EP4 – New Horizon for Environmental and Social Responsibility in Project Financing

Bryan Cave Leighton Paisner


The Equator Principles Association (“EPA”) recently released an updated draft of the Equator Principles (“EP4”) with the proposed revisions focusing on four areas:

i) social impact and human rights;

ii) climate change;

iii) broadening the scope of applicability; and

iv) the use of “designated countries” to determine where the Equator Principles (“EPs”) should apply. We discuss the impact of approving these proposed changes below.

The EPs guide the assessment of environmental and social risks that arise through the provision of the following financial products:

  • Project Finance Advisory Services;
  • Project Finance;
  • Project-Related Corporate Loans; and
  • Bridge Loans.

Impact of approval of EP4

If approved, EP4 will:

  1. clarify the responsibility of financial institutions and the infrastructure sector to consider, undertake and integrate human rights, climate change and sustainability risk due diligence (of potential and actual risks) as market standard in any project finance transaction structure, documentation and on-going management; and
  2. require adaption of legal and governance risk management approaches – not only for project finance, which is the priority, but other types of financing as market sector practice and parallel standards develop.

Although voluntary, more than 95 financial institutions (known as Equator Principles Financial Institutions (“EPFIs”)) have now adopted the EPs.  Incorporation of the EPs into financing agreements creates legally binding contractual obligations for the agreement parties.  Further, increased adoption of the EPs contributes to evolving international standards and market expectations and practice. This creates the potential for enforceable common commercial law standards to apply to: (a) transactions even where the EPs are not specifically referenced; and (b) financial products beyond EPs scope.

The EP4 preamble now explicitly acknowledges EPFIs have broader responsibilities for identifying and managing environmental, social and governance (“ESG”) risks for financial products outside EPs scope. This is consistent with the universal application of the UN Guiding Principles on Business and Human Rights (“UNGPs”) to all types of business enterprises and their operations and business relationships. EP4 comes at a time of heightened attention on the role of financial institutions in sustainable development and there are some important parallel standards on ESG due diligence for the finance sector: the prospective OECD Guidance on Due Diligence for Responsible Business Conduct in General Corporate Lending and Securities Underwriting expected this year and on-going work, following the political agreement between the EU Parliament and Member States, on a disclosure regulation as part of the EU’s Sustainable Finance Plan requiring disclosure and integration by financial market participants and financial advisors of ESG risks and opportunities into their processes, procedures, and policies.

Proposed changes in EP4

1.      Scope of applicability

The current consultation draft increases the scope of EP4 by including:  

  • More Project-Related Corporate Loans (from $50M, including the total aggregate loan amount and the EPFI’s individual commitment, before syndication or sell down) – a material decrease from an aggregated prior commitment of total loan of $100M and EPFI individual commitment of $50M; and
  • New financial products, covering Project-related Refinancing and Project-related Acquisition Financing where the underlying Project was financed in accordance with the EPs, there has been no material change in the scale or scope of the Project, and completion has not occurred at the time of the signing of the facility or loan agreement.

2.      Extension of Applicable Standards in Designated Countries

The amendments to Principle 3 now require an EPFI to evaluate the specific risks of projects in Designated Countries (that are deemed to have robust environmental and social governance, legislation systems and institutional capacity).  Further, EPFIs must determine whether the International Finance Corporation’s Performance Standards could be used, effectively, as best practice guidance to address such risks in Designated Countries, in addition to compliance with host country laws. As a result, EPFIs would be required, in high income OECD countries, to continue to enhance their ESG performance by reference to international standards.  This, notwithstanding the general robustness of a country’s governance environment, is likely to enhance its regulatory standards, address any technical gaps and align it with the international frameworks for addressing human rights and climate risks.

3.      Human Rights and Social Risk

The revision focuses on two key themes:

  • overarching alignment of EP4 with key international human rights, climate and sustainability frameworks and standards, and, accordingly, assessment of potential and actual risks; and
  • the development of Principle 5 with the inclusion of two consultation options to address the challenging issue of articulating the requirements of Free Prior Informed Consent ) of indigenous peoples.

EP4 states in the Preamble that EPFIs will fulfil their responsibility to respect Human Rights in line with the UNGPs.  This means avoiding negative impacts on the human rights of others and addressing those impacts with which they may be involved. Accordingly, businesses are expected to adopt a human rights policy commitment, due diligence and integrated risk management systems and processes to identify, prevent, mitigate and account for, or remediate, relevant harm. Human rights are described in international standards aimed at securing dignity and equality for all and at a minimum include those in the International Bill of Human Rights.[1]

EP4 has specifically focused on developing Principle 5, Stakeholder Engagement, concerning the “Free Prior and Informed Consent” of indigenous peoples and includes two options for consultation – either, in summary terms, the client is expected to undertake “documented good faith efforts to meaningfully consult” or “must demonstrate consent is obtained”:

1     Clients “are expected to engage in meaningful consultation with affected Indigenous People, with the goal of achieving their Free Prior and Informed Consent”.

If it is unclear at the time of EPFI’s due diligence whether consent has been achieved, the EPFI should evaluate whether further consultation efforts are required and whether the clients’ mitigation and remedy plans are appropriate.


