Piotr Mazurkiewicz, policy officer for environmental and social development at the IFC
Banks across Latin America are gradually signing up to the rules designed to ensure major project finance is environmentally responsible. But take-up is still slow and commitment varies from institution to institution. Writer Jane Monahan
In the past few years, several locally owned banks in Latin America - more than in any other developing region - have signed up to a set of international environmental and social impact standards when financing large-scale infrastructure projects such as dams, power plants and pipelines, in a clear sign they are waking up to the risks of socially irresponsible investing.
The Equator Principles (EPs) provide banks with strict but voluntary guidelines and procedures to evaluate the social and environmental impact of large infrastructure projects. The principles are based on the sustainability standards of the World Bank's private sector arm, the International Finance Corporation (IFC), and cover rules on issues ranging from environmental assessments and natural habitats to indigenous people and child and forced labour.
No compliance, no money
If it is shown that a project does not comply with the principles, or a client is unwilling or incapable of following the requirements, EP-participating banks agree to provide no financing for the project. But of the 68 banks worldwide that have committed to the EPs so far, Piotr Mazurkiewicz, policy officer for environmental and social development at the IFC, says: "This is not a homogenous group. You have big international banks with a lot of capacity that are very strong on the implementation side and a lot of newcomers, for instance from Latin America, that still need to build their internal capacity. They need to establish some environmental and social management systems that would allow them to appropriately implement the EPs."
Degrees of commitment, capacity and experience also vary among Latin American EP financial institutions (EPFIs). Brazil has the biggest project finance market in Latin America, with $7.2bn in deals in 2008, according to the IFC. It also has the greatest number of financial institutions that are signatories of the principles. There were four EPFIs until last October, when Brazil's second and third biggest, locally owned private banks, Itaú and Unibanco, merged to become the nation's biggest bank and potentially the region's first ever global bank.
Marcelo Battisti, credit and social and environmental risk manager of Itaú BBA, the group's wholesale and investment bank, and chair of the EPs steering committee since last September, says one reason why so many Brazilian banks adopted the EPs might be because of "the fact that Brazil has such an important part of the world's biodiversity, the world's water supplies, the world's tropical forests. It is something that influences Brazilians' perception towards the environment. I'm talking about society as a whole."
But those considerations have not deterred Brazil's EPFIs from financing highly controversial and difficult projects, including in the Amazon. Indeed, all of Brazil's EPFIs (Itaú-Unibanco, Bradesco and Banco do Brasil) are helping to finance the construction of the Santo Antonio and Jirau hydroelectric dams on the Madeira River, the Amazon's principal tributary.
Non-profit groups, including BankTrack (which is dedicated to making the banking sector more accountable) and environmental advocacy organisations, such as International Rivers Network of the US and UK-based Friends of the Earth, warn the project could have an irreversible impact on ecosystems, fishing communities and indigenous and local people - several thousands of whom will have to move when the reservoirs are filled, according to the project's environmental impact assessment.
But Mr Battisti says: "There is no policy within Itaú or in the Equator Principles that claims you cannot have dams in the Amazon. But it is necessary to assess the impact and ensure that, even if there are some impacts they are limited, and the overall contribution [of the project] is positive." He adds: "Many times the most important contribution of EPFIs is when projects with large impacts are financed and the performance standards, developed by the IFC and applied all over the world, are followed."
Emerging influence
Meanwhile, Spain's Banco Santander, a leading bank in emerging markets and a financial adviser, co-ordinator and equity investor in the Santo Antonio dam, adopted the principles in April this year. The IFC's Mr Mazurkiewicz attributes the move, in no small measure, to the acquisition of Banco Real, a Brazilian bank with well established social and environmental risk management and a strong socially responsible investment commitment, by Santander, when the Spanish bank took its share of the 2007 ABN Amro carve up.
"This is a nice story: you see a bank from an emerging market [Banco Real] having some say in changing a bank from the industrial world [Banco Santander]," he says. "I don't want to say persuade, but they [Banco Real's managers] had some effect."
Nevertheless, from an EP perspective, even with first and third biggest private commercial banks (Itaú-Unibanco and Bradesco) as adherents, as well as state-owned Banco do Brasil, these banks' combined share of Brazil's project finance is still less than 20%, IFC officials say. In contrast, the country's biggest project credit providers, state-owned national development bank BNDES and state-owned Caixa Economica Federal, Brazil's biggest infrastructure lending bank, have not adopted the EPs despite being approached by the IFC more than a year ago.
