Equator Principles

Author: Justin Smith ~ Nedbank

( Article Type: Explanation )

In June 2003, 10 leading banks (representing approximately three quarters of the global project finance market) adopted the Equator Principles. These principles were developed by several leading banks and are based on the environmental and social policies and safeguards of the International Finance Corporation (IFC). They aimed to provide a guideline for banks to ensure that the projects they finance are developed in a socially responsible and environmentally sound manner.
Perhaps one of the most unique features of this initiative is that it marked the first time that this very competitive sector had united to present a common approach to a problem that affects all financial institutions. It also marks the sector’s realisation that it faced increasing reputational risk, particularly from the media and non-governmental organisations (NGOs), for its involvement in financing controversial projects such as China’s Three Gorges Dam and needed to respond.
The principles, however, were and still are subject to certain caveats such as a $50-million minimum threshold before the principles need be invoked, they apply only to project financing and participation is voluntary.
At the time the principles were adopted, the initiative was generally welcomed and received praise from both the financial community and NGOs such as the Friends of the Earth, the Rainforest Action Network and the World Wildlife Fund. Nevertheless, even at the outset, several major problems were highlighted, such as the lack of a mechanism for ensuring ongoing compliance by the borrowers; the failure to identify non-development zones for large projects in sensitive areas such as the Amazon Rain Forest and the limitation of the principles to project finance only, which leaves other financing mechanisms unfettered.
While there still are a few major banks that have chosen to opt out of the principles, it is estimated that participating banks represent 80% to 90% of the global project finance market. By 2005 the number of adopting banks had risen to 35.
Clearly, banks that are promoting these very high environmental and social-responsibility standards are serving a massive portion of the market.
A number of banks operating in South Africa and Africa, such as Citigroup, Barclays, HSBC and Standard Chartered Bank, have subscribed to the Equator Principles though, putting some pressure on South African banks regarding their African operations.
The Equator Principles have clearly thus also affected the manner in which project finance is taking place in emerging markets, and have also been adopted by a number of Brazilian financial institutions, but no South African banks have done so – until Nedbank’s decision to adopt the Principles in November 2005.
Social and environmental issues have nevertheless received increasing attention in the South African context, with initiatives such as King II and the JSE Socially Responsible Investment Index adding much impetus. The Equator Principles represent a significant step forward for financial institutions and, while the proof is in the performance, the efforts to adopt more responsible business practices may just enable a more sustainable world.