The Equator Principles have been one of the principal frameworks for managing sustainability and ESG risk in projects by financial institutions since 2003. The latest update – known as EP4 – renews the focus on human rights and climate change with effect from October 1, 2020.
EP4 is the latest update of the Equator Principles framework used by signatory financial institutions (known as Equator Principles Financial Institutions, or EPFIs) to assess and manage environmental and social risk in international project finance. There are now 110 EPFIs which include banks and export credit agencies.
Key differences from the June 2013 version (EP3) relate to the scope of transactions covered by the Equator Principles, and new requirements in relation to projects in high-income Organization for Economic Cooperation and Development (OECD) nations, human rights, impacts on indigenous peoples and climate change. While EP4 is scheduled to take effect on October 1, 2020, some lenders have been implementing EP4 since it was released in 2019.
While the Equator Principles are voluntary and not legally binding, they take force of law from the financing agreements into which they are incorporated. EPFIs commit that they will not finance projects that do not comply with the Equator Principles. In the case of non-compliance with Equator Principles requirements, lenders are guided to prescribe remedial measures and may invoke remedies under the applicable financing agreements.
The new EP4 requirements include:
- EP4 will now apply to a wider range of transactions and projects, including refinancing and acquisition finance. It will also apply to project-related corporate loans of US $50 million or more that are of two years or more in duration.
- EP4 includes additional review standards for projects in high-income OECD nations, known as “Designated Countries”, that are historically perceived as having robust environmental and social governance systems and institutions. Changes in EP4 address concerns that domestic laws and regulations in Designated Countries may not meet international standards. Now, financings in Designated Countries may be subject to greater requirements under EP4 than what is necessary to satisfy local laws and regulations. Under EP4, projects in these high-income OECD countries, like the United States, Australia and European countries, may also be subject to the same thresholds on environmental and social matters as only applied to projects in developing countries under prior versions of the Equator Principles.
- EPFIs will be required conduct more expansive human rights and climate change assessments. EP4 requires an evaluation of any potential adverse human rights impacts, including impacts to indigenous peoples, even if the level of risk does not warrant a full Environmental and Social Impact Assessment.
- EP4 also requires that a Human Rights Impact Assessment is prepared with reference to the UN Guiding Principles on Business and Human Rights. EP4 makes clear that assessment of social impact must include risks and impacts on workers (including employees and contractors), in addition to affected communities.
- Consultation must be undertaken with indigenous peoples potentially impacted by projects affecting lands or resources subject to traditional or customary use, requiring relocation or resettlement, or impacting cultural heritage. This includes evaluating whether the free, prior and informed consent (FPIC) of indigenous peoples has been obtained for projects with specific impacts on indigenous peoples.
- EPFIs will also be required to support the objectives of the Paris Agreement. Environmental and Social Impact Assessments must include a climate change risk assessment identifying physical risks (e.g., direct damage to infrastructure, indirect impacts to supply chains) and transition risks (e.g., policy and legal risks from national policy changes, reputational risk) in alignment with the recommendations of the Task Force on Climate-related Financial Disclosures.
EP4 was scheduled to take effect on July 1, 2020. However, due to the impact of the COVID-19 pandemic, the Equator Principles Association (“EPA”) extended the transition date by three months and issued its “Guidance on Implementation of the Equator Principles During the Covid-19 Pandemic”. The EPA has also published general implementation and thematic guidance notes on EP4, addressing implementation of human rights assessments, climate change assessments, affected indigenous people and biodiversity. EP4 is available in six languages: English, French, Portuguese, Spanish, Chinese, Korean and Japanese.
With the added environmental and social discipline of EP4, sponsors of new or expanding projects will need to address the climate change and human rights-related aspects of their project to satisfy EPFI requirements, and ensure they have the systems and plans in place to ensure their ESG commitments are enduring through the life of the project. Proactively addressing these matters can streamline and reduce the complexity of the environmental and social due diligence during the project financing phase, and mitigate the potential for legal claims or NGO investigations concerning the environmental and social aspects of the project. Sponsors considering financing a project should evaluate the effects of EP4 in the early stages of the project in order to avoid bankability risks, even if the project is located in a high-income OECD country. This evaluation may involve incorporating the assessments and consultations required to comply with EP4 into the development stage of a project, and tailoring development plans to meet lender requirements in addition to legal requirements.