Interpretation Note on Environmental and Social Categorization

January 1, 2012

Introduction

IN1. This Interpretation Note (IN) explains IFC’s approach to environmental and social (E&S)
IN1
categorization of proposed investments, and becomes effective on January 1, 2012. This IN also
contrasts the updated approach with the approach that prevailed before and was introduced as part of the
2006 Sustainability Policy for the purpose of highlighting how the practice has evolved over the years.
Like most other multilateral financial institutions (MFIs), IFC utilizes a system of E&S categorization as
part of its E&S due diligence (ESDD) process to convey a sense of the relative magnitude of potential
risks and impacts associated with the investments it is considering for financial support. The most recent
changes are in part responding to requests to harmonize the categorization methodology between MFIs
(including IFC and the IBRD). While this IN attempts a comprehensive overview of the approach to E&S
categorization, it is not intended nor can it cover all possible investment scenarios or categorization
variables and therefore IFC’s categorization will continue to be the result of professional judgment
exercised in a manner consistent with the principles outlined in this interpretation note.

I. Background and Context

IN2
IN2. The 2006 Sustainability Framework, which came into Box 1: Categorization Before the
2006 Sustainability Framework
effect on April 30, 2006, introduced several changes to IFC’s
categorization methodology. The 2006 IFC Policy on Social and The E&S categorization system in use prior to
Environmental Sustainability included provisions for three the introduction of the 2006 Sustainability
Policy (generally referred to as the “Safeguards
categories for direct investments, namely A, B, and C, in Framework” or “Safeguard Policies”) was based
accordance with the level of potential impacts of the proposed on the World Bank’s methodology for public
sector projects, where categorization was
investment. For indirect investments (i.e., investments through linked specific process requirements for the
financial intermediaries (FIs)), the Policy refers to category “FI” ESDD. For example, the Safeguard Policies
as well as category C when there is no adverse E&S risks required that all Category A projects conduct an
Environmental Impact Assessment by
and/or impacts. independent experts not affiliated with the
project, develop a Public Consultation and
IN3. The revised approach sought to de-link the Development Plan, and have annual monitoring
verified or conducted by a third party. For
categorization decision from procedural requirements related to Category B projects the Safeguard Polices only
IN3 required a project summary (Environmental
IFC’s ESDD and from the tools that IFC required clients to
Review Summary) written by IFC and did not
apply to assess impacts. The changes introduced through the require any community consultation.
2006 Sustainability Policy were intended to result in more
informed categorization decision-making since the outcome of Under the Safeguards Framework,
categorization was generally determined before
IFC’s ESDD process would determine investment-level initiating the ESDD and was based on limited
categorization, in contrast with the earlier approach (see Box 1). project-level information and/or on the typical
sector/industry risks or E&S footprint. This early
The revised approach would allow IFC to apply the most categorization often determined the
appropriate ESDD tool(s), regardless of the categorization. assessment tools that were applied, even if
they were not the most appropriate for the
specific project circumstances. This
IN4. The 2006 Sustainability Framework more clearly methodology can work well for greenfield
articulated the roles of IFC and its clients with regards to operations categorized at the planning stage;
but is more difficult to implement its procedural
disclosure of information and sought to de-link IFC’s institutional requirements at later stages in the project cycle
E&S categorization decision from project-level disclosure as is often the case with private sector
requirements (as required in Performance Standard 1). IFC’s financings.

IN1
This IN should be read in conjunction with the 2012 IFC Policy on Environmental and Social Sustainability, as well as IFC’s
Access to Information Policy.
IN2
The 2006 Sustainability Framework consists of the Policy on Environmental and Social Sustainability, the eight Performance
Standards and the Policy on Disclosure of Information. In the 2012 update of the Sustainability Framework, the 2006 Policy on
Disclosure of Information became the Access to Information Policy.
IN3
E&S tools include, but are not limited to, E&S Impact Assessment, Resettlement Action Plan, Hazard Operability Assessment,
Risk Assessment, and Community Engagement Plan.

