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The Equator Principles: Changing the Face of Financing Construction Projects
Imagine a time in the future when financial institutions worry not just about profit but also people and the planet. It may seem unlikely, but that time is not in the future it is now. Banks throughout the world are voluntarily adopting a set of regulations called the Equator Principles, which are revolutionizing the way large construction projects are financed. The Equator Principles are a voluntary set of guidelines for assessing and managing environmental and social risks in the area of project financing. They provide clear and understandable procedures for financing projects greater than $50 million.
Primary Sources
The Equator Principles -written by Darren Abbott, Sam Brown, Doug Dentler, Caele Gambs, Elena K'Meyer, Mark Kaydo, Jay Neidermeyer, Jill Rankin, Cara White
In order for a firm to obtain project funding from an Equator bank, it must conduct an environmental assessment as well as address issues such as sustainable development, socioeconomic impact, land acquisition, involuntary resettlement, and pollution prevention. Additionally, in some cases, a plan for mitigating environmental and social risks may be required. Banks that adopt the Equator Principles apply them globally to project financing in all industry sectors including mining, oil and gas, and forestry, and they make loans only to those projects whose sponsors aim to be socially responsible and environmentally sound. The Principles have flowed toward the projects with the most grievous history of environmental calamity. As a result, the majority of the projects affected by the Equator Principles are in the extraction sector - mining and oil drilling.
To date, twenty-nine banks have adopted the Equator Principles, and in 2004, they controlled approximately 75% of global project financing resources (Lazarus interview). This number is particularly astounding considering that the Equator Principles are just two years old. Their genesis, however, traces back to 1998, when the IFC adopted their environmental and social policies. Vigorous internal debate ensued over whether the policies were a benefit or a burden for the organization. When in early 2003 several large international banks independently decided to adopt IFC's policies as the Equator Principles, it served as "an independent validation" of the policies and their goals and thus, ended IFC's internal debate over whether or not to continue to adhere to the policies (O'Keefe interview). From there, Peter Woicke (then Executive VP at IFC) and Suellen Lazarus (then head of Syndications at IFC) led the charge to build a collaborative effort among large project finance banks in support of the Principles.
The idea of the Equator Principles came to life in late 2002/early 2003. Originally called the Greenwich Principles, the Equator Principles were a result of the ongoing discussion between several large international banks (ABN Amro, Barclays, Citigroup and West LB, to name a few) and backlash over a rising number of controversial projects that caused harm to the environment and societies. Intense social pushback and ever-increasing environmental litigation raised the awareness within the financial industry that something had to be done to address the problems created by the absence of environmentally and socially responsible project financing. Funding harmful projects was starting to cost banks money in addition to negatively impacting their corporate reputation. An "enterprise exists on sufferance and exists only as long as the society and the economy believe that it does a necessary, useful, and productive job" (Drucker 37). Leaders of the financial services industry realized that they could not continue to conduct business as they had previously.
In October 2002, an initial meeting was held among several project finance banks to share recent negative experiences as well as explore future potential for collaboration. The meeting resulted in the formation of a core working group of four banks (Citigroup, Barclays, ABN Amro and West LB) that were truly committed to finding ways to become more environmentally and socially responsible in their project financing activities. During the discussion, the group agreed that a certain number of banks or a certain percentage of the market must adopt the principles in order to achieve the critical mass required to make the initiative viable (O'Keefe interview). Without enough support, it was believed that the Principles would simply lead project organizers to seek funding from non-Equator banks. The member banks did not want to be too far ahead of the sustainability curve. Rather, they wanted to "take one step forward together" (O'Keefe interview).
Until 24 hours before the official announcement, banks were still conducting emergency meetings to determine whether or not they would adopt the voluntary guidelines. On June 4, 2003, the announcement regarding the Principles was made at IFC in Washington D.C., and ten banks from seven different countries officially adopted the Principles (ABN Amro, Barclays, Citigroup, Credit Lyonnais, CSFB, HypoVereinsbank, Rabobank, Royal Bank of Scotland, WestLB and Westpac). "The first job of management is, therefore, to identify and to anticipate impacts - coldly and realistically. The question is not, is what we do right? It is, is what we do what society and the customer pay us for?" (Drucker 53) This announcement highlighting the collaborative efforts of such fierce competitors in the project finance market signaled that, given time, businesses can and will make conscious decisions to pursue a triple bottom line of economics, environment, and people.
