With the ever-increasing focus on climate change risk assessment and management, we felt it timely to remind ourselves of the existence and nature of the Equator Principles, a long-standing set of social and environmental due diligence and monitoring standards launched in 2003 and which now also contain greater emphasis on climate change.
What are the Equator Principles?
The Equator Principles (EPs) are a ‘risk management framework’ produced by an association of financial institutions (known as the Equator Principle Financial Institutions or EPFIs). They aim to ensure that construction and development projects determine, assess and manage local environmental and social risk, and address issues such as biodiversity, human rights and climate change. Currently, 118 banks and other financial institutions have officially adopted the EPs, including the four largest US banks (JP Morgan Chase, Bank of America, Citigroup and Wells Fargo).
The EPs apply to any project finance or project finance advisory service provided by member EPFIs globally, across all industry sectors, where the total new project capital cost of USD10million or more, and certain project-related corporate loans and bridge loans. Recent changes to the EPs now mean that they apply to the financing of expansions or upgrades to an existing project, not just to new projects.
In November 2019, the Equator Principles Association released updated EPs (EP4). A number of changes and additions were made and new climate related considerations were introduced. These came into effect on 1 October 2020.
How do they apply to EPC contractors?
By virtue of their adherence to the EPs, EPFIs are obliged to include covenants in project finance agreements which stipulate adherence to the EPs. The obligation to comply with the EPs is generally then passed down to the EPC contractor as a contractual requirement, insofar as the principles apply to the EPC works. It follows that, where an EPFI is financing a project, adherence to the principles is compulsory, not merely desirable or negotiable, as other corporate social responsibility requirements may be.
The EPs at a glance
There are 10 principles which, for convenience, can be split into three broad categories: pre-project assessments, ongoing obligations, and reporting and transparency.
Principles 1, 2 and 3 (respectively: Review and Categorisation, Environmental and Social Assessment, and Applicable Environmental and Social Standards) deal with pre-project assessments, reviews and categorisations. The EPFI will categorise the project in relation to the relevant risks, assigning it to either Category A (projects with potential significant adverse risks), Category B (those with potential limited adverse risks) or Category C (those with minimal or no adverse risks).
For Category A and B projects, an Environmental and Social Impact Assessment (ESIA) will then be carried out by the EPFI, as well as a Climate Change Risk Assessment (CCRA). Principle 3 emphasises that the Assessments should ensure compliance with the laws and regulations of the host country. A distinction is drawn here in EP4 between Designated Countries (i.e. countries with robust environmental and social protections, institutions and legislation in place) and Non-Designated Countries (jurisdictions without robust frameworks). EPFIs will expect projects in Non-Designated countries to demonstrate compliance with further standards as stipulated by the EPFIs (such as the IFC Performance Standards). These standards represent the minimum standards expected by the EPFIs.
Principles 4, 5, 6 and 7 introduce a number of obligations concurrent with the life of the project. Principle 4 requires the client to draw up and maintain an Environmental and Social Management System (ESMS) throughout the lifecycle of any Category A or B project. Principle 5 requires the client to engage with stakeholders in a ‘structured and culturally appropriate manner’ especially in relation to environmental or social risk, any effects on Indigenous Peoples (a new requirement in EP4) and any impact on cultural heritage.
To ensure accountability in relation to principle 5, principle 6 requires the client to have an effective grievance mechanism in place to deal with issues in relation to ‘Affected Communities and Workers’. Principle 7 then requires an independent review of the ESMS, any Stakeholder Engagement documentation and other requirements stipulated by the EPs. Project clients and their EPC contractors need to be aware of the obligations imposed by these principles and ensure that they are complied with when contractually required.
Principle 8 acts as a standalone principle which differs in nature from the other EPs. It relates to covenants and, crucially, obliges all EPFIs to incorporate the EP requirements into any project finance documentation through actual contractual obligations. This is the main mechanism through which the EPs seek to ensure compliance with environmental and social laws, regulations and any other applicable, defined standards.
Finally, principle 9 (Independent Monitoring and Reporting) and principle 10 (Reporting and Transparency) require reporting and monitoring of the compliance (or otherwise) of the project client with the EPs. This includes encouragement to publicly share bio-diversity data, together with requirements to report on an annual basis on Greenhouse Gas emissions and to have an ESIA readily available online.
What Climate Change considerations are in the EPs?
EP4 imported a number of climate change related obligations. Explicit reference to the 2015 Paris Climate Change Agreement (PCCA) has been introduced, so that Assessment Documentation for a project may now include requirements derived from the PCCA. EP4 also states that EPFIs support the objectives of the PCCA and should improve availability of climate related information in relation to the Task Force on Climate-related Financial Disclosures (TCFD).
Similarly, the EPs themselves incorporate alignment to the TCFD. As an example, principle 2 stipulates that a Climate Change Risk Assessment (CCRA) is required for all Category A and appropriate Category B projects, and also where combined Scope 1 emissions (direct CO2 emissions from facilities within the project boundaries) and Scope 2 emissions (indirect CO2 emissions i.e. those associated from energy used by the project) are expected to be more than 100,000 tonnes per annum. For such projects, the concept of Climate Transition Risks has been introduced as a mandatory consideration. These are risks to a project associated with commercial, legal, social or other responses to climate change, and acknowledge the increasing prominence given to addressing climate change in the project finance sphere.
It can be seen that, despite the apparently advisory nature of the principles, they should be a very real consideration for EPC contractors in a project finance context. If the project is financed by an EPFI (as is likely) it is important that the EPC contractor is cognisant of how its obligations under the EPC contract may be extended or otherwise impacted by the EPs.