Equator Principles III: What Do Financial Services Companies Need to Know?

Authors

• John Hodges

  Former Vice President, BSR

John Hodges, Financial Services Director, BSR

While many industries grapple with which sustainability standards to follow, the banking industry has a clear framework for infrastructure finance: the Equator Principles. With the launch of the third version of the Equator Principles, or EP III, last month in Amsterdam, the scope and scale of how banks manage environmental and social risks in their financing activities has significantly increased.  

In 2003, ten banks sought to improve their environmental and social risk management practices by collectively developing the Equator Principles. In order to ensure a focused, consistent impact, the standards were voluntary, limited to the banking sector, and focused on projects with the greatest environmental and social issues, mainly infrastructure. To date, nearly 80 banks are Equator Principles Financial Institutions (EPFIs). Combined, the EPFIs constitute more than 70 percent of project financing in emerging markets.

In the past ten years, the principles have been a clear step in the right direction. However, prior to the release of EP III, EPFIs’ due diligence process was mainly a validation of the environmental and social analysis that many infrastructure firms were already doing as part of their own standard risk management practices. Therefore, the Equator Principles in general did not raise the bar much on best practice; rather, they set a minimum standard. In addition, other stakeholders, such as NGOs, regulators, and local communities, were taking the lead on external monitoring of environmental and social compliance and providing transparency on project implementation.

While some civil society organizations, such as BankTrack, argue that EP III has not gone far enough, they do push environmental and social risk-management best practice further. Banks are now required to conduct due diligence in areas that were not traditionally covered under many clients’ environmental and social risk management practices.

Three points in particular demonstrate the greater strength of EP III: 

1. The expanded scope means an expanded scale. Traditionally, the Equator Principles had only covered project finance and advisory roles, which have been decreasing as a business for many banks since the principles were founded. A typical EPFI was only applying the principles to a few dozen projects each year, although some were also voluntarily applying them to other forms of infrastructure financing. EP III has now formally added bridge loans and project-related corporate loans to the mix, and many EPFIs expect that this expanded scope will significantly increase the number of projects requiring formal review.
2. Human rights are now front and center. For projects where human rights could be a major issue, EP III specifically requires that human rights due diligence is undertaken according to the Guiding Principles on Business and Human Rights. EP III is not prescriptive in how human rights due diligence must be conducted, however, and EPFIs have some discretion in how to apply EP III. Since human rights assessments are not common practice among project developers, banks will have important influence on how industries will approach this issue.
3. Greenhouse gas emissions are now tracked. EP III identifies climate change as a key issue and discusses what banks can do to reduce emissions more directly. Rather than mandating what can be and can’t be financed, the approach focuses on transparency. Project developers are required to conduct analyses to evaluate less-intensive alternatives and report on larger projects’ emissions publicly.

What does all this mean for EPFIs? They will now conduct more environmental and social due diligence on more projects for more clients than ever before. They will have to get much smarter about human rights and climate change. And they will have to be more transparent about what they are financing and the associated project-level environmental and social impacts.

BSR assists our members, including EPFIs and project developers, with environmental and social risk management through our industry expertise, such as energy and extractives, issue expertise, such as ecosystem services, and regional expertise, such as China. With the launch of EP III, we have also already seen a significant increase in BSR member banks asking about human rights implementation and climate change support as well.

A follow-up blog will discuss the implications of EP III for the energy and extractives industry. For more information about BSR’s Financial Services practice, visit our industry webpage.