UK: Proposed Changes To Equator Principles Enhance ESG Requirements For Project Debt

In brief...

The Equator Principles Association has published a consultation draft of version four of the EquatorPrinciples (EPs), the international baseline for the identification, assessment and management of environmental and social risks in international project finance debt markets. The proposed changes to the EPs, if implemented, will require project sponsors and lenders alike to adapt their respective assessment, screening and due diligence processes to reflect the revised EPs, particularly as they relate to human rights impacts, climate change risks and effects on indigenous peoples.

Lenders would be well-served by moving early to adopt – and communicate the adoption of – enhanced screening and due diligence processes in relation to human rights, climate change and indigenous peoples. In particular, lenders should consider their approach to due diligence on projects in high income OECD countries where there is divergence between the host country laws and the requirements of the IFC Performance Standards (IFC PS), and they should plan to communicate their preferred approach to clients.

The proposed changes include two discrete options in relation to the proposed approach to impacts on indigenous peoples, each with Free, Prior and Informed Consent (FPIC) as their object, one requiring consent in all circumstances, the other requiring consultation with the goal of obtaining consent and, where consent is not able to be obtained, leaving residual mitigation measures to the discretion of the lender. Lenders should analyse the implications of each and consider providing feedback to the Equator Principles Association regarding their preferred option.

The draft EPs were open for feedback throughout July and August 2019.

What are the proposed changes?

• Removal of aggregate loan amount threshold for project-related corporate loans: eliminating the USD100 million aggregate loan amount threshold for project-related corporate loans, resulting in the application of the EPs to any project-related corporate loan where a lender makes an individual commitment of at least USD50 million (before syndication or sell-down).
• Application to project-related refinancing and acquisition financing: applying the EPs to projectrelated financing and acquisition financing for projects previously financed in accordance with the EPs that remain both incomplete and unchanged in scope.
• Lifting of exemption for project-related corporate loans to sovereign borrowers: removing the exemption from application of the EPs for project-related corporate loans to national, regional or local governments, governmental ministries and agencies for a project with adverse environmental and social impacts, aligning the requirements for sovereign borrowers with the existing requirements for government-owned corporations and state-owned enterprises.
• Assessment of human rights impacts: requiring analysis of human rights impacts in all relevant assessments, a substantive change from the previous suggestion that human rights due diligence would likely only be required in "limited high risk circumstances."
• Enhanced assessment of climate change risks: in addition to the existing requirement for an alternatives analysis, projects with Scope 1 (direct) and Scope 2 (indirect) emissions in excess of 100,000 tonnes of CO2 annually, will also be required to include consideration of relevant transition risks (i.e. risks associated with policy, regulatory, technological and commercial responses to climate change). All assessments, including for projects that do not meet the emissions threshold, will be required to include consideration of relevant physical risks (i.e. effects of acute and chronic risks on assets, operations and markets).
• Application of IFC Performance Standards in Designated Countries: the draft EPs retain the concept of Designated Countries (i.e. high income OECD countries) as a proxy for governance, applying relevant host country laws as the basis for assessment in those countries. However, the changes also require lenders to evaluate the specific risks of the project to determine whether or not the IFC PS could be used as guidance to address those risks, in addition to host country laws.
• Requirement for engagement with workers: requiring projects with adverse environmental or social impacts to demonstrate engagement with workers, in addition to affected communities and other stakeholders (e.g. relevant authorities and civil society).
• Global standard for indigenous engagement: seek to apply a global standard for engagement with indigenous peoples affected by projects with impacts on lands or resources subject to traditional or customary use, requiring relocation or resettlement, or impacting or deploying indigenous cultural heritage, including in Designated Countries. However, uniquely among the proposed changes, the draft includes two options for consideration; one requiring the FPIC of indigenous peoples (i.e. the current standard applicable in relation to all except Designated Countries), and the other requiring "meaningful consultation with affected indigenous peoples, with the goal of achieving FPIC."
• Enhanced grievance mechanisms: modify the existing requirement for grievance mechanisms to require that they be "effective" (i.e. legitimate, accessible, predictable, equitable, transparent, rights-compatible and incorporating mechanisms for continuous improvement, based on the effectiveness criteria in the Guiding Principles on Business and Human Rights, (GPs)) and that they be designed for use by both affected communities and workers.
• Sharing of information with GBIF: a requirement encouraging lenders to have borrowers share commercially non-sensitive, project-specific biodiversity data with the Global BiodiversityInformation Facility.

What are the implications for project sponsors?

Sponsors of applicable projects will need to ensure that human rights impacts and climate change risks are adequately identified and assessed during the project development phase and that appropriate management and mitigation measures are incorporated into their environmental and social management systems, in advance of project financing.

In relation to human rights impacts, sponsors will need to adopt practices for human rights impact assessments consistent with the scope of the human rights defined in the EPs, which is aligned with the concept of internationally recognised human rights in the GPs (incorporating both the rights contained in the International Bill of Rights, together with the principles concerning fundamental rights identified in the ILO Declaration on Fundamental Principles andRights at Work). Sponsors should consider drawing on existing guidance, including the Human Rights ImpactAssessment Guidance and Toolbox published by the Danish Institute for Human Rights.

On climate change, the identification of climate change risks should be consistent with the Recommendations ofthe Task Force on Climate-related Financial Disclosures (TCFD Recommendations), from which the dichotomy between physical risks and transition risks is drawn. In particular, sponsors should consider the application of Scenario Analysis to the assessment of transition risks.

Sponsors will need to seek to engage with workers – which will be challenging where workforce mobilisation is contingent on project finance – and may need to adopt an iterative approach to engagement and development of grievance mechanisms. Grievance mechanisms, particularly where worker-facing, will need to be aligned with employment laws, contracts, policies and procedures, with an eye to minimising duplication.

Project sponsors in Designated Countries will, to a greater degree than is presently the case, need to identify divergence between host country laws and the requirements of the IFC Performance Standards, particularly in relation to human rights, climate change and impacts on indigenous peoples. In particular, these sponsors will need to be aware that compliance with host country laws may be inadequate to satisfy the requirements of the revised EPs, and to ensure that any assessment of bankability is not premised solely on compliance with host country laws.

What are the implications for lenders?

If implemented in their current form, the changes will require lenders to revise internal procedures to reflect the changes to the scope of the application of the EPs, including:

• to remove the aggregate threshold, include relevant refinancing and acquisition financings and to capture project-related loans to sovereign borrowers; and
• to supplement existing due diligence and screening process to ensure proper assessment of project impacts on human rights, climate change and indigenous peoples.

As with project sponsors, lenders should consider drawing on existing industry guidance to implement process for assessment of human right impacts, climate change risks and adverse effects on indigenous peoples. In particular, in relation to climate change risks, lenders should consider the outcome of the United Nations Environment Programme Finance Initiative pilot project on implementing the TFCD Recommendations, as recorded in the Expanding our Horizons report on transition risks and the Navigating a New Climate report on physical risks.

For projects in Designated Countries, lenders – like sponsors – will need to form a view in relation to the extent of any divergence between host country laws and the requirements of the IFC Performance Standards and be prepared to articulate their requirements to clients. Ideally, lenders would seek to record a consensus view on this point to avoid splintering of the market.

Lenders should – armed with a full understanding of the extent of any divergence between host country laws and the IFC PS in relation to impacts on indigenous peoples – form a view in relation to the practical implications of the two options proffered in proposed changes and consider providing feedback to the Equator Principles Association on their preferred outcome.

What's next?

The Equator Principles Association is seeking feedback on the consultation draft through July and August 2019 ahead of finalisation and launch later this year.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.