Counting The Costs? The Equator Principles and Indian Banks

Counting The Costs? The Equator Principles and Indian Banks

 

Recently, representatives of more than 60 banks from around the world met in Sao Paulo. The occasion, held on 24-25 October 2017, was the annual meeting of the Equator Principles Association.

What are Equator Principles (EPs)?

The Equator Principles (EPs) acknowledge that financial institutions, through unscrupulous financing and lending practices, can literally bankroll ventures and companies that do considerable harm to human rights and the environment.

The EP framework thus supports financial institutions to identify, assess and manage a wide array of risks associated with project finance, encompassing labour and working conditions; community health and safety; displacement and resettlement; indigenous peoples and their Free, Prior and Informed Consent; and conservation and natural resource management.

A necessary standard, but not sufficient

However, the EPs as they exist currently are far from perfect. The framework provides guidance on assessment of risks but does not ensure that the results of assessments are properly evaluated. They lack any third party auditing or enforcement mechanism, with its guiding body comprising EP members themselves.

Doubts thus persist about the EPs’ impact on the practice of project finance. It may not always be clear whether a Financial Institution that adopts them does so in order to make its environmental and social risk assessment more rigorous or to more effectively communicate existing practice to interested stakeholders.   

There are concerns, too, about the strength of the EPs’ commitment to addressing the contemporary crises of human rights, the environment and climate change. Around the same time as the meeting in Brazil, there was a 3-day protest across 44 cities globally, with strong representation from indigenous groups. The protests drew attention to the failure of the Equator Principles to align with the Paris Agreement on Climate Change and uphold the right of indigenous communities to Free, Prior and Informed Consent.

To their credit, the EP Institutions have now embarked on a journey to revise the EPs and develop a fourth iteration of the framework, ‘EP4’, which will consider key issues of applicability, human rights (inclusive of the rights of Indigenous Peoples), and Climate Change, amongst others. It remains to be seen, though, if EP4 will represent a leap from a minimum requirement to a sufficient global standard for responsible project finance.

The Equator Principles and India

The Reserve Bank of India has recognized the value of the EPs in the Indian context. Ten years ago, the RBI issued a statement to financial institutions identifying their role in supporting sustainable development, including respect for human rights. The note spoke of the need for banks to make urgent efforts in this area, forming plans of action with Board approval. Banks were exhorted in particular to refer to IFC Principles on project finance – the Equator Principles – as well as carbon trading guidelines.

Yet in the intervening period since that 2007 RBI notification, many Indian financial institutions – and foreign banks operating in this country – have funded projects that have had negative impacts on human rights and on the environment.

A large number of these harmful projects have been documented by civil society organizations, such as BankTrack and, in India, the Centre for Science and Environment and Programme for Social Action. At the same time, the responsibility of the financial sector has been called into question time and again with the unfolding of the NPA crisis, with failures of social and environmental due diligence cited as contributory factors behind at least a proportion of so-called bad loans.

And yet, among these 92 financial institutions that have signed up the EPs, just one – IDFC Bank – is Indian.

This is not because Indian banks are not involved in project finance. Out of the 50 biggest mandated project arrangers globally during the first half of 2017, 5 were Indian financial institutions: State Bank of India (the fourth largest arranger), Axis Bank, Yes Bank, IDFC and ICICI Bank. Of these 50, 32 are EP signatories, demonstrating that most of the largest mandated arrangers globally have found EP adoption to be feasible from a business perspective.

The need to integrate social and environmental risk assessment

For the financial sector in India to more widely integrate ESG practices, and adopt the Equator Principles, in nature and in name, there needs to be awareness about the business benefits of E&S risk management as ingredient to holistic risk management and so to prudent financing practice.

Currently for many Indian banks, the need is either not clear, has not been explored in terms of long term business impacts, or the costs are considered too great – since EPFIs need to develop the internal architecture and systems required to integrate more rigorous non-financial risk assessment into their business. This will necessitate building the human resources and systems to carry it out.

Another factor is reputational risks, or the lack thereof. A key reason for embedding ESG standards such as the Equator Principles into financing practices is that, apart from addressing risks to the financial performance of the institution, and risks to society and environment, they also help to manage reputational risks. This is an area in which circumstances in India, Asia and elsewhere in the developing world are quite different from regions in which the distribution of EPFIs is much more concentrated, such as Europe and North America.

Clearly, from the perspective of the Sustainable Development Goals, and indeed from the human rights perspective which runs right through these Goals, the Equator Principles, suitably strengthened, signal a way forward. Respectful engagement with the most excluded stakeholders and changes to the way that business is done in order to meet climate targets is, quite frankly, our only hope as a global community. This means a role for all of us, including financial institutions.

Sensible social and environmental risk assessment is thus the most sustainable approach for financial institutions. Yet the imperatives of the broader business space in India and other developing economies, and low prevailing levels of commitment to responsible practices, is likely to mean that many financial institutions see social and environmental risk assessment as a risk in and of itself: a financial risk, since there is a danger of excluding business opportunities in the short-term.

Clear roles for regulators

Here, government and regulatory agencies must also step in. To facilitate more rapid change, stringent integration of environment and social risk assessment into credit risk appraisal should become a regulatory requirement; as Centre for Science Environment has previously argued, the RBI has a clear role here.

And in terms of reporting, with the National Voluntary Guidelines on the Social, Environmental and Economic Responsibilities of Business (NVGs) under review, SEBI now has an opportunity to update the Business Responsibility Reporting (BRR) framework so that it explicitly invites financial institutions to comment on whether they extend their human rights and environmental policies to entities they finance.

In the current SEBI BRR format, this expectation is missing: whereas other businesses are asked to report on the integration of these policies to their supply chain, financial institutions are let off the hook with respect to profit-making activities within their own value chains.

For more responsible financing, boards and senior management of financial institutions need to also take a step back and identify the opportunities and the materiality of adopting E&S safeguards like the EPs in their respective business lines. They need to recognize the value of a proactive approach to due diligence that the EPs enshrine, as well as the relevance of a human rights lens when assessing risks. This will require courage; but developing these capacities as a critical minimum is an investment that more Indian financial institutions should make.  

It will serve at least three important functions. It will help to lay the foundations for long term stability of financial institutions; it will support a flow of information on social and environmental issues to relevant stakeholders, including interested depositors; and it will help to ensure that these businesses’ decisions do not have unwanted impacts on human rights and the environment.

This article was written by Rohan Preece. The views expressed in this article are personal.

equator-principles

Rohan Preece works as a Project Manager at Partners in Change in New Delhi. 

 

 

 

 

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