Updates to the Equator Principles will take effect on 1 October 2020, introducing new commitments on human rights and climate change for Equator Principle Financial Institutions.
In June 2019, the Equator Principles Association (EP Association) published its fourth draft version of the Equator Principles (EPs) for consultation. The updated EPs were launched in November 2019 and were initially scheduled to take effect in July 2020. Because of the COVID-19 pandemic, the implementation date has been pushed back to 1 October 2020, although financial institutions may choose to apply them before then.
The EPs are a voluntary set of principles that financial institutions across the globe have adopted in connection with project finance deals. Their principal aim is to ensure that social and environmental issues are considered when banks and other financial institutions are providing debt finance for infrastructure projects. The banks and other financial institutions that have signed up to the EPs are known as Equator Principles Financial Institutions (EPFIs).
Although the EPs are not mandatory legal requirements, the fact that over 100 banks and financial institutions worldwide (a figure that continues to grow) have signed up to the EPs means they will be insisted upon by financial institutions in the project financing documentation for many projects. The EPFIs have agreed to comply with these standards and have undertaken not to provide loans for the development of a project where project sponsors refuse, or are unable, to demonstrate that the project will be constructed and operated in accordance with the environmental, social and governance considerations set out in the EPs.
Why update the EPs?
Part of the original rationale behind the EPs was a recognition that, as banks and financial institutions provide the debt finance to make project deals happen, they are therefore in a strong position to negotiate and influence the terms of the contractual agreements with an eye to social and environmental factors. The EPs are also widely accepted by many global banks and so, by complying with the EPs, EPFIs are able to hold themselves out as responsible lenders. In the event that large projects are scrutinised, they allow the EPFIs funding the project to point to the social and environmental standards that have been used to evaluate the project. In order to keep up with changing markets and societies, the EPA recognises the need to keep the EPs under review and to be proactive in issuing updates, including the most recent fourth update (EP4).
Importance of the changes
The key changes in EP4 look to widen the scope of the EPs to cover project finance transactions that previously would not have been caught by the EP criteria. The updates include lowering the threshold for project-related corporate loans and removing the exception that previously applied to project loans made to national, regional or local governments and agencies.
Another key focus of EP4 is the revision of Principle 2 in order to strengthen the language on human rights, including specific provisions on the impact of projects on indigenous peoples. This revision also introduces a Climate Change Risk Assessment for certain projects, reflecting the EPFIs’ role in the 2015 Paris Agreement on climate change.
What are the Principles?
There are currently 10 principles, which touch on the following areas:
- Review and categorisation of projects
- Social and environmental assessment
- Applicable social and environmental standards
- Action plan and Environmental & Societal Management System
- Consultation and disclosure
- Grievance mechanisms
- Independent review
- Independent monitoring and reporting
- EPFI reporting and Transparency
We will look in closer detail at two of the key principles:
Review and categorisation of projects - the EPFI will carry out an internal social and environmental review and due diligence. It will then categorise the project based on the magnitude of its potential impacts and risks. This is important as the category to which a project is allocated will determine the requirements that will need to be complied with. The classifications are:
- Category A – projects with potential significant adverse social or environmental impacts that are diverse, irreversible or unprecedented;
- Category B – projects with potential limited adverse social or environmental impacts that are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures; and
- Category C – projects with minimal or no social or environmental impacts.
As Category C projects are such low risk, there is no need to comply with any requirements. The strictest requirements are for Category A projects, some of which also apply to Category B projects including, for example, the requirement to have a Climate Change Assessment.
Covenants – the EPs gain a form of legal footing in the finance documentation in project finance deals. This occurs by their inclusion and undertakings given by the project company, as borrower, to the bank lenders in the credit agreement. These are agreements or promises to do or provide something, or to refrain from doing or providing something, which are binding on the party giving the covenant. There is standard wording contained in the EP Loan Guidance that deals with clauses on representations and warranties, conditions precedent, covenants and events of default. This forces the borrower to comply with the covenant. However, rather than a breach of a covenant leading to an automatic event of default, the EPFIs are usually required to work with the borrower to help bring it back into compliance “to the extent feasible” when there has been a breach.
The EP Association plans to issue implementation guidance to members and stakeholders – which now include over 100 institutions from 38 jurisdictions worldwide – ahead of the 1 October 2020 effective date.
It will be interesting to see how the EPs continue to develop through EP4 and beyond as greater attention is placed on the social and environmental impacts of projects, particularly given the current focus on a green and resilient recovery from the ongoing pandemic.