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institutional disclosure of E&S information under the 2006 Policy on Disclosure of Information is achieved
through the Environmental and Social Review Summary (ESRS), which is made public prior to IFC Board
of Directors’ consideration of a proposed investment. IFC’s ESRS was purposefully no longer to serve as
the primary mechanism for local public disclosure of project-level information. IFC has, however, helped
to facilitate the general public’s access to clients’ project information by providing links to websites and
copies of key documents as attachments to the ESRS.

IN5. IFC’s overall experience with the E&S categorization under the 2006 Sustainability Framework has
been positive. Five years of implementation have highlighted opportunities to more effectively address
challenges related to E&S categorization resulting from the changing nature of IFC’s investment activities,
which will contribute to achieve even better signaling of E&S risk through categorization. In addition,
requests for greater institutional harmonization on categorization have led IFC to include inherent sector
risk as an element for consideration (in addition to expected or potential impacts). Given the increasing
importance of corporate financing and investments in financial intermediaries, IFC has given further
attention to (i) categorization of business activities with undefined scope (e.g., very early phase
investments, certain equity and corporate finance structures, credit facilities, and funds, among others)
where a full picture of E&S risks becomes apparent only after IFC’s investment; and (ii) differentiating risk
levels in FI investments through categorization.

II. Categorization Approach Under the 2012 Sustainability FrameworkIN4

IN6. IFC’s categorization review and update was

guided by a number of principles, as outlined in Box Box 2. Key Principles of IFC’s Updated
2. The updated approach intends to articulate more Approach to E&S Categorization
clearly why and how IFC uses E&S categorization to • Maintain a project-level E&S categorization framework
reflect the relative magnitude of E&S risks and as it is a widely recognized and accepted practice
IN5 among MFIs for signaling relative projects risks and/or
impacts based on information available at the time impacts to stakeholders.
of IFC’s ESDD. Moreover, the updated approach also • Maintain the separation of process and documentation
specifies certain aspects of IFC’s institutional requirements from the categorization to the extent
practicable.
requirements for disclosure in accordance with IFC’s • Use a risk-based categorization approach for projects
new Access to Information Policy. These categories with undefined scope/assets (e.g., some corporate
IN6
are now defined as follows: loans, some equity deals, most FIs).
• Recognize the disclosure constraints and limitations
associated with projects that have undefined or limited
Category A: Business activities with potential scope/assets at the time of approval.
significant adverse environmental or social risks • Recognize the need to be more aligned with peer
and/or impacts that are diverse, irreversible, or institutions, but that complete alignment is unlikely given
unprecedented. that IFC investment is 100% private-sector oriented and
that its product and lending mix is unique.

IN4
The full text can be found in paragraphs 40 to 44 of the 2012 Policy on Environmental and Social Sustainability.
IN5
E&S impacts refer to any potential change to the physical, natural, or cultural environment; impacts on surrounding community;
and/or health of community or workers resulting from the business activity to be supported. E&S risk refers to a combination of
probability of certain hazard occurrence and severity of impacts resulting from such an occurrence. In making categorization
decision CES will take into consideration the following characteristics of severity of impact(s) a) major and permanent, b) major but
temporary, c) minor but permanent, d) minor but temporary, c) no impact; and the following characteristics of probability of impact(s)
occurrence: a) common occurrence, b) known to occur, c) could occur, d) not expected to occur, e) extremely unlikely to occur. For
more see Annex A.
IN6
IFC applies specific monitoring and supervision requirements to category A and B including production and submission of annual
monitoring reports, status reports on the Environmental and Social Action Plan, cooperation with periodic Site Supervision Visits
(SSVs), and data required to update the Development Outcomes Tracking system (DOTS). Moreover, these categories of
investment are also scored at the end of appraisal and during supervision using the environmental and social risk rating (ESRR), an
internal tool designed to aid in quantifying the scrutiny to which the investment is subjected during supervision and to determine the
frequency of SSVs. Category A and B projects are also scored at the end of appraisal and during supervision using the
Performance Standards Achievement Rating (PSAR) to define the investee’s performance before and after IFC intervention.
IFC applies neither monitoring, reporting nor supervision requirements to category C investments.

