FOCUS

PROJECT FINANCE

August 2006

UPDATE ON THE EQUATOR

PRINCIPLES – 2006 REVISION
In our Focus: Project Finance – August 2005, we looked at the ‘Equator
Principles’ and their impact on the project finance sector. The Equator Principles
have since been revised to broaden their application and strengthen the social
and environmental standards they impose. Partner Steve Pemberton and Lawyer
David Donnelly of our Singapore office look at the recent revisions.

ADOPTION AND KEY CHANGES

An overview of the
latest revision of the
REVISION The revised principles implement four key
changes.
In June 2003, a group of major financial
‘Equator Principles’ institutions adopted the Equator Principles, a 1. The 2006 Principles have broader application
than the original principles. They apply to all
and their impact on set of voluntary guidelines for the categorisation,
assessment and management of social and new project financings with a total capital

the project finance environmental risks in the project finance cost of US$10 million or more. While this
sector. The impact of the original principles was change represents a significant reduction
sector discussed in Focus: Project Finance – August from the former US$50 million threshold,
2005. The principles were revised in July this it is not surprising. Both commentators and
year, a little over three years after they were first financial institutions have recognised that
adopted. a project’s capital cost, and its social and
environmental impact, are not necessarily
The revised principles (the 2006 Principles) correlative. The change also follows the
are the product of three years’ collective practise of some Equator financial institutions
learning. They reflect the collective experience that had independently lowered or abandoned
of the financial institutions that have adopted the US$50 million threshold.
the principles to date (the Equator financial
institutions), and address many of the concerns
raised by NGOs and environmental groups
since the principles were first adopted. Thirty-
nine institutions have now adopted the 2006
Principles.
 The 2006 Principles will apply to project 4. The 2006 Principles include a commitment
financings covering expansions or upgrades to periodic reporting. This change seeks to
of existing facilities where changes to the address a common criticism of the original
scale or scope of the facility may create principles: a lack of transparency. However,
significant environmental or social impacts, the 2006 Principles also expressly recognise
or significantly change the nature or degree that confidentiality must be taken into
of an existing impact. They will also extend account in reporting.
to project finance advisory activities.
At a minimum, the Equator financial
In short, the 2006 Principles will apply to a institutions commit to report annually
wider range of projects. on the number of transactions screened
and the categorisation accorded to them,
2. The baseline requirements imposed by and on their experience in implementing
the 2006 Principles will differ depending the 2006 Principles. It is expected that
on where a project is located. The 2006 reporting will exceed this benchmark.
Principles draw a distinction between
high-income OECD countries (as defined in To the extent that the Equator financial
the World Bank’s development indicators institutions are able to balance periodic
database) and ‘other countries’. As local law reporting on the kinds of items described
requirements in high-income OECD countries in BankTrack’s working document,
generally meet or exceed the International Transparency and the Equator Principles,
Finance Corporation’s (IFC) performance with their confidentiality obligations, the
standards, and environmental, health and 2006 Principles may avoid some of the
safety (EHS) guidelines, the 2006 Principles criticism levelled at the original principles.
do not seek to supplement local law
requirements with these standards for projects
located in high-income OECD countries. It
is hoped that the change will streamline the
application of the 2006 Principles, without
compromising the social and environmental
standards they seek to impose.

3. The 2006 Principles adopt stronger social

and environmental standards. They place
a greater emphasis on the social risks and
impacts associated with a project. These
changes are reflected in both the language
(eg the shift to ‘social and environmental
assessment’) and substance (eg the clear
separation of social and environmental
impacts in the revised project categories) of
the 2006 Principles.
 Broadly speaking, the implementation structure
STRUCTURE involves the following stages:

The revised principles retain the same • screening and categorisation;

implementation structure as the original • social and environmental assessment;
principles. An overview of the implementation • risk management planning; and
steps is set out in the diagram below. • monitoring.
Each of these stages has been revised to some
extent.

