INSIGHT

What you need to know about the draft Equator Principles 4

By Phillip Cornwell, Jo Ye
Banking Human rights obligations Project Finance Risk & Compliance

In brief 4 min read

Lenders (and project sponsors) should consider the potential impact of changes proposed in the consultation draft of Equator Principles 4. These entail greater focus on climate change, human rights and social risk, including new requirements for designated countries, as well as some scope and other minor changes. The draft is open for public consultation in July and August, with a view to finalisation by the end of 2019. To most Equator Principles Financial Institutions already well attuned to the zeitgeist mandating heightened sensitivity to environmental and social governance issues, the changes will reflect business as usual. On the other hand, NGOs pressing for major changes may be disappointed.

Key takeaways

Responding to the broader responsibilities flowing from the UN Sustainable Development Goals, the UN Guiding Principles on Business and Human Rights and the 2015 Paris Agreement, as well as the Task Force on Climate-related Financial Disclosures, the main changes in the proposed fourth iteration are:

  • Enhanced assessment of human rights impact and climate change risks: the revisions require more extensive due diligence assessments, including, in the case of climate change, assessment of physical and transition risks, and annual public reports on greenhouse gas emissions for high emissions projects.
  • Not just host country laws: for projects located in designated (high income OECD) countries, Equator Principles Financial Institutions (EPFIs) need to evaluate the specific risks of the project against the International Finance Corporation (IFC) performance standards where these may differ from host country laws. For category A and category B projects, the due diligence is to include a review against each principle of Equator Principles 4 (EP4). This will help address back-tracking in some developed nations, though the new wording only requires 'evaluation' of the gap to consider whether the stricter IFC rules could be used.
  • Elect now: the draft offers two options relating to the free, prior and informed consent of affected Indigenous Peoples (FPIC) for feedback, option 1 encouraging 'meaningful consultation' while option 2 requires their actual consent.
  • Looking at project lifecycle: for project-related corporate loans, the threshold has reduced to US$50 million (before syndication or sell-down) and the sovereign borrower exemption is gone. Certain project-related refinancings and acquisition financings are now in scope.

Who else in your organisation needs to know about this?

Legal, risk and compliance teams need to be aware of the proposed changes, especially any operatives tasked with site inspections, environmental and social review and due diligence, human rights impact assessments, and credit risk policy review.

'Equator Banks, Act!'

Needless to say, the changes do not respond to all the criticisms of the Equator Principles. For example:

  • The Principles are not binding and they are expressed in broad terms, open to subjective or convenient interpretation. While a grievance mechanism is required, ultimately the Principles are only enforceable in the court of public opinion. The reporting requirements go some way to mitigating this concern, but those requirements are not very proscriptive and the reporting is only required annually. Because each bank chooses its own format, NGOs say it is difficult to obtain aggregated or comparative figures.
  • In terms of climate change mitigation, while many EPFIs have vowed to cease financing thermal coal projects and coal fired power stations, EP4 only requires an alternatives analysis to evaluate less greenhouse gas-intensive alternatives.
  • The definition and application of FPIC remains a major concern for NGOs. Their fear is that option 1 will be the lowest common denominator, requiring no more than 'good faith' negotiation between the client and affected Indigenous communities.
  • Since their launch in 2003, the Equator Principles (whose name implies a global reach) have been officially adopted by 96 financial institutions in 37 countries. In the Asia-Pacific region, although Export Finance Australia and all major banks in Australia are signatories, only 19 Asian banks are current EPFIs, and none of the major banks and export credit agencies in China and India is on the list. Infrastructure projects in this region may fall short of the minimum sustainability standards until those key players have joined.
  • While the preamble to EP4 explicitly references supporting biodiversity conservation, the only new requirement is for the EPFI to encourage the client to share biodiversity data with the Global Biodiversity Information Facility.

Actions you can take now

  • Read the draft text and summary.
  • Consider the impact of changes on current Equator Principles compliance procedures, and, in particular, your existing environmental and social due diligence, human rights and social risks review, and climate change risk assessment and reporting.
  • For projects in designated countries, consider the potential impact of any material divergences between host country laws and IFC performance standards.
  • Determine which option in relation to FPIC is supported.
  • Prepare and submit your feedback on EP4 before the end of August.

Allens is ready to assist you.