Ten global banking giants have taken a bold step toward ensuring projects they finance around the world meet strict environmental and social criteria. The impact of this move could be dramatic.

Early last month 10 of the world’s leading project finance banks adopted the Equator Principles, a set of voluntary environmental and social guidelines covering investments in major projects. Modeled on the International Finance Corporation’s and the World Bank’s environmental and social guidelines and policies, the Equator Principles (EP) require environmental management plans (EMPs) for sensitive projects to ensure that they protect natural habitats and the rights of indigenous peoples and provide safeguards against child and forced labor.

Praise for the move has come from both commercial and watchdog organizations, with some remarking that the Equator Principles represent something the export credit agencies, hampered by a diverse set of political allegiances, have so far failed to accomplish.

“The adopting banks are doing something that financial institutions rarely do,” says Peter Woicke, International Finance Corporation’s executive vice president--the IFC is part of the World Bank Group--who helped facilitate the process that led to Equator. “They are stepping forward in a leadership role on global environmental and social issues.” The potential effect of EP is great. “Even if you use an extremely conservative estimate,” he says, “this adoption will change the rules of the road for over $100 billion in global investment over the next 10 years.” The principles will apply across all industry sectors for project finance loans of $50 million or more.

Last year alone the 10 adopting institutions underwrote $14.5 billion of project loans, representing about 30% of the project loan syndication market globally. Citigroup, ABN AMRO, Barclays and West LB together comprised the drafting team. The other banks giving first voice to the Equator Principles are Crédit Lyonnais, Credit Suisse First Boston, HVB Group, Rabobank Group, The Royal Bank of Scotland and Westpac Banking Corporation. The founding members anticipate that another six to 10 financial institutions are close to joining their group. Last year banks did some $48 billion in project loans, the IFC chipped in with around $2.5 billion, and the export credit agencies contributed between $5 billion and $10 billion.

Targeting the business, not environmental, side of the banks was crucial. “With ABN AMRO playing host, heads of project finance and risk management were invited to London last October,” says Suellen Lazarus, an IFC director. “These are the people making the core business decisions, who have to deal with the economic or NGO fallout in the event a problem child surfaces.” In participants’ minds the primary motivating factor for banding together is, says Lazarus, to level the playing field. Presenting a united front is an antidote to the likely tendency that sponsors with sensitive projects would gravitate to institutions with lax standards. Adopting the Equator Principles also makes sound business sense for the banks involved. “Banks face both credit and reputation risk when they finance development around the world,” says Citigroup’s global head of project finance, Chris Beale, who played a pivotal role in achieving the EP declaration. “If sponsors adopt and follow EP for sensitive projects,” he says, “they might well enjoy a faster implementation period, with the end result being that the project starts generating a revenue stream earlier, avoiding the specter of costly interruptions, delays and retrenchments.” The belief is, he says, that “Equator will lead to more secure investments on the part of our customers and safer loans on the part of the banks.”

The downside to not paying heed to EP concerns could be dire, Beale implies. If banks finance something dirty or that harms people, it’s possible the host government or local people will interfere with or even confiscate the private development project. “Environmental risk is business risk; it’s as simple as that,” says Bernd Schanzenbacher, Credit Suisse Group’s head of environmental issues.

Environmental groups, while welcoming the initiative, are reserving judgment. “EP is something that potentially can be very significant,” says Michelle Chan-Fishel, Friends of the Earth green investments project program manager. “We do welcome it when banks have the guts to go on the record … but the proof is in the implementation pudding.”

Project Finance A,B,C

The first step in the process is to categorize projects A, B or C, with “A” projects having the highest risk for impact and the greatest need for mitigation and “C” projects being merely financial transactions. The “A” projects will require the most careful EMPs. Lead arrangers to the deal will have to negotiate differences of opinion where they arise. But as Paul Mudde, ABN AMRO’s head of reputation management and sustainable development, says, “The arranger group will determine the deal’s conditions, and the other participants will follow its lead.” Citigroup’s Beale adds, “It’s the impact of the project that counts, not the project itself. A pipeline through a forest is likely to be an ‘A’. The same pipeline being built in an industrialized area would be a ‘B’.” The Equator Principles apply only to direct project finance loans and not to corporate deals, says Beale, “because in a corporate deal banks don’t have the market power to impose covenants.” Corporate loans are usually undefined for general corporate purposes. They’re made on the good faith and credit of the corporation, eschewing specific covenants. It’s through the covenant vehicle that EP shows its teeth. “Even in the case where a particular plant, financed by a ‘corporate’ loan, lost its operating permit,” he says, “defaulting the loan might set in motion unwarranted repercussions to the total credit of the corporation. It could in effect bring the whole house down.” Allocating responsibility between lenders and sponsors ends in a split decision. Banks set the process in motion by building into the language of covenants what is required of the sponsor. It’s then up to the sponsor to live up to the terms of his contract. “If they don’t comply,” says Beale, “banks could default on the loan, which in turn could stop construction draw downs or cause the loan, if the project is in operation, to be accelerated.” In the EP preamble it states that sponsors who are unwilling or unable to comply with EP policies are not eligible. The whole process of developing the EPM involves a third-party consultant and public review by all the stakeholders. The prevention-versus-mitigation debate highlights contrasting perspectives between NGOs, which stress the need for “no-go” zones, and banks, which focus on economic development, urging clients to develop plans to mitigate the impact. Individually, banks might reject undesirable projects. For example, Rabobank Group, involved in palm oil plantations in Indonesia, refuses to allow virgin forests to be cut down for new site locations.

Actions Versus Words

Actual enforcement of the principles will remain a gray area, however. Banks have made it clear that EP is a voluntary private initiative and that policing stipulations would be contrary to the spirit of the initiative. But banks can, in effect, police one another through peer pressure. Also, they acknowledge that each lead arranger is only as good as the syndicate’s weakest link. Freeloaders, those who are part of the deal but who are not party to EP, will be under the scrutiny of lead arrangers; after all, reputations and financial risk are at stake. Some projects are intractable by their very nature. WestLB, with its OCP pipeline project in Ecuador, knows first hand how indeterminate the dispute can be. Even after revising its mitigation plan to ameliorate the direct impact of the pipeline, it is faced with the realization that the NGOs’ main concern is broader and goes to the oil exploration in the Amazon that will follow on the heels of the pipeline project.

If initial reactions to the Equator Principles are indicative, the prospects look good. Concerned parties on all sides can take heart from the fact that banks are taking a bold and effective step toward operating with greater transparency and a greater sense of their responsibilities.

Bo Glasgow