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Mind the gaps in the Equator Principles

8 February 2018

The $3.8 billion Dakota Access Pipeline (DAPL) has proved to be a highly controversial project, with its impacts exceeding the wildest expectations of investors. It was accompanied by protests, court cases, accusations of political interference and even a presidential memorandum.

The banks financing the project claim to have adhered to the Equator Principles1 (EP or the Principles), a credit risk management framework for determining, assessing and managing environmental and social risks in projects. They have been adopted by 92 financial institutions in 37 countries, covering over 70% of project finance debt in emerging markets. An Equator Principles Financial Institution (EPFI) will require its clients – the borrowers – to conduct environmental and social impact assessments for each project.

Different standards

However, the Principles only apply to emerging markets, so-called non-designated countries. Different standards exist for projects located in designated countries – countries deemed to have robust environmental and social governance in place. For projects located in designated countries, the environmental and social impact assessment can follow the host country’s laws and regulations instead of adhering to the performance standards of the International Finance Corporation (IFC) on which the Principles are based. As the DAPL is located in the US, a designated country, many financing banks followed the US rules for assessments under which, for example, if a project is not sited on Indian country, informed consent is not legally required.

Response from financing institutions

Following investor pressure, some institutions sold their stakes in the loans financing the DAPL. Meanwhile, the chief executive of Citigroup apologised for not having given sufficient consideration earlier in the DAPL process to ensure free, prior and informed consent (FPIC) had been obtained. The bank has since published a number of blogs to provide transparency of its impact assessment and consultation processes. Citigroup and Toronto-Dominion, another lead financier of the 17-strong syndicate, have made commitments to improve their due diligence approaches. They undertook an independent assessment, which pointed out that the existing approach to consulting indigenous communities in the US does not meet IFC performance standards. For example, there is insufficient governance over the consultation process. Encouragingly, some banks have since moved to enhance their processes, applying global best practice standards to all the projects they finance, whether they are located in designated or non-designated countries.

Other gaps

A closer examination of the Principles has helped us identify other areas of improvement.

Principle 9 states that to assess project compliance, EPFIs require the appointment of an independent environmental and social consultant or that their clients retain qualified and experienced external experts to verify their monitoring information. This would be shared with the EPFI. It means that the cost of initial and ongoing impact assessments could potentially be externalised to the customer of the financing institution or EPFI. While this is similar to an external audit where the company pays a third party expert to verify its accounts, we believe that this process is only robust if the EPFI has sufficient in-house expertise to judge whether the external assessment has been conducted thoroughly, and if it can potentially make specific enhancements to the process before coming to a financing decision. Regular assessments should also be put in place to monitor the compliance of the project.

Additionally, in relation to governance, each EPFI is responsible for its own internal procedures to achieve compliance with the Principles. An EPFI must meet reporting requirements and sector-specific guidance and pay an annual membership fee. We encourage EPFIs to seek independent advice, especially, as in the case of the DAPL, when the in-house teams of some banks identified material risks. A widely adopted three lines of defence approach to effective risk management deserves a deep dive into environmental and social risks.

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1 The Principles was launched as an outcome of a work group composed of banks and the International Finance Corporation (IFC) in 2003.

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