Dual classification of project. The Equator Principles are

Projects are classified Project expressed to apply where
according to: Equator Principles Financial
(a) the magnitude of potential Institutions (EFPIs) directly
social and environmental fund:
impacts and risks; and (a) projects with a total capital
(b) the location of the project: cost of over US$10m; and
high-income OECD countries (b) expansions or upgrades of
are accorded different existing facilities which may
Review create significant
treatment to other countries.
environmental and/or social
A social and environmental impact or significantly change
assessment (assessment) is an existing impact.
required for all A and B
Classified as A, B or C:
projects. Classification
A is the potential significant
Assessments address relevant
adverse social or
social and environmental
environmental impacts that are
impacts and risks, including
diverse, irreversible or
proposals for mitigation and Assessment unprecedented.
management. In the case of
projects located in countries B is the potential limited
other than high-income OECD adverse social or
countries (other countries), environmental impacts that are
the assessment must also refer few in number, generally site
to IFC performance standards specific, largely reversible and
and applicable industry specific readily addressed through
EHS guidelines. Public mitigation measures.
consultation C is minimal or no social or
An action plan and environmental impacts.
management system (AP) is
required for all A and B projects Public consultation is required
located in other countries (and for all A projects. It may be
may be required for projects required, if appropriate, for B
located in high-income OECD Action plan and projects located in other
countries). The AP addresses management countries. Free, prior and
the findings, and draws on system informed consultation with
conclusions, of the affected communities in a
assessment. It must describe structured and culturally
and prioritise mitigation appropriate manner is required.
measures, action plans, and Adequate incorporation of the
monitoring. The social and affected communities'
environmental management concerns.
system manages the identified
A grievance mechanism for
impacts, risks and corrective
Grievance and receiving and resolving the
action. independent concerns and grievances
The documentation of all A and review during the life of the project is
B projects will include required for all A projects. It
covenants requiring: may be required, if appropriate,
compliance with applicable for B projects located in other
social and environmental laws, countries.
regulations and permits; Documentation Independent expert review of
compliance with the AP (where the assessment, AP and
applicable); periodic reporting; consultation process is
and compliance with agreed required for all A projects. It
decommissioning plans. may be required, if appropriate,
for B projects.
Where the borrower is not in
compliance with its social and Independent monitoring is
Independent required for all A projects. It
environmental covenants,
monitoring may be required, if appropriate,
EFPI's will work with the
borrower to bring it back, to the for B projects. This requires the
extent feasible, into Non-compliance appointment of an independent
compliance. EFPI's reserve the environmental and/or social
right to exercise remedies expert or experts to verify the
where compliance is not re- borrower's monitoring
established within an agreed information.
grace period.
 1. They require mitigation and management
SCREENING AND measures to be addressed in the social and
environmental assessment.
CATEGORISATION 2. For all category ‘A’ projects and, as
appropriate, category ‘B’ projects, they require
The 2006 Principles retain the three-tier (‘A’,
an independent social or environmental
‘B’, ‘C’) categorisation system. However, the
expert to review the social and environmental
category descriptions have been amended to
assessment.
refer directly to social impacts. The categories
3. For all category ‘A’ projects and, as
are now described as follows.
appropriate, category ‘B’ projects located in
• Category A – Projects with potential ‘other countries’, they require a grievance
significant adverse social or environmental mechanism to be set up to allow project-
impacts that are diverse, irreversible or affected communities to raise concerns and
unprecedented. grievances throughout the construction and
• Category B – Projects with potential limited operation of the project.
adverse social or environmental impacts that
The grievance mechanism represents a
are few in number, generally site-specific,
significant extension of the consultation and
largely reversible, and readily addressed
disclosure process, which is also retained in the
through mitigation measures.
2006 Principles. In addition to increasing the
• Category C – Projects with minimal or no
potential for input from project-affected groups,
social or environmental impacts.
the grievance procedure may also assist in the
As noted above, the revised category ongoing monitoring of the project.
descriptions clearly separate social and
The revised principles introduce equivalent
environmental impacts. The new language calls
changes at the risk management stage, where
for a direct assessment of whether a project
the ‘environmental management plan’ is
gives rise to a potential adverse social impact
renamed the ‘action plan and management
as opposed to requiring an assessment of
system’.
whether any potential environmental impacts
may result in a social impact (eg displacement It is during the social and environmental
or resettlement). To the extent that Equator assessment and the risk management stages
financial institutions are already asking the that projects located in high-income OECD
direct question, the change provides an countries are afforded differential treatment.
affirming codification of the approach.

SOCIAL AND MONITORING

For all category ‘A’ projects and, as appropriate,
ENVIRONMENTAL category ‘B’ projects, the revised principles
require Equator financial institutions, or
ASSESSMENT borrowers, to retain independent environmental
and/or social experts to verify for the benefit of
AND RISK the Equator financial institution, the monitoring
information supplied by the borrower.
MANAGEMENT This requirement is stronger than the equivalent
The 2006 Principles replace the ‘environmental provision in the original principles, which only
assessment’ with a ‘social and environmental called for the appointment of independent
assessment’. Again, the change in language experts where necessary for additional
emphasises the need to independently consider monitoring and reporting. In combination with
the social risks and impacts. the feedback loop established by the grievance
mechanism, this requirement should help to
The 2006 Principles introduce three other ensure ongoing compliance during the life of the
important changes at this point. project.
 The 2006 Principles place a greater emphasis
COSTS on the social impacts of projects, and provide
for increased mechanisms for consultation and
The streamlined treatment accorded to projects
dialogue with project-affected groups.
located in high-income OECD countries is likely
to reduce compliance costs. However, several In summary, they are a stronger set of baseline
changes introduced by the 2006 Principles, requirements than the original principles.
most obviously the compulsory involvement of
experts during the social and environmental While some have criticised the 2006 Principles
assessment, risk management and monitoring for not going far enough, they are widely
stages, and the new grievance mechanism, are regarded as another positive step towards
likely to increase compliance costs. responsible and sustainable development.
However, as with the original principles,
These additional compliance costs are part the success of the 2006 Principles will be
of the overall cost of ensuring that the true measured by the social and environmental
economic cost of the project, including negative benefits they secure for project-affected
externalities, is borne by project sponsors. communities. It is hoped the information the
The additional costs are intended to result in Equator financial institutions provide as part
better outcomes for project-affected groups of their new commitment to periodic reporting
and corresponding benefits for the reputations will make these benefits, and the success of the
of Equator financial institutions and project Equator Principles easier to gauge.
sponsors.

CONCLUSION
The 2006 Principles have a wider application
than the original principles. The social and
environmental standards they impose have been
strengthened, while their application to projects
in countries with existing high standards for
social and environmental issues has been
streamlined.

CONTACTS
Steve Pemberton Phillip Cornwell Stephen Spargo
Partner, Singapore Partner, Sydney Partner, Melbourne
Ph: +65 6535 6622 Ph: +61 2 9230 4748 Ph: +61 3 9613 8861
[email protected] [email protected] [email protected]

Bangkok Alan Millhouse Steven Cole

Beijing
Brisbane
Partner, Brisbane Partner, Perth
Hong Kong Ph: +61 7 3334 3149 Ph: +61 8 9488 3743
Jakarta
[email protected] [email protected]
Melbourne
Perth
Phnom Penh
Port Moresby
Shanghai
Singapore
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