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Equator Principles Large Group Discussion

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Title: Equator Principles Large Group Discussion


1
Equator Principles Large Group Discussion
  • Professor Doug Cerf
  • Donald Bren Graduate School of Environmental
    Science and Management
  • Environmental Risk Management (ESM 286)
  • Winter 2008

2
Fundamental questionWhat problems are the
Equator Principles trying to solve?
3
  • How do you foster economic growth and increase
    the quality of life without
  • damaging the environment,
  • compromising the human rights of some or
  • jeopardize cultural traditions?
  • How do you avoid/manage risk (environmental,
    social and political)?

4
The Dilemma
  • There has been an increase in economic
    development as a result of increase in large
    projects (500 million or more) in recent years
  • Large projects in developing nations where
    environmental policies are either in their
    infancy or ignored by government authorities are
    particularly susceptible to causing environmental
    or social harm (creating environmental risk)

5
ExampleChad-Cameroon Pipeline Project
  • Economic growth to the west coast of Africa
  • Threatened the areas fragile ecosystem
  • Forced relocation of a number of the areas
    indigenous people
  • Case for next time

6
Equity in benefits and costs
  • There is asymmetric distribution of the benefits
    and costs when environmental and/or social
    degradation occurs form a large project
  • Costs accrue to the host country and local
    citizens
  • Benefits accrue to the project sponsors and
    financers
  • It is difficult to quantify the costs related to
    environmental and social degradation
  • Sponsors may pay to minimize the environmental
    and social costs and risks
  • Sponsors may benefit from managing the
    disruption

7
Which parties should bear the environmental and
social risks?
  • Theory risk should be allocated to parties that
    best able to control the risks.
  • Possibilities
  • Host government
  • Project sponsors
  • Lenders

8
Which parties are best able to control
environmental and social risk?
  • The sponsors (e.g. construction contractors) are
    best able to control the risk because they have
    the power to eliminate or remove the risk
  • Short term risk
  • Example peoples livelihoods as a result of
    being displaced
  • Long term risk
  • Example air pollution from the project facility

9
Sponsors motivation to mitigate the environmental
and social risk
  • They are not charged for the degradation
    therefore have little economic incentive to take
    action
  • They are particularly concerned if the
    environmental damage will delay successful
    completion or operation of the project
  • This is different than for firms that are in it
    for the long term
  • Example air pollution for a firm owned refinery
    versus air pollution from a project finance new
    power generation facility where the sponsor
    leaves after the project is on-line

10
Are private banks responsible for sustainable
development?
  • Banks in question are private banks that
    participate in project finance.
  • Do these banks through their lending practices
    contribute to environmental and social
    degradation?
  • Analogy Banks have responsibility under the
    superfund law

11
Private banks involvement in large projects
  • Banks provide
  • financial advisory services to project sponsors
  • help arrange project financing
  • provide portion of project debt
  • Unlike the project sponsor banks do not play a
    role in conceiving, promoting or managing the
    large project
  • Banks have an incentive for projects to be
    successful because some fees are dependent on
    successful completion
  • Banks fees are dependent on timely completion

12
Private bank risk
  • Banks consider environmental and social risk as
    credit risk because the degradation could lead to
    project interruption which could impact
    collection of interest and fees
  • Banks consider environmental and social risk as
    reputation risk because of the risk of being
    involved in harmful project.
  • Can impact banks other lines of business such as
    consumer lines

13
Private bank responsibility
  • Should banks be held accountable for sustainable
    development given sponsors have few incentives to
    promote sustainable development?
  • Possibilities.
  • Fully responsible (i.e. retroactive, joint and
    several liability similar to superfund law)
  • Somewhat responsible because they were party to
    the deal.
  • Not responsible
  • Students should vote and provide justification

14
Non government Organizations
  • A non-governmental organization (NGO) is a
    non-profit group or association that acts outside
    of institutionalized political structures and
    pursues matters of interest to its members by
    lobbying, persuasion, or direct action. The term
    is generally restricted to social, cultural,
    legal, and environmental advocacy groups having
    goals that are primarily noncommercial.
  • There are 29,000 international NGOs
  • The US and India each have approximately 2
    million NGOs

15
The World Bank
  • The World Bank Group is a group of five
    international organizations responsible for
    providing finance and advice to countries for the
    purposes of economic development and poverty
    reduction, and for encouraging and safeguarding
    international investment.

16
The NGO impact on large projects
  • The likelihood that projects financed by private
    commercial banks will go bad has increased in
    recent years because of the actions and the
    growing sophistication of NGOs.
  • The World Bank has sustainable development
    mandates
  • Private banks involved in large projects did not
    have sustainable development guidelines

17
Will Equator Principles help solve the problem of
environmental degradation?
  • Theoretically, if the principles promote
    sustainable development, the NGOs will cease
    their attacks
  • Concerns about Equator Principles include, scope,
    implementation, enforcement
  • Student vote Do you think equator principles
    will help promote sustainable development?
  • If not, why not.

