The Equator Principles: The Private Financial Sector's Attempt at Environmental Responsibility

Hardenbrook, Andrew, Vanderbilt Journal of Transnational Law

ABSTRACT

The Equator Principles are a set of voluntary environmental guidelines created to manage environmental degradation that results from large-scale developmental projects in the Third World. On June 4, 2003, ten private financial institutions adopted these guidelines, and by the end of 2006 this number had grown to forty. Moreover, in June 2006 the Principles were revised, raising the level of scrutiny for companies that adhere to these guidelines.

At first blush, the adoption of the Equator Principles by private financial institutions appears to be a substantial step toward implementing environmental standards in developing countries that lack adequate regulations. However, three years after their inception, debate as to whether the Principles are actually spurring environmental change remains. This Note analyzes whether the Equator Principles are having a positive impact and achieving their stated goals related to the local environment in developing countries. This Note concludes that, despite a great deal of uncertainty regarding their real impact, the Equator Principles clearly have improved the situation by placing the private sector in a proactive environmental role and strengthening the public's ability to hold the financial sector accountable for its actions.

TABLE OF CONTENTS

   I. INTRODUCTION
  II. THE EQUATOR PRINCIPLES
 III. SETTING THE STAGE FOR PRIVATE ACTION
      A. Introduction
      B. Potential Causes
  IV. CRITICISMS OF THE EQUATOR PRINCIPLES
   V. INCENTIVES FOR ADHERING TO THE EQUATOR
      PRINCIPLES
  VI. SAKHALIN II: A TEST CASE
 VII. THE FUTURE OF THE EQUATOR PRINCIPLES
      A. Liability
      B. The Equator Principles II.
         i. Methodology Behind the Changes
         ii. Changes to the Equator Principles
      C. The Impact of the Equator Principles
VIII. CONCLUSION

I. INTRODUCTION

Hydroelectric dams, power plants, and other large-scale developmental projects can substantially improve local economies; however, these projects frequently come at a great cost to the environment. (1) In most cases, governments of the developing world (2) have failed to establish environmental regulations to prevent the degradation of the local environment from these large-scale projects. (3) This lack of governmental regulation has allowed private institutions to set their own bar for the environmental standards in the developing world. Initially, project standards set by these private institutions were minimal and resulted in large environmental degradation. (4) However, as private funding for these projects increased, public criticism intensified, and private financial institutions were targeted for their role in contributing to the environmental degradation. (5)

As a result of the increased public backlash, ten private financial institutions adopted a set of environmental guidelines known as the Equator Principles on June 4, 2003. (6) These private institutions, known collectively as the Equator Principles Financial Institutions (EPFIs), created the Equator Principles to "manag[e] social and environmental issues related to the financing of projects." (7) By their third anniversary, the Equator Principles had been adopted by forty financial institutions including banks, export credit agencies, and development finance institutions. (8) These financial institutions control approximately 80% of all project lending world-wide. (9) Although the ability of the EPFIs to enforce these Principles is limited to the contractual relationship of a specific project, their influence over the industry grows as more banks adopt the Equator Principles. (10) In turn, this creates the possibility for the Principles to become the international standard for all large-scale developmental projects. (11)

It is tempting to think of the Equator Principles as a substantial step toward enhancing environmental regulations in countries without adequate standards. However, three years after the inception of the Equator Principles, public criticism of them remains. In July 2006, the EPFIs launched the Equator Principles II (12) (EPII) to address many of these criticisms. (13) Currently, thirty-three of the forty original EPFIs have adopted the EPII. (14) Because the EPII are new to the marketplace, little information exists regarding their impact. However, an analysis of the revisions to the Equator Principles and how these changes were made is important to understanding the effect of the Principles on the private sector.

This Note analyzes whether the Equator Principles have positively impacted the environment in the developing world and achieved their stated goals of managing social and environmental risk. Part II of this Note outlines the requirements of the Equator Principles. Part III discusses the events leading up to the formation of the Principles. Part IV sets forth the common criticism of the Principles. In Part V, this Note considers the incentives private financial institutions have for adopting and adhering to the Equator Principles. Part VI then presents a case study, analyzing the effects of the Equator Principles on Sakhalin II, an integrated oil and gas development project in Russia. In order to determine the impact and future of the Principles on bank activities, Part VII examines each of the following: (1) whether an EPFI can be held liable for violating the Equator Principles, (2) the impact of the Equator Principles on the banking industry and the environment, and (3) the amendments to the Equator Principles and reasons for theses changes. Finally, Part VIII concludes by arguing that despite a great deal of uncertainty surrounding the Equator Principles, they have improved environmental performance by placing the private sector in a proactive environmental role and by increasing the public's ability to hold the financial sector accountable for its actions.

II. THE EQUATOR PRINCIPLES

The stated purpose of the Equator Principles is to "ensure that the projects [the EPFIs] finance are developed in a manner that is socially responsible and reflect sound environmental management practices." (15) The Principles apply to all financial projects with a total capital cost of at least $50 million. (16) These projects are initially categorized for their level of environmental and social risks based on internal guidelines that are derived from screening criteria used by the International Finance Corporation (IFC), the private sector arm of the World Bank. (17) Specifically, the project's risks are assessed depending on the "type, location, sensitivity, and scale of the project and the nature and magnitude of its potential environmental and social impacts." (18)

