Pursuit of Responsible Investment Practices Beyond ESG: The Equator Principles Help Guide International Investment and Finance Projects

Written by Jeffrey Karp

Recently, we discussed the reboot of the Prosper Africa Initiative by the Biden Administration, whose aim is to increase trade between U.S. companies and African countries and encourage investment across the African continent. We also identified several factors such as infrastructure and financing risk for consideration by U.S. companies interested in Africa opportunities. Given the heightened emphasis worldwide on sustainable project development, which encompasses environmental, social and governance (ESG) criteria, U.S. companies considering investment in Africa also must become familiar with the Equator Principles (EPs), a tool for assessing and managing environmental and social risk in projects.[1]

Across the world, more than 100 financial institutions and export credit agencies in 37 countries have voluntarily adopted the EPs. These institutions, including JPMorgan Chase & Co, Standard Chartered PLC, UK Export Finance, TD Bank Financial Group, Wells Fargo Bank, N.A., and the United States Ex-Im Bank,[2] apply the EPs to facilitate consideration of environmental and social risks and project impacts , and pursuit of sustainable environmental and social performance in order to achieve improved financial, environmental, and social outcomes, particularly involving infrastructure and industrial projects. Access to finance is often dependent on meeting the EPs[3]. Like the ESG movement, which in large part was started by the United Nations via its support for the Principles for Responsible Investment, the EPs also align with United Nations goals, such as its Sustainable Development Goals.[4]

The EPs apply globally and to all industry sectors, including financial products such as project finance advisory services, and project finance that meet certain thresholds. For project finance advisory services and project finance, the EPs apply when the total project capital costs are $10,000,000 or more. The EPs have 10 guiding principles of which this article focuses on the following four: Principle 1: Review and Categorization; Principle 2: Environmental and Social Assessment; Principle 3: Applicable Environmental and Social Standards; and Principle 8: Covenants.[5] Based on Principle 1, Review and Categorization, the project must be placed in a Category – designated as A, B, or C. Category A refers to projects with “potential significant adverse environmental and social risks and/or impacts that are diverse, irreversible or unprecedented;” Category B refers to 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;” and Category C refers to projects with “minimal or no adverse environmental and social risks and/or impacts.”[6]

Principle 3, Applicable Environmental and Social Standards, discusses the importance of identifying and engaging with relevant host country laws, regulations and permits that pertain to environmental and social issues.[7] Principle 3 has two tracks for projects: those located in Designated Countries, and those located in Non-Designated Countries. Projects located in Designated countries apply the relevant host country laws, regulations, and permits to the project. In Non-Designated countries, the Environmental and Social Assessment (Principle 2) evaluates a project’s compliance with the International Finance Corporation’s (“IFC”) Performance Standards on Environmental and Social Sustainability,[8] and the World Bank Group’s Environmental, Health, and Safety Guidelines (EHS).[9] The EHS guidelines serve as a technical reference to the IFC Performance Standards, containing examples of Good International Industry Practice (GIIP), which provide performance levels and measures normally considered acceptable for projects in Non-Designated Countries. The list of 34 Designated Countries[10] includes a number of countries in Europe[11] in addition to Australia, Canada, Chile, Israel, Japan, New Zealand, Republic of Korea, and the United States. Countries are categorized as Designated if they are deemed to have “robust environmental and social governance, legislation systems, and institutional capacity designed to protect their people and the environment.” Further, while projects in Non-Designated countries must adhere to the IFC and World Bank guidelines, Principle 8 of the EPs (Covenants) further states that the client “will covenant…to comply with all relevant host country environmental and social laws, regulations, and permits in all material respects.” Finally, regardless of whether the project is located in a Designated or Non-Designated country, the standards identified and referenced in the EPs represent the minimum standards adopted and do not preclude any additional standards that may be imposed by other project stakeholders.