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Category B: Business activities with potential limited adverse environmental or social risks and/or
impacts that are few in number, generally site-specific, largely reversible, and readily addressed through
mitigation measures.

Category C: Business activities with minimal or no adverse environmental or social risks and/or impacts.

Category FI: Business activities involving investments in financial intermediaries or through delivery
mechanisms involving financial intermediation. This category is further divided into:

• FI–1: when an FI’s existing or proposed portfolio includes, or is expected to include,

substantial financial exposure to business activities with potential significant adverse
environmental or social risks or impacts that are diverse, irreversible, or unprecedented.
• FI–2: when an FI’s existing or proposed portfolio is comprised of, or is expected to be
comprised of, business activities that have potential limited adverse environmental or
social risks or impacts that are few in number, generally site-specific, largely reversible,
and readily addressed through mitigation measures; or includes a very limited number
of business activities with potential significant adverse environmental or social risks or
impacts that are diverse, irreversible, or unprecedented.
• FI–3: when an FI’s existing or proposed portfolio includes financial exposure to
business activities that predominantly have minimal or no adverse environmental or
social impacts.

IN7. IFC recognizes that the investments it considers have different levels of information available at
the time of IFC’s ESDD. In some cases, the use of proceeds from IFC’s investment is known and well
understood, as is typical in traditional project finance. In many other cases, however, IFC’s investment is
not directed at specific physical assets (such as working capital finance and most equity investments) or it
will lead to future investments (such as most FI operations or investment facilities or funds), and the use
of proceeds is therefore indeterminate at the time of IFC’s decision to invest.

IN8. Given the inevitable uncertainty associated with future investments, IFC has included an important
provision in the updated approach to E&S categorization in the 2012 Sustainability Policy. When there is
a material change in client’s businesses activities or when the client plans to enter into a new business
area that is materially different from what was represented when approved by IFC’s Board of Directors,
IFC will assess whether this change alters the client’s environmental and/or social risks profile. In cases
where the changes are material, IFC will require clients to adjust its management system in a manner
consistent with (i) potential E&S risks and/or impacts associated with material changes of the new
businesses activity; and (ii) other applicable requirements stipulated in the Performance Standards. This,
however, will not affect the E&S category assigned to the original investment as IFC’s institutional
disclosure has already taken place.

III. Categorization of Direct Investments with Defined Scope/E&S Footprint

IN9. Where the use of proceeds of IFC financing and the associated E&S footprint of the business
activity are known/largely known at the time of the decision to invest (such as in traditional project
finance), IFC will determine the business activity’s E&S category based on its E&S risks and impacts. The
proposed categorization approach for this category of investments will include the assessment of inherent
IN7
risks related to the sector of operation, as well as the context of the business activity’s likely geographic
setting. Assessing inherent risks represents an additional consideration to the current practice of E&S

IN7
Inherent E&S risk is the E&S risk related to generic aspects of an industrial sector or commercial activity excluding management
or mitigation measures.

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categorization, which has been based largely on potential or actual impacts. In practice, this will translate
into having a larger number of projects categorized as Category A. This approach will better align IFC
with the prevailing practice across other MFIs, including the World Bank.

IV. Categorization of Direct Investments with Undefined Scope/E&S Footprint

IN10. In traditional project finance, IFC’s ESDD focuses on the client’s assessment and mitigation of
specific project E&S risks and impacts in reference to the Performance Standards. The situation is
materially different in the case of some corporate loans, equity, working capital finance, or
predevelopment phase investments (often in the form of equity), where the use of proceeds is
undefined/largely undefined and not dedicated to a specific investment activity, where the use of
proceeds is for exploratory / investigative work to determine if a development may be feasible or where
little is known about the physical attributes, site, and impacts of the investment at the time of IFC’s ESDD
and investment decision.

