPs: (i) environmental and/or social assessments (Principle 2); (ii) management systems and plans (Principle 4); (iii) Stakeholder Engagement (Principle 5); and (iv) grievance mechanisms (Principle 6). This is no longer the case under EP4. EP4 eliminates the “deemed in compliance” language, meaning that Projects sited in Designated Countries (and otherwise meeting the EP4 applicability threshold) will be required to satisfy all of the EPs. This change should not be overlooked — the EPs are prescriptive, and the undertakings required to satisfy the EPs may not align well with typical due diligence and environmental/social management approaches undertaken in Designated Country-based Projects.

Second, under EP3, Projects located in Designated Countries are only required to meet host-country environmental/social laws, regulations, and permits; by contrast, Projects located in Non-Designated Countries are required to meet host-country laws in addition to applicable International Finance Corporation Performance Standards on Environmental and Social Sustainability (IFC PS). EP4 maintains that approach, subject to a significant caveat. Under EP4, Equator Principles Financial Institutions (EPFIs) will evaluate the specific risks of Projects located in Designated Countries to determine whether one or more IFC PS should be used to address such risks, in addition to host-country laws. Notably, when launching EP4 in November, the EP Association wrote that EP4 will now require that transactions in Designated Countries benchmark against the requirements of IFC PS 7 (Indigenous Peoples), marking a “substantial move” from EP3 and representing “the first example of EP utilizing the IFC PS more broadly in Designated Countries.” The EP Association also indicated that guidance will be issued in 2020 to help clarify how such requirements are to be implemented in Designated Countries. (More on the indigenous peoples point below.)

3. Human Rights and Indigenous Peoples (as Defined in EP4). Whilst the adopted text of EP4 is broadly very similar to the draft text published earlier this year, the final text differs significantly from the draft text in relation to Indigenous Peoples and Free, Prior, and Informed Consent (FPIC).

The draft text included two options to update EP3’s Principle 5 (which contains the requirement for Projects with adverse impacts on Indigenous Peoples to obtain the FPIC of those Indigenous Peoples with respect to the Project).

The first option proposed in the draft text was for EP4 to contain a requirement that clients “are expected to engage in meaningful consultation with affected Indigenous Peoples, with the goal of achieving their FPIC”. Under this option, the client would likely achieve compliance with Principle 5 if it demonstrated good-faith efforts to engage with the indigenous community and put in place appropriate plans to mitigate and remedy potential adverse impacts.

The other option offered in the draft text was to make Principle 5 require a client to “demonstrate, to the EPFIs’ satisfaction, that the FPIC of the Indigenous Peoples affected by the Project is obtained”. This option was more robust in its expectations of the client, as it would have required actual consent to be obtained.

However, the adopted text of EP4 contains a new approach that combines aspects of both options. The final text of Principle 5 requires a consultation process between the client and the indigenous community. This consultation process, along with any outcomes of that process, will be evaluated by an independent consultant on behalf of the EPFI. The consultant will then determine whether that process and the outcomes of that process are compliant with both the host-country laws relating to Indigenous Peoples and IFC PS7.

If the client has followed a process of good-faith negotiations that meets the consultation requirements of IFC PS7, but it is unclear as to whether the FPIC of the Indigenous Peoples has been obtained, the EPFI will decide if there has been a “justified deviation” from the requirements of IFC PS7, and therefore whether the client should perform corrective action in order to ensure compliance.

As noted above, all Projects affecting Indigenous Peoples — including those located in Designated Countries — will be required to satisfy IFC PS7. This will potentially have significant impact on Projects in jurisdictions such as the United States, where the levels of engagement contemplated in EP4 exceed or differ from national standards, including most prominently with respect to EP4’s FPIC requirements.

4. Climate Change. EP4 revises the Preamble to include recognition of EPFIs’ role in achieving the 2015 Paris Agreement, and its responsibility to improve the quality of climate-related information in the context of the EPs.

Principle 2 of EP4 introduces the requirement of a Climate Change Risk Assessment for Category A Projects and some Category B Projects, which involves consideration of relevant physical risks. In addition, if combined annual Scope 1 and Scope 2 emissions of the Project are anticipated to exceed 100,000 tons of CO₂ equivalent, there are now requirements to consider transition risks and complete an analysis of less greenhouse gas (GHG) intensive options.

Finally, if the threshold of Scope 1 and Scope 2 emissions referred to above is met, Principle 10 of EP4 introduces an annual reporting requirement on GHG emission levels of combined Scope 1 and 2 emissions, and, if relevant, the GHG efficiency ratio.

Summary of Key Differences Between EP3 and EP4*

*For a more detailed review of all the changes, please see here.

This post was prepared with the assistance of James Bee in the London office of Latham & Watkins.