18
Equator principle issues
  • Narrow scope
  • Impact a small percentage of the projects
  • Principles apply only to project finance loans
    5-10 of total capital expenditures
  • Remainder uses corporate finance
  • Does not apply to project bonds 10-20 of
    projects
  • Only applies to projects of 50 million or
    more14 between 1997 and 2002 were below 50
    million
  • NGOs do not approve of the coverage of human
    rights
  • There arent any no-go zones (location where
    projects are forbidden)

19
Equator principle issues
  • Inconsistent implementation
  • No industry wide implementation guidelines so
    banks must develop their own internal guidelines
  • Limited enforcement mechanisms
  • Voluntary compliance program
  • Have voluntary compliance programs worked in the
    past?
  • Degree of transparency is limited
  • Without explicit reporting requirements
    stakeholders will not know if banks are
    implementing the principles or how effective they
    are
  • Free rider problem of banks that adopt the
    principles but do not implement them (fully)

20
Equator principle issues
  • Equator banks claim that principles would not
    dramatically change the approach to environmental
    and socially risky projects
  • They already have internal policies for this
    purpose
  • Are these best practices principles or a least
    common denominator principles?

21
Reasons why Equator Principles will work
  • Represents a major step in the right direction
  • Adequate scope
  • Increase in the use of project finance
  • About half of all projects over 500 million used
    project finance
  • Project finance investments have reached 132
    billion in 2002
  • The 10 original equator banks arranged 31 of all
    the project finance loans in 2002
  • Principles will affect 100 billion in global
    investment over the next 10 years

22
Reasons why Equator Principles will work
  • Implementation flexibility
  • Principle establish a common baseline
  • Banks can implement internal policies that are
    superior to the equator principles
  • Banks can determine the policies that work in
    their organization
  • Flexibility should benefit implementation

23
Reasons why Equator Principles will work
  • Adequate enforcement
  • Free riders will not impact the benefits of
    participating banks
  • Risk reduction measures will be part of the loan
    covenants and therefore will be enforceable on
    the sponsors

24
What should the banks do next?
  • Marketing--Existing equator banks recruit non
    equator banks
  • At some point if there are enough banks involved
    the principles become an industry standard (one
    the original objectives)
  • Should they target lead arranging banks
  • Four of the top lead arranging banks have not
    adopted
  • Should they target banks in other areas of the
    world besides US, Europe and Australia where the
    originating banks reside?

25
If you were a project finance banker and received
a call would you adopt the principles?
  • Reasons to adopt the principles
  • Prevent project interruptions and derailments due
    to NGO opposition
  • Minimizing environmental risk leads to
    minimization of credit risk
  • Cooperation minimizes reputation risk
  • Even if the bank already has internal principles
    equivalent or superior to equator principles
    there may be reputation benefits by being
    associated with Equator Principles
  • Required by some development banks that require
    similar principles

26
If you were a project finance banker and received
a call would you adopt the principles?
  • Reasons not to adopt the principles
  • If you are not a bank that is being scrutinized
    by the NGOs adopting the equator principles may
    bring attention to you and result in a negative
    reputation impact
  • Original banks suffered from negative reputation
    impact from the NGO spotlight
  • Competitive advantage because non participating
    banks will put less requirements on the project
    sponsors (borrowers)
  • Why adopt the policies if they are flawed.
  • Difficult to compete with regional banks in parts
    of the world where lenders are not equator banks
    (Asia, Latin America, Middle East)

27
Should equator banks work on implementation?
  • This strategy will buy the banks some time from
    NGO criticism
  • Engage NGO during the implementation process
  • This comes with the risk that the NGOs will want
    too much
  • NGOs will have difficulty being critical of a
    implementation process they are involved in
  • How do they select the NGO(s) to engage?

28
Case Questions
  • What problems are banks trying to solve by
    adopting the Equator Principles? How do banks
    contribute to this problem? Will the Principles
    solve the problem?
  • Why are the NGOs criticizing the Equator
    Principles? Is their criticism valid?
  • What should the Equator banks do now marketing
    (encouraging other banks and ECAs to adopt the
    principles), implementation (develop policies and
    procedures), or damage control (respond to the
    NGO criticism)?

29
Case Questions
  • If you were a banker would you adopt the Equator
    principles?
  • How will history judge the actions taken by the
    Equator bankers? Will the Equator Principles be
    seen as a bold step towards achieving sustainable
    development, a negligible step with long term
    impact, or simply a public relations stunt?
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