The Equator Principles Association (EPA) has released a third version of the Equator Principles (EPs) for public consultation and comment (available here). Amongst the key changes proposed by the draft are a greater emphasis on human rights and climate change.  According to the EPA, this amendment acknowledges the second pillar of the UN’s Protect, Respect and Remedy Framework for Business and Human Rights developed by Professor John Ruggie, urging businesses to “act with due diligence to avoid infringing on the rights of others and to address adverse impacts with which they are involved.”

The Equator Principles were launched by 10 financial institutions and the International Finance Corporation (IFC) in 2003. They establish an environmental and social risk management framework, and a minimum due diligence standard for identifying, assessing and managing environmental and social impacts in project finance transactions. They have been adopted by 77 financial institutions to date, which together are responsible for the vast majority of project financings around the world.

The principles, whilst not legally binding, are widely followed and of real practical significance.  Banks will refuse to fund or accelerate funding in relation to projects that do not demonstrably comply with the principles, since otherwise banks themselves will be exposed to reputational risk.  The proposed changes demonstrate the increasing regard that companies operating in the international sphere, and particularly in emerging markets, should have to human rights.  Moreover, it is likely that they will establish an internationally recognised standard and that other entities will follow suit.

Scope

The final version of the EPs is expected to be adopted and launched in early 2013.  The EPA’s stated purpose in updating the EPs is to ensure that they remain “gold standard” for environmental and social risk assessment and management in financing.  As well as the proposals set out above, the draft extends the application of the EPs beyond their current project finance scope to cover project-related corporate and bridge loans and enhanced monitoring and reporting requirements for lenders and borrowers.

Currently, the EPs apply to project finance lending and advisory activities, although they have sometimes been applied voluntarily to other types of financial products. The draft would formally extend the scope of the EPs to cover:

  • project-related corporate loans of at least US$100 million and of two years in term, and where the borrower has effective operational control (direct or indirect) over the project; and
  • bridge loans that will be refinanced by project finance or a project-related corporate loan.

The EPA acknowledges that lenders have less influence over a project financed through a corporate loan than through project finance, and so the draft EPs impose significantly fewer requirements in respect of corporate loans.

Human rights

The draft places greater emphasis on human rights considerations than previous versions of the EPs. The preamble and Exhibit II (which lists potential environmental and social issues to be assessed) refer to the importance of addressing human rights in the due diligence process. Although the references are brief they would be the first use in the EPs of the term “human rights”.

According to the EPA, this amendment acknowledges the second pillar of the UN’s Protect, Respect and Remedy Framework for Business and Human Rights developed by Professor John Ruggie (available here), namely the corporate responsibility to respect human rights, urging businesses to “act with due diligence to avoid infringing on the rights of others and to address adverse impacts with which they are involved.” (For our latest blogpost on the UN Guiding Principles on Business and Human Rights, see here.)

Projects with adverse impacts on indigenous people in non-OECD countries or OECD countries that are not ‘High-Income’ (as designated by the World Bank Development Indicators Database) will require the free, prior and informed consent of those people. This is a significant change and reflects both amendments made to the revised IFC Performance Standards earlier this year (available here) and the text of the UN Declaration on the Rights of Indigenous Peoples of 2007.

Climate change

For projects expected to emit over 100,000 tonnes of carbon dioxide equivalent annually, borrowers would be required by lenders to:

  • conduct an analysis of alternatives, including less carbon intensive fuel sources and technologies based on requirements stipulated in the updated IFC Performance Standards; and
  • publicly report greenhouse gas emissions levels during the operational phase of the project.

Applicable standards

Both the current EPs and the new draft acknowledge that laws, regulations and permits in High-Income OECD countries will generally meet or exceed the requirements of the EPs.

The draft expressly states that the Environmental and Social Impact Assessment (ESIA) carried out by the borrower must establish a project’s overall compliance with or justified deviation from:

  • for projects in High-Income OECD countries: applicable local laws, regulations and permits; and
  • for projects in other counties (i.e. non-OECD countries or OECD countries that are not designated as High-Income): applicable IFC Performance Standards and IFC Environmental, Health and Safety (EHS) Guidelines.

For projects in High-Income OECD countries, the draft confirms that compliance with local  laws, regulations and permits will be sufficient to comply with Principles 2 (environmental and social assessment), 4 (management systems and plans), 5 (stakeholder engagement), and 6 (disclosure and grievance mechanisms). The draft also confirms that individual lenders may, at their sole discretion, apply additional standards and requirements.

Enforcement

The EPs do not include any provisions or mechanism for enforcement as they were conceived as a set of voluntary guidelines. Principle 6 requires borrowers to establish a grievance mechanism through which a third party might challenge the borrower, but not the lender. This can be contrasted with the Compliance Advisor Ombudsman which is an independent recourse mechanism for complaints relating to IFC funded projects, and the role of National Contact Points (NCPs) which handle complaints alleging breaches of the OECD Guidelines for Multinational Enterprises. The draft proposes no changes with respect to enforcement, even though the inability to enforce compliance by lenders with the EPs has been criticised by NGOs who claim that it results in an inconsistent application of the EPs and a lack of accountability.

The EPs demonstrate the increasing regard that companies operating in the international sphere, and particularly in emerging markets, should have to human rights.  The 77 financial institutions signed up to the principles will have a soft law obligation to adhere to these principles, and if followed to the same extent as the existing EPs they will have a very real practical effect.  Moreover, it is likely that they will establish an internationally recognised standard and that other entities will follow suit.

Institutions that have adopted the EPs and borrowers should assess and prepare for the proposed changes, particularly in respect of financings which will be brought within the scope of the EPs for the first time and projects for which additional requirements will apply.