The Revised Equator Principles

New York Law Journal

September 1, 2006
by Stephen L. Kass and Jean McCarrol

On July 6, 2006, 41 of the world's largest financial institutions released a revised set of the "Equator Principles," the much-anticipated new version of voluntary standards originally adopted in June 2003 by the Equator Principle Financial Institutions (EPFIs) as a benchmark for environmental and social responsibility in project financing, particularly in developing countries.

The revised Equator Principles are intended to complement the new "Sustainability Policies" of the International Finance Corp. (IFC), the World Bank affiliate that took the lead in encouraging an initial group of 21 EPFIs to launch the original Equator Principles.

The Original Equator Principles

The goal in 2003 was to encourage private lending institutions to follow the lead of the World Bank, IFC and other multilateral institutions in assessing the environmental and social impacts of their loans and, by so doing, to encourage borrowers to carry out their projects in a more responsible way that, not so incidentally, did not embarrass their lenders or threaten the value of their lenders' security. In our April 2004 column for the New York Law Journal discussing the original Equator Principles in 2004, we applauded the initiative of the sponsoring EPFIs but noted several of the major criticisms made against the Equator Principles during their first year. These included the lack of a review body to enforce the principles and the absence of public accountability and transparency with respect to implementation of the principles. We discussed these concerns in light of the 1,700-kilometer-long "BTC" pipeline project, which was to carry crude oil from Baku, Azerbaijan, through Tiblisi, Georgia, to Ceyhan, Turkey, and which was considered the first major test of the Equator Principles.

In the ensuing two years, there have been significant developments with respect to the Equator Principles. The number of EPFIs has more than doubled to 41. However, there has been continuing concern that many signatories view the entire program as a public relations campaign while failing to implement the principles seriously or consistently, as in the BTC pipeline project and, more recently, the Karahnjukar hydro project in the highlands of East Iceland, both of which were financed despite alleged violations of the Equator Principles and applicable IFC Sustainability Policies.

Unsurprisingly, most EPFIs have been reluctant to reveal the projects that they have reviewed under the Equator Principles, regularly citing a "fiduciary duty" to preserve client confidentiality. Commenting on a questionnaire survey conducted by the World Wildlife Fund in Great Britain and another nongovernmental initiative known as "BankTrack" to gauge the implementation of the Equator Principles, David B. Hunter noted that a comprehensive evaluation was foreclosed by the near total lack of information the banks have placed in the public domain. Their lack of transparency regarding implementation not only makes independent evaluation impossible, . . . ; they are adopting environmental rhetoric with little commitment to changing their performance.[1]

Nongovernmental organizations have also cited the lack of an independent enforcement or monitoring body to assure meaningful compliance with the Equator Principles. In the absence of such a reviewing body, the Center for Human Rights and Environment recently filed a formal complaint against the ING Group, an Equator Bank.[2] The complaint, submitted to the bank itself, alleged a number of violations of Equator Principles with respect to a highly controversial paper mill project in Fray Bentos, Uruguay. The complaint was supported with findings by the IFC's Compliance Advisory Ombudsman, a body created to review complaints submitted against IFC-sponsored projects.

The Revised Principles

In response to this criticism, the EPFIs recently embarked on a revision of the principles, inviting clients, nongovernmental groups and official development agencies to suggest improvements. The resulting revised Equator Principles were released on July 6, 2006 and generally welcomed. Some of the more promising changes include:

(1) expanding the applicability of the principles to include all projects costing $10 million or more (compared to the $50 million threshold for the original principles);

(2) making the principles applicable to expansions and upgrades of existing projects that result in significant new social or environmental impacts;

(3) a pledge by the EPFIs to report on the progress, performance and overall implementation of the Equator Principles at least annually;

(4) incorporation by reference of IFC's new and more stringent Sustainability Policies, particularly with regard to public consultation and grievance mechanisms; and

(5) stronger covenants to ensure that borrowers comply with their lenders' social and environmental policies.

The heart of the Equator Principles is the EPFI's commitment to require each borrower to prepare a Social and Environmental Assessment (SEA) that is similar to, but broader than, an environmental impact statement under the National Environmental Policy Act in the United States. The SEA must identify, assess and seek to mitigate both environmental and "social" impacts of a project, including impacts on indigenous communities and provisions for resettlement of affected families, both subjects of intense concern for projects in developing countries. For developing country projects, the SEA must also comply with (or justify its deviation from) the applicable IFC environmental performance and safety standards and the World Bank's pollution prevention handbook, both of which provide detailed guidance in the assessment of major industrial and infrastructure projects. As with public projects financed by the World Bank, the Equator Principles also require the SEA for major projects to be supplemented by an "Action Plan" that describes the measures to be undertaken to mitigate adverse social and environmental impacts and to monitor the borrower's compliance with that plan. The borrower (or an "independent expert") must also consult with affected communities in a "structured and culturally appropriate manner intended to ensure "free, prior and informed consultation" concerning significant project impacts.

Beyond the Action Plan, the Equator Principles also require borrowers to covenant to comply with local social and environmental laws, submit periodic reports on their compliance with the Action Plan and such laws and, where applicable, carry out an approved decommissioning plan at the end of a project (a subject of great importance for many natural resource and aquaculture projects). Each EPFI also commits to report publicly on its overall experience in implementing the Equator Principles.