IN11. Where the use of proceeds of IFC financing and/or the E&S footprint of the business activity
cannot be well enough understood/defined at the time of IFC’s ESDD, IFC will determine the E&S
category based on risks inherent to the particular sector, as well as on the likelihood of a development
taking place and on what can be reasonably known about the environmental and social characteristics of
the business activity’s likely geographical setting. Consequently, it is expected that investments which
involve sectors that are of inherent high risk and are expected to be located in sensitive environmental
areas or areas with significant social disruption will be categorized as A. Investments in sectors of
inherent high risk but likely located in lower E&S risk settings will be categorized as A or B depending on
availability of specific information. For instance, when IFC's investment is not related to any specific
activities which would increase the company's footprint (e.g., financial restructuring or liquidity support) or
financed activities which are within existing footprint (e.g., brownfield) or financed activities which are for
exploratory / investigative work, the IFC's investment would typically be categorized as B.

IN12. In case of corporate investments IFC’s ESDD will focus on two aspects of the client’s operations.
First, IFC will review the capacity, maturity, and reliability of the client’s E&S corporate management
system to effectively manage E&S performance, including its ability to enable current and future project
compliance with IFC’s PS. The review will also consider the E&S performance of a representative set of
the client’s existing operations and assets (where they exist) where these serve as a proxy for the general
type of E&S risks and impacts associated with the proposed investment that need to be managed.

IN13. Notwithstanding those situations where the project context mitigates inherent sector risk, it is
expected that the approach outlined above will result in some investments being categorized as Category
A on the basis of very limited information. In such cases, moreover, since it is too early to fully understand
the investment’s physical footprint, it may also be too early for clients to conduct full-fledged impact
assessment and/or undertake a process of Informed Consultation and Participation (ICP), or for IFC to
undertake an analysis of whether Broad Community Support (BCS) exists. In such situations attempts to
undertake ICP could lead to raised expectations amongst communities that a project is about to go ahead
when in reality, it may not do so. These clients will still need to demonstrate PS compliance (including
appropriate E&S assessment, stakeholder engagement and disclosure), and evidence of ICP, where
required). Furthermore, clients will be required to develop full E&S Assessment and undertake ICP and
disclosure as part of project feasibility studies as the physical footprint is defined. The disclosure of this
information will be managed in accordance with IFC’s Access to Information Policy.

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V. Categorization of Financial Intermediary investments

IN14. In its determination of FI–1, FI–2, or FI–3 E&S categorization, IFC will consider the tenor, size, and
type, as well as the sector-level exposure of its proposed investment in an FI.

IN15. For each investment, IFC’s ESDD will include the review of the existing and prospective portfolio
of the FI client to assess reputational risks to IFC, including those arising from E&S issues. E&S
categorization for FI-related investments will consider the nature of the FI’s portfolio that can be attributed
IN8,IN9
to IFC financing.

IN16. Category FI-1: Where the FI's portfolio and planned financing activities include a significant
number of higher risk transactions (namely project finance and large long-term corporate loans) with
exposure to high risk sectors, IFC will categorize such a proposed investment as FI-1. The following types
of investments will typically be categorized as FI-1:

• General purpose debt, sub-debt, Tier 2 and Tier 3 capital or equity investments in banks with
significant exposure to project finance and long-term corporate loans;
• Targeted-debt or risk sharing facilities where the pool of assets covered is high risk in nature,
such as infrastructure; and
• Investment funds, including private equity funds, where the fund invests in high risk sub-projects,
such as an infrastructure or natural resource fund.

IN17. Category FI-2: Where the FI's portfolio and planned financing activities are comprised primarily of
lower risk transactions (all transactions other than project finance or large long-term corporate loans) to
borrowers exposed to low- or medium-risk sectors and/or a limited number of higher risk type of
transactions (project finance and long-term corporate loans) in high- and medium-risk sectors
(e.g., infrastructure, extractive industries, large agribusiness, and energy), FI-2 category will be assigned.
The following types of investments will typically be categorized as FI-2:

• Universal banks where there is limited portfolio exposure to higher risk transactions in high- and
medium-risk sectors;
• Targeted debt or risk sharing facilities where the pool of assets covered is low to medium risk in
nature;
• IFC support for financial workout of distressed asset facilities;
• Construction finance with limited adverse environmental or social risks and/or impacts that are
few in number, generally site-specific, largely reversible, and readily addressed through mitigation
measures;
• Leasing finance where the assets leased are for corporate use (e.g., light and heavy equipment);
• Insurance coverage such as maritime, construction, large-scale agribusiness, environmental
insurance, , and performance guarantees; and
• Private equity and investment funds where the fund invests in low- and medium-risk sub-projects.

