Adoption of Equator Principles 4

On 18 November 2019, the updated version of the Equator Principles (EP), EP4, was adopted by the Equator Principles Association. EP4 will apply to mandated transactions from 1 July 2020.

The key amendments are as follows:

(a) Scope: a broader range of financial products will be subject to the EPs;

(b) Designated Countries: new requirements for projects in certain high-income OECD countries (referred to in the EPs as Designated Countries);

(c) Climate Change: new requirements with respect to the assessment of climate change risk and reporting; and

(d) Human Rights: new requirements with respect to social impact, human rights, stakeholder consultation and "Free, Prior and Informed Consent".

With the exception of the amendments to Principle 5 (Stakeholder Engagement) concerning Free, Prior and Informed Consent, the amendments are substantively the same as those contained in the draft EP4 released for public consultation on 24 June 2019.

1. Free, Prior and Informed Consent (FPIC)
EP4 further strengthens the stakeholder engagement obligation in Principle 5 in respect of any project with potential impacts on Indigenous Peoples by including requirements with respect to the FPIC of affected communities.

The draft EP4 proposed two alternative options for stakeholder feedback relating to obtaining the FPIC of affected communities.

• Option 1: A client must document good faith efforts to engage in meaningful consultation with affected Indigenous Peoples, with the goal of achieving consent. Where the client has not  obtained consent, the client must demonstrate appropriate plans to mitigate and remedy potential adverse impacts.
• Option 2: A client must demonstrate that they have obtained the consent of Indigenous Peoples affected by a project.

EP4 largely adopts Option 1 and requires, in special circumstances, that a qualified independent consultant evaluates the consultation process with Indigenous Peoples, and the outcomes of that process, against the requirements of the host country laws and IFC Performance Standard 7. The special circumstances are outlined in paragraphs 13 -17 of IFC Performance Standard 7 and include any of the following:

• Projects with impacts on lands and natural resources subject to traditional ownership or under the customary use of Indigenous Peoples,
• Projects requiring the relocation of Indigenous Peoples from lands and natural resources subject to traditional ownership or under customary use,
• Projects with significant impacts on critical cultural heritage essential to the identity of Indigenous Peoples, or
• Projects using their cultural heritage for commercial purposes.

The requirement for an evaluation applies to Projects both in Designated Countries and Non-Designated Countries. This marks a substantial change from EPIII and is the first example of EP utilising the IFC Performance Standards more broadly in Designated Countries. The EP Association has advised that during 2020, guidance will be issued to help clarify how the requirements of IFC Performance Standard 7 are to be implemented in Designated Countries.

Where it is not clear whether FPIC has been achieved following the process under IFC Performance Standard 7, the EPFI will determine, with supporting advice from the qualified independent consultant, if this qualifies as a justified deviation from the requirements of IFC Performance Standard 7, and whether the client should pursue additional corrective actions to meet IFC Performance Standard 7’s objectives.

2. Scope – application to financial products
EP4 broadens the scope of products subject to the EPs in three key respects.

(a) It introduces a fifth category of financial products, namely Project-Related Refinancing and Project-Related Acquisition Financing. These products will be subject to the EPs where:

• the underlying project was financed in accordance with the EPs;
• there has been no material change in the scale or scope of the project; and
• the project is not yet completed. A project is completed at the date at which the project has been finished, functions, and performs according to certain pre-defined measures. After this date, the project’s cash flows become the primary method of repayment.

(b) It reduces the total aggregate loan amount for applicable Project-Related Corporate Loans from $100 million to $50 million.

(c) It includes loans to sovereign borrowers as Project-Related Corporate Loans in all Category A and, as appropriate, Category B projects.

• Category A projects continue to be defined as projects with potential significant adverse environmental and social risks and/or impacts that are diverse, irreversible or unprecedented.
• Category B projects continue to be defined as projects with potential limited adverse environmental and social risks and/or impacts that are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures.

3. Designated Countries
EP4 will continue to require that the environmental and social assessment for a project in a Designated Country evaluates the project’s compliance with the relevant laws, regulations and permits of that Country. It now also requires EPFIs to evaluate whether the environmental and social risks of the relevant project warrant the application of one or more of the IFC Performance Standards, in addition to the Designated Country’s laws and regulations.

EP4 removes the language from EP III that provided a Designated Country’s laws to meet the requirements of Principle 2, Principle 4, Principle 5 and Principle 6. In practice, this will mean that, for a project in a Designated Country, the project’s compliance with the Designated Country’s laws, regulations and permits may not necessarily be sufficient to address the relevant environmental and social risks and impacts of the project.

4. Climate change – risk assessments
EP4 contains additional language in the preamble and throughout that recognises that EPFIs have a role to play with respect to achieving the goals of the 2015 Paris Agreement.

• Principle 2 proposes a climate change risk assessment as part of the environmental and social assessment for:
  • Category A and, as appropriate, Category B projects; and
  • any project in which the combined Scope 1 (direct GHG emissions) and Scope 2 (indirect GHG emissions) are expected to exceed 100,000 tonnes of carbon dioxide equivalent (CO2e).
• Principle 10 proposes to require clients of Category A and, as appropriate, Category B projects with annual CO2 equivalent emissions exceeding 100,000 tonnes to report their GHG emission levels publicly on an annual basis.

5. Human rights
EP4 includes additional language in the preamble recognising the responsibility of EPFIs to respect human rights, consistent with the United Nations Guiding Principles on Business and Human Rights (UNGPs).

Principle 2 now also requires an assessment of potential adverse human rights impacts as part of any environmental and social assessment. This is a significant change from EP III, which only requires a human rights due diligence as a complement to an environmental and social assessment “in limited high risk circumstances”.

EP4 does not provide guidance on what is expected by way of this assessment, but the scope of due diligence required could be informed by the UNGPs (assessing the actual and potential human rights impacts, integrating and acting upon findings, tracking responses and communicating how impacts are addressed).

EP4 extends the requirement to engage with stakeholders and provide appropriate grievance mechanisms to “Workers”. The proposed definition captures all workers engaged directly or indirectly on a project, including contractors and sub-contractors, but expressly excludes supply-chain workers.

6. HSF Contacts
If you have any queries about EP4 and the new requirements, any of our team members below can assist you.