IFC Policies

This revision of the Equator Principles followed closely on IFC's expansion of its own earlier Environmental and Social Safeguard Policies (Safeguard Policies), which had been adopted by the IFC in 1998. These Safeguard Policies formed the backbone of the original Equator Principles, providing a project-categorization scheme (Categories A, B and C), as well as measurement thresholds to determine the environmental and social risks presented by a project. In April 2006, after evaluating many of the same criticisms made against the Equator Principles, the IFC adopted its new Sustainability Policies, broadening the scope of the Safeguard Policies Performance Standards for different kinds of development projects.

Although IFC's new Sustainability Policies generally broaden the scope of the IFC's original Safeguard Policies, a few of IFC's changes may in fact permit EPFIs to finance projects that would violate the old Safeguard Policies. For example, the new IFC Performance Standard 1 has eliminated mandatory retention of an independent expert to conduct SEAs for Category B projects (which can present significant environmental and social risks). This may expedite some projects but will also reduce the confidence of the public in the objectivity of the borrower's SEA.

Similarly, the new IFC Performance Standards give discretion to borrowers to establish grievance mechanisms if they anticipate adverse comments from the affected community. The standards do not, however, require that the grievance procedure be independent of the lender or include authority to correct violations of the standards. Moreover, while the revised Equator Principles reference the IFC Performance Standards, application of the Performance Standards is not binding. It will be interesting to observe how EPFIs respond when presented with an opportunity to go beyond the Performance Standards in their SEAs or, conversely, when the Performance Standards present significant obstacles to project financing.

Future Implications

The revised Equator Principles, like the original principles, require EPFIs to assess and consider not only environmental but also "social" impacts of proposed loans. The social impacts required to be assessed include violation of rights under the International Covenant on Civil and Political Rights (ICCPR) and the International Covenant on Economic, Social and Cultural Rights (ICESCR), two of the pillars (along with the Universal Declaration of Human Rights) of international human rights law. The United States, however, has not ratified the ICESCR and generally does not recognize the social, economic and cultural "rights" set forth in that covenant. Those U.S. institutions, including CitiBank and Wells Fargo Bank, that have become EPFIs under the revised Equator Principles will thus be in the interesting position of protecting rights under the ICESCR that are not widely recognized in the United States. This is a logical result of acting in a global marketplace that has, of necessity, become more sensitive to respecting such rights and may foreshadow the beginning of more general acceptance of social and economic rights by U.S. firms and, ultimately, the public and the courts.

While these improvements to the Equator Principles are welcome--and deserving of real credit for those who crafted them and have committed to their implementation--three important questions require continuing attention: (1) How effectively are individual EPFIs implementing their Equator Principles commitments? (2) What effects are the Equator Principles actually having in reducing adverse social and environmental impacts in developing countries? (3) Should the Equator Principles or a comparable set of standards for financial institutions become legally binding and, if so, how?

With respect to individual EPFI performances under the Equator Principles, the greater transparency called for by nongovernmental groups seems appropriate. This need not involve confidential business information about borrowers but should focus instead on the degree to which project impacts have been satisfactorily avoided or mitigated, both in social and environmental terms, by pre-approval assessment and planning in the SEA or by Action Plan mitigation. It would also be important to know the degree and kinds of community consultation that borrowers have undertaken for individual projects and whether it has succeeded in avoiding the rancorous, and sometimes violent, disputes and abuses that have The substantive impact of the revised Equator Principles also requires attention. In U.S. environmental practice, the role of banks and insurance companies proved a critical catalyst for improved corporate waste disposal practices, hazardous cleanups, and environmental management systems. The EPFIs have an opportunity (many would say a responsibility) to help stimulate improved environmental and social performance by borrowers in developing countries, but there needs to be a serious effort to assess the "on the ground" effectiveness of the revised Equator Principles.

Finally, the long-term role of the Equator Principles in the development of international law and corporate standards merits attention. While the principles are explicit that they are voluntary and do not create any legal rights in anyone, the adoption of an SEA, Action Plan and community consultation procedure by major financial institutions may well contribute to the development of industrywide standards for both lenders and borrowers. Over time, those standards can become part of customary international law or, before that, be adopted legislatively by individual countries for certain types of large-scale projects. While legislative incorporation of the ISO 14001 and "EMAS" environmental management standards that are now used by many transnational corporations has proven attractive for some developing countries, a similar effort to incorporate the more substantive Equator Principles could lead to more environmentally and socially responsible conduct by both lenders and borrowers in many developing countries.

Stephen L. Kass and Jean M. McCarroll, together with Clifford P. Case III, direct the environmental practice group at Carter Ledyard & Milburn LLP. Richard Kistnen, a student at CUNY School of Law assisted in the preparation of this column.

Reprinted with permission from the September 1, 2006 edition of The New York Law Journal
© 2006 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.


[1] David B. Hunter, "Shaping the Future of Sustainable Finance Moving From Paper Promises to Performance," American Law Institute-American Bar Association Continuing Legal Education Course of Study, SL098 ALI-ABA 403, 407-08 (2006).


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