The Equator Principles (EPs) are a voluntary set of principles that have been adopted by certain banks in connection with project finance deals. In particular, the EPs are aimed at ensuring 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). By way of background, the first set of EPs were originally launched in 2003 by the International Finance Corporation, but the management of the EPs was put on a more formal footing when the EP Association was established in July 2010. The EP Association is governed by a set of Governance Rules, which provide guidance to existing and prospective EPFIs on the processes for the management, administration and development of the EPs.
Part of the rationale behind the EPs is the 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 on 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.
The EPs currently only apply to projects with a capital value in excess of $10 million so it is important to be aware of the EPs when undertaking projects of this value. Although they are not mandatory legal requirements, the fact that over 70 banks and financial institutions worldwide have signed up to the EPs means they will be insisted upon by banks and financial institutions in the project financing documentation for many projects. These EPFIs have agreed to comply with these standards as all EPFIs 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.
What are they?
So what are the Equator 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 management system
- Consultation and disclosure
- Grievance mechanisms
- Independent review
- Independent monitoring and reporting
- EPFI reporting
It is not proposed to go into detail on each of these in this article. However, it is worth giving some more detail on two of the key EPs – 1. Review and categorisation of projects; and 8. Covenants.
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 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 for these projects to comply with any requirements. The strictest requirements are for Category A projects, some of which also apply to Category B projects.
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 is binding on the party giving the covenant. There is standard wording contained in the EP Loan Guidance which 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.
Update of the EPs
As well as providing a general overview, the purpose of this article is to highlight that the EPs are currently undergoing a period of review and updating. The EP Association has been running a consultation process since July 2011 off the back of a strategic review. They are now aiming to finalise and launch the third version of the EPs (EP III) between May and July 2012. The discussions have included industry and clients, peer financial institutions, and civil society organisations and have focused on the scope of the EPs, reporting, and transparency and governance issues, including membership criteria. One of the suggestions in the current review is that the scope of the EPs should be extended to cover corporate loans. This was because some projects were being disguised as corporate loans in order to avoid having to comply with the EPs. It will be interesting to see the end result of the review and what changes are in store for the EPs in EP III.