The Guidance Note aims to support Equator Principles Financial Institutions navigating the environmental and social due diligence process.
In July 2022, the Equator Principles Association published a Guidance Note on how to apply the latest iteration of the Equator Principles (EP), EP4, during the Environmental and Social Due Diligence (ESDD) process. In particular, the Guidance Note addresses the scope of work and terms of reference for Independent Environmental and Social Consultants (IESCs) undertaking ESDD on behalf of Equator Principles Financial Institutions (EPFIs) under EP4, including the appropriate scope for the development of an EP4-compliant Environmental and Social Impact Assessment (ESIA).
The Guidance Note is significant because it addresses the changes to the pre-financial close ESDD required to be undertaken by IESCs under EP4, including with respect to projects located in Designated Countries that are no longer “deemed in compliance” with the Equator Principles solely by virtue of satisfying host country law. on the transition to EP4 and our analysis of its implications for projects in Designated Countries, see this December 2019 blog post, June 2020 Client Alert, and December 2020 Client Alert.
This blog post summarizes key elements of the Guidance Note for project lenders and sponsors to consider.
IESCs and Pre-Closing ESDD
The overall objective of the IESC scope of work is to assess the environmental and social (E&S) compliance and capacity of a project. In particular, the IESC must undertake an assessment of the project’s compliance with Applicable Standards (as such term is used in the Guidance Note) and its E&S management capacity, among other things. The Applicable Standards against which a project is assessed depend, in part, on whether the project is to be located in a Designated Country (those countries deemed to have robust environmental and social governance, legislation systems, and institutional capacity, such as the United States) or a Non-Designated Country — although the distinction between the level of pre-financial close ESDD that must be undertaken for projects in Designated Countries and Non-Designated Countries is less pronounced under EP4 than was the case under the previous version of the EPs.
Generally, the Applicable Standards include all relevant local and national laws and regulations, international laws and conventions, the International Finance Corporation’s Environmental and Social Performance Standards (IFC PS), and the World Bank Group’s Environmental, Health and Safety Guidelines (EHS Guidelines), plus applicable sector-specific guidelines and the United Nations Guiding Principles on Business and Human Rights. Other sources of Good International Industry Practice (GIIP) may also be relevant.
The Guidance Note clarifies the following points with respect to the IESC’s required scope of work/ESDD under EP4:
- The E&S standards applied by export credit agencies (ECAs) and development finance institutions (DFI) do not generally distinguish between Designated Countries and Non-Designated Countries. As such, if ECAs or DFIs are involved in the financing of a project, then the scope of the IESC’s ESDD should be the same regardless of whether the project is located in a Designated Country or a Non-Designated Country (i.e., the IESC will need to assess compliance against the IFC PS and the relevant EHS Guidelines).
- If only commercial banks are involved, the scope of the IESC’s ESDD for a project in a Designated Country will largely follow the scope of ESDD required for a project in a Non-Designated Country, with one notable exception. The IESC’s review will focus more heavily on assessment of compliance with host country standards, and will include a review of compliance with national laws and regulations; however, the IESC will also need to determine, based on the project, the extent to which aspects of the IFC PS (and other relevant GIIP) should be used as guidance to address specific project-related risks in the ESDD. The Guidance Note recommends that EPFIs may wish to identify such risks themselves, or otherwise include a requirement for this analysis to be undertaken by the IESC, in the IESC’s scope of work.
The Guidance Note explains that parties should identify such gaps by performing a high-level comparison of the scope of the local/national legal requirements against the IFC PS and EP4 and a review of the regulatory submissions to identify whether any significant elements of the IFC PS have not been addressed. The Guidance Note further provides the following list of items where consideration of the IFC PS may be relevant to address potentially significant risks: (1) the definition of the project Area of Influence, which is defined as the total area likely to be affected by both onsite and offsite impacts of project-related activities (especially consideration of associated facilities, the supply chain, and treatment of cumulative impacts); (2) biodiversity; (3) aspects of resettlement (e.g., treatment of informal land owners); and (4) assessment of particular social impacts.
