After decades of mutual antagonism, Oliver Balch reports on how environmental activists and bankers are entering a new era of understanding through the Equator Principles.

Bankers and environmentalists have traditionally had little in common. Five years ago, inquiries from environmental organisations would have been shunted in the direction of the community affairs office. Now, the same groups are being invited in to give lectures.

That, at least, is the case at HSBC. In the past three years, the UK-based bank has adopted a raft of environment-related policies and procedures. The list includes specific guidelines on dangerous chemicals, freshwater infrastructure and forest products. In May 2005, it became the first major private bank to put its name to the World Commission on Dams. Within the next 12 months, it plans to add an extractive industry policy to its growing catalogue of green tape.

Underpinning what HSBC terms its “restricted appetite” for environmentally sensitive transactions lies its environmental risk standard. Launched in 2002, the standard is designed to minimise the environmental, credit and reputational risk associated with the bank’s investments.

Most of the procedural steps are straightforward. HSBC’s due-diligence register, for example, now features environmental impact assessments and reviews by external auditors.

HSBC’s conversion is by no means the exception. Merrill Lynch, JPMorgan and Goldman Sachs joined the growing list of international banks with environmental policies last year. As with HSBC, many have complemented general statements with sector or issue-specific guidelines. Bank of America, for example, recently adopted a policy designed to protect ecologically fragile forest areas. ABN AMRO has a similar policy on oil and gas investments, as does Rabobank on human rights.

Contrary to perceptions, bankers are not becoming tree-huggers. Their reasoning is far more down to earth. Banks are increasingly conforming to the view that social and environmental risks pose a threat to long-term shareholder value.

“Protecting our assets in a traditional sense is risk management and protecting shareholder returns,” explains Andre Abadie, head of sustainable business advisory at ABN AMRO. “So if we are financing potentially socially and environmentally egregious projects in far flung corners of the world, then we also have the commitment to ensure that the social and environmental footprint of those projects is well managed.”

But there are short-term reasons as well. International banks are increasingly under attack. Environmental groups have begun to make the connection between the projects they campaign against and the financiers that back them.

Campaigning pressure

Only last month, BBVA and Calyon found themselves the subject of public lobbying for their role in financing two potentially contaminating pulp mills in Uruguay. “Banks are still very sensitive to project-based campaigning,” argues Johan Frijns, coordinator of BankTrack, a non-profit group dedicated to making the banking sector more accountable.

But the scope of non-financial due diligence has its natural limits. The financier needs to know the end purpose of the loan if it is to assess the environmental impact of its lending activities.

“If you’re advancing a corporate loan to a large company that is not being used specifically for a project, it is not going to be reasonable or practical to get that [environmental] information across all the projects that the company might be working on,” says Jon Williams, head of group sustainable development at HSBC in London.

Naturally, for some corporate or government loans, banks will be aware of a loan’s end use. The same is true for certain debt securities placements and underwritings, equity transactions and letters of credit.

But one area where banks certainly have prior knowledge is, by definition, project finance. Consequently, this is where the banking industry has channelled the bulk of its efforts to date.

The vehicle for doing so is the Equator Principles. Based on the International Finance Corporation’s social and environmental standards, the principles provide a series of guidelines and procedures to help banks evaluate the potential non-financial impacts of large-scale infrastructure projects.

If a project is shown not to comply with the principles, the participating banks commit not to finance it.

Since the Equator Principles launch in June 2003, the initial 10 banks have increased to 41. Collectively, they now cover around 85% of the world’s cross-border project finance. The participating banks maintain that the principles have realised their initial objective of providing an industry-wide standard for institutions involved in project finance.

Yet sceptics still abound when it comes to assessing the banking industry’s green credentials. In May, campaign group Rainforest Action Network (RAN) took out a full-page advert in the Washington Post denouncing Dutch bank ABN Amro for “outstanding environmental hypocrisy”.