Based on the level of environmental and social risk, each project is placed into either Category A, Category B, or Category C, correlating with high, medium, and low levels of risk. (19) Category A projects are "likely to have significant adverse environmental impacts that are sensitive, diverse or unprecedented." (20) The risks to the natural habitat or cultural heritage sites of Category A projects are potentially irreversible and may extend beyond the project site. (21) Category B projects pose potentially adverse environmental impacts on human populations or on important areas, such as grasslands, forests, wetlands, and natural habitats. (22) In contrast to the potential impacts of Category A projects, the potentially adverse impacts of Category B projects are site specific, often can be mitigated, and rarely are irreversible. (23) Finally, Category C projects are likely to have minimal or no adverse impact on the environment. (24)

Both Category A and B projects require the company proposing the project to compile an Environmental Assessment (EA). (25) Although an EA for Category B projects contains the same essential elements as those required for Category A projects, Category B analyses typically are narrower in scope. (26) Projects that fall into Category C do not require an EA. (27)

The EA must include an examination of both the negative and positive potential environmental impacts. (28) The company is also required to compare the potential impacts with feasible alternatives, including a scenario where the project is not implemented at all. (29) Finally, the EA includes recommendations for potential minimization, prevention, mitigation, or compensation measures. (30)

The EA must also address the project's compliance with the laws of the host country. (31) The EA will indicate the minimum applicable standards under the Pollution Prevention and Abatement Guidelines of the World Bank and the IFC. (32) If the host country is a low or middle income country, (33) the EA must take into account the applicable IFC Safeguard Policies. (34) Finally, the EA should be consistent with the categorization procedures, as well as address the key environmental and social issues identified in the categorization process. (35)

Based on the conclusions of the EA, the borrower or a third-party expert for all Category A projects and certain Category B projects must develop an Environmental Management Plan (EMP). (36) The EMP addresses any "mitigation, action plans, monitoring, management of risk and schedules" for the project. (37) The borrower then covenants to: (1) obey the EMP throughout the project's construction and operation, (2) regularly report the borrower's compliance with the EMP, and (3) decommission the facility in accordance with an agreed upon Decommissioning Plan as needed. (38)

The Equator Principles also require a borrower or third-party expert for all Category A projects and certain Category B projects to consult with potentially impacted groups. (39) Accordingly, the EA must be translated into the language of the host country for public comment. (40) Typically the potentially impacted groups are comprised of the indigenous population and local non-governmental organizations (NGOs). (41) Both the EA and the EMP must address the comments made by these parties. (42)

The EPFIs are responsible for determining whether the borrower is in compliance with the Equator Principles. (43) If necessary, the banks are able to appoint an independent expert to provide additional review and reporting services. (44) If a borrower is found to be in violation of the Equator Principles, the lender can seek a proposed solution from the borrower to bring the project into compliance. (45) However, adoption of the Equator Principles is voluntary, and the internal policies banks establish are independent of the IFC and the World Bank. (46) Therefore, adoption of the Equator Principles does "not create any rights in, or liability to, any person, public or private." (47)

III. SETTING THE STAGE FOR PRIVATE ACTION

A. Introduction

Traditionally, private entities are viewed as reactionary to governmental regulations. (48) However, this reactionary stance is evolving, and private institutions are beginning to take an increasingly proactive role by self-regulating. (49) The Equator Principles represent this proactive stance in the area of environmental regulation and are a major change in the private sector's traditional role. (50)

EPFIs adopt the Principles by pledging to provide direct funding only to those projects that comply with their requirements. (51) The decision to adhere to the Equator Principles is voluntary, and EPFIs do not sign a formal agreement. (52) Generally, an EPFI adheres to the Principles by including additional environmental requirements in its loan provisions, as well as by establishing internal screening and monitoring procedures. (53)

These provisions, which generally exceed the environmental regulatory requirements of developing countries, fall into a category of agreements known as private second-order regulatory agreements. (54) This term demonstrates that these agreements are between private parties, rather than governmental organizations. (55) These agreements are second-order because "they are entered into in response to the existence or absence of first-order government regulatory requirements." (56) With this background in mind, it is important to examine the potential causes that spurred these private, profit-driven institutions to incorporate the Equator Principles into their loan provisions.

B. Potential Causes

Currently, there is no worldwide first-order environmental regulatory scheme. Generally, international first-order agreements occur through treaties, which are only binding on the signatories, if at all. (57) Developed countries prevent large-scale environmental degradation in their own countries by passing legislation and monitoring industry activities to ensure compliance. (58) These methods allow governments of the developed world to set the bar for their own environmental standards. (59) In sharp contrast, the governments of the developing world frequently do not have environmental regulations in place or fail to enforce their established regulatory scheme. (60) The lack of environmental regulations in the developing world, and a failure to establish a worldwide agreement, has allowed corporations building large-scale developmental projects in the developing world to set their own bar for environmental standards. Since establishing and enforcing environmental standards increase the costs of the project and affect profits, little incentive exists for these corporations to impose strict environmental standards. As a result, projects in the developing world frequently have resulted in large-scale environmental degradation.

Previously, developmental organizations such as the World Bank and the International Monetary Fund (IMF) were able to regulate industry activities in the developing world. (61) The mission of these organizations is to reduce poverty and improve standards of living in developing nations. (62) To compensate for a country's absence of environmental standards, developmental organizations would incorporate environmental and social guidelines into the loan agreements of the projects they financed. (63) Over time, the growing dependency on the World Bank and the IMF to fund these projects caused their guidelines to become the prevailing environmental and social standards for international project finance in the developing …

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Publication information: Article title: The Equator Principles: The Private Financial Sector's Attempt at Environmental Responsibility. Contributors: Hardenbrook, Andrew - Author. Journal title: Vanderbilt Journal of Transnational Law. Volume: 40. Issue: 1 Publication date: January 2007. Page number: 197+. © 1999 Vanderbilt University, School of Law. COPYRIGHT 2007 Gale Group.

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