IN8
In cases where IFC's investment is targeted to a specified end use (e.g., microfinance credit line), IFC’s requirements regarding
E&S risk management (as described in paragraph 33 of the Sustainability Policy) will cover the specified end use only. However, if
the FI supports similar activities from its own account, then IFC’s requirements will apply to the entire asset class in order to avoid
different risk management approaches across the same asset class. IFC will also encourage its clients to manage E&S risks
throughout their entire portfolio.
IN9
In cases where IFC provides equity or financial support of a general purpose, without a specified end use, IFC requirements
regarding E&S risk management (as described in paragraph 33 of the Sustainability Policy) will apply to the entire portfolio of the FI
that is originated from the time IFC became a shareholder or investor.

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IN18. Category FI-3: FI-3 category will be assigned to FIs where IFC supports investments that typically
carry limited or no E&S risks. The resulting portfolio of lower risk transactions will typically consist
predominantly of short-term finance, microfinance, retail, consumer finance, student loans, mortgage
finance, retail consumer leasing finance, as well as transactions such as insurance (apart from surety
bonds and performance guarantees for large development or infrastructure projects), certain types of
trade finance products (typically not including warehouse and supply chain finance), interest, and
currency swaps.

VI. E&S Categorization and Disclosure

IN19. In accordance with IFC’s Access to Information Policy, E&S categorization determines IFC’s
institutional disclosure requirements for E&S information as well as the timing of disclosure of investment-
IN10
related information before IFC Board consideration of the investment. This section only covers those
IFC’s institutional disclosure requirements that are linked to E&S categorization. A full presentation of
disclosure and access to information requirements are available in IFC’s Access to Information Policy.

VII. Disclosure for Direct Investments with Defined Scope/E&S Footprint

IN20. For those business activities where the use of proceeds from IFC financing and the associated
E&S footprint are known/largely known at the time of the decision to invest (such as in traditional project
finance), IFC will follow its current practice related to its institutional disclosure of E&S and investment-
related information. IFC will disclose a Summary of Investment Information (SII) no later than 60 days, in
the case of Category A investments, or 30 days, in the case of all other investments, prior to
consideration of the investment by IFC’s Board of Directors. In addition, for each proposed Category A or
B investment, IFC will disclose an ESRS. The ESRS will be disclosed no later than 60 days in the case of
Category A investments, or 30 days, in the case of Category B investments, prior to consideration by
IFC’s Board of Directors. Along with the ESRS, IFC will disclose the Environmental and Social Action
Plan (ESAP) (where such a plan is required by IFC) and any other relevant E&S documents pertinent to
the investment.

IN21. The Access to Information Policy introduces post-Board disclosure requirements for IFC, some of
which are contingent on E&S categorization. For category A and B investments where an ESAP was
required by IFC and disclosed before IFC Board consideration, the status of implementation of ESAP
actions will be disclosed by IFC as updates become available to IFC via client reporting.

IX. Disclosure for Direct Investments with Undefined Scope/Assets

IN22. For business activities where the use of proceeds is largely unknown at the time of IFC’s ESDD,
IFC will continue to follow the timeframes established in its 2006 disclosure practice, which is no later
than 60 days in the case of category A investments and 30 days in the case of all other categories. The
client will disclose relevant E&S information to the Affected Communities, following the requirements of
Performance Standard 1, once this information is available. This may be after IFC has received Board
approval for its investment.

IN23. The 2012 Access to Information Policy introduces important post-Board disclosure requirements
for business activities with undefined scope/assets. Some of these requirements are contingent on the
E&S categorization. In the case of category A and B investments, once the use of proceeds is known, IFC

IN10
The Access to Information Policy addresses IFC’s institutional disclosure requirements and general provisions on access to
information. IFC client requirements for community engagement, consultation, sharing of information and local disclosure are
outlined in Performance Standard 1.