RAN argues that the bank’s potential financing of Shell’s Sakhalin II pipeline contravenes its commitment to the Equator Principles. The pipeline is alleged to pose a threat to whale feeding grounds off Russia’s Pacific coast.

“I’ve heard some NGOs [non-governmental organisations] say that if banks finance this project, it’ll be the death of Equator. I think that’s obviously exaggerating for effect,” says ABN Amro’s Mr Abadie.

Indeed, he maintains that campaign groups have got it the wrong way round. The Equator Principles, he argues, have provided ABN Amro with a framework against which to fully assess the non-financial risks posed by the Sakhalin II project. They have also facilitated discussions between the bank and the project sponsors regarding the project’s more problematic areas.

“If we can be faulted for anything, it’s for doing due diligence, which is what the Equator Principles require of us,” he says. “Once that due diligence is completed, we have to see where the decisions come out.”

Decision-making transparency

Details about such due-diligence steps are increasingly appearing in banks’ communications. Barclays’ latest Corporate Responsibility Report, for example, reveals that it turned down two of the six high-risk project finance deals it considered last year. Overall, it chose not to participate in 25 out of a total of 68 project finance transactions.

Under revisions to the Equator Principles, due to be released on July 6, all participating banks will be required to disclose similar evaluation data.

Yet Equator banks remain severely restricted in terms of transparency, points out Sabine Lehan, vice-president of portfolio management at German bank HVB. While banks can report their decisions on an aggregated basis, client confidentiality prevents them from giving detailed information on specific project decisions.

When Dutch bank ING recently announced its withdrawal from the disputed Uruguayan pulp mill project, therefore, it declined to reveal the reason why.

“In the revised Principles there are minimum requirements for disclosure, but of course not to that level and extent that every stakeholder would like,” admits Ms Lehan.

Finance transactions can be refused for a wide range of reasons, she says. These may or may not include environmental issues. When they do, it is rare for these to be the only factor leading to a bank’s decision to decline a deal.

Extraneous limitations

External, not internal, reasons limit banks’ environmental due-diligence efforts, many risk specialists argue. Short of calling in its loan, a bank’s influence over a project sponsor depends largely on delicate client management. The revised Equator Principles aim to add an extra safeguard by covenanting certain environmental commitments up front. They also require all high-risk projects to be assessed independently throughout the lifetime of a loan.

Experience has shown that a bank’s ability to influence other actors can be even more limited than with their clients. The ExxonMobil-backed Chad-Cameroon pipeline is a case in point. The deal was carefully structured to guarantee that a large percentage of the oil revenue from the project would be directed to social development programmes. The Chadian government has since voted that the money can also be used for defence purposes.

“We found we had very little influence, if any,” admits one of the participating private banks following its attempts to intervene.

Martin Hancock, chief operating officer of Australian bank Westpac and chair of the United Nations Environment Programme Finance Initiative, puts it more bluntly: “Now everybody’s looking to us to change the world. We can do our bit, but there are boundaries to how much influence we can have. You have to look at all the other parties involved in the project life cycle and also the banks that are not part of Equator.”

As with his Equator peers, he insists that primary responsibility for social and environmental issues should remain with the operating company concerned. For that reason, the Equator banks have consistently declined demands by civil society groups to introduce a formal complaints procedure.

By way of a concession, the revised Equator Principles will require companies sponsoring high-risk projects to provide a “grievance mechanism”. The measure is designed to provide communities effected by large-scale projects to voice their concerns directly to the project sponsors rather than the banks.

The biggest limitation remains the relatively small size of project finance, which is typically less than 10% of most banks’ lending activities. Still, the experience of applying the Equator Principles provides useful lessons for other aspects of a bank’s portfolio, risk management experts maintain.

Chris Bray, head of environmental risk at Barclays, believes the Principles have sent a clear message that social and environmental issues represent mainstream business risks.

More than that, the principles have shown banks their main environmental impacts derive from how they use their money. As Mr Bray puts it: “Equator has fairly and squarely put lending centre-stage.”


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