Update to Equator Principles Expands Scope of Diligence Required for Projects

The EPs are based on the International Finance Corporation Performance Standards (IFC PS) and the World Bank Group Environmental, Health, and Safety Guidelines (WB Guidelines). The EPs serve as a framework for EPFIs to identify, assess, and manage environmental and social risks and effects when financing or lending to projects. EPFIs that have adopted the EPs are required to encourage their clients (primarily borrowing entities) to address such risks and effects at all stages of a project’s lifecycle. 

While the focus of the original EPs was primarily environmental, more recent versions have increased attention on social and community standards. The Equator Principles Association recently adopted a fourth iteration of the EPs (EP4). It expands on previous versions of the EPs, both in terms of the scope of their application and the increased obligations and standards imposed on EPFIs and their clients. This Update identifies the key changes in EP4 compared with the prior iteration of the EPs (EP3) and highlights certain issues that EPFIs should be aware of as they engage with and lend to both new and existing projects.

Expanded Scope

EP4 expands the scope of the EPs such that they now also apply in the following circumstances:

1. Project-Related Corporate Loans of at least two years where both the total aggregate loan amount and an EPFI’s individual commitment are each at least US$50 million (previously, the EPs applied only where the total aggregate loan amount was US$100 million)

2. Project-Related Refinancings and Project-Related Acquisition Financings where the following criteria are met:

• The underlying project was financed in accordance with the EP framework.
• There has been no material change in the scale or scope of the project.
• Project Completion had not yet occurred at the time of signing the facility or loan agreement.

The key takeaway is that the EPs now apply to a wider range of transactions. Importantly, it is not only greenfield projects that must comply with the EPs but also existing projects that are being refinanced, acquired, expanded, or upgraded. EPFIs cannot afford to ignore EP4 simply because the project in question already exists or the debt quantum is limited.

Updated Principles

The fundamental framework of the EPs remains the same. However, EP4 contains updates and provides that additional issues now take a more prominent role in the underlying due diligence that EPFIs must perform on a project. In particular, EP4 requires a heightened focus on climate change, human rights, and biodiversity. Any due diligence must be commensurate with the nature, scale, and stage of the relevant project.

1. Climate Change

EP4 contains a new requirement to conduct a climate change risk assessment (CCRA), which should be performed as part of any Environmental and Social Impact Assessment (ESIA). A CCRA may need to consider both “physical” risks (namely those that result from climate change and involve event-driven or longer-term shifts in climate patterns, such as floods, fire, or sustained higher temperatures) and “transition” risks (that arise as part of political or technological changes as the world shifts to a lower-carbon economy). Whether physical and/or transition risks need to be assessed will depend on the categorization of the project and the expected materiality or severity of the risks associated with the project, including any expected carbon dioxide (CO₂) emissions. An EPFI should determine the likely categorization of the project it is financing and the potential risks involved as this will determine the nature of the CCRA to be undertaken. Given the expected lengthy timeframe involved in undertaking and preparing a CCRA, EPFIs should prioritize the performance of this task.

2. Human Rights and Indigenous People

While EP3 recognized the importance of conducting human rights due diligence, this was restricted to “limited high risk circumstances.” EP4 builds on this by requiring a full assessment of any potential adverse human rights effects of a project in an ESIA. EPFIs must also refer to the United Nations Guiding Principles on Business and Human Rights when conducting this assessment. Not only should the ESIA propose measures to minimize and mitigate potential risks, but EP4 now requires proposals to remedy, and compensate workers and affected communities for, such risks and effects in a manner relevant and appropriate to the nature and scale of the proposed project.

Both EP3 and EP4 require that all projects affecting indigenous peoples will be subject to a process of informed consultation and participation and will also need to comply both with host country laws and certain of the IFC PS. In addition, EP4 imposes an obligation on the EPFIs to engage an independent consultant (which may be the Independent Environmental and Social Consultant previously required under the EPs or another independent consultant or legal adviser) to evaluate the consultation process with indigenous peoples and the outcomes of that process against the requirements of host country laws and applicable IFC PS. This may entail collaboration with any relevant government agencies and requiring corrective actions to ensure appropriate compliance.

3. Designated vs. Non-Designated Countries

The EPs have always required any due diligence process to confirm whether the relevant project complies with applicable host country environmental and social laws, regulations, and permits. Under EP3, that was sufficient for projects located in Designated Countries (namely countries deemed to have robust environmental and social governance and legislation systems). But additional obligations were imposed on projects located in Non-Designated Countries. Projects in these Non-Designated Countries also needed to demonstrate compliance with the applicable IFC PS and the WB Guidelines.

However, given increasing levels of concern around the effectiveness of local environmental and social regulations in Designated Countries, EP4 has imposed a higher threshold on projects there. First, a Designated Country must now be both a member of the Organization for Economic Co-operation and Development and appear on the World Bank High Income Country list. Second, an EPFI must now assess the specific risks of a project to determine whether one or more of the IFC PS could be used as guidance (in additional to compliance with host country laws) to address those risks. Therefore both EPFIs and borrowers will need to conduct a more detailed analysis of a project to evaluate compliance both with host country requirements and the IFC PS.

Next Steps

In light of EP4, EPFIs should consider taking various steps to ensure that they, and the projects they fund, comply with the updated principles. In particular, EPFIs should

• check internal compliance procedures, checklists, and reporting documentation to ensure they are up-to-date and reflect the requirements of EP4
• review any lists of environmental and social consultants and confirm that they are able to conduct the more stringent and expansive assessments required by EP4
• ensure that any environmental and social consultant is engaged as early as possible in a transaction and that work in respect of any CCRA is commenced at an early stage
• conduct a gap analysis between the laws of any host country (particularly as regards climate change and human rights) in which a potential (or existing) project is located and the applicable IFC PS to identify gaps that will need to be addressed as part of an environmental and social management plan 
• ensure that all project-related documentation, in particular financing documentation, is updated to reflect the additional reporting requirements necessitated by EP4, including'
  • updating all relevant representations, covenants, and events of default; and
  • confirming that any environment and social-related schedules to such documentation include all updated requirements of EP4