After the announcement, questions still remained. For instance, why would banks adopt voluntary guidelines that may prevent them from acquiring new loan business to the benefit of less scrupulous competitors? Have these banks become environmentally and socially responsible overnight? In reality, the adoption of the Equator Principles is based on the banks' desire to mitigate two negative effects of financing disastrous projects: the higher risk and lower returns of projects that run into environmental problems as well as the damage to their corporate reputation from involvement in projects that become high-profile disasters. During the initial talks, each bank felt that they had the worst war story relating to the public relations of project financing, but they soon found that they were not alone in their woes. These shared experiences shifted their mindset. Although they were aggressive competitors in many arenas, the banks realized that in order to solve their common problems, they must collaborate. Many of the issues project financiers deal with are too hard for one institution to tackle alone. By coming together, however, the banks have been able to work with each other to raise standards and to ensure the long-term sustainability of their projects and clients.
Today, there is a growing sense of obligation for banks to adopt the Equator Principles because no bank wants to be the last to join. This is vital since a crucial factor to the viability of the Equator Principles remains their adoption by all banks, making it impossible for project borrowers to go to non-Equator banks after being declined by an Equator institution. Suellen Lazarus notes that "today successful and broad syndication of a project finance deal means Equator compliance is expected" (Lazarus article).
The Equator Principles offer a unique opportunity for banks to voluntarily regulate themselves. "What consumers, employees, and investors are demanding is a conduct of business that takes into account the effect of its activities on all its stakeholders" - including the environment and local communities (Laszlo 24). This change is revolutionary in the financial services industry because the Equator Principles have a far-reaching impact. They cut globally across a spectrum of industries, including but not limited to finance, healthcare, education, infrastructure, manufacturing, and extraction.
The Equator Principles represent a golden-green innovation - they are transforming the way banks think about social and environmental issues. This shift in mindset, along with the banks' voluntary participation, demonstrates an increasing awareness and concern for the triple bottom line as well as a cognizance of potential negative ramifications of ignoring these issues. Adoption of the Equator Principles is a catalyst for change in thinking throughout an organization because it requires banks to rewrite credit procedures, educate and train staff, as well as adopt new internal audit procedures. In some cases, the adoption of the Principles has led to creation of full sustainability departments. The Equator Principles are also bringing together fierce competitors that would not have considered collaboration five years ago. Banks are working together to determine best practice procedures for implementing the Equator Principles and regularly hold coordination meetings to facilitate implementation. Leaders from the impacted industries are also included in these meetings to build additional support for the initiative.
Looking ahead, the most valuable aspect of the Equator Principles will likely be their dynamic and inclusive nature. The Principles are a living document that will remain at the center of the world's most important debates - bio-diversity, climate change, agri-business, and employment standards - because of their impact on the way that major investments are organized and executed (O'Keefe interview). The future adoption of the Equator Principles-inspired regulations by private equity groups, bond-rating agencies, socially responsible investment funds, and retail banking is a very real possibility (Lazarus interview). By beginning with one area of their business, banks will inevitably begin to think about adopting similar initiatives in other areas. For example, Citigroup is preparing to launch a Sustainable Mortgage Program, which will promote the design, construction, and purchase of "green" homes. The Equator Principles present an opportunity to fundamentally shift the way business is done.
"Corporations as an institution are facing the prospect of an evolutionary leap to sustainable value - or irrelevance and extinction. Making this leap successfully will require both a shift in mindset and practical initiatives integrated into operations" (Laszlo 15). Banks have money, and without money, few things get done. By adopting these Principles, banks have the ability to create a limitless positive chain reaction. Included in the preamble of the Equator Principles document is the following: "We recognize that our role as financiers affords us significant opportunities to promote responsible environmental stewardship and socially responsible development" (the EP website). The golden innovation of the Equator Principles represents the first of several major "leaps" that the financial services industry will take toward achieving sustainability.
Further Reading
http://www.equator-principles.com/principles.shtml
Drucker, Peter F. The Essential Drucker. Harper Business.
Laszlo, Chris. The Sustainable Company. Washington: Island Press, 2003.
Lazarus, Suellen Banking on the Future: The Equator Principles and the Project Finance Market.
Acknowledgements
Writer: Darren Abbott, Sam Brown, Doug Dentler, Caele Gambs, Elena K'Meyer, Mark Kaydo, Jay Neidermeyer, Jill Rankin, Cara White
© 2005 World Benefit Productions, All Rights Reserved
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