By way of hypothetical example, the following provides an overview of what a company seeking to comply with the EPs may expect to encounter. Suppose that a company, EnergyCo, wishes to utilize a technology that extracts minerals from mining waste in a country in Africa. In order to implement the technology, a number of costly items must be financially accounted for such as engineering, procurement, and construction (EPC) costs and obtaining permits. EnergyCo may have use of the technology for this process but may not have the financial resources or the investors to provide capital for all phases of the project. Thus, credit guarantees and/or financing from an export credit agency may be the available avenue to pursue the project. If the financial institution has adopted the EPs, the EPs would apply if the project meets the various thresholds. If the EPs apply, this project likely would be categorized as a Category A or Category B project because it involves the treatment and transport of hazardous substances, which may result in greater emittance of air pollutants, and the discharge of wastewater effluent. Moreover, the nature of the project raises a host of other environmental and social issues. If the project was designated into either Category A or Category B, the EPs would require the conduct of an Environmental and Social Assessment (Principle 2) to further identify the project’s potential risks and impacts.

Further, as mentioned above, under Principle 3 additional considerations may be imposed depending on whether the project is in a Designated or Non-Designated country. Because no African countries are on the list of Designated Countries[12], the International Finance Corporation (“IFC”) Performance Standards on Environmental and Social Sustainability and the World Bank Group Environmental, Health, and Safety Guidelines would be consulted – in this case the EHS Guidelines for Mining.[13] Potential environmental issues associated with mining activities that EnergyCo may encounter include water use and quality, waste containment, handling of hazardous materials, and impacts on land use, biodiversity, air quality, noise and vibrations, scenery, and energy use. EnergyCo may also consider implementing guidelines for workplace occupational health and safety as well as community health and safety such as safe transport routes and protocols requiring proper handling of waste materials.

In addition to the IFC and World Bank guidelines, pursuant to Principle 8 of the EPs, EnergyCo must covenant to comply with all relevant host country environmental and social laws, regulations, and permits “in all material respects.” This covenant would include obtaining all necessary permits for mining (treating, recovery, recycling, storage, etc.), as well as compliance with applicable air quality emissions and any water effluent discharge limitations.

While compliance with the multiple requirements presented in the EPs may seem daunting to companies wishing to pursue opportunities in other parts of the globe, the reality is that the EPs are just one aspect of a growing sustainability movement that necessitates companies’ engaging in infrastructure projects to behave as responsible stewards of the environment, positively address the social impacts of their activities, and fulfill expectations presented in new models for corporate governance. Companies that develop the tools to fulfill ESG standards, and the experience and knowledge required to navigate the EPs will enhance their ability to successfully participate in programs such as Prosper Africa.

[1] https://equator-principles.com/about/

[2] https://equator-principles.com/members-reporting/

[3] See for example “Sustainability In Export Finance - Leveraging Export Finance to support the delivery of the SDGs” ICC White Paper September 2021

[4] https://equator-principles.com/wp-content/uploads/2020/05/The-Equator-Principles-July-2020-v2.pdf . These goals are intended to avoid or minimize negative impacts on ecosystems, communities, and the climate while   also protecting human rights in accordance with the United Nations Guiding Principles on Business and Human Rights.

[5] The 10 principles are: (1) Review and Categorization; (2) Environmental and Social Assessment; (3) Applicable Environmental and Social Standards; (4) Environment and Social Management System and Equator Principles Action Plan; (5) Stakeholder Engagement; (6) Grievance Mechanism; (7) Independent Review; (8) Covenants; (9) Independent Monitoring and Reporting; and (10) Reporting and Transparency. This article focuses on Principles (1), (2), (3), and (8) as these principles outline preliminary considerations and goals of the EPs while the other principles come into play at more advanced stages of a project.

[6] The EPs are intended to provide a minimum standard for due diligence and monitoring to support responsible risk decision-making. Based upon the project’s categorization and other details about the project, additional evaluation and diligence processes will be identified as further assessment steps.

[7] https://equator-principles.com/wp-content/uploads/2020/05/The-Equator-Principles-July-2020-v2.pdf

[8] https://www.ifc.org/wps/wcm/connect/Topics_Ext_Content/IFC_External_Corporate_Site/Sustainability-At-IFC/Policies-Standards/Performance-Standards

[9] https://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/sustainability-at-ifc/policies-standards/ehs-guidelines

[10] https://equator-principles.com/designated-countries/

[11] Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Latvia, Lithuania, Luxembourg, Netherlands, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, and the United Kingdom.

[12] https://equator-principles.com/designated-countries/

[13] https://www.ifc.org/wps/wcm/connect/1f4dc28048855af4879cd76a6515bb18/Final%2B-%2BMining.pdf?MOD=AJPERES&id=1323153264157