The Equator Principles (EPs) is a set of ten voluntary principles or guidelines established to assist financial institutions with identifying, assessing and managing environmental and social risk in international and domestic project finance. The EPs have been officially adopted by over 100 global financial institutions (EPFIs). Revised twice since their establishment in 2003 (in 2006 and then again in 2013), the fourth version of the EPs, known as EP4, becomes effective on October 1, 2020, after the Equator Principles Association granted a three-month extension from the original date of commencement of July 1, 2020, due to COVID-19.
The main changes to the risk management framework under EP4 include:
Lenders financing projects and project sponsors developing projects in OECD countries and/or those on the World Bank High Income Country list (including Canada) will want to review the EP4 revisions in close detail. Compliance with local laws in those jurisdictions is no longer a sufficient means of ensuring compliance with the EPs, and there will be more involved due diligence and monitoring processes required under the EPs when considering the impact of projects on indigenous peoples and on the climate.
With the effectiveness of E4, the EPs, which currently apply to project finance advisory services, project finance and bridge loans, will also apply to:
Previously under Principle 3 (Applicable Environmental and Social Standards) of the EPs, projects located in designated countries (that is, countries that have well developed, legislated environmental and social governance systems) were deemed in automatic compliance with Principle 2 (Environmental and Social Assessment), Principle 4 (Environmental and Social Management Systems and Equator Principles Action Plan), Principle 5 (Stakeholder Engagement) and Principle 6 (Grievance Mechanism) if the project complied with local laws. Under EP4, assuming compliance with local laws as sufficient to meeting the EPs is no longer acceptable. Projects located in designated countries must also be evaluated using International Finance Corporation Performance Standards in respect of specific risks, with a view to determining how those risks can be addressed during project development, in addition to considering the host country's laws. Any assessment of Category A and Category B projects needs to include a comprehensive review of how the project meets each of the ten EPs.
Under EP4, the Preamble and Principle 2 of the EPs now set out the expectation that each EPFI will carry out due diligence with respect to any adverse human rights impact in connection with project development, taking into consideration the UN Guiding Principles on Business and Human Rights in the process.
EP4 supplements existing provisions dealing with projects affecting indigenous peoples by making it clear that there must be a process of informed consultation and participation in connection with all such projects in order to achieve the "free, prior, informed consent" (FPIC) of impacted indigenous communities. EPFIs must consider both the host country's laws and International Financial Corporation's Performance Standard 7 in respect of such consultations, with an emphasis on ensuring that proper consultation and documentation methods have been followed. Where it is not clear if FPIC has been achieved, the EPFI and a qualified independent consultant may decide if FPIC has been achieved, whether further action is required or whether deviation from International Financial Corporation's Performance Standard 7 is justified.
Under EP4, the Preamble also sets out the expectation that EPFIs should support the 2015 Paris Agreement and ensure that climate related reporting complies with the Recommendations of the Task Force on Climate-related Financial Disclosures. Under revised Principle 2, a climate change risk assessment is expected for all projects, and is required for projects with adverse environmental and social risks (Category A or B) or projects where combined Scope 1 emissions (on-site emissions) and Scope 2 emissions (off-site emissions) are expected to exceed 100,000 tons of CO2 equivalent annually (even if the project is not expected to have other environmental risks). When a project fits into the latter category, any climate change risk assessment must include evaluation of options that result in less greenhouse gas intensive outcomes.
Under revised Principle 10 (Reporting and Transparency), project companies/sponsors are required to report greenhouse gas emissions levels for Category A and Category B projects. The sharing of commercially non-sensitive project-specific biodiversity data with the Global Biodiversity Information Facility and relevant national or global data repositories is now encouraged to support ongoing research.
With the current increased emphasis on adherence to higher environmental, social and governance performance standards (ESG), understanding and evidencing consideration of the impact of the EPs on project development is critical to a project sponsor's ability to finance that development. Bennett Jones' highly skilled lawyers are here to help clients successfully navigate these important considerations.