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will update its disclosure documents to reflect the findings of any ESDD-related work that has taken place
post-Board approval. This includes IFC disclosure of any ESAP required for review by IFC that has been
produced post-Board approval as well as regular updates on the status of implementation of the ESAP.

X. Disclosure of Financial Intermediary Investments

IN24. For all FI investments, regardless of E&S category, IFC will disclose an SII 30 days before
consideration of the investment by IFC’s Board of Directors. For investments with E&S category FI-1 and
FI-2, the SII will include (i) the rationale for IFC’s E&S categorization; (ii) a description of the main E&S
risks associated with the investment and key elements of the Environment and Social Management
System (ESMS); and (iii) key measures identified to strengthen the ESMS.

IN25. The 2012 Access to Information Policy introduces post-Board disclosure requirements for IFC in
regard to FI investments, some of which are contingent on E&S categorization. For category FI-1 and FI-2
investments where an ESAP was required by IFC and disclosed before Board consideration, the status of
implementation of ESAP actions will be disclosed by IFC as it becomes available. IFC will also disclose
any ESAP that it required but that was produced after approval of the investment by IFC’s Board of
Directors.

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SUMMARY OF THE REVISED APPROACH

Investment Category Basis for Pre-board disclosure Pre-board disclosure Post-disbursement Post-disbursement
Type categorization IFC Client – project level disclosure by disclosure by
IFC Client
Direct, A Both actual and IFC discloses SII and Clients disclose locally IFC discloses periodic Periodic reports on
Defined potential impacts ESRS/ESAP no later than 60 (and/or in an appropriate status on implementation Action Plan
assets identified during days before Board place) E&S of ESAP, prepared by Implementation to
IFC ESDD. presentation along with client- documentation as soon client. affected stakeholders.
Inherent sectoral prepared E&S information. as possible but no later
and setting risk than 60 days before IFC reports on project-
will also be IFC discloses a summary of Board. level DOTS indicators.
considered in the BCS determination before the
categorization Board (if applicable)
B determination. IFC discloses SII and ESRS/ Clients disclose locally IFC discloses annual Periodic reports on
ESAP no later than 30 days (and/or in an appropriate status of implementation Action Plan
before Board presentation place) E&S of ESAP, prepared by Implementation to
along with client-prepared documentation asap but client. affected stakeholders.
E&S information. no later than 30 days
before Board. IFC reports on project-
IFC discloses a summary of level DOTS II.
BCS determination before the
Board (if applicable)
C IFC discloses SII no later None None None
than 30 days before Board
presentation.
Direct, A, B Inherent sectoral IFC discloses SII and ESRS None IFC’s discloses client Client publicly
Undefined and setting risk. no later than 60 days for documentation including discloses all relevant
assets Category A or 30 days for Action Plan on its website. E&S documentation.
Category B prior to Board Thereafter, IFC discloses
consideration. annual status of Periodic reports on
implementation of the Action Plan
Action Plan, as relevant. Implementation to
affected stakeholders.
IFC discloses DOTS
indicators when required.

IFC updates ESRS/ESAP

with project information
C IFC discloses SII no later None None None
than 30 days prior to Board
consideration.

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Investment Category Basis for Pre-board disclosure Pre-board disclosure Post-disbursement Post-disbursement
Type categorization IFC Client – project level disclosure by disclosure by
IFC Client
FIs 1 Risks based on IFC discloses SII no later None IFC discloses periodic
tenor, size, type than 30 days before Board status of implementation
and sectoral presentation along with of the ESAP, as relevant
exposure information on the E&S
Management System and For high-risk private
ESAP, if required. equity funds, IFC
discloses a list of the high-
risk subproject
investments made by the
fund

IFC discloses DOTS

indicators for FIs.

2 None Same as above None

3 None None None

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Annex 1: Sustainability Policy, Performance Standard and Guidance Note

Language Related to Supply Chains

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