The Nickel Report

The Equator Principles (EPs) are a framework for assessing and managing environmental and social risks associated with project financing. The EPs provide a minimum due diligence standard and monitoring protocol supporting responsible risk assessment and decision-making. The EPs apply globally, to all industry sectors, and are focused on risk management for projects financed by the financial institutions that have adopted the EPs. Currently, the EPs have been adopted by 105 financial institutions across 38 countries. The EPs oblige financial institutions to make informed investment decisions and withhold or withdraw financing on projects or assets not conforming to “good international industry practice.” The EPs incorporate IFC’s Environmental and Social Performance Standards (IFC Performance Standards) and World Bank Group Environmental, Health, and Safety Guidelines.

As we previously explained, since their adoption the EPs have seen broader applications in relation to energy, extractive industries, infrastructure and other large-scale projects with significant potential to affect the environment and local communities, particularly in developing economies. However, it is not just financial institutions and their borrowers who should pay close attention to the EPs – even where not imposed through project financing; the EPs may have significant implications for projects both in the US and abroad.

As we have also previously described, the EPs are tied to the larger trends associated with corporate social responsibility (CSR), as also reflected by the evolving CSR standards imposed in international trade agreements, bilateral trade agreements and international arbitration decisions. Further, the EPs are viewed as a tool toward delivering on the objectives of the United Nations Sustainable Development Goals. Hence, there’s an increasing trend toward imposing the EPs outside the project finance context or to reference the EPs protocol as a model for defining “good international standards” where such an obligation has been imposed by local law, treaty, or other relevant legal or contractual frameworks.

In November 2019, the Equator Principles Association released “EP4,” the fourth and latest iteration of the EPs. On June 19, 2020, the Equator Principles Association issued guidance on the implementation of the EPs during the global pandemic. Further, EP4 was due to take effect on July 1, 2020; due to the pandemic, however, the Equator Principles Association approved a 3-month extension until October 1, 2020.

Thus, it is timely to consider the differences between EP4 and its prior iteration, EP3. Notably, EP4 applies the EPs to a broader range of financial products, reduces inconsistencies between “developed” and “developing” countries and includes substantive new requirements on climate change, human rights, and Indigenous Peoples. Several of the more significant changes are summarized below.

• Applicability. The EPs apply to various financial products. The preamble to EP4 also contains, for the first time, a statement recognizing a broader responsibility for managing adverse environmental and social risks and impacts, and respecting human rights, even for financial products that fall outside the EPs’ current scope.

For in-scope financial products, there are a few notable changes, with the practical implication that more transactions and projects are covered by the EPs. For example, Project-Related Corporate Loans over $50M now are in-scope, down from $100M; the threshold applies to both the aggregate loan amount and the financial institution’s individual commitment. The EPs also now apply to Project-Related Refinancing and Project-Related Acquisition Financing, if:  (i) the underlying project was financed in accordance with the EP framework, (ii) there has been no material change in the scale or scope of the project, and (iii) the project completion has not occurred at the time of signing of the relevant facility. Notably, certain loans to national, regional or local governments, governmental ministries and agencies are now within the scope of EP4, including existing project expansions or upgrades.

• Environmental and Social Review and Due Diligence. The EPs mandate that financial institutions require their clients (e., the borrower) conduct an appropriate environmental and social risk assessment. For many projects, this will be achieved by an Environmental and Social Impact Assessment (ESIA), which is similar to an Environmental Impact Statement in the US under the National Environmental Policy Act (NEPA). EP4 Exhibit II now makes more explicit the issues that should be included in such an assessment, including human rights, climate change, and biodiversity.
• Designated v. Non-Designated Countries. Historically, the EPs addressed projects differently depending on location (e., “designated” or “non-designated” countries). A designated country is a member of the Organization for Economic Co-operation and Development (OECD) and appears on the World Bank High Income Country list (i.e., US, Japan, and most European Union countries). Non-designated countries are all others generally considered to be “developing” nations. EP4 makes significant changes to this framework.

Under EP3, projects in designated countries complying with local law were deemed to be in compliance with the EPs (e.g., the requirement to perform an environmental assessment, etc.). EP4 eliminates the “deemed in compliance” language. This means projects in designated countries subject to the EPs may be required to satisfy all of the EPs standards, even where those standards may exceed requirements of local law. This is an important change. Under the EP4 framework, for example, a project in the US may be required to take assessment or mitigation measures beyond those typical to due diligence, environmental assessment, or authorizations necessary to demonstrate compliance with US law.

Next, under EP3, projects in designated countries were required to meet only the host country’s environmental and social laws and regulations. By contrast, projects located in non-designated countries were required to meet local law, in addition to applicable IFC Performance Standards (which in turn generally impose a “good international industry practice” standard). EP4 largely maintains this framework. However, financial institutions must evaluate the specific risks of a project in a designated country and decide whether one or more of the IFC Performance Standards should be assessed when reviewing the project, in addition to host country law. One catalyst for this change was a project in the US – the Dakota Access Pipeline project (DAPL), a multistate crude oil transport project from the Bakken fields in North Dakota funded by financial institutions adopting the Eps; the DAPL project became controversial, in part, because of perceived risks to sacred Native American burial grounds.

As a practical matter, EP4 means projects in designated countries may be subject to more than what is necessary to satisfy host country law; NEPA, the National Historic Preservation Act, or the Clean Air Act in the US, for example. This could include a divergence between what is necessary to comply with applicable law and what is necessary for a project to obtain and keep funding for the project consistent with EP4.

• Climate Change. EP4’s preamble identifies a proactive climate change mitigation role for financial institutions. EP4 states that the EP-signatory financial institutions support the objectives of the Paris Agreement. Under EP4, ESIAs must include a climate change risk assessment identifying physical and transition risks, consistent with recommendations of the 2017 Task Force on Climate-related Financial Disclosures. Physical risks include physical climate change impacts (g., direct damage to infrastructure, indirect impacts to supply chains, etc.), while transition risks include factors facilitating transition to a lower-carbon economy (e.g., policy and legal risks from national policy changes, technological innovations, reputational risk associated with customer perceptions, etc.). For projects in all locations triggering the specified greenhouse gas (GHG) emissions threshold, the environmental assessment must evaluate alternative lower-emitting options.
• Human Rights and Social Risk. EP4 strengthens human rights assessment criteria, requiring an assessment of adverse human rights impacts regardless of whether the level of risk warrants a full ESIA or a lesser assessment. EP4 clarifies that the UN Guiding Principles on Business and Human Rights (UNGPs) are adopted as the operative human rights due diligence risk management framework.
• Indigenous Peoples. Indigenous People's stakeholder engagement was one of the key areas of focus in adopting the enhanced EP4 ESIA framework. As such, EP4 requires consultation with Indigenous Peoples against the requirements of host country laws and the IFC Performance Standards, including whether Free, Prior and Informed Consent (FPIC) has been obtained. Under EP4, this consultation process must be evaluated by an independent consultant on behalf of the financial institution. Projects affecting Indigenous Peoples are subject to this process, including those located in designated countries such as the US.
• Biodiversity. For certain high-risk projects, EP4 encourages the sharing of biodiversity data with the Global Biodiversity Information Facility and relevant national and global data repositories.

Comparison of EP3 and EP4 Applicability and Substantive Requirements

EP4 includes significant changes from EP3, with potentially significant implications for financial institutions and their clients seeking to finance projects. Given the EPs have seen broader application in relation to energy, extractive industries, infrastructure and other large-scale projects, companies in those sectors should pay particular attention to EP4 and its implementation in the real world, in particularly for projects situated in developing economies.