In the past five years there has been a significant change in the way that the financial sector approaches environmental and social (E&S) risk. These changes have been driven by a growing recognition that E&S issues represent material reputational and lending risks to a range of financial institutions — especially where there is clear attribution of E&S issues to a specific financial transaction. Nowhere is this link clearer than in project finance — where a bank’s lending activities can be clearly linked to a defined and clearly articulated ‘project’.

Financing projects
The oil and gas sector relies on project finance in particular as a vehicle for financing the development of new assets, and the recent furor over the financing of the Sakhalin II project is testament to the leverage that is being exerted on the financial sector. But project finance is an important financing tool across a range of other industry sectors also, and as the potential for exposure and reputational damage has increased the response from the financial sector has been to establish a set of principles (the Equator Principles) that serve as the basis for project finance E&S due diligence.

They are based on the International Finance Corporation’s (IFC) Performance Standards which include requirements for the protection and sustainable use of biodiversity: “protect and conserve biodiversity and promote the sustainable management and use of natural resources through the adoption of practices that integrate conservation needs and development priorities”

Principles for biodiversity
The Equator Principles (EPs) provide a voluntary framework for addressing biodiversity issues in project financing and require project sponsors to assess a project’s impacts on biodiversity (including specifically, impacts to ecosystem services and natural habitats, the introduction of invasive alien species, sustainable use, and social impacts). Importantly, the EPs stipulate circumstances where biodiversity impacts would be so significant as to preclude the banks’ involvement. Such circumstances include:

Impacts to critical natural habitats (such as protected areas); Significant loss or conversion of natural habitats; The introduction of invasive alien species as a direct or indirect consequence of the project; Significant impacts to habitats or endangered species that might be apparent through supply chains (e.g. in forestry or fisheries projects).

This places the onus on project sponsors to assess potential biodiversity impacts, avoid impacts where possible and mitigate remaining impacts through habitat and species management plans, offsets or other mechanisms. In all circumstances where biodiversity issues are identified and require management in a project finance transaction, the bank and sponsor develop an Action Plan that defines how impacts will be managed (essentially this would resemble a legally binding Biodiversity Action Plan) which is then included in the loan documentation and which, in theory at least, provides an extremely high level of leverage that can be applied to the sponsor if progress in delivering the Action Plan is not as planned. To help EP banks and their clients understand the requirements of the biodiversity Performance Standard, IFC has developed a good practice guide

Biodiversity profile
Since the Equator Principles came into effect (in 2003), adopting banks have grown from 4 to over 50 institutions and an estimated 85% of global project finance is now covered by EP requirements, thus potential leverage (especially in locations where state / public capacity to manage biodiversity and land use may be weak) is considerable. It is early days yet to gauge the impact of the EPs, but indications are that they have raised the profile of biodiversity in both financial institutions and also the companies that are seeking finance.

Interestingly, it is also clear that some banks are informally extending the use of the Performance Standards to a range of other financial products and services (such as corporate loans) which further extends the reach and influence of the Standards. Further, the impact of the EPs on project finance biodiversity assessment and management provide a particular point of reference and source of good practice in relation to wider moves within the financial sector.

Mark Eckstein is an Associate, Sustainable Finance Ltd and a former environment specialist with the International Finance Corporation. He has advised a number of financial institutions and companies about the implications and application of the Equator Principles.

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(1) For instance, BankTrack focuses on the activities of the financial sector and the environmental and social impacts of lending and investment practices (www.banktrack.org).
(2) Equator adopters undertake to apply the International Financial Corporation’s Performance Standards to certain types of project financing. These Standards include specific expectations and requirements in relation to both biodiversity and ecosystem services. (www.equator-principles.com).
(3) A Guide to Biodiversity For the Private Sector