Many in the banking industry now say, however, that Caixa Economica Federal may sign up to the EPs imminently, making it easier for other EPFIs to work with it and leaving BNDES isolated.
Comparison criticisms
However, a far bigger limitation of the EPs, criticised by non-governmental organisations, academics and some bank clients, is that because of weak reporting requirements and the principles' lack of any independent auditing/compliance mechanism, it is difficult to compare sustainability between one signatory bank and another, or how a bank's performance compares from one year to the next. Mr Mazurkiewicz emphasises the IFC "is not an enforcer", of the EP initiative.
"It is based on IFC performance standards, but commercial banks own it," he says. But even allowing for "appropriate client confidentiality considerations", he says, existing EP reporting requirements are "soft". Banks only have to report on the number of projects they finance in a year and what was their category of environmental and social impact, A, B or C - severe, moderate or minimal.
"The guideline on reporting is really short. It would be great in the future if [EPFIs] could expand this, because having only this data, it is very difficult to say how effective the principles really are," adds Mr Mazurkiewicz.
As a remedy, for three years the IFC has been organising so-called "community of learning events" alongside the annual gatherings in Washington, DC, of EPFIs and IFC standard practitioners, which include Organisation for Economic Co-operation and Development (OECD) export credit agencies and eurozone financial development institutions. In May more than 100 bankers attended meetings.
The aim is to improve consistency in the implementation of the IFC's environmental and social standards, through sharing information on participating banks' social and environmental risk management systems and a discussion of case studies - "trying to interpret whether an approach used by a particular bank was right or whether things could have been done better," says Mr Mazurkiewicz.
The current EPFI chairman, Banco Itaú's Mr Battisti, says this sharing of information is one of the initiative's most notable strengths. And, the IFC says, it is an area where banks from emerging markets are also contributing quite a lot.
Take Banco Galicia, a medium-sized bank and the only one in Argentina to have adopted the principles. After only one year of adherence, it presented a case study at an IFC event of a $10.5m loan for an eco-resort in a national reserve near the spectacular Iguazu waterfalls, giving details on what the bank did to comply with the IFC's biodiversity conservation standard.
Inconsistencies in the way banks implement and report on the EPs are issues for the organisation now, says Mr Mazurkiewicz. But leaving banks free to decide what business models suit them for assessing and managing environmental and social risk has been a prerequisite of the EPs from the start, reflecting the different governance rules, the different regions where banks engage in project financing, the different industries they lend to and many other variables.
Flexibility on risk
There is also flexibility about when banks establish appropriate risk assessment systems. For example, Bancolombia, the largest bank in Colombia and the country's biggest infrastructure lender, provided credits for road building, energy generation and coal mining (Colombia is the world's fourth biggest coal exporter), designed its environmental and social risk management system first and then adopted the principles last December, say IFC officials.
In other cases, banks sign up to the principles and start working on their internal risk management systems after. Either way, EP banks have a year's grace before they need to start reporting on what they really do in project finance, whether they implemented the principles and how they did this.
The reasons Latin American banks adopted the principles are basically the same. "Aside from the 'feel good' [factor], it makes sound financial sense," said Tom Vaughn from the Loyola Business School of Marymont University, California, during a video presentation on Latin American EPFIs at an IFC event in May.
"As a risk management tool, the EPs can be extremely helpful. With project finance transactions, if an environmental or social problem ends up affecting the construction schedule of a project or creates legal problems or fines, that potentially impacts the ability of the borrower to pay back their loan on time and the banks [because of the non-recourse nature of project financing] are on the hook for all of it. They cannot go to the balance sheet of the company to get paid back," says Michelle Chan, director of green investments at Friends of the Earth, US.
Additionally, Latin American financial institutions are becoming sensitive about the reputational risk of participating in transactions that do not comply with social and environmental standards, because of the threat this may pose for long-term shareholder value.
"We became a signatory of the principles to further promote our relations with all our stakeholders: stockholders, clients, customers, employees, opinion makers and communities. The signing of the principles was a way to commit ourselves to better [corporate social responsibility] standards," says Constanza Gorleri, corporate social responsibility manager at Banco Galicia in Buenos Aires.
And Juan Mora, vice-president of risk management at Bancolombia, says his bank signed the principles because the environment "is something we want to be responsible about as a matter of conviction".
