Overview of the Equator Principles for Project Finance Transactions


The Equator Principles (the Principles) are a set of 10 voluntary guidelines adopted by an increasing number of global banks and financial institutions. They are aimed at managing the social and environmental impacts of projects through voluntary requirements imposed on project financing. Financial institutions that have adopted the Principles are individually responsible for developing their own internal policies, practices and procedures to ensure that the projects to which they lend (or provide financial advisory services) are implemented in a socially and environmentally responsible manner. While they are voluntary, the Principles are becoming an industry standard in the project financing market.

First adopted in June 2003 by a group of 10 major financial institutions, the Principles (www.equator-principles.com) were revised in July 2006 and have now been adopted by a total of 60 banks and other lending institutions worldwide. The Principles are based on the policies and guidelines of the International Finance Corporation (IFC), the private sector lending affiliate of the World Bank. The IFC participated in drafting both the original and more recent version of the Principles.

Banks and other financial institutions that adopt the Principles (Equator Principles Financial Institutions or EPFIs) commit to develop internal policies and practices consistent with the Principles. These policies and practices allow the EPFIs to finance only projects where borrowers demonstrate a capacity to comply with standards similar to those applied by the IFC in project-financing transactions. A number of Canadian banks and financial institutions have adopted the Principles, including BMO Financial Group, CIBC, Export Development Canada, Manulife Financial, RBC Financial Group, Scotiabank, and TD Bank Financial Group.

Application of the Principles

The Principles apply to all new project financing, including project finance advisory services, with a total project capital cost of US$10 million or more, and across all industry sectors. The Principles define project financing, in effect, as long-term financing where the revenue generated by the project is used to repay the loan, which is typically secured by some or all of the project assets. The Principles do not apply retroactively to financings entered into before an EPFI adopted the Principles. Nonetheless, they do apply to project financings for expansions or upgrades of existing projects if the scope of the expansion or upgrade could create significant environmental or social impacts, or significantly change the nature or scope of an existing impact of the project.

In particular, the Principles provide a uniform framework for assessing and managing social and environmental risks that arise from any stage of a project in all industry sectors, including the development of energy, mining, oil and gas, and infrastructure projects. As a result, sponsors in extractive industries, such as mining, oil and gas, and in the energy industries, should expect a careful examination of social and environmental issues related to proposed projects.

Requirements Under the Principles

Pursuant to the Principles, as part of an EPFI’s project funding approval process, the lender will categorize new projects according to their level of potential environmental and social risks based on the screening criteria of the IFC. The three categories are as follows:

  • Category A — projects with potential significant adverse social and environmental impacts that are diverse, irreversible or unprecedented;
  • Category B — projects with potential limited adverse social or environmental impacts, largely reversible and addressable through mitigation measures; and
  • Category C — projects with minimal or no social or environmental impacts.

For Category A and B projects, the borrower must have conducted a social and environmental assessment to identify the relevant impacts and risks. Borrowers must also prepare environmental management plans that include strategies to mitigate, monitor and manage the identified environmental and social risks associated with any project. Projects in countries that do not belong to the Organization for Economic Co-operation and Development (OECD), and lower-income OECD countries, will be held to IFC performance standards. Projects in high-income OECD countries may be made subject to local laws, which generally meet or exceed such standards.

The loan documentation will be used as a contractual framework between the EPFIs and the project borrowers for the application of the Principles. As such, the loan documentation for a project would provide for undertakings by the project borrower with respect to compliance and reporting with the environmental management plan throughout the life of the project. For Category A and B projects, such undertakings would include:

  1. compliance with host country social and environmental laws, regulations and permits;
  2. compliance with the applicable action plan;
  3. periodic reporting to the EPFI, including, where appropriate, by an external expert over the life of the project; and
  4. adherence to an agreed decommissioning plan for the facilities.

Non-compliance with these undertakings, depending on their materiality, could constitute an event of default under the loan documentation.

Other provisions of the Principles require lenders to ensure appropriate consultation with affected communities and the implementation of a workable grievance mechanism through which those communities can seek redress and public reporting (subject to confidentiality arrangements) at least annually by EPFIs on their implementation processes and experience.

Benefits and Challenges

These contractual arrangements between the EPFIs and project borrowers should create strong incentives for borrowers to (i) document and manage identified social and environmental risks, and (ii) ensure compliance with national social and environmental laws or recognized international standards. Although not all lending banks are EPFIs, the presence of an EPFI in a lending syndicate should cause the non-EPFI members of the syndicate to either raise their review processes to a level closer to compliance with the Principles or otherwise benefit from the greater level of oversight required by the EPFIs. In addition to exemplifying corporate social and environmental responsibility, a key benefit for lenders of adherence to the Principles is to enable them to better assess, mitigate and monitor the credit risk and reputational risk associated with financing development projects.

The effectiveness of the Principles will depend largely upon the specific policies, practices and procedures adopted by the EPFIs, as well as upon their application to the circumstances of particular projects. The Principles are not policed by the IFC or any other organization, and do not contain punitive measures against EPFIs that breach them. The effectiveness of the Principles, therefore, is based entirely on the willingness of EPFIs to apply and enforce them. Despite this potential structural weakness, the extent to which lenders have adopted the Principles is evidence of an increasing awareness amongst lenders that social and environmental responsibility makes good financial sense. Corporate social responsibility and policies provide an additional impetus for financial institutions to adopt the Principles. This adoption results in a common framework EPFIs can use to assess and manage environmental and social risks relating to projects. In short, the Principles encourage responsible banking.

Loan Documentation

The Principles provide a common framework (or protocol) for EPFIs to (i) document and manage environmental and social risks, (ii) ensure compliance with applicable national environmental laws, and (iii) ensure compliance with the EPFI’s own environmental and social standards applicable to relevant industry sectors. The Principles are generally reflected in the loan documentation, which provides for specific provisions dealing with these three basic objectives.

Normally, borrowers have to satisfy conditions precedent before drawing funds under a credit facility. These conditions precedent allow the EPFI to maintain a certain level of control and supervision over the social and environmental aspects of a project. They also provide confirmation that the environmental representations and warranties are satisfied, and that all material regulatory authorizations and approvals (including environment compliance and receipt of an environmental consultant’s report) have been obtained (or will be obtained within an agreed period).

Specific required representations and warranties would normally reflect that all material environmental and social requirements are satisfied, including compliance with all permits and other government authorizations. The loan documentation would also require:

  • notice of all material environmental matters reports and violations (actual or potential) to be provided to the EPFI, in addition to notice of all environmental and social claims (such as human rights abuses);
  • compliance with national environmental laws; and
  • establishment of a monitoring, supervision and reporting process to ensure compliance.

Moreover, to ensure compliance with these contractual arrangements, the Principles would be enforced by the use of events of default in the loan documentation. Such events would be triggered by any material non-compliance or violation with the provisions of the loan documentation.

Ultimately, the practical effect of the Principles will depend upon the individual internal practices adopted by each EPFI.

Laurent Levac co-authored this article.

EPFI Equator Principles Equator Principles Financial Institutions IFC International Finance Corporation principles



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