The Guidance Note provides that the scope of ESDD in Designated Countries will also need to cover review of climate change risk assessments (as applicable), human rights assessments (as applicable), ESIAs, Environmental and Social Management Plans/Environmental and Social Management Systems, and Stakeholder Engagement Plans (including Free Prior and Informed Consent for Indigenous Peoples, as applicable), internal and external grievance mechanisms, and biodiversity data sharing.
The Guidance Note recommends that the IESC scope of work should define appropriate and realistic timeframes for the performance of the ESDD. The Guidance Note advises that pre-financial close ESDD for more complex projects typically takes anywhere from six to 12 months, or longer when significant and time-intensive compliance gaps are identified against the Applicable Standards. To ensure the success of a project, parties should engage the IESC sufficiently early in the process, and with sufficient scope, to enable the IESC to conduct its ESDD in a manner and on a timeline that reduces the risk of ESDD considerations becoming gating items for financial close.
ESIA Scope of Work
ESIAs and similar E&S assessments are central to the ESDD required under EP4. As the Guidance Note explains, an ESIA that comprehensively addresses the full range of E&S risks of a project and satisfies the Applicable Standards allows for an efficient and timely ESDD process. By contrast, addressing deficiencies in an ESIA often requires specialists and can result in extended project delays. With that in mind, the Guidance Note outlines the steps necessary for appropriately scoping and procuring a comprehensive ESIA early in project planning to avoid extensive delays in the project financing. Those steps include: (1) screening for E&S requirements; (2) scoping required studies for impact identification; (3) performing an impact assessment; and (4) developing mitigation plans.
- Screening identifies the extent and complexity of impacts on the project’s Area of Influence. The Guidance Note states that screening should be completed at a time when the project is sufficiently defined, the preferred location is known, and the design concepts and resource/infrastructure requirements are understood. Effective screening will consider a number of issues, including the extent to which the Applicable Standards may apply to projects in Designated Countries.
- Scoping is an important component of early identification of potential E&S issues and assists in determining whether the project is considered high risk or medium/low risk. Importantly, outcomes of the scoping process can allow the borrower/sponsor, with guidance from the EPFI, to determine if a comprehensive ESIA is needed (for high-risk projects) or if a targeted and limited E&S assessment would suffice (for medium- or low-risk projects) — a determination that has direct bearing on the time required to complete the required ESDD.
- Impact Assessments. Depending on whether significant adverse impacts and risks exist for the project (as determined in the screening and scoping phases), the performance of an impact assessment may require external experts to assist in all or part of the assessment. The use of such outside experts is required under the IFC PS and EP4 for issues involving biodiversity, indigenous peoples, and matters of cultural heritage. Additionally, primary site-specific data is often required if a project is likely to have specific E&S impacts, especially those involving (1) identifying and characterizing potential biodiversity receptors; (2) identifying and verifying social livelihoods and land use; (3) characterizing receiving environments for direct and indirect emissions/discharges to air, water, and soil; and (4) identifying the use of natural resources for ecosystem assessments. This baseline data-gathering exercise is often the key determinant of the time required for completing the assessment.
- Impact Mitigation. Once potential impacts are identified, additional mitigation measures must be developed to satisfy EP4. The ESIA will document mitigation measures either through a description of design controls or within a management program or plan that is implemented through the Environmental and Social Management System for the project.
As the Guidance Note emphasizes, project lenders and sponsors should prioritize ESDD early in the financing process to avoid any potential and unnecessary delays related to satisfying the more robust diligence requirements introduced by EP4. In particular, lenders and sponsors are encouraged to engage an IESC early in the financing process. With the effective utilization of IESCs, appropriate ESIA scoping, and consistent coordination among participating parties, EPFIs and their clients should be well positioned to meet the ESDD requirements of EP4 consistent with their desired project financing timelines.