2     Clients “must demonstrate to the EPFI’s satisfaction, that the Free, Prior and Informed Consent of the indigenous peoples affected by the Project is obtained.” EPFIs’ expectation for the client to collaborate with a host government/agency where it is responsible for stakeholder engagement, including with Indigenous Peoples, is also explicitly addressed.

Even if the first option is ultimately accepted, in circumstances where there is the potential for severe human rights risks associated with a project, it may only be appropriate to proceed on the basis of the client obtaining demonstrable Free, Prior, Informed Consent of indigenous peoples.  This is to ensure optimal social licence to operate, human rights protection and prudent management of legal and governance risk, particularly where the indigenous peoples are not provided with recognition under national law.

These amendments focus on Stakeholder Engagement specifically concerning indigenous peoples. Yet, as stakeholder engagement is a critical part of undertaking broader human rights due diligence in line with the UNGPs, it should form part of an EPFI’s (and client’s) on-going processes to consider and address salient human rights risks. It should also support collaboration with the client on remedial actions in the event of a breach of environmental and social covenants, as is required under the amendments to Principle 8.  

Human rights and climate change risks are explicit issues contributing to the risk categorisation of a Project under Principle 1 and the scope and content of an Environmental and Social Impact Assessment (“ESIA”) under Principle 2 (and Exhibit III). The ESIA should specifically assess and document potential (as well as actual) adverse human rights impacts and climate change risks. It should also be appropriate to the type of Project and nature of the risks – including materiality and severity.  Under the UNGPs this means the risks to the people potentially impacted by the Project (and the client and/or EPFI only in a derivative sense).

EP4 still maintains a bifurcated approach as between developing and developed countries (even with the proposed amendments to Principle 3 (paragraph 2)).  However, the obligations under Principle 2 are very likely to extend the scope of the risk assessment beyond what may be included in host country laws in Designated Countries.  To date, of the Designated / OECD countries, only France has implemented a human rights due diligence approach aligned with the UNGPs through the Duty of Corporate Vigilance Law. However, a number of other current legislative proposals and initiatives may also follow this direction.  Further, the IFC has also reviewed the UNGPs and its Sustainability Framework and “confirmed that [the IFC’s] approach of assessing and managing the environmental and social risks and impacts of its investment operations, including IFC procedural and substantive requirement (sic) placed on its clients through the Performance Standards is broadly convergent with the [UN]GPs and their emphasis on due diligence.”[2]

The EPFI banks are meeting in Toronto this week to discuss the EP4 consultation draft and it is clear that maintaining this divided approach is the subject of continuing debate and divergent views.  Perhaps the time has come to dispense with this divide, and instead unify standards, expectations and performance around a common approach that explicitly integrates the internationally authoritative standards for addressing risks to human rights and climate – and provides clarity and international comity because these standards are leading the development of international standards, public policy, law and regulation, commercial agreements and guidance more generally.

3.      Climate Change

The preamble to EP4 recognises the role of EPFIs in respect of the 2015 Paris Agreement and improving the availability of climate-related information, such as the TCFD Recommendations. Principle 2 has been revised to require conduct of a climate change assessment for:

  • Category A and, as appropriate, Category B Projects[3], including consideration of relevant physical risks.
  • All Projects, in all locations, when combined Scope 1 and Scope 2 Emissions are expected to be more than 100,000 tonnes of CO2 equivalent annually and should consider the relevant transition risks and the completion of an alternatives analysis concerning less Greenhouse Gas intensive alternatives.

EP4, Annex A set outs specific climate related risks and also annual public reporting requirements on GHG emission levels for all category A and, as appropriate, category B projects that emit over 100,000 tonnes of CO2 equivalent per year.

Achieving the SDGs

More generally, these developments set out in EP4 are an important recognition that the EPs can contribute to delivering on the objectives and outcomes’ of the SDGs – the global 17 interconnected goals addressing broad environmental, social and governance issues with the intention of creating a more sustainable future.

Considerations going forward

We encourage financial sector institutions to contact us to:

  1. Discuss the EP4 consultation draft – stakeholders are invited to submit feedback on the draft here by Friday 9 August 2019; and
  2. Assist them assess and develop their risk management and due diligence processes in alignment with both the EP4 draft and the broader international convergence trends that will continue to be integrated into international standards, public policy, law and regulation, commercial agreements and guidance regarding the projects and infrastructure sector.

A guide to key issues for EPFI’s and their clients to consider when reviewing and adapting their legal and governance risk management approaches is attached here .

Please contact us to discuss key ESG risks for infrastructure projects and due diligence approaches. 

[1]         This means the Universal Declaration of Human Rights, the International Covenants on Civil and Political Rights and the on Economic, Social and Cultural Rights and the principles concerning fundamental rights set out in the International Labour Organisation’s Declaration on fundamental Principles and Rights at Work.

[2]       https://www.ifc.org/wps/wcm/connect/012f5800-acf6-42d1-807f-67f712a35420/UNGPsandIFC-SF-DRAFT.pdf?MOD=AJPERES&CVID=jonf21S

[3]     Principle 1 defines the categories as follows:
Category A- Projects with potential significant adverse environmental and social risks and/or impacts that are diverse, irreversible or unprecedented;
Category B - Projects with potential limited adverse environmental and social risks and/or impacts that are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures
Category C - Projects with minimal or no adverse environmental and social risks and/or impacts.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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