He adds: "But it's also because we want to avoid financial risks that could result from not upholding adequate environmental standards and risks to our reputation participating in the financing of projects that don't follow certain minimum standards. That's why the Equator Principles are so important, as a way to evaluate projects with standards which are accepted internationally."
Regulation variation
The regulatory and legal framework in Latin American countries can vary, which has an impact on the degree of responsibility a signatory bank has. For example, in his video presentation at the IFC event in May, Mr Vaughn described a dilemma faced by Banco Galicia some years ago when it gave an agricultural client a large loan to plant lemon trees - a project with a minimal environmental impact - only to find, after inspecting the site, that the client had switched to growing soy beans. Soy beans have a higher profit margin but, in the absence of a government agency in Argentina that decides whether the land was zoned for this type of production or not, the task of doing the necessary due diligence to determine if planting soy in the area was environmentally sound, fell to the bank.
Notwithstanding this, Banco Galicia's Ms Gorleri says: "The purpose of the principles is not to exclude clients but to work together with them and try and help them to adapt their proposals so they conform with IFC standards." Similarly, in the absence of any enforcement or exclusion mechanism in the principles, Itaú's Mr Battisti says that if a member bank is found to be failing in its implementation of the EPs, "then we reach out to them and try to reform the bank".
Branching out
A further outcome of adopting the principles is that some Latin American EPFIs have extended social and environmental risk assessment and management beyond project finance to other business areas, such as corporate loans, initial public offerings or buyer credits in trade finance, when the purpose of the client's borrowing in each case is known to be for a large project, such as a gas pipeline.
Itaú BBA in Brazil, for example, now does environmental and social due diligence that is less specific than the EPs in terms of the standards applied, but which now covers all transactions of 5m reais ($2.3m) or more. Likewise, at Banco Galicia project finance represents only 3% to 6% of the bank's total loan portfolio ($3.6bn in 2008).
"This is a very small amount. That's why Banco Galicia has decided to apply the principles to transactions of $5m or more even though the threshold for Equator Principles is $10m or above. We decided to go beyond the principles," says Javier Gutierrez, Banco Galicia's credit risk controller.
Bad example
Chile is the second largest project finance market in Latin America, worth almost $3bn in 2008 alone. Here Corpbanca, a signatory of the EPs since 2007, now applies the standards in all its project financing, regardless of project size or dollar amount.
Corpbanca is also an example of a bank that came to the EPs after a bad risk management experience. "Corpbanca invested in a construction project: toxic waste was dumped into a vacant lot; the project was closed; the loan was unpaid," says Mr Vaughn.
Mr Battisti adds: "At Equator we understand, and I think its members understand, the issue of environmental and social impacts of financing projects is much broader than that. It's just that project finance is such a specific type of operation that it allows a bank to have more capacity to negotiate standards with its clients."
Meanwhile, in Uruguay, state-owned Banco Republica, which covers more than half of the country's credit market and does practically all the project finance, signed up to the principles in January 2008. As a result, seven Latin American banks have adopted the principles, a small number which partly reflects how few banks in the region have significant project finance portfolios.
"At this point, the biggest gap is Mexico [$2.5bn in project finance in 2008]," notes the IFC's Mr Mazurkiewicz. "There are some banks in Mexico with a strong project finance part of their business. So it is quite strange that no bank from Mexico has adopted the principles."
The global spread of EP banks
According to the International Finance Corporation (IFC), Equator Principle banks collectively cover 70% of total project finance in emerging markets, which amounted to $250bn in 2008.
The Middle East was the biggest emerging market by far in value terms in 2008, and in 2007 this region's project finance was bigger than Latin America's, China's and east Asia's combined.
However the big surprise this year, according to the IFC, is that India alone is accounting for about 12% of total global project finance, and five financial institutions in India are among the world's top 100 project finance arrangers.
They are the State Bank of India, which currently has almost the same global market share as BNP Paribas (about 6%), and four other smaller Indian banks, which have a 4% global share.
2008 World Project Finance Figures
Europe, Africa and the Middle East: $138bn (Middle East and northern Africa - $42.5bn. Rest of Africa - $4.3bn)
Asia-Pacific (including Australia and Japan): $70bn (India - $19.2bn.)
Americas (including the US and Canada): $42bn (Latin America and the Caribbean - $15.4bn. Brazil - $7.